In this publication: EM FX profits from weaker USD. Weaker Chinese yuan bets resuming. Outperformance in Indonesian rupiah unlikely to persist
EM-FX-weekly-4-Feb-2016.pdf (215 KB)
EM FX profits from weaker USD
Emerging market currencies have performed well since last Thursday. There are several reasons for this. First, oil and metal prices have recovered, improving sentiment towards currencies of commodity exporting countries. Second, weaker-than-expected US data have resulted in a downward adjustment in Fed interest rate hike expectations and cause a sharp sell-off of the US dollar across the board. Going forward we expect commodity prices to continue their recovery path. However, we also expect the US dollar to rally when US data come in stronger again. Both forces should result in a stabilisation in emerging market FX excluding Asia. Despite the much weaker-than-expected industrial production, the Brazilian real has been the strongest performing currency since last Thursday. It is likely that most of the negative news is reflected in the price and investor sentiment towards the real seems to have improved following the efforts to revive the economy.
Weaker Chinese yuan bets resuming
The People’s Bank of China (PBoC) has continued to fix a stronger yuan daily fixing reference rate in the past week. This has helped to support sentiment in the yuan spot market. However, financial markets have increased again their positions that profit from a weaker yuan. This was triggered by a weakening of the official PMIs in January, both for the manufacturing and the services sector. Our view that a sharp devaluation in the yuan is not the best solution to stimulate the economy has not changed as it will exacerbate capital outflows from China. Tighter surveillance and minor capital controls to curb speculative activities in the yuan are likely to be imposed. Fiscal stimulus to support the economy before long will also aid sentiment in the yuan. Indeed there are some encouraging signs of economic stabilisation as Caixin’s services PMI rose by 2.2 point to 52.4 in January and the composite PMI recovered to 50.1 (December: 49.4). We maintain our year end yuan target versus the USD at 6.70.
Outperformance in IDR unlikely to persist
The Indonesian rupiah (IDR) has outperformed in recent weeks as economic growth prospects in Indonesia have improved. This is due to several economic stimulus measures announced by the government and expectations (including ours) that Bank Indonesia will lower monetary policy rates later this month to stimulate the economy. The IDR has also been in favour due to market expectation that the Fed will delay tightening monetary policy. While we acknowledge an increasing risk that the Fed may raise interest rates less than signalled. A too strong IDR may not be desirable as it will hurt exports growth and spur domestic demand (imports), widening the current account deficit. As Indonesia’s current account deficit is expected to widen this year, a reversal of capital outflows when the Fed tightens monetary policy is likely to pressure the IDR. This risk is exacerbated by the fact that foreign ownership of government bonds are elevated (39% as of January 2016). In addition, the government is likely to issue more bonds to fund its fiscal deficit, limiting the effectiveness of looser monetary policy. We also expect Bank Indonesia to replenish its foreign currency reserves given that holdings have declined by more than 5% in 2015. Last but not least, the government has a weak policy implementation record and hence the full effects of various stimulus measures announced may not materialise, just as in 2015. We expect the IDR to decline towards 15,000 against the USD by the end of this year.