Asia’s time to shine

IFR Asia Awards 2012
14 min read
John Noonan, Amanda Tan

After an unstable, but robust year, Asian currencies are set to continue reaping benefits in 2013 on solid domestic growth and global central bank easing. However, economic uncertainties in Europe, the US and China threaten to upset momentum in the region.

With central banks dampening the appeal of the world’s three biggest currencies, many of Asia’s currencies have emerged as star performers and are set to build on that trend in 2013.

Asian currency units, outside Japan, have continued to attract attention despite bouts of extreme risk aversion.

The eurozone sovereign debt crisis remained the main source of investor fright. Yet, at times throughout 2012, fears of a hard landing in China led to heavy selling of high-beta assets in the region and currencies closely tied to the PRC growth story.

It was mid-2012 when one of the first worrying signs began to emerge out of Asia. The spot price of iron ore, a key raw material for China’s construction sector, began to freefall in early July.

Concerns over what this meant for China’s many close trading partners in Asia were far from unfounded. Reports were awash with anecdotal evidence of large-scale inventory stockpiling in China, as well as offshore miners scaling back their investment plans. Private surveys also showed a noticeable drop in foreign orders for Asia’s manufactured goods.

The spectre of a hard landing in the world’s second-largest economy awakened the China bears just as the eurozone crisis was intensifying. Those most pessimistic had Greece making an exit from the euro, and Spain, Ireland and Portugal needing bailouts.

Fears of a global slowdown sent key commodity prices plummeting with the spot price of iron ore plunging almost 40% in just two months from early July to the start of September to touch levels not seen since the 2008–09 crisis. Meanwhile, trade data from Asia’s “workshop of the world” disappointed, as the headwinds from Europe challenged their economic models.

Exports from China, the hub of the Asian supply chain to the West, decelerated from double-digit growth rates to just 1.0% per annum in July, while imports contracted 2.6% in the year to August. In South Korea, exports fell as much as 8.7% in the year to July and did not grow again for the next two months. Meanwhile, Taiwanese exports fell 11% in July and another 4% in August, and Malaysian exports dropped a much as 5% over the same period. Indonesia’s exports were among the worst hit, falling as much as 24.3% year on year in August.

From gloom to boom

In this environment, investors headed for the safety of risk-free, low-yielding bonds, resulting in Triple A sovereign debt yields plummeting to zero or even, in some cases, turning negative. Investors with cheap central bank funding shied away from emerging Asia in search of better returns. The prospect of a hard landing in China had them putting money in US equities. During the height of the eurozone crisis, between early May and early June, the MSCI Asia ex-Japan Equity Index fell nearly 5% against the S&P 500, as the HSBC Asia ex-Japan currency index fell close to 2.70% against the US dollar.

Fears of a catastrophe in Europe, however, faded fast after ECB President Mario Draghi declared “we will do what it takes to save the euro!”

The unveiling of the bond-buying programme (OMT) backed up the claim. Even though the scheme has yet to be triggered on a request from eurozone countries (Spain, in particular), its introduction was enough to push down yields of stressed sovereigns and buy time before the next phase of the crisis.

Chinese manufacturing and growth numbers eventually improved, too, as did trade data from other emerging Asian powerhouses, mitigating concerns that the PRC was in for a rapid slowdown.

By the time of the US presidential election, the investment world looked like a safer place. Global stock markets were steaming higher, credit spreads were tightening; currency option volatility was trading at four-year lows, and the VIX index traded at levels not seen since before the financial crisis.

The re-election of President Barack Obama soon gave way to fears of another round of budget brinkmanship ahead of the so-called fiscal cliff, resulting in a slide in global equities and a return to safe-haven destinations, including the US dollar.

Despite the post-US election rise in risk aversion, however, Asian assets and currencies managed to hold up reasonably well. As of November 22, the HSBC Asia ex-Japan currency index was up 4.15% for the year, even though the US-dollar index had posted a 0.70% gain for that period. The basket of emerging-market Asian currencies gained an eye-popping 12% against the Japanese yen since the start of the year.

However, not all Asia, ex-Japan, currencies performed well in 2012. Investors were far more discerning than in the past after incurring huge losses on the Indian rupee in 2011. This is evident when breaking down the relative performances of currencies within the region in 2012. For example, the Singapore dollar, Philippine peso and South Korean Won each gained between 5.5% and 6.5% against the US dollar since the start of the year, while the darling of the investor world for 2010 and 2011 – the Indonesian rupiah – fell 6.35%.

Trends for 2013

Although foreign exchange forecasting is a challenge, especially after a treacherous 2012, there are a few predictions that can help chart a path for forex traders in 2013.

Based on growth expectations of between 7.5% and 8.0% in 2013, a hard landing in China is unlikely. Official Chinese data suggest that the economy is improving in the fourth quarter with growth set to top Beijing’s 2012 target of 7.5%. While there are some doubts about the accuracy of official data, signs that the worst has passed are substantiated by private surveys such as HSBC’s manufacturing survey, an upturn in Chinese electricity output growth and the uptrend in exports from some of China’s key Asian trading partners.

Many of the assets earning positive risk-adjusted returns are located outside the countries undertaking quantitative easing. As a result of this, there is an incipient outflow of capital from these countries, and, by extension, downward pressure on their currencies.

Imminent US fiscal tightening and Europe’s debt troubles still present headwinds to Asia’s trade and manufacturing sectors, meaning the duration and magnitude of the rebound remains uncertain. Ultimately, however, China’s economy is likely to grow in the 7%–8% range in the medium term.

At the same time, the US economy should avoid the fiscal cliff, but the expected fiscal tightening will temper growth. Europe, too, will avoid a catastrophe, but will muddle through another year of weak economic growth and slow progress in dealing with its sovereign debt crisis.

Meanwhile, Japan will desperately try to reflate its moribund economy through more unorthodox monetary policy, with the express aim of significantly weakening its currency. The US Fed will continue its quantitative easing efforts, and the ECB will be more aggressive in easing its monetary policy to avoid a prolonged recession.

Those assumptions suggest that investor risk appetite will increase, and that global investors will need to venture outside the developed economies to find acceptable returns. The combination of sluggish growth in the developed economies, shrinking yields and hyper money-printing by their central banks just might result in a flood of freshly printed US dollars, Japanese yen and euros heading for emerging-market Asia.

As Royal Bank of Australia Deputy Governor Philip Lowe put it in a recent speech: “With the rest of the world doing better than the troubled advanced economies, many of the assets earning positive risk-adjusted returns are located outside the countries undertaking quantitative easing. As a result of this, there is an incipient outflow of capital from these countries, and, by extension, downward pressure on their currencies. Of course, this means that the currencies of some other countries are under upward pressure.”

Currency investors will not have to venture outside the Asian-Pacific region to find the most rewarding risk/returns. In an exclusive interview with Reuters, Lou Jiwei, chairman and chief executive of China Investment Corp, China’s wealth fund, said the fund was increasing exposure to Asia due to the potential for rapid growth in the region. He cited rising protectionism in the west and the underwhelming policy response to the European sovereign debt crisis as reasons to stay underweight bonds and stocks there. A large number of global fund managers are likely to share his view.

Sliding yen

The Japanese yen has been in a steep slide since Prime Minister Yoshihiko Noda called for a surprise snap election on November 14. The yen slid nearly 4.0% against the US dollar during November 14–22, and there appears to be plenty more in store.

Opposition LDP leader Shinzo Abe called for the Bank of Japan to embark on unlimited easing. There has even been speculation that Abe may stack the BoJ policy board with enough radical doves to embark on foreign bond buying if all else fails – an unprecedented move that could result in a collapse of the yen in 2013.

The rupiah offers better value than the likes of the Singapore dollar, Korean Won and Philippine peso after falling sharply against those currencies in 2012.

The Australian dollar may also be ready for a slide. The Aussie has been one of the best-performing currencies over the past three years. The China-led commodity boom ignited a surge in the currency, while relatively high yields and the country’s Triple A rating have kept it elevated through times of heightened global crisis and falling commodity prices.

While China’s growth and commodity demand look set to stabilise, the supply of key commodities is increasing rapidly. The relatively high production costs in Australia means that even stable commodity prices will not be enough to stop the major miners from cutting costs. This means culling jobs and reviewing major mining projects.

The RBA predicts that mining investment in Australia will peak some time in 2013 and it will be vital at that time for underperforming sectors of the Australian economy to rebound strongly. The high Australian dollar is an impediment to growth in the non-mining sectors, and the RBA has plenty of incentive to slash the cash rate further to push the dollar lower and fire up the broader economy. The cash rate currently sits at 3.25% and an easing closer to 2.0% cannot be out of the question.

Value in Indonesia

Among the Asia-Pacific currencies, the unit offering the best potential value for 2013 is the Indonesian rupiah, the worst-performing currency in 2012. According to Jonathan Cavenagh, senior forex strategist at Westpac Singapore, the deterioration in Indonesia’s trade balance (which weakened more in 2012 than it did during the 2008–09 global slowdown) “has clearly been a major driver” of the rupiah’s underperformance.

Coal (predominantly thermal) has grown in importance in terms of driving Indonesia’s overall trade performance, and thermal coal prices have been under pressure through much of 2012 due mostly to weaker global growth conditions and increased US coal exports on the back of rising natural gas consumption.

Cavenagh believes there is light at the end of the tunnel, however. The rupiah offers better value than the likes of the Singapore dollar, Korean Won and Philippine peso after falling sharply against those currencies in 2012.

“The stronger domestic backdrop for Indonesia (growth held above 6.0% for eight straight quarters), along with foreign investors’ continued buying of local bonds, should see rupiah recovery as we move through 2013,” he said.

He said US investors, in particular, feared ongoing rupiah weakness due to the potential of rising inflation.

“There has been some concern that the Bank of Indonesia easing actions would stoke inflation pressures … (but) … the link between money supply growth and inflation in Indonesia is certainly not as strong as it used to be,” he said.

Central banks in China, South Korea, Taiwan and Singapore are far more likely to respond with heavy currency intervention to a radical weakening of the yen than the Bank of Indonesia.

The recent yen weakness is already giving Japanese exporters a decided advantage over the other major exporting nations in the region and, if the yen weakness accelerates in 2013, currency wars could return with a vengeance.

While those currencies are also likely to strengthen due to foreign inflows, the rupiah offers investors the chance of making outsized returns of between 5% and 15%, if crossed against the yen or Aussie dollar.

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Asia’s time to shine