How is the surging U.S. dollar affecting Asian currencies?

With contributions from the Asian fixed-income, China fixed-income, Singapore fixed-income, Taiwan fixed-income, and Malaysia fixed-income teams. Additional inputs from our India, Malaysia, and Philippine equity teams.

The region’s currencies—a granular outlook

Australian dollar—strategic opportunities amid rate hikes and exporting strength

The Reserve Bank of Australia (RBA) is one of Asia's most hawkish central banks—after the Bank of Korea and Monetary Authority of Singapore (MAS)—due to an increasing need to tame inflation.¹

Australia’s inflation rose by 5.1% year over year in the first quarter of 2022, exceeding the RBA’s target range of 2.0% to 3.0% over time. Rising inflation is being driven by domestic and external factors, such as higher wages (a function of previous lockdown measures and labor shortages), supply chain disruptions, and higher commodity prices.

What makes the Australian dollar unique in this macro backdrop is that Australia is one of the few Asia-Pacific economies that’s a net commodity exporter with a hawkish central bank. Of note, Australia is a net exporter of base metals and soft commodities. The latter is experiencing increased external demand due to disruptions stemming from the Russia-Ukraine conflict. 

Year to date, the Australian dollar has weakened, along with other Asia-Pacific currencies amid the robust U.S. dollar (USD) environment and economic slowdown in China (lower Chinese exports due to weaker demand). Global financial markets have priced in around ten 25 basis points (bps) hikes by the Fed. At this juncture, we believe the Australian dollar could present tactical opportunities given current currency levels, RBA rate hikes, and Australia’s position as a net commodity exporter. 

Increasing inflationary pressures in Singapore

At its April meeting, the MAS continued to tighten policy by recentering the midpoint of the Singapore dollar’s nominal effective exchange rate (SGD NEER) higher and slightly increasing the appreciation rate of the policy band.² Much like the rest of Asia, the Singapore dollar has depreciated in the face of broad USD strength. We think this trend will likely continue in the short term as the U.S. Federal Reserve (Fed) normalizes interest rates and commences quantitative tightening.

The surge in global energy and commodity prices and a tight labor market will likely create further inflationary pressures in Singapore. As such, there’s a strong chance the MAS could further tighten its monetary policy in October.  

Weaker global growth could potentially weigh on the domestic economy, and we think it’s likely that Singapore’s growth could moderate to the lower range of between 3% and 5%. Yet Singapore will maintain its solid AAA external rating, which should underpin higher-quality local currency issuers with stable credit fundamentals.

RBI joins expeditious path to neutral rates

On May 4, 2022, the Reserve Bank of India (RBI) unexpectedly raised its repo rate by 0.4% to 4.4% and announced a cash reserve ratio (CRR) hike of 0.5% (bringing the ratio to 4.5%). With the country’s Consumer Price Index set to breach the RBI’s upper tolerance limit of 6.0% year on year, and pressure on the current account due to high energy prices that could depress the Indian rupee (INR) (i.e., inflation due to food and energy may not be transitory), the RBI appears to have joined the expeditious path to neutral rates. The central bank’s decision is likely to maintain the stability of the INR versus other Asian emerging-market (EM) currencies and keep the INR intact. We now expect the RBI to hike its policy rate to 5.5% by March 2023. Despite the CRR increase, the system should remain liquid with a surplus; in addition, we think that lenders will raise their deposit and lending rates by 1.0% to 1.5% (by March 2023). In any case, the current one-year bank deposit rate of 5.5% is low relative to the 10-year bond yield, which is around 7.2%. 

Policy divergence puts pressure on the renminbi

As the Fed continues to raise interest rates, the nominal yield differential between the United States and China is reduced. This is a development that could place the renminbi under further pressure in the second half of the year. Having said that, we believe that the renminbi will remain well supported at the current level given China’s strong trade position. China bonds are also likely to outperform U.S. Treasuries given that China’s monetary policy is expected to remain dovish.

The People's Bank of China is likely to continue with monetary easing despite some constraints. The impact of further policy divergence between China and the United States will most likely be felt in the foreign exchange (FX) rather than rates markets. For this reason, we’re adopting a more neutral view on the renminbi for now.

The New Taiwan dollar—outflows and rich valuations

The New Taiwan dollar (TWD) declined by 3.41% against the USD in the first quarter of the year, closing at 28.626 at the end of March. This downward momentum was primarily a result of the Fed’s hawkish policy stance, which drove significant capital outflows; however, despite a solid external sector, we expect the TWD to weaken in the coming quarter given the headwinds from outflows—both domestic and foreign—and rich valuations of the TWD.

Taiwan is an export-oriented economy and has a leading position in the semiconductor and high-tech manufacturing industries. This has resulted in a sizable current account trade surplus for decades. Even though a weaker currency may benefit domestic exporters or the whole economy, it could also increase inflationary pressures. As a result, Taiwan’s central bank will need to balance and smooth any abnormal or speculative currency movements to minimize any impact on exporters and consumers. 

In our view, Taiwan’s central bank has sufficient monetary policy instruments to deal with recent outflows caused by the hawkish Fed. The central bank has raised its policy rate to narrow the differential between the TWD and the USD and released its long-accumulated US$550 billion FX reserve to dampen depreciation pressure. 

Taiwan’s fundamentals remain strong: GDP growth is above trend thanks to substantial private investment, external demand, and personal consumption recovering from the COVID-19 slowdown. Therefore, we’re optimistic about Taiwan’s economy and believe that the currency will stabilize once the Fed’s moves are fully priced in.

Malaysian ringgit weakness to continue in the short term

The Malaysian ringgit lost ground against the USD in the wake of the Fed’s hawkish interest-rate stance, a slowing Chinese economy, and commodity-price inflation. The ringgit has always been highly correlated with China’s renminbi, which recently depreciated against the USD. This, plus other factors, such as overseas investor outflows from the bond market and FX deposit hoarding by local participants, probably explains why the currency has performed worse than neighboring markets. 

In the short term, the dynamic of USD strength and ringgit weakness could persist for the reasons above. Coupled with this is the possibility of further risk-off sentiment induced by geopolitical tension, which is usually unfavorable for EM currencies. 

From a medium-term perspective, the outlook is brighter. As we move into the second half of the year and toward the end of 2022, the Fed may start to tone down its hawkish stance (once it has raised interest rates several times), and the Chinese economy could stabilize. 

We also note that Malaysia’s trade balance remains fundamentally strong given that it’s a commodity-exporting country. It has also experienced substantial foreign direct investment (FDI) flows—indeed, Malaysia’s FDI recently overtook Vietnam and is among the strongest among ASEAN countries. We also see portfolio inflows into Malaysian equities. These factors are all supportive and should limit further ringgit depreciation, which could reverse in the second half of the year.

Furthermore, given that the ringgit hasn't softened for a prolonged period, the impact of currency weakness has yet to filter through to the economy. We’re closely monitoring issues such as imported inflation together with the performance of those companies (e.g., exporters) with potential FX exposure. 

Finally, we’re also keeping a close eye on foreign investor activity in the bond market to detect signs of selling induced by a weak ringgit. 

Economic reopening could offset the effects of a declining Philippine peso

 The Philippine peso has depreciated by 2.6% year to date, reaching P52.19 versus the USD at the end of April. The currency’s weakness was driven by the country’s large account deficit, coupled with the flight to more developed markets due to perceived geopolitical risks and the country’s upcoming local elections. We expect the peso to remain weak throughout 2022, primarily due to the country’s current account deficit³ and a delay in rate hikes implied by Bangko Sentral ng Pilipinas (BSP). 

A weaker peso is typically inflationary, as the country largely imports its energy requirements, such as crude oil and petroleum products. Consequently, periods of high inflation hurt domestic consumption, which accounts for two-thirds of GDP. The BSP has raised its inflation forecast this year to 4.3%, while consensus GDP estimates are around 6.7%; however, we continue to downgrade our GDP estimates due to higher inflationary expectations. On the other hand, a weaker peso is typically positive for overseas Filipino worker (OFW) remittances and business process offshore (BPO) industries. OFW remittances and BPO revenues represent around 10.0% of GDP. 

In terms of the effect on the Philippine equity market, a weaker peso is usually negative for corporate earnings. Most revenue streams still rely on domestic operations while importing a portion of raw materials. This varies from wheat and cooking oil for consumer-food manufacturers and restaurants to telecom equipment for communication services and steel requirements for construction-related activities. There are also companies with a sizable USD-denominated debt, given their capital expenditure requirements are in a foreign currency. As such, aside from weaker consumer demand driven by high inflation, there’s also an impact on corporate margins. 

Overall, a weaker peso is unhelpful for the Philippines economy and equity markets; however, in our view, the reopening of the economy following the mobility restrictions of the past few years would more than offset the inflationary impact of a weak currency. Therefore, GDP estimates for 2022 are still higher than last year. 

A recovery in the tourism sector could bolster the Thai baht

The Bank of Thailand (BoT) has kept its interest rates stable at 0.5% to support economic growth. It also views inflation as being transitionary: The BoT raised its headline inflation forecast to 4.9% (from 1.7%) in 2022 but expects inflation to slow to 1.7% in 2023. 

Before the pandemic, tourism made up around 18.0% of Thailand’s GDP, meaning that the Thai baht could present a medium-term opportunity as the country reopens its economy and tourism recovers.

Conclusion 

USD strength, a hawkish Fed, and slowing growth in China should continue to place pressure on Asian currencies through the summer months. Even though the region’s central banks are expected to normalize monetary policy, this will likely take place at a slower rate than developed markets. More positively, the outlook for the second half of the year is relatively upbeat. 

1 The Bank of Korea has already increased its policy rate by 75bps so far this year. On May 3, the RBA hiked Australia’s official cash rate by 25bps to 0.35%, from a record low of 0.10%, with the central bank signaling the likelihood of more rate hikes in the coming months. Australian consumer prices rose 5.1% year over year in the first quarter, with core inflation rising 3.7%. 2 In the last six months, MAS moved to raise the slope of the policy band twice amid rising inflation, including an off-cycle move in January 2022. 3 Note that in terms of consensus estimates, the Philippines’ current account deficit is estimated to remain elevated in 2022 to 2023; meanwhile, consensus estimates point toward a depreciating Phippine peso until 2024.