Volatility in Developed Market rates spilled over to Asian markets - BNPP

Volatility in Developed Market rates has spilled over to Asian local markets and as a result, popular carry trades remain vulnerable to position adjustment, according to Mirza Baig, Head of Asia FX & IR Strategy at BNP Paribas.

Key Quotes

“But this is no Taper Tantrum-2. Balance of payments, sovereign balance sheets and the growth cycle are all in a much better position.” 

“The shift in tone from several major central banks has caught markets by surprise. There has been a modest decline in Asian currencies, and carry trades in front-end swaps, and bond markets have come under pressure, amidst a broader adjustment in global rates.”

“Asian currency trend

• The Fed is no longer the only central bank in tightening mode. The scope for possible adjustment is larger in non-US DM curves, because their rates are rising off a lower base. As such rate differentials might move against the US dollar, making “policy convergence” essentially a soft accord to reverse the “currency wars” dynamic that lifted the US dollar in 2014-16. Moreover, the political will shown by China to reverse RMB depreciation also suggest that risks of disruptive fall in RMB have lessened.
• Asian currencies have depreciated in recent weeks, despite US dollar weakness vs. the majors. This disconnect is unlikely to last for very long. Short-term capital flows might be volatile, though large current account surpluses and stable economic outlook are likely to reconnect Asia FX with US dollar weakness. Over the medium-term, we believe Asian currencies are likely to be on a rising trend, though there may be volatility.”

“Asian monetary policy

• Unlike some of the developed market central banks, Asian central banks are in no rush to shift their monetary policy stance. It is one thing for a DM central bank to become “less dovish” when they are at the zero-bound doing QE, and quite another for an Asian central bank to hike rates when real rates are positive, and the local currency is rising. As such, we believe most Asian central banks are firmly on hold for the next 6-12 months. We believe Asian central banks will prefer to “let the Fed/ECB tighten for them”, and will hope that the resulting increase in rate differential will diminish the upward pressure on their currencies. There are some exceptions to this of course, especially in China, where the context for monetary policy setting is very idiosyncratic. 
• While believe the correction in Asian local markets is still ongoing, we think some opportunities are starting to appear.”

“We believe markets are probably mid-way through a position correction. But pockets of opportunity are starting to appear.”