EM FX Macro – Asian FX Focus
12th May 2023
This week I discuss the following:
Market/Trading update
Macro Developments
EM Central Banks
Asian Currencies, Themes and Drivers of Performance
Benign and mildly supportive outcomes from this week’s risk events delivered a supportive backdrop for my Carry-hungry approach. I was treated to some follow-through to the downside in USDMXN and some mild progress in BRL. A long in USDCNH also delivered some gains.
The outlook remains similar to that discussed in prior notes. Viewed through the rear-view mirror the macro backdrop looks supportive for risk, with sticky inflation and central bank impatience the principal concern. On the inflation side, we negotiated the week with no further bad news on that front. Even though the road looks clear for now, there seems a strong sense from many that there is congestion ahead, and quite possibly a multi-car pileup. We have been living with US recession fears for some time, and predicting the timing is difficult.
This week we looked to bank lending surveys to give us some indication of what might lie ahead. The Fed’s senior loan officers survey was a possible source of evidence from which to extrapolate catastrophe. Whilst it told us that we are in the midst of an ongoing credit contraction, the latest set of responses didn’t deliver any signs of intensification from the recent regional bank failures. Market commentary seems focused on the upcoming debt ceiling, which we discussed last week.
With last week’s global PMIs and this week’s trade data releases, I’ve taken the opportunity to have a closer look at Asian currencies. Some interesting trends have developed that are worth analysing, with some substantial divergences across the region. This week’s analysis might give way to a number of deeper dives into individual countries.
Macro developments
This week saw a number of Asian economies releasing trade data, many of which are looked upon keenly by investors as an early barometer for global demand. Taiwan led the way with a big jump in the trade balance for April, led by an upside surprise from exports. On Tuesday we had trade data out of China, which showed some loss of momentum in the rebound we saw in Q1. Perhaps we’re entering a period where other regional economies can catch up. The recovery in exports from the Philippines lent weight to that thesis. On Wednesday we saw a round of credit data out of China, with downside surprises across the board. Upside surprises in Q1 likely led to an overshoot of expectations for the latest credit data. Looked at in aggregate, Chinese lending has been very strong so far this year.
After the US lending surveys, which I mentioned earlier, US CPI was the most anticipated event of the week. The market was treated to a broadly inline set of readings, with those of a dovish bent happily discounting a significant rise in used car prices. Claims rose to 264k, 19k more than expected, as a result, the 4-week average rose to 245.25k.
Central Banks
In Poland, rates were left unchanged expected. The NBP expects weaker global demand to feed through to the Polish economy. They see domestic credit growth decreasing and assess that their historical tightening will see inflation return to target gradually. They mention the benefits of currency strength in achieving their goals and see it as fundamentally merited.
We await the outcome of deliberations by Banco Central de Chile at the time of publication.
Next week we have meetings in Mexico and the Philippines. In the Philippines, we may see a further 25bp hike. In last month’s statement, BSP stated that “The balance of risks to the inflation outlook for 2023 and 2024 also continue to tilt heavily towards the upside”. Since then, we had a softer-than-expected headline CPI report, but YoY core inflation at 7.9%, moderated only slightly.
In Mexico, Banxico is expected to be on hold, with consensus expectations for a prolonged pause. Both headline and core inflation surprised mildly to the downside earlier this week.
EM FX Focus on Asian FX
In late 2022 and early 2023, we saw a broad downtrend in USD/Asia. There was a decisive reversal in the USD which drove a recovery in Asian FX. This trend hit turbulence after the Jan payroll report, and despite some USD weakness elsewhere, has not meaningfully resumed.
We have some similar winners and losers across the two periods, with the Korean Won weakest on both timeframes and the Indonesian Rupia and Thai Baht strongest on both.
As we can see from a look at correlations, 2022 was dominated by global beta, with markets becoming more idiosyncratic in 2023. This dispersion makes for more interesting markets, with a chance to implement thematic RV strategies or to look for mean-reversion opportunities.
Within both the trend and the chop periods there have been some important themes. The most notable of these are Carry and the weakness of global manufacturing. Both dynamics are a source of regional dispersion. The former manifests in a reversal of portfolio flows as the pace and magnitude of US policy tightening transformed the value proposition of regional bond markets. The latter manifests in falling exports and a deterioration of the relevant trade balances.
Let’s first look for some context on valuation.
Looking at the Real Effective Exchange Rate (REER) provides a longer-term perspective, adjusted for inflation differences. On the right-hand side below, we see REER evolution over the past 5 years. This gives a clear illustration of the recent trajectory. On the left-hand side below, I track the deviation of each REER from its 20-year average. This approach gives a better impression of valuation. Both show a cheapening up of the Korean Won, for example.
To look at shorter-term moves we can analyse the Nominal Effective Exchange Rate (NEER) series provided by the BIS. This gives us a better picture of the fundamental trajectory of the currency, removing some of the noise from the US dollar. Again, Korea is notable, in that we see a relatively smooth depreciation from the start of the year.
Carry/Yield
Before getting bogged down in the macro let’s look at Carry differences and portfolio flows. The fed hiking cycle turned a number of Asian currencies from positive to negative carry investments. We discussed the impact on the Chinese bond market a few weeks back.
On the left-hand side above we can see how US policy rates sit above those of all but 3 of the 8 EM Asia economies I track. Despite the inverted US curve, US 10-year yields are also competitive. On the right-hand side are my estimates of the ex-ante real policy rates for 2023 and 2024. Here we see more of the strong variation within the region.
This bond flow data tells us part of the story of KRW's underperformance, with inflows from 2020 and 2021 reversing sharply in December 2022 and January 23. You can also see Indonesia and Thailand as the beneficiaries of some of that flow.
And to complete the picture, we can look at shorter-term FX carry. This will have an impact on faster-moving speculative flows. Here is the usual carry/vol analysis I provide each week, isolating USD/Asia.
Manufacturing Weakness
Last week we received the full set of global PMI data. I don’t have the underlying data so I’m relying upon the numerous charts produced by S&P in articles such as this one PMI Monthly Bulletin.
At the global level, we can see the upswing that the PMI reports point to is a story of strength in services over manufacturing. Demand for services is strong, and demand for goods weak, after a post-pandemic bounce and an alleviation of supply constraints.
S&P breaks down PMI by sector. Their Asia Sector PMIs, bear out the global trend with some specifics of note. There is particular strength in consumer services, software and Transportation. Its weakest sector is Technology Equipment. Selected sectors are illustrated below.
Within manufacturing you can see the variation within the region with particular strength in Thailand and India, and notable weakness in Malaysia, Korea and Taiwan.
They also produce a useful heatmap which gives some more texture to the trajectory.
These PMIs seem to have been a good guide for currency performance, and to the extent that they are forward-looking, they don’t point to a change in trend at this juncture.
Trade/BoP
Before we look at individual countries’ recent BoP data I thought it interesting how the structural current account and recent FX performance underline the regime we currently occupy. These surplus countries are typically the manufacturing exporters who are currently suffering and have the lowest rates.
A strong and improving current account is often an indicator of currency strength. All else equal it provides a flow argument for appreciation. Let’s examine the balance of payments from some of these countries to see what recent dynamics are in play. It’s a good time to do this as we had updates in many countries this week. Beginning with the weakest FX of late, we can see the recent deterioration of the Korean trade balance. Seasonally adjusted monthly data show some modest improvement, but it would be brave to call a turn.
In China, YoY export figures look impressive, but the recent month-on-month figure fell 6.4% in April. Some commentators have questioned the strength of earlier prints during a period of such weak global goods demand. Below we can see the strong performance of net trade in goods in recent years from the balance of payments (left-hand chart below), and the more recent customs releases below right.
In Malaysia, you can see a strong structural surplus, and in Indonesia, you can observe a recent improvement in the goods balance.
The Philippines relies on strong remittance flows to balance the current account, these fall within primary and secondary income. The Philippine Statistics Authority (PSA) break out an estimate of remittance flows which you can see on the right, below. The goods trade deficit has continued to narrow in Q1 2023 based on preliminary figures.
The Indonesian Central Bank was kind enough to publish reserve data for its regional peers. As you can see, Asian central banks drew down on reserves in 2022 to manage depreciation pressures. Indonesia, China, Taiwan and Malaysia had replenished lost reserves by Jan-23.
We can potentially infer some preferences from this, as we see Malaysia has taken the opportunity to accumulate reserves more rapidly than some of its peers via its strong trade surplus in spite of some relative currency weakness. We see outperformance from Indonesia despite substantial FX smoothing efforts on the strong side.
In summary, we look like we are still in the midst of a regime where the currencies of low-carry manufacturing exporters will continue to underperform until we see a turn in the manufacturing cycle or a substantial deterioration in the environment for Carry. Hopefully the above will be a useful point of reference on where to target trades when things change. Alternatively, it’s an invitation to hop on the trend with some fundamentally sound inter-Asia carry trades.
Signing off
Please share the note with anyone you feel might enjoy it. As always, any feedback and engagement would be very welcome.
In the meantime, if you’re trading, be disciplined and be lucky,
Stephen