Conclusion: We are covering our Asian currency basket short in our Virtual Portfolio as Asia is not likely to pick up the pace of rate cuts with oil (inflation) up here in November.
Shortly before this afternoon’s close, Keith covered AYT for a modest appreciation vs. our cost basis within our Virtual Portfolio. We remain bearish on emerging Asian currencies vs. King Dollar over the intermediate-term TREND, but we have chosen to manage the immediate-term risk of crude oil prices breaking out from a quantitative perspective on our proprietary factoring – particularly given the inflationary impact of higher energy and transport costs. Be it what we can model (QE3 speculation) vs. what we can’t (Iran/Israel shouting match), we don’t like what we are seeing in the oil markets because it will bring on more Stagflation. Refer to Keith’s 11/8 Early Look titled “Self Indulgence” for additional analysis on this subject.
The quick and dirty as it relates to the knock-on effects of higher energy prices across Asian currency markets is that it could slow the deceleration in headline CPI readings across the region and keep Asian central banks on the sidelines in the short term, which limits, on the margin, any near-term scope for further monetary easing – an outcome that has been largely priced into Asian interest rate swaps markets for the past couple of quarters.
Of course, a sustained breakout in global energy prices would indeed be a particularly growth-negative event for Asia, as well as the more developed economies such as the U.S. and the E.U. We think the USD is the ultimate winner here as Asian export earnings dwindle and short-term capital flows seek the perceived safety of U.S. instruments. Managing the duration risk will be critical to manage (i.e. don’t short Asian currencies too early in this scenario b/c the beta chase is likely to prevail in the short term). For further analysis behind the extremely damaging side-effects of further U.S. monetary easing from current levels of global growth/inflation, refer to our 10/25 note titled, "Global Growth Update: Incremental Deterioration Forthcoming?".