EM FX Weekly – EM FX swings higher

by: Roy Teo , Georgette Boele

Please note that this will be the last edition of our EM FX Weekly. We have decided to put more focus on FX thematic research notes, and to cover short-term FX developments with our FX update notes, which are published soon after significant moves and/or events. We would like to take this opportunity to thank you for your support. Comments and feedback are always welcome.

In this publication: A lower US dollar and higher commodity prices support EM FX. EM monetary policy decisions were mixed. RBI, NBP and COPOM left monetary policy unchanged… while the BoK surprised with a rate cut. More SGD strength envisaged in June; higher risk of October easing. Chinese yuan volatility and depreciation expectations decline.

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A lower US dollar and higher commodity prices support EM FX

Since the end of last week, emerging market currencies have rallied strongly following the much weaker-than-expected US employment report. This report and the comments of Fed Chair Yellen have resulted in substantial downward adjustment of Fed rate hike expectations. Our base case remains for no Fed rate increase this year, while market participants still see a 58% probability. In addition, higher commodity prices have also supported currencies of commodity exporting countries. The Brazilian real, Colombian peso, Russian ruble and South African rand were the main outperformers and rallied between 4.5-7% versus the US dollar since last Thursday. The latter mainly because rating agency Fitch decided to keep South Africa’s credit rating at BBB- (lowest investment grade) with a stable outlook.

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RBI, NBP and COPOM left monetary policy unchanged…

The Reserve Bank of India (RBI) left interest rates unchanged as expected, but financial markets are more concerned whether Governor Rajan will stay for another term. Our Asia economist expects the RBI to keep the repo rate unchanged for the remainder of 2016. The RBI is now focusing more on improving monetary transmission. Moreover, inflation has risen, there are upward inflation risks stemming from wage increases and weather conditions and the economy has accelerated in Q1.

The National Bank of Poland also left monetary policy unchanged as expected. All but one policy maker will be replaced and Adam Glapinsky is taking over the helm from Governor Marek Belka. They have signaled that they will continue the current policy of stable interest rates as they would like to leave room to respond to potential shocks. Moreover, economic growth remains healthy and inflation will likely pick up later this year due to positive base effects.

The COPOM in Brazil also left policy unchanged and kept its bias neutral. It stated that the high level of inflation and inflation expectations being distant from objectives do not allow enough room for an easing of monetary policy. Later this year we expect rate cuts, because of lower inflationary pressures, a stronger real and to need to support the economy.

…while BoK unexpectedly cut interest rate

The Bank of Korea (BoK) unexpectedly lowered the 7 day repo rate by 25bp to 1.25%. A more accommodative monetary policy setting is desired as corporate restructuring is likely to put some downward pressure on economic activities. Indeed, the BoK has highlighted that the decision to lower the repo rate was unanimous given that downside risks to economic growth in the second half of this year have increased. As a rate cut was mostly priced in by financial markets, losses in the South Korean won were limited.

Indonesia rupiah recovers; foreign currency reserves decline likely to be temporary

In Asia, the Indonesia rupiah (IDR) recovered by 3% as carry trades resume. Separately foreign currency reserves in Indonesia declined to USD 103.6bn in May, the lowest level since January this year. Bank Indonesia calmed market fears by clarifying that the decline in foreign currency reserves is temporary due to seasonally high demand for foreign currency payments and external government debt payments. Current level in the foreign currency reserves remains healthy, covering 7.6 months of imports and external government debt payments. Our year end USD/IDR forecast is 13,500.

More SGD strength envisaged, resilient S$NEER increase risk of October easing

The Singapore dollar (SGD) has strengthened by about two cents to 1.35 and is likely to strengthen further towards 1.3350 in the coming weeks. Currently, the S$NEER is around similar levels when the Monetary Authority of Singapore (MAS) last eased policy earlier this year in April. A sustained resilience in the S$NEER will increase the risk that the MAS may shift the mid-point of policy band lower later this year in October. Our year end USD/SGD forecast is 1.40.

Chinese yuan volatility and depreciation expectations decline

Recent data on China’s FX reserves point to stabilisation, contributing to a further easing of hard landing fears. In May, China’s FX reserves fell by USD 28 bn to USD 3192 bn. Although this drop was a touch larger than expected, FX reserves were more or less flat if exchange valuation effects are discounted for. That is encouraging, even more so if we take into account that the US dollar strengthened in May as markets did price in Fed rate hikes more strongly on the back of hawkish signals by Fed Board members. This shows that capital outflows from China have moderated even in more turbulent times. All in all, we still think it is unlikely that the sharp capital outflows seen in late 2015 and early 2016 will repeat.

Export growth was slightly weaker than expected in May. Inflation also eased lower as food inflationary pressures have declined. In our view, the level in the yuan is not a key impediment to exports growth and inflation. Hence there is little economic justification to devalue the currency sharply. Indeed, financial market volatility and yuan depreciation expectations have declined. We maintain our view that the yuan will depreciate moderately and gradually this year to 6.70 against the US dollar. For more details, please refer to our FX Watch – Chinese yuan depreciation to remain gradual and modest published on 6 June 2016.