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Currencies Economics – Markets – Strategy sharp fluctuations in major currencies and their possible implications for economic and financial stability. As oil prices spiked in 2Q08, inflation became a serious policy challenge globally. By Jun 3, this oil/inflation spiral became a problem serious enough for Fed Chairman Bernanke to identify the USD as a risk to inflation and inflation expectations. Bernanke’s comments came one day after US Treasury Secretary Henry Paulson told Middle East countries not to abandon their USD pegs, reaffirming the US’s commitment to the USD as a reserve currency. On Jun 9, Paulson did not rule out intervention as a tool to stabilize the USD. The G7 meeting in June is likely to reinforce its early message for the USD to stabilize against major currencies. Although the communique is likely to continue calling for a trade-weighted appreciation in the Chinese yuan, the market believes that the CNY will slow its appreciation pace. This can be attributed to diminished overheating risks in China’s economy, as well as the G7 nations prioritizing the global oil/inflation crisis over global imbalances. (3) US interest rates - from recession risks to inflation risks With the US Treasury curve normalizing to an upward sloping curve from March, the Fed has become comfortable with the market’s view that the worst was probably over for the US mortgage crisis. Believing that recession risks have diminished, at least relative to inflation worries, Bernanke began in June to shift the focus of monetary policy to prevent an erosion in longer-term inflation expectations. Subsequently, interest rate futures market started to discount the Fed to start taking back rate cuts this year. DBS is looking for Fed to begin hiking in 4Q08 and lift Fed Funds Rate from 2.00% to 4.00% by July 2009. While this happens, we expect the USD to remain firm, as it did during the last rate hike cycle in 2005. Currency revisions – postponing the next phase of Asian currency appreciation Taking into account our rising US interest rate profile and Asia’s weakened economic landscape, we have downgraded outlook for Asian currencies over the next 6-12 months. We are not abandoning, but merely postponing our longer-term outlook for Asian currencies to appreciate. Like the rest of the world, Asia will be required to bite the inflation bullet in order to return to a path of sustainable noninflationary economic growth. Performance in 2007 Performance in 2008 ytd PHP 18.9 TWD 7.2 INR 12.3 SGD 5.7 THB 7.2 CNY 5.5 CNY 6.9 MYR 1.5 MYR 6.5 THB 1.4 SGD 6.2 IDR 0.8 TWD 0.3 HKD -0.1 HKD -0.3 PHP -7.4 KRW IDR -4.3 -0.7 % ch vs USD INR -8.0 31 Dec 07 vs 31 Dec 06 KRW -9.4 % ch vs USD 9 Jun 08 vs 31 Dec 07 -15 -10 -5 0 5 10 15 20 25 -15 -10 -5 0 5 10 15 20 25 26
Economics – Markets – Strategy Currencies The Good ... The three Asian currencies that have consistently held up so far this year were the Chinese yuan (CNY), the Singapore dollar (SGD) and the Taiwan dollar (TWD). These three currencies share one common feature. All three favour stronger exchange rates to fight inflation. Of the three currencies, we like the TWD most on a relative basis. As at Jun 9, the TWD is still the Asia’s best performing currency this year. Our optimism is based on the return of the Kuomintang government. Since the presidential elections in March, Cross-Straits relations have improved with policymaking returning focus towards boosting the Taiwan economy. On the other hand, we are wary of the SGD’s strong correlation with major currencies, which we expect will bow to the USD’s recovery especially when the US start hiking rates again. At witnessed in 2005, a higher USD/SGD is also not inconsistent with an appreciating SGD NEER policy, which started in Apr 2004. ... the Bad ... The three Asian currencies that have consistently underperformed this year were the high yielders - Indian rupee (INR), Korean won (KRW) and the Philippine peso (PHP). Last year’s winners - INR and PHP - turned out to be this year’s losers. The KRW’s depreciation, which started in 2007, turned from bad to worse. Due to increased external borrowings over the past few years, KRW and INR are vulnerable any unwinding of JPY carry trades and shortages of USD liquidity. In terms of international liquidity position, the KRW is considered to be more vulnerable because external debt overtook foreign reserves in Korea, while India’s foreign reserves continued to outpace external borrowings. Both INR and PHP are more sensitive to downsides in their stock markets compared to the KRW. Since they were the first to start, these three currencies are also likely to be the first to finish returning some of the past years’ gains to the USD. Once the correction is completed, these currencies have a track record of consolidating in a wide range, as they await their peers in the region to do likewise. ... and the Ugly The market is looking for the Vietnamese dong to suffer a devaluation of 20% to 40% over the coming year. For now, we do not consider this to be an imminent risks and sees a full-year devaluation of 5% instead in 2008. Although Vietnam has the worst inflation and trade deficit in Asia, FDI inflows still appear to be covering the latter. Political risks to watch There are three currencies with political risks that we are paying close attention to. (1) Post-election Thai baht (THB) is persistently troubled by rumours of another military coup, which have the potential to distract the government from the economy. (2) Post-election Malaysian ringgit (MYR) is worried about leadership challenges confronting its weakened prime minister. Barring political uncertainties, the MYR is actually a fundamentally sound currency that the US Treasury considers as undervalued. (3) The INR will be vulnerable if the protests to inflation and higher fuel prices become loud enough for the communist allies to pull its support from the government ahead of next year’s elections. 27
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