Another Asian Financial Crisis?
Currencies across Asia including the Chinese yuan dropped sharply against the U.S. dollar Thursday, with markets caught off-guard as the Singapore central bank restrained the appreciation of its currency to stoke growth.On Tuesday I discussed whether the yen's surge will trigger a crisis, stating the following:
The yuan saw its biggest one-day depreciation since January, and the Singapore dollar fell by the most within a day this year. Meanwhile, the South Korean won weakened after the ruling party lost its parliamentary majority.
Asian currencies had firmed up against the greenback in recent weeks, partly thanks to the Federal Reserve having signaled it would raise interest rates at a slower rate this year than previously expected. Economic policy makers from the Group of 20 nations had pledged at a meeting in February to avoid sparking a currency war through competitive devaluation.
A weakening of the yuan against the U.S. dollar in its daily fix weighed on currencies across the region, after a 0.46% depreciation—the biggest since January.
The region’s currency markets had started the day on the back foot as traders assessed first the impact of South Korea’s elections, followed by Singapore’s surprise easing.
Movements of the yuan fix, which determines the levels at which the currency can trade inside mainland China, have recently been more determined by market forces. Today’s depreciation reflects strength in the U.S. dollar on Wednesday.
Thursday’s yuan depreciation was the biggest since Jan. 7, when markets had speculated that moves to weaken the yuan could trigger a global currency war. Competitive currency devaluation hasn’t materialized among major economies since then, but other central banks in smaller countries in Asia are loosening policy in the meantime.
The Monetary Authority of Singapore became the latest to surprise markets by easing its policy stance as it warned of threats to growth. The Singapore dollar fell as much as 1.1% to 1.3654 against the U.S. dollar, the biggest intraday move since mid-December.
The Korean won weakened 0.7% to 1153.305 to the dollar after South Korea’s ruling party lost its parliamentary majority, raising doubts about the government’s ability to push ahead with economic reforms.
“The Singapore economy is projected to expand at a more modest pace in 2016 than envisaged in the October policy review,” the Monetary Authority of Singapore said in a statement. The central bank also forecast a decline of between 0% and 1% this year in headline consumer price inflation, which has been falling every month since November 2014 as a result of measures intended to cool the economy. It warned, too, that any pickup this year in core inflation, which strips out the cost of private road transport and accommodation, may be less than previously anticipated.
Singapore’s central bank flattened the expected appreciation of the Singapore dollar, setting the rate of appreciation of its nominal effective exchange rate to zero. Previously, it had been set to gradually strengthen to avoid importing inflation from overseas. The Singapore dollar trades in a band against a basket of currencies.
In easing, Singapore’s central bank was following others around Asia. India, New Zealand and Indonesia have all cut interest rates in the past six weeks, and Japan implemented negative interest rates on some deposits earlier this year.
The International Monetary Fund lowered its global growth forecasts for the year ahead to 3.2% this week, down 0.2 percentage point from projections issued in January. The IMF raised its forecast for emerging and developing Asia to 6.4% by 0.1 percentage point, lifted by an improved forecast for Chinese growth, upgraded by 0.2 percentage point to 6.5%.
The Korean won’s decline Thursday—following a 7.5% rise against the dollar in March—came after the conservative Saenuri Party lost its parliamentary majority and its chairman resigned. That’s a setback for President Park Geun-hye’s efforts to push economic deregulation and overhaul the labor market.
“There will be more policy gridlock,” said James Kim of the Asan Institute for Policy Studies, a Seoul think tank.
Singapore also reported preliminary estimates of GDP growth for Q1 of 1.8% on year earlier today. The estimate beat expectations of a 1.7% increase by economists polled by The Wall Street Journal. Some said that the data pointed to Singapore’s central bank looking ahead to risks to future growth.
“Risks to growth are intensifying and it’s only right for them to take a proactive approach to monetary policy at this point,” said Irvin Seah, senior economist at DBS Bank, which had correctly anticipated the Singapore policy change.
Though Singapore is less exposed to the slowing Chinese economy than countries like Taiwan and South Korea, it may be feeling the effects of China’s slowdown spreading throughout Asia, he added. “If the region slows down, we could be getting the impact in Singapore because of the small and open nature of the economy.”
The Indonesian rupiah, Malaysian ringgit, Philippine peso, and Thai baht all fell against the dollar on Thursday as well. The U.S. dollar index, which tracks the greenback’s strength against a basket of six developed market currencies, rose 0.2% to 94.93.
Asian equities were unruffled by the volatility in currency markets, with South Korea’s Kospi Composite closing up 1.8% and the FTSE Straits Times Index rising 0.8% Hong Kong’s Hang Seng Index gained 0.9%, while Japan’s Nikkei 225 rose 3.2%, extending gains into a third consecutive day.
At this writing on Tuesday, the yen eased after Japan's finance minister reiterated that officials could intervene in the forex market to stem its steep rise, but analysts warned this could trigger a currency war in Asia.The key thing to remember as you read articles on Asian currencies is that the region is suffering from anemic growth and many Asian economies are mired in deflation, so it's hardly surprising that Singapore's central bank "shocked" markets by becoming the latest to ease monetary policy in response to the deteriorating global economic outlook.
Why? Because China and other Asian countries like Korea aren't going to stand idle if Japanese authorities unilaterally decide to intervene in the forex market to stem the yen's decline. And while some think Japan won't intervene without U.S. blessings, the truth is if the yen declines below 105, there will be growing pressure on Japanese authorities to intervene.
And this is where things get interesting. Go back to read my Outlook 2016 on the deflation tsunami where I warned you to keep your eye on emerging market currencies as this will be where the global battle on deflation takes place. What can spur a crisis in emerging markets? A rising yen that forces Japan to massively intervene in the forex market, sending shock waves throughout Asia.
And what happens if an emerging markets crisis ravages Asia? What else? Global investors scramble into good old U.S. bonds in a massive flight to safety which is another reason why I have a hard time buying the story that the Treasury rally will turn to a rout.
Moreover, as demand for U.S. bonds rises, it could spell the end of the decline of the greenback, placing more pressure on commodity currencies and stocks which rallied sharply since bottoming in late January. This is why I have a hard time believing oil will double by year-end no matter what OPEC decides to do.
Think of the world like this: Europe is a basket case, Jamie Dimon says the U.S. economy is roaring (mostly for Wall Street, not so much for Main Street), and Asian economies are stuck in deflation, desperately trying to export to increasingly weaker American and European consumers and their own internal demand is weakening in the process.
This is where things get very interesting from a macro perspective. The Bank of Japan is ready to loosen its credit grip further if necessary as it seeks to conquer nearly two decades of deflation, its chief Haruhiko Kuroda said Wednesday.
And in his latest comment, the Telegraph's Ambrose Evans-Pritchard warns, Beijing 'must devalue yuan by 15pc' to avert crisis:
A top adviser to the Chinese government has warned that Beijing risks a currency blow-up akin to Britain's traumatic ordeal in 1992, if it continues trying to defend its exchange rate peg amid a deepening deflation crisis.I will let you read the rest of this article here but the dire warning is the world might experience another Big Bang from China and that will clobber risk assets and bolster good old U.S. bonds.
Yu Hongding, a director of the Chinese Academy of Social Sciences, said China is caught in two concurrent "deflationary spirals" that are feeding on the other. A major devaluation and a blast of well-targeted fiscal stimulus will be needed to break out of the trap.
"They must stop intervening on the exchange market. China needs to devalue by 15pc. They are creating conditions for speculators," he told the Daily Telegraph, speaking at the Ambrosetti forum of global policymakers on Lake Como.
Prof Yu, a former rate-setter for the central bank (PBOC) and currently a member of the national planning committee, said the government is making a serious mistake in trying to defend the yuan by burning through foreign exchange reserves, already down to $3.2 trillion from $4 trillion in mid-2014.
He warned that the slowdown in capital outflows in March may prove fleeting. "Reserves will continue to fall until we devalue. Once we get towards $2 trillion the markets will start to panic. They won't believe that the government can control it any longer," he said.
Prof Yu said Beijing had been caught off guard by the relentless slowdown over the last five years. "In 2011 we thought the economy would stabilize, and we thought the same thing in 2012, and again in 2013, and it continued to slide," he said.
It is far from clear whether the world could handle a 15pc devaluation given the vast scale of Chinese overcapacity, or that the US Treasury and Congress would tolerate such a move.
Fears of uncontrollable capital flight and a yuan devaluation were key reasons for the plunge in global equity markets earlier this year, and are clearly what prompted the US Federal Reserve to delay rate rises.
The fate of China's currency has become the most neuralgic issue in global finance. One worry is that a sharp drop in the yuan would set off a second round of 'currency wars' across East Asia, transmitting a deflationary shock through the international system as cheap Asian exports flooded into Western markets.
So, no matter what happens in Doha this weekend, I find it hard to envision oil doubling by year-end and more worrisome, I am baffled by those who claim the Treasuries rally will turn to a rout.
And this brings me to another important point. If you trade stocks and made profits in Q1 buying the bottom in energy (XLE), mining and material (XME), oil and gas exploration (XOP), and emerging market stocks (EEM), it might be a good time to unload or go neutral or short here.
I track many stocks in various sectors and have witnessed spectacular moves in stocks leveraged to global growth (click on image):
But I keep looking at the bond market and it's telling me that stock traders are getting very excited over nothing and they're in for a whole lot of hurting.
Admittedly, a big reason behind these spectacular moves was the weakness in the U.S. dollar which up until recently was dropping relative to other currencies. Now that global growth concerns are back on the table, it will be interesting to see how commodity shares and currencies perform going into the summer.
For me, this was a tradeable rally -- albeit a huge one -- but it remains a sucker's countertrend rally and I would avoid all these commodity and energy stocks (look at what happened to Peabody Energy and you'll get a glimpse of the future for many of these highly levered commodity companies defying gravity right now).
Are we headed toward another Asian financial crisis? I don't think so but reading this old Wall Street Journal article from 1997, Deflation Reappears in Asia As Prices Fall, Growth Sags, gets me thinking that we're in a similar position and what my former BCA Research colleague Chen Zhao was warning of back then still rings true now:
"There's a risk of an Asian recession that becomes a world recession," says Chen Zhao, editor of the newsletter China Analyst. "Asia is big enough now to influence world prices, and the direction is down."
(Chen and Francis Scotland, another former BCA heavyweight, are now with Brandywine Global Investment Management)Keep this in mind as the media makes a big deal of Brexit or Grexit in the coming weeks. These events don't worry me anywhere near as much as a full-blown currency war in Asia and another Big Bang out of China which will heighten global deflation fears.
Below, Citi's Asia investment strategist, Ken Peng, discusses currencies with CNBC's Bernie Lo as Singapore eases its exchange rate-based monetary policy.
Second, unless global demand recovers, Singapore's economy will post slow growth in the 1%-3% range, says Singapore Business Federation CEO, Ho Meng Kit.
Third, commenting on whether Singapore just joined the currency wars, Vishnu Varathan, senior economist at Mizuho Bank, says the MAS has realized there's no need to consistently allow the local dollar to appreciate given the weak global environment.
Lastly, Kirk West, executive director and global head of international offices at Principal Global Investors, discusses the surprising easing decision from Singapore's Monetary Authority, what it means for the markets and where he sees opportunity. He speaks to Bloomberg's Angie Lau and Rishaad Salamat on "Asia Edge."