August 2019

Asia-Pacific currencies have weakened significantly over the past few months, culminating in the Chinese renminbi breaching the psychologically important seven per US dollar level on 7 August. The Australian dollar has also hit a decade low against the US dollar at 0.6756, the Hong Kong dollar moved to the weaker end of its trading band against the US dollar at 7.8464, and even the safe haven Singapore dollar hit a nine-month low against the US dollar at 1.3847.

While these movements have been partially caused by the strength of the US currency, they still have implications for regional cash investors. With this in mind, we take a look at the major currencies, the reasons for their recent weakness and the outlook for cash rates in the current uncertain environment.

Why this time may be different for the renminbi?

The escalation of trade tensions with the US triggered a classic market response from China, which weakened its currency. The renminbi experienced one of its largest single-day movements in several years on 7 August. Both the CFETS index and the CNH (renminbi funded in the onshore market) weakened, with the latter hitting a record high of 7.1403 to the US dollar, before rebounding slightly.

Ongoing trade tensions, combined with domestic economic weakness and broad US dollar strength suggest the currency could weaken further, with most economists now predicting a range of 7.10 to 7.20 by year-end. The declaration of China as a “currency manipulator” by the US administration should not have significant implications, but will likely raise anxiety further among investors—particularly as further currency weakness could raise concerns about capital flight. In 2015, the authorities spent over USD 1 trillion (a quarter of reserves) defending the renminbi.

Fortunately, with the People’s Bank of China (PBoC) likely to emphasize stability and support the currency around current levels, the current weakening of the renminbi should be steady and managed, as opposed to the abrupt and unexpected devaluation in August 2015. Given the more managed nature of the current depreciation and the broader range of tools available to the PBoC, the probability of large capital outflows is therefore lower this time round.

It should also be remembered that the renminbi depreciated in 2018 in response to the first round of US trade tariffs, without causing capital outflows. Domestic economic weakness combined with an escalating trade war suggests the PBoC will likely implement further monetary policy easing – potentially cutting open market operations, or reducing short-term or medium-term lending rates.

Will the Hong Kong dollar require intervention?

The recent escalation of local political protests, combined with the weakness of the renminbi, have triggered a sharp weakening of the Hong Kong dollar whilst Hibor rates have also jumped higher. With US Libor yields falling, Hibor-Libor spreads have widened back to their quarter-end highs.

The Hong Kong dollar peg looks safe given Hong Kong’s USD 446 billion of reserves backing up the territory’s USD 208 billion monetary base. Nevertheless, markets expect a further depreciation and more outflows from the currency, which will keep liquidity tight and Hibor rates high. If the Hong Kong dollar hits the lower boundary of its convertibility range, the Hong Kong Monetary Authority (HKMA) will have to intervene, draining local liquidity and pushing Hibor rates even higher.

What is causing the decade low for the Australian dollar?

Weak housing, muted inflation and low wage growth have convinced the Reserve Bank of Australia (RBA) to cut rates twice in the last two months to a record low of 1%. While the RBA left rates unchanged in August, markets continue to price in one additional rate cut in 2019.

In anticipation of rate cuts, Bank Bill Swap Rate yields have fallen dramatically and the yield curve has inverted. The US-Australia central bank interest rate differential has hit a record high of 150bps – triggering the sharp sell-off in the Australian dollar, which has pushed the currency to a decade low.

The RBA remains dovish and has explicitly mentioned its focus on employment and inflation as key indicators for future rate cuts. The latest unemployment rate was unchanged while inflation edged higher, but remains below the RBA’s target level. Exports, an economic bright spot, remain robust due to strong demand and high commodity prices. However, any weakness in exports demand could lead to further currency weakness.

Will the Singapore government or turn dovish?

Escalating global trade tensions have significantly impacted Singapore’s export dependent economy, with GDP growth falling to its lowest level in a decade. Against a backdrop of muted inflation, weak consumer sentiment and low tourist spending, the Monetary Authority of Singapore (MAS) moved from a hawkish to a more neutral policy stance at their last policy meeting in April, leaving the slope (~1%), width and centre point of the Singapore dollar nominal effective exchange rate (S$NEER) unchanged.

Despite the economic weakness, the S$NEER has held up remarkably well, remaining close to the top of the trading band for the past several months. However, in recent weeks, both the Singapore dollar and S$NEER have weakened.

Given the continued economic weakness and heightened trade tensions, many economists expect the MAS to assume a more dovish policy stance at its October monetary policy meeting, potentially reducing the S$NEER slope by 1% to 0%. This would trigger further currency and S$NEER weakness. Historically, when the S$NEER trades below its mid-point, swap offer rate (SOR) yields increase.

What are the implications for investors?

Asian economies are facing multiple headwinds, from escalating trade tensions, slower economic growth, to muted inflation and weak domestic demand. Following the US Federal Reserve’s lead, regional central banks have turned more dovish. Most economists now expect additional interest rate cuts in the coming months. This is a significant pivot from earlier in 2019 when economists expected further, gradual rate hikes and steeper yield curves.

The impact of lower yields and flatter yield curves has reignited the challenges of identifying good investments and locking in reasonable yields. Critical to this is having a robust investment policy that well defines objectives and acceptable levels of risk and return.

In a falling rate environment, time deposits rate decline in line with central banks’ rate cuts. Active management plays a critical role in offering extra cushion of yield.

For investors that can segment their cash balances by liquidity needs, maintaining high liquidity for operating cash, whilst extending the duration, reducing the liquidity and broadening the range of acceptable credit ratings on reserve and strategic cash balances (where cash is not needed for several months) can help boost the overall returns achieved – especially during the current period of foreign exchange and interest rate volatility.

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