Asian currencies – long-term optimism after a near-term pause
While the June move in Chinese currency policy was derided as a largely political move, the timing of the change appears to suggest that China may be open to a more meaningful appreciation in its currency than has been the case since 1992. We remain strategically positive on Asian (ex-Japan) and Emerging Market currencies, given the lack of policy constraints faced by the major developed economies. However, the recent pace of appreciation in Asian currencies suggests they may need to pause for breath before resuming a long-term strengthening trend.
Historically, when China's real effective exchange rate has reached the levels it did in June, China has preferred to weaken rather than strengthen it (see chart opposite). However, the move over the summer from a yuan peg to the dollar to a 'managed float' represents an unusual shift in policy near the upper end of its historical band. This suggests China's exchange-rate policy may have shifted to accommodate a more rapid pace of yuan strengthening than seen in the past. Indeed, such an increase in the pace of appreciation would support our expectation for medium- to long-term appreciation of other Asian currencies against the major 'G4' currencies – the dollar, euro, yen and sterling.
But why now, given the shift in policy was announced in June and the yuan appreciated a negligible 0.3% against the USD following announcement of the policy shift. While we believe political pressure does factor into the decision, the relaxation of concerns about domestic overheating and slowing global growth have likely freed Chinese policy-makers to re-focus on their strategic priorities of rebalancing economic growth away from their export sector and towards more sustainable domestic demand.
At the time of the June announcement, the Chinese economy was growing rapidly and the consensus expectation was continued policy tightening through year-end. While currency appreciation can be a means of tightening policy, in the past China has made it clear that currency policy is viewed more in the context of strategic liberalization of its economy, rather than a cyclical tool to manage its near-term growth trajectory.
Thus, for China to refocus on the liberalization of its currency regime, it would need to address the near-term, cyclical issues facing its economy. We believe that is what has taken place over recent months. From a perception of overheating risk and a potential real estate bubble through much of the first half of the year, industrial activity in China has slowed from a 17-18% pace in late-2009/early-2010 to 13-14% over the summer. Similarly, with concerns over accelerating real estate prices having been the focus of policy-makers from late-2009, the annual change in prices has slowed in each of the past 4 months from over 13% to now 9%. We believe it is now on a trajectory to reach flat growth going into end-2010. Moreover, rapid slowing in auto sales and a peak in retail sales further suggests that resilient Chinese consumers are easing up from their heady pace of growth in 2009.
Similarly, concerns about a slowdown in global growth have also abated as financial system concerns in Europe have waned following July's European bank stress tests. 'Double-dip' fears in the US during July and August also appear to be easing. So with both domestic and external concerns having abated, China appears to now be comfortable refocusing on its strategic objective of liberalizing its currency and rebalancing demand within its economy.
Such a shift in focus by China should be encouraging to investors strategically positioned for appreciation of Asian and emerging-market currencies against their G4 counterparts. However, short-term caution may be warranted after the strong performance of other Asian currencies, particularly against the yuan itself.
Indeed, other Asian currencies (see chart below) as well as the Australian dollar and Japanese yen (not pictured) are now strengthening significantly against the yuan, as they did in late-2009/early-2010, approaching close to (AUD and JPY) or beyond (other Asian currencies) the upper bands of their trading ranges since the floating of the yuan in mid- 2005. From those levels in late-2009, modest weakening took place against the yuan as well as the dollar before they resumed their climb following China's June announcement.
Conclusion
We believe this recent change in China's exchange rate policy will support the medium- to long-term appreciation of Asian and emerging-market currencies we envisage. Indeed, we believe it is likely that the Chinese yuan will shift to being a driver of Asian currency appreciation, rather than a follower as was the case in early-2010. However, by strengthening through the upper end of their historical trading ranges versus the yuan, other Asian currencies may need to see a pause in their strengthening against the dollar, similar to early- 2010, before the longer-term strengthening trend resumes.
Disclaimer
Issued by Coutts & Co, which is authorised and regulated by the Financial Services Authority. Coutts & Co is registered in England No. 36695. Registered office: 440 Strand, London WC2R 0QS.
The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your original investment. Past performance should not be taken as a guide to future performance. Where an investment involves exposure to a foreign currency, changes in rates of exchange may cause the value of the investment, and the income from it, to go up or down.
The information in this document is not intended as an offer or solicitation to buy or sell securities or any other investment or banking product, nor does it constitute a personal recommendation. The information is believed to be correct but cannot be guaranteed. Any opinion or forecast constitutes our judgement as at the date of issue and is subject to change without notice. Any Coutts company, or a connected company, its clients and officers may have a position or engage in transactions in any of the securities mentioned.
The analysis contained in this document has been procured, and may have been acted upon, by Coutts & Co and connected companies for their own purposes, and the results are being made available to you on this understanding. To the extent permitted by law and without being inconsistent with any applicable regulation, neither Coutts & Co nor any connected company accepts responsibility for any direct or indirect or consequential loss suffered by you or any other person as a result of your acting, or deciding not to act, in reliance upon such analysis.
Not all products and services offered by the individual Coutts companies are available in all jurisdictions, and some products and services may be available only through particular Coutts companies.
None of the overseas Coutts companies or offices is an Authorised Person subject to the rules and regulations made under the Financial Services and Markets Act 2000 for the protection of investors and depositors, and compensation under the Financial Services Compensation Scheme will not be available in respect of business transacted with them.
