A man watches the foreign currencies exchange rate in Rio de Janeiro, Brazil
Fear has crept into the foreign exchange markets: fear of central banks. Currency traders are rapidly shifting assets to countries seen as less likely to try to weaken their currencies, amid concern that the fresh round of US monetary easing could trigger another clash in the “currency wars”.
Fund managers are rethinking their portfolios in the belief that “QE3” – the Federal Reserve’s third round of quantitative easing – will weaken the dollar and trigger sharp gains in emerging market currencies. Such moves would cause a headache for central banks worried about the domestic impact of a strengthening local currency, leading to possible intervention.
Some investors are allocating money towards countries with beaten-up currencies, such as India or Russia, or those with more benign central banks, such as Mexico, that do not have a history of frequent forex intervention.
Currencies whose central banks have either intervened or threatened to intervene since QE3 have been underperforming the US dollar as investors have steered clear.
The Czech koruna is the worst-performing major currency against the dollar since QE3 was launched this month, according to a Bloomberg list of expanded major currencies. The governor of the Czech central bank last week raised the prospect of forex intervention as a tool to stimulate the economy.
The Brazilian real is also weaker in the past two weeks after Guido Mantega, finance minister, made it clear that the government would defend the real from any fresh round of currency wars sparked by the Fed’s move.
Even the Japanese yen is weaker against the dollar overall since the Fed’s move, despite having clawed back all its losses after the Bank of Japan’s move to add to its bond-buying programme last week.
Currency desks at Baring Asset Management and Amundi are avoiding the Brazilian real, which the country’s central bank keeps managed at around R$2 against the US currency, and are instead buying the Mexican peso, where the central bank has signalled it is happy for the currency to appreciate further.
James Kwok, head of currency management at Amundi, said: “Mexico is an emerging market currency many managers like as they believe the central bank won’t intervene. The Singapore dollar and the Russian rouble are managed by a range, instead of one-way direction, and so are also good candidates for QE play.”
He is concerned that another “big scale” intervention from Tokyo is on the cards after the BoJ failed to weaken the yen substantially this month, and is avoiding the currency as a result.
“We definitely take the intervention risk into account when investing in a currency,” says Dagmar Dvorak, director of fixed income and currency at Barings. “In Asia, intervention risk is fairly high. We have still got positions in the Singapore dollar but remain cautious on the rest of the region.”
Other investors are opting for currencies that have weakened substantially this year. Clive Dennis, head of currencies at Schroders, says: “Russia and India have currencies with strong rate support and levels which remain well below their best levels of the last year, hence pose less intervention risk. I like owning those currencies in a US QE3 environment.”
Some currencies are strengthening on a combination of Fed easing and domestic factors. While the Indian central bank is not seen as likely to intervene to stem any appreciation in the rupee, the currency has also been popular this month due to a reform package from the Indian government aimed at stimulating the economy.
Commodity currencies including the Russian rouble are responsive to expectations of a rise in commodity prices fuelled by Fed easing, while investors view the Mexican peso, along with the Canadian dollar, as a play on any economic recovery in the US because of their strong trade links.
However, some investors believe the QE3 effect could be lower this time. They argue that central banks in emerging markets face a tough decision over whether to weaken their currencies to help struggling exporters and stimulate growth, or allow them to strengthen to offset the impact of rising food prices.
In fact, the US dollar has shown signs of resilience since QE3 as fears over the health of the eurozone continue.
While flows into EM debt and equity funds rose substantially last week, according to data from EPFR Global, Cameron Brandt, research director, says this week’s flows looked more muted: “There’s a certain amount of reaction fatigue setting in.
By Alice Ross, FT.com
What QE3 means for China and rest of Asia?
China recently announced plans to boost spending on subways and other transportation infrastructure to boost its economy. But China may not be as aggressive with stimulus as the Federal Reserve and European Central Bank.
Now that most of the developed world's major central banks have all committed to some form of open-ended quantitative easing, we can start to make some concrete predictions about the effects this will have in Asia.
In general, QE is being undertaken in the West to stabilize debt markets that are deflating. So this may do little to actually stimulate sustainable economic growth. But, the uncertainty as to whether the central banks would act aggressively kept a lid on many emerging growth markets for months. Here's what may happen next.
China has been lowering interest rates but it cannot afford to do print money to buy bonds like other central banks have done. China's central bank can still announce more fiscal stimulus due to its strong trade surplus. The recent plan to spend $156 billion on domestic infrastructure is significant, but compared to the amount of money the Federal Reserve and European Central Bank may wind up spending, it might was well be $156.
The political situation in China is proving to be more volatile than we may have originally thought as the response to Japan's buying the Senkaku islands seems completely out of proportion with the level of threat or even insult this is represents. It speaks to a party that needs to redirect anger at its own mishandling of the economy.
That this is coming just a few months after Japan and China signed the most sweeping currency and trade agreement of any that China has signed with another country seems very odd.
Japan's response to the QE announcement by the Fed was to extend their existing QE program another 10 trillion Yen (~$128 billion US). That may sound like a lot but it's even less than China's most recent stimulus program.
This suggests that the Bank of Japan is uninterested in printing to oblivion at the same rate as the Fed and ECB, and that Japan will manage the yen's rise while shifting its focus towards more regional trade. Japan and China are each other's largest trading partners, which makes this row over the Senkaku Islands seem manufactured to force the Japanese to choose a side in the growing cold war between the U.S. and China.
So far, Japan has been trying to work with both sides. It is helping to internationalize China's yuan currency and is giving China a clear alternative to U.S. Treasuries with its own bonds. At the same time, Japan has stepped up its purchase of Treasuries, buying more than $200 billion's worth in the past 12 months.
I expect the Bank of Japan to continue to try and position the yen as an alternative regional reserve currency as other Asian nations like Thailand, Malaysia and Indonesia try to lessen their reliance on the U.S. economy.
By keeping the yen strong versus the euro and the dollar, Japan can attract capital from overseas and use it to deploy it around Asia. There should be enough money sloshing around the region so that Asian nations can continue their trade with the West at current levels while also focusing more on regional growth.
The economies of Indonesia, Thailand and Malaysia are already growing above expectations this year despite volatility in their currencies because of the fear over Europe. With worries about Europe starting to wane, these countries, as well as the best companies in them, should have little trouble raising capital through bond sales.
The wildcards for Asia are Hong Kong and Singapore. We're already seeing signs of a property bubble in Hong Kong thanks to the Fed's four-year old policy of interest rates near zero. That's because Hong Kong's dollar is nominally pegged to the U.S. dollar.
Now that the Fed has implemented a program that will further debase the dollar -- and expand its already bloated balance sheet -- Hong Kong is being forced to reassess its currency peg. If they do not make changes, this could result in an even bigger property bubble. That would lead to loan problems for Hong Kong banks similar to those plaguing those in the U.S., Europe, China and, to a lesser extent, Singapore.
Since the Monetary Authority of Singapore (MAS) pegs its interest rates to that of the Fed, its economy is vulnerable to a property bubble like the one in Hong Kong. Inflation is currently above 4% and has recently been above 5%. While Singapore's banks are all very well capitalized and their foreign exchange reserves are higher than their annual GDP, the Fed's QE3 policy will put pressure on an economy already dealing with sluggish growth.
But all in all, the latest round of QE is mostly bullish for Asia as it creates some certainty after the past 12 months of extreme uncertainty. Even though the actions by central banks in the West appear to indicate that their economies are worse than the headlines make it seem, the mere fact that the Fed and ECB have acted should reassure investors throughout Asia.
@CNNMoneyInvest
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