Rupee, yuan win as forex investors cherry-pick in Asia

From a rapidly rising rupee to a falling Singapore dollar, 2014 is shaping up to be a year in which investors in Asian currencies will not merely discriminate heavily but also pick trades that reduce exposure to the fickle U.S. dollar.

There is far greater consensus this year than in 2013, when the main drivers of currencies were concerns over when the Federal Reserve will begin tapering its easy policy and how much of money will leave emerging markets.

Analysts and traders alike concur that the Fed's gradual policy tightening will strengthen the dollar, while causing sporadic volatility, and that country-specific factors will become market drivers.

The consensus thus favours trades that limit exposure to the dollar and exploit intra-regional divergences.

The rupee's rally against the Singapore dollar, Thai baht and even the Indonesian rupiah, which along with the rupee was severely hit during last year's volatile selloff of emerging markets, is evidence of investors cherry-picking.

Being long the rupee against other Asian currencies is a top trade for analysts at Citi. Morgan Stanley's Asia analysts recommend likewise.

Analysts at HSBC reckon north Asian currencies such as Korean won and China's yuan could outperform the South Asians, but they also like relative value trades that play off the rupee or won against the Thai baht or Indonesian rupiah.

"These relative value trades are a quicker way to express a relative macro view within Asia and how that can impact Asian currencies, than just a specific dollar-centric view," said Paul Mackel, head of currency strategy at HSBC in Hong Kong.

"You are less tied to what is going to happen to the dollar and what happens with U.S. data. And, some of these Asian currencies trend more, rather than getting caught up in the noise of the U.S. dollar. That is one obvious benefit."

Analysts are most unanimous about the yuan, citing China's proposed financial and economic reform and the push to rebalance the economy inward and away from exports as reasons it will keep appreciating. Investors have been rewarded. Yuan traded offshore has risen more than half a percent against the dollar in the past two months, and four percent against the Thai baht.

"Risk-on/risk-off is no more. The long yuan trade seems like the only safe dollar short but that view will probably be questioned at some stage," said Jonathan Cavenagh, strategist at Westpac Bank.

Still, investors' faith in other widely held consensus calls has been tested in the first few weeks of January by the traditional adjustment of positions and booking of profits over the turn of the calendar year.

VALUATIONS OR VOLATILITY?

For instance, even though the Thai baht is a favourite currency for investors to be short-selling, the currency has barely moved against the dollar this year. Currencies which investors have ranked as better bets than the baht, such as the Malaysian ringgit and Philippine peso, have incurred losses nearing 2 percent against the dollar so far in 2014.

One explanation for that contradictory performance is that the baht had fallen almost 7 percent between the end of October and early January owing to a domestic political crisis.

Over that period, the baht crosses have paid off. The ringgit is up 2.3 percent against the baht since early October. The won has done even better, gaining 4.5 percent versus the baht since mid-November

But the decisions on what to buy and what to sell are far from straightforward, and depend on the various metrics used.

"The North-Asia versus Southeast Asia theme looks set to dominate, although within these regions there are some relative value trades," said Cavenagh, while recommending buying the yuan and won versus the Taiwan dollar, or the rupee against the Singapore dollar. The rupee, for instance, has rallied 1.3 percent against the Singapore dollar in the past month.

The appeal of the domestic equity or bond market is one metric. Thailand's central bank has cut rates once in the past three months to support an economy reeling from the political unrest and loss of confidence. That increases the appeal of bonds, whose value keeps rising as yields decline, therefore attracting foreign money into Thailand.

But the carry, or the yield on the currency, is a swing factor. It costs about 3.5 percent to borrow and short-sell baht for three months, which means one would have to buy the higher-yielders such as rupee or rupiah to compensate for that cost.

Citi strategist Siddharth Mathur suggests buying the yuan and won against the Singapore dollar and Taiwan dollar because that allows an investor "to capture the trend while minimising the risk and still earning carry."

Taken one step further, the currency to buy wouldn't merely offer a good yield, but a yield that's attractive when adjusted for volatility.

Which is why the Indonesian rupiah isn't on the average investor wishlist - it's near-8 percent yield for a month is completely offset by the 13 percent expected currency volatility, not to mention the fundamentally weaker growth and external balance-sheet.

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