After a strong start to 2014, particularly during the spring months, most Asian currencies may be headed for a bout of weakness as the US Federal Reserve continues to unwind its accommodation and as the Chinese growth engine continues its attempted transformation. The Japanese yen may be the surprising beneficiary in this environment, even if in the longer term, it may be destined to weaken versus most major currencies.
The last couple of months have seen most ex-Japanese yen Asian currencies strengthening versus the US dollar, though to widely varying degrees. Strongest has been the Korean won, which has managed to gain more than 4% gain versus the US dollar since April 1 (through mid-June). The weakest currencies were the Thai baht, which was held back by the country’s political instability, and the Indonesian rupiah, where concerns about the widening current account deficit and upcoming July election have triggered made it the weakest currency in Asia over the last quarter.
Asian currencies from here: risks abound
One can’t paint Asian currencies with too broad a brush, as each of the economies and currencies has its individual merits and drawbacks, but many of them will be responding to key global developments in the months ahead. Over the next few months, a number of factors could conspire to pressure Asian currencies back lower. These include:
US Fed policy: much of the recent outperformance in Asian currencies can be attributed to the world’s very complacent view of Fed policy, as few are expecting the Fed to change what appears to be an iron-clad schedule of slowly unwinding its rate of asset purchases and then not touching the interest rate until around mid-2015. If the Fed feels that this complacent view is encouraging too much risk-taking, it might have to send up the financial stability warning flag, which would generally pressure riskier assets worldwide, including EM currencies in general, particularly those dependent on funding of their current account deficits.
Chinese demand: China is facing the difficulty task of transforming its growth model away from overinvestment in infrastructure and construction of buildings. This represents a generalized risk of a shortfall in demand if this effort continues, particularly for the raw materials and capital goods that feed that kind of growth. Korea’s currency might be most at risk from further growth retrenchment in China as it is a larger scale exporter of advanced goods. Already, the recent strength in Korea’s currency is at odds with signs of slowing manufacturing sector. As well, Korea’s May exports to China dropped sharply.
Geopolitics: The situation in Iraq and rising oil prices are a wildcard for which many of the Asian economies are ill-prepared. High oil prices are a tax on global growth. Any significant further rise in prices to new highs for the cycle offer a general risk across Asia. The Asian economies and currencies most at risk are those that are most oil-intensive per unit of GDP and most dependent on crude imports, like the Philippines, India, and Thailand.
Of course, if the Fed fails to ring any alarm bell on financial stability and China shies away from taking too much of its growth adjustment now, there may be less pressure on Asian currencies to weaken and their recent strength could continue for a while longer.