EM FX Weekly – Steady or weaker yuan?

by: Roy Teo , Arjen van Dijkhuizen

  • Emerging market currencies supported
  • Steady or weaker Chinese yuan?
  • Bank Indonesia expected to remain on hold next week

Emerging market currencies supported

Most emerging market currencies benefited as sentiment towards the US dollar was generally weak. The Turkish lira strengthened to the strongest level in one month as political uncertainty eased ahead of next month’s elections. Firmer oil prices and a better than expected trade balance supported the Russian ruble. However gains were limited after the Bank of Russia said that they would buy USD 100-200 million daily to boost reserves. On the other hand, the Brazilian real declined as the weak growth and high inflation outlook is expected to persist.

 

Steady or weaker Chinese yuan?

The Chinese yuan was resilient against the US dollar this week as financial markets have priced in the recent interest rate cut. Market bets that China will allow a weaker yuan declined as the currency remained steady against the US dollar in the past two months. However we think that a currency easing bias is already underway as the yuan has declined by about 3% on a trade-weighted basis since the middle of March.

We maintain our view that the yuan will decline against the US dollar later this year for several reasons. First, we expect the US dollar to recover as economic growth in the US picks up and financial markets anticipate Fed rate hikes.  Second, outward investment is expected to rise this year, possibly exceeding foreign investment into China.  Third, though there has been encouraging signs that China’s transition towards a more domestic led economy is in progress, a weaker exchange rate remains necessary to support exports given the uneven pace of the global recovery. Fourth, the yuan is no longer undervalued in our view. Fifth, the yuan’s attractive carry is expected to be less supportive as monetary policy divergence between the US and China widens later this year. Last but not least, we expect the authorities to allow the exchange rate to be more reflective of economic fundamentals and market determined in order to achieve their aim of the yuan being included in the SDR basket. Nevertheless they will likely not tolerate a sharp yuan deprecation.

 

BI expected to remain on hold next week

Since the disappointing Q1 GDP print on 5 May 2015, the Indonesian government has urged the central bank to cut interest rates to stimulate economic growth. However we think that Bank Indonesia is likely to keep interest rates unchanged on 19 May given that inflation remains above target. In our view, the central bank is unlikely to allow a sharp depreciation in the IDR given that less than 30% of Indonesian companies’ new foreign currency corporate debt is hedged. We see some room for monetary easing this year when inflation starts to fall in late 2015 and if the current account remains under control. We maintain our view that the IDR is likely to ease lower towards 13,300 against the US dollar later this year.