Conclusion: Asian currencies will continue to come under selling pressure vs. the USD due to broad-based monetary easing throughout the region over the next 3-6 months, as well as continued slowing in export demand. Positioning/concentration risk also remains a factor to the downside for Asian currencies as well.
Position: Short a Basket of Asian Currencies (AYT); Long the U.S. Dollar (UUP).
This morning, Keith added a short position in the Barclays GEMS Asia-8 ETN to our Virtual Portfolio. The thesis behind this positioning is one we’ve been hitting on for a couple of quarters now: Asian central banks will begin to ease monetary policy as our themes of Deflating the Inflation and Global Growth Slowing percolate into reported CPI and PPI data, in addition to stunting real GDP growth rates across the region.
To that point, even after last week’s +3.9% melt-up across in the CRB Index, this basket measurement of the commodity complex remains quantitatively bearish across our TREND and TAIL durations. Further strength in the U.S. Dollar Index, which has regained its TREND line (now support), is supportive of this trend. Not ironically, one of the factors in support of our King Dollar thesis is, in fact, a global monetary easing cycle being perpetuated by Asian, Latin American, and European central bank dovishness. Soros calls this self-reinforcing concept “reflexivity”; we call it “globally-interconnected risk”.
The Fed, having floored U.S. benchmark short-term interest rates near ZERO percent can’t cut any further and both reported inflation and inflation expectations will keep him from unleashing incremental QE into 2012. Meanwhile, on a relative basis rate-cutting out of these regions will continue to compress real interest rate differentials that have been largely supportive of their currencies relative to the USD since the March ’09 bottom. Asian rate markets – particularly short-term sovereign debt and interest rate swaps – continue to signal to us that our forecast remains the most probable of all potential scenarios.
Asia, which relies heavily on U.S. and E.U. capital and consumer demand to spur export growth may see their currencies experience incrementally less demand on the margin as growth continues to slow in these key economic blocs. Refer to our 10/25 report titled, “Global Growth Update: Incremental Deterioration Forthcoming?” for a more in-depth, quantitative analysis of this phenomenon and the recent trends therein.
Shifting gears a bit, the multi-factor, multi-duration dynamic analysis that continues to exert a game of tug-o-war on the global FX market is one that we would expect to continue at least over the intermediate term. In early 2009, investors could largely “set it and forget it” when it came to investing in Asian currencies via USD-denominated carry-trading strategies. Now, the breakout in cross-asset volatility in 2011 is creating a great deal of performance pressure in the FX fund universe:
- Three out of four of RBS’s various FX trading strategy indices are down in the YTD;
- As of last Friday, Deutsche Bank AG’s dollar-denominated Currency Returns Index has fallen -3.4% YTD – the largest decline since a 4% fall in 1991; and
- John Taylor, founder of FX Concepts LLC – the world’s largest currency hedge fund – is reported by Bloomberg to having been down -12% YTD as of Friday while AUM has fallen roughly -37.5% to $5 billion; “What’s really frustrating is that we’re supposed to do well in a lousy world market… We are doing badly,” he remarked in an Oct. 19 interview.
As always, the purpose of highlighting these data points is not to point fingers or humiliate anyone. Rather, we present them as opportunities to front-run incremental capital withdrawals from Asian countries as redemption requests mount. Just as concentration risk remains a critical risk to manage in the equity market, it has become increasingly so in the much-larger FX market given the one-sided trading patterns that have developed over the past few years of U.S. ZIRP.
Turing back to the AYT specifically, Indonesia has already begun its rate-cutting cycle and China, India, South Korea, Thailand, Philippines, and Malaysia have all recently signaled to the market that rate hikes are done and/or monetary easing is forthcoming. Taiwan, who reported overnight an annualized QoQ contraction of -1.1% in 3Q real GDP, took down both its 2011 and 2012 GDP forecasts by 20-30bps – paving the way for future rate cuts. Though not part of the AYT basket, the Monetary Authority of Singapore, which doesn’t use interest rates to dictate monetary policy, has already slowed appreciation of the Singapore dollar (SGD) alongside a downward revision to its 2011 and 2012 GDP forecasts.
All told, we continue to think King Dollar trends higher over the intermediate term and that the hollowed-out melt-up of last week did two things to the global currency market: a) its forced a lot of short-covering; and b) it created attractive entry points on the short-side for opportunistic funds. We’ve chosen to capitalize on this opportunity afforded by the latest round of Big Government Intervention by shorting the AYT in our Virtual Portfolio.