No ‘twist’ for FX
We maintain a defensive stance in FX amidst few surprises from the Fed
The FOMC announces much anticipated ‘twist’ operation to extend the average maturity of its balance sheet. Overall the Fed’s dovish stance reaffirms a weak growth outlook and keeps us defensive on global currencies. Our preferred trades include: CAD, NOK, CNH, THB, CZK, PEN, and gold.
To the extent that markets have had plenty of time and guidance from the Fed to prepare for today’s outcome, the immediate reaction should be rather muted. We maintain a bias against QE currencies, and in that regards, signals of further policy accommodation and support for longer-dated rates in the US to remain low over a more sustained period of time, reinforce our structural bearish view on the USD. The lack of more meaningful support to financial assets out of today’s decision is likely to keep the focus on more immediate sources of market stresses, namely Greece. While liquidity restrictions in other currencies could see the USD benefit as a temporary refuge amidst bouts of risk aversion, this unlikely to last. We expect volatility to remain high and stick to our preferred defensive trades: CAD, NOK, CNH, THB, CZK, PEN, and gold.
G10 FX: Nowhere to hide
Central bank action has slammed shut the doors to traditional safe-haven currencies like the JPY and the CHF. Sadly, there are no safe-havens left in the G10 currency space. Currencies with enough liquidity do not possess safe-haven characteristics, whereas currencies with the necessary safe-haven credentials are nowhere near liquid enough. This has led people to gravitate to the USD by default, despite the woeful structural characteristics of the US.
The EUR is clearly not a suitable safe-haven as a result of the problems in the Eurozone periphery; the AUD suffers from Australia’s poor external position; and the fiscal problems in the UK hardly make a compelling case for GBP. In contrast, the NOK and the SEK would appear to be good safe-haven candidates, but are not liquid enough to cope with the vast demand for safe-havens without appreciating significantly, which in turn, would trigger central bank response. The least-bad option is probably the CAD, but the arguments in its favour are far from overwhelming. The conclusion has to be that there is no place to hide in the G10 currency market. We therefore expect further upward pressure on the price of gold.
ASIA FX
In our view, Asian currencies are likely to remain at the mercy of the ‘risk on – risk off’ environment. We see KRW and INR versus the USD as the most sensitive to this dynamic.
In the past few weeks, we have also seen some notable position liquidation in equities held by foreign investors. If fears of a USD liquidity crunch persist, or increase, this could spread more notably into the Asian bond market. MYR, IDR and KRW would be most at risk from an unwinding given the heavy foreign bond exposure.
The currencies that would likely retain most stability would be the CNH, as the authorities continue to guide steady appreciation, and the THB, which has low foreign holdings in local equity and bond markets. While we also like the SGD as a currency for good times and bad, its close link to ‘risk on – risk off’ dynamics suggests the currency will remain volatile versus the USD in the short term. More medium term however, given Singapore’s domestic investors hold large foreign portfolio positions, ongoing ‘risk off’ conditions would likely see repatriation of funds from offshore. This should reduce upside pressure on USD-SGD.
EMEA FX
The FOMC outcome does not change the panorama and the outlook for EMEA currencies. Any market relief would be short-lived as the eurozone crisis and the consequent reduction in positioning, particularly on the bond markets, remain the main driving forces.
The HUF and the PLN are likely to underperform. Although Hungary has a current account surplus and a prudent monetary policy, the government’s plan to allow households to repay foreign currency debt at below-market rate puts financial stability and the HUF at risk. The PLN status as a “proxy” for the CEE region coupled with a wide current account deficit also makes it vulnerable.
The CZK is the well-known defensive currency. The Czech Republic’s macro fundamentals are robust, with a low level of debt and a strong banking sector. The CZK should maintain its outperformance vs. the PLN and HUF, although the crown is not totally insulated from the consequences of eurozone crisis.
The TRY and ZAR are special cases. The CBRT is actively fighting TRY depreciation and this offers support against peers. However, the currency would not withstand a global liquidity shock giving Turkey’s huge current account deficit. Meanwhile, the ZAR remains very sensitive to the ‘risk on – risk off’ variable and the dependence on bond inflows constitutes a source of vulnerability.
LATAM FX
External risks continue to trump over local fundamentals in the region. MXN and BRL have borne the brunt of the sell-off and look overdone to us. In contrast, we see CLP and COP lagging some of the recent moves and turn more cautious on both from here.
The MXN and BRL have depreciated 16% and 20% since early July, respectively. Valuations are attractive while positioning in those currencies is now much reduced. In our view much of the bad news has been priced in, although short-term, the risk of unwinding of foreign investments in the local fixed income markets remain a source of concern. Timing is of the essence, but we believe that improvement in the external environment may see more bargain-hunters emerge.
Currencies such as the CLP and COP have held in better, garnering support from still relatively firm commodity prices. As risk aversion persists, we would expect these currencies to come under more pronounced selling pressures. We thus prefer them as short legs to relative value trades against MXN and BRL.
Meanwhile, the heavily managed ARS and PEN are likely to outperform the ongoing risk shock. In Argentina, we see the authorities intervening heavily to prevent a massive sell-off ahead of the 23 October election, but beyond that we think the probabilities rise for a much more aggressive move higher in USD-ARS.
HSBC Global Research