International | May 24 2006
By Chris Shaw (Tokyo)
When mixed economic data in the US last week suggested inflation was becoming a greater concern, the reaction in share and commodity markets was quite severe. Equally significant were the moves in currency markets, as the potential for higher interest rates in the US have brought to an end, at least temporarily, the bull market in Asian currencies.
Citigroup currency analysts Cliff Tan and Puay Yeong Goh have adopted a more cautious stance with respect to the Asian currencies, pointing out there are now some short-term risks. These risks reflect not only the uncertainty regarding US monetary policy, but also the fact investors are now factoring a higher risk premium into emerging markets.
The pair suggest this process could have further to run, as while markets have adjusted to this change in recent sessions a shift to structurally higher risk premiums usually takes more than a week to complete.
Danske Bank agrees, noting last week’s sell-off was in riskier asset classes, which means the benign risk environment that has been in place for the last few years may now be over. In the bank’s view the process of withdrawing liquidity from markets will continue for some time, so it is not time to be bullish on emerging market currencies.
Danske also argues the current economic climate supports a more cautious stance, as growth appears to be slowing globally at the same time as inflationary concerns are increasing. The bank suggests this is a negative environment for higher yielding currencies, but at the same time suggests it is not a buying opportunity as the emerging market currencies would miss out in any flight to quality.
Barclays Capital agrees, noting the uncertainty makes investors risk-averse and so results in a shift to the US dollar given its status as a reserve currency.
Also working against those looking for a bounce in emerging market currencies is the fact the futures market shows a better than 50% chance of a further increase in interest rates at the next Federal Reserve meeting in June. The Citigroup team takes the view it will be August before there is a clear indication of the direction of rates in the US, but they also note the Bank Of Japan appears to be all but telling investors rates there will not increases as soon as the market had expected.
This uncertainty, combined with the possibility both the Indian and Chinese markets could show signs of overheating later in the year, which would require a policy response, there is now a general lack of certainty in the outlook for Asian currencies generally and the emerging market currencies in particular.
