EM FX Weekly – China stimulus and weak dollar

by: Roy Teo , Arjen van Dijkhuizen , Georgette Boele

  • China stimulus speculation and weak US dollar support EM FX…
  • …except the Chinese yuan, Thai baht and Russian ruble…
  • …while budget concerns are back in Brazil

 

China stimulus speculation supports EM FX…

Market speculation has grown recently about the possibility of the PBoC following other major central banks in launching  unconventional QE policies. This would come in the form of the PBoC buying local government bonds directly. We believe that China will continue to add further stimulus to keep economic growth at around its 7% target for 2015, but do not think that China needs to implement such unconventional policies at this stage, because there is plenty of room for more easing using conventional instruments. The PBoC could cut banks’ reserve requirements (RRRs), the main policy rate (5.35%) and/or the benchmark deposit rate. In addition, the authorities can use specific lending instruments targeting banks and can even stimulate banks to buy local government bonds.

 

 

…so does the weaker US dollar

The US dollar fell under heavy pressure because of a weak US Q1 GDP report and an overall improvement in investor sentiment (see G10 FX weekly). Most emerging market currencies were able to profit from this weakness.

Given their larger export exposure to China, the South Korean won, Taiwan dollar and Singapore dollar made gains due to expectations that China will further stimulate its own economy.

 

…but sentiment towards the Chinese yuan is weak…

Though the People’s Bank of China continued to engineer a strong daily yuan fix, investor sentiment in the currency remains weak due to market concerns that the central bank will inject more liquidity into the system.

 

…and larger rate cuts weigh on the Thai baht and the Russian ruble…

The Thai baht underperformed as the Bank of Thailand surprised financial markets by cutting interest rates earlier than expected. This was triggered by higher risks to economic growth due to the strong baht and a slowing Chinese economy. In addition, the central bank of Thailand is of the view that government spending and a rebound in tourism will not be enough to offset the weak export outlook. Despite higher oil prices, the Russian ruble also moved lower, because of the sharper-than-expected interest rate cut by CBR.

 

…while investors remain concerned about Brazil’s budget deficit

The Brazilian real was also not able to profit from a weaker dollar. Investors are concerned that if Brazil fails to reduce its budget deficit, the risk of a credit rating downgrade would increase. The 50bp rate hike by the central bank to 13.25% failed to support the real this week, because of expectations that the central bank will not hike in June amid a weak economy, although we expect a 25bp rate hike.