- Weakness in EM FX because of a stronger US dollar…
- …with the exception of the Turkish lira
- It is unlikely that the low volatility in the Chinese yuan will persist
Weakness of EM FX especially CEEMA FX…
Emerging market currencies have generally moved lower this week because of a stronger US dollar. Central and Eastern European currencies were the weakest performing currencies. Weaker domestic data (Poland), an interest rate reduction (Hungary), and accumulation of foreign currencies reserves (Russia) weighed on the respective currencies.
…with the exception of the Turkish lira
A positive exception was the Turkish lira. The central bank decided to leave interest rates unchanged. Although the CBRT left its policy rates on hold during its June meeting, the accompanying press statement struck a slightly more hawkish tone. While the CBRT has already pushed interbank rates to the upper bound of its interest rate corridor, we think that it needs to do more later this year as it needs to combat stubbornly high inflation, a weak lira, and possible market unrest due to prospects of Fed tightening. In addition, there are some tentative signs that the AKP is more willing to form a coalition than was initially thought. Going forward, we expect the lira to weaken to 2.85 versus the US dollar, mainly because of US dollar strength.
Asian currencies lacking direction
In Asia, the Singapore dollar (SGD) underperformed as core inflation in May declined for the third consecutive month to 0.1% yoy, below the central bank’s forecast of 0.5-1.5%. Core inflation is expected to remain subdued in the coming months before rising later this year due to higher oil prices and as the effects of budgetary measures dissipate. In our view, USD/SGD will rise towards 1.40 by the end of this year given the SGD’s rich valuation and vulnerability to higher interest rates in the US.
Low volatility in the yuan to persist?
The Chinese yuan has been stable in the past three months as Chinese authorities aim to calm investor sentiment in the yuan currency after China experienced capital outflows earlier this year. Another possible reason is that a stable currency is necessary ahead of further capital liberalisation of the yuan, including widening of the trading band. We remain cautious that this low volatility environment in the yuan will persist. It is likely that the central bank will widen the trading band from +/-2% to +/-3% later this year as they seek to allow a more flexible exchange rate regime ahead of IMF review of including the yuan in the SDR basket. This is likely to result in greater volatility in the currency and a weaker exchange rate as economic growth in China remains fragile. Second, the current low volatility environment in the yuan is likely to attract more carry trades as the yuan’s yield is still relatively more attractive compared to other major currencies. This may trigger a response from the central bank to warn speculators that yuan carry trades are not a one-way bet.