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Takeaway: The two countries diverge in their responses to the ongoing int’l Currency War, leaving behind sobering clues in the process.

SUMMARY BULLETS:

  • Virabongsa Ramangkura, chairman of the Bank of Thailand, was out with some interesting commentary on capital inflows that vividly reminds us of the broad-based capital outflow risks facing many developing economies when developed-country central banks (mostly the Fed) are done pumping trillions of USD liquidity into the global financial system.
  • Arguably the biggest tail risk to asset prices in my space is a sustainably strong USD, which has historically perpetuated BOP crises that ultimately lead to currency crashes, hyperinflation, corporate insolvency and properly market collapses across emerging market economies (see: India’s Rupee Devaluation, Mexico’s Tequila Crisis, Brazil’s Hyperinflation Saga, the Asian Financial Crisis, the Turkish Financial Crisis and Sovereign Defaults by Russia and Argentina). No two EM BOP crises look the same, but they all tend to have one common denominator: Strong Dollar – either trailing USD strength or an outlook for sustainable USD appreciation.
  • With RBNZ Governor Graeme Wheeler’s latest statement of intentions, New Zealand has become the latest economy to join the international Currency War. Simply put, in an economic scenario where the RBA stops easing aggressively and the RBNZ has no bias to tighten amid a particularly dovish inflation outlook and concerns about excess currency strength, one could easily see the kiwi give up a decent amount of recent gains vs. its aussie counterpart over the next few months. That same central bank commentary can also be applied to the NZD/USD cross, which is down over a full percent on the day.

Thailand: Thailand’s central bank kept its policy interest rate unchanged at 2.75% for a third straight meeting, resisting the central government’s calls for monetary easing to combat baht appreciation.

With the THB/USD cross up at levels last seen since mid-2011, we are impressed by Governor Trairatvorakul’s resolve to resist pressure from the Finance Ministry – specifically Finance Minister Kittiratt Na-Ranong – to lower rates in order to discourage capital inflows.

CURRENCY WAR UPDATE: THAILAND AND NEW ZEALAND SOUND THE ALARM BELL - 1

Virabongsa Ramangkura, chairman of the Bank of Thailand, was out with some interesting commentary on capital inflows that vividly reminds us of the broad-based capital outflow risks facing many developing economies when developed-country central banks (mostly the Fed) are done pumping trillions of USD liquidity into the global financial system. Take heed:

“Thailand is an attractive place for hot money because our regulations are not that tight like China. I am concerned, but not panic-stricken yet. There have been huge amounts of inflows to stocks, bonds and property. The situation may be similar to 1... 

Land prices in some areas, like by the sea, have risen more than 10-fold. Our economic growth at 4 percent to 5 percent is not enough to cope with such an increase. When money flows in, many people, especially investors in stocks and properties, are happy. I just hope that we have learned our lesson during the crisis and that laws and bank rules have been improved... 

Money is like water. It will flow from low- to high-yield places. No matter what regulations or barriers you have, it will always find a way. I can’t think what measures we should use to slow it down. Using a Tobin tax is not easy. Any direct controls like reserve requirements or non-market measures have strong side-effects. If prices of property and financial assets increase enough, investors will suffer a lot when they fall. So no government will be willing to use such drastic measures.”

CURRENCY WAR UPDATE: THAILAND AND NEW ZEALAND SOUND THE ALARM BELL - 8

Arguably the biggest tail risk to asset prices in my space is a sustainably strong USD, which has historically perpetuated BOP crises that ultimately lead to currency crashes, hyperinflation, corporate insolvency and properly market collapses across emerging market economies (see: India’s Rupee Devaluation, Mexico’s Tequila Crisis, Brazil’s Hyperinflation Saga, the Asian Financial Crisis, the Turkish Financial Crisis and Sovereign Defaults by Russia and Argentina). No two EM BOP crises look the same, but they all tend to have one common denominator: Strong Dollar – either trailing USD strength or an outlook for sustainable USD appreciation.

We’ll be doing a lot more long-term cycle work here in preparation for a deep dive in the coming months, but you can rest assured that a retreat of the structural appreciation pressures underpinning EM FX is the base-case scenario if the USD continues on a path of sustainable appreciation amid a backdrop of European growth woes, Japanese Policies To Inflate, #HousingsHammer and #6-HandleUnemploymentRisk.

Our Summary Thoughts On How Bubbles in EM FX and EM Property Markets Are Formed:

  • Have US monetary and fiscal policy perpetuate expectations for a sustainably weak USD. Check.
  • Have international capital allocators (investors and/or corporations) chase higher rates of return abroad (often in emerging markets). Check.
  • Have EM corporations increasingly tap international debt markets as weak dollar pacifies Libor/the cost of international capital and the strength of their local currencies makes servicing int’l debt increasingly cheap. Check.
  • Have all those capital inflows inflate the liabilities of EM financial intermediaries’ balance sheets (time and demand deposits). Check.
  • Have EM financial intermediaries seek assets to correspond with this rise in liabilities. Check.
  • Have EM capital markets not be large enough to absorb all the additional liquidity. Check.
  • Have EM financial intermediaries/investors park the excess capital in fixed assets (i.e. PP&E), both as an inflation hedge (down dollar/up int’l food  & energy prices) and out of necessity (EM capital markets aren’t big enough). Check.
  • Rinse & Repeat.

How It All Becomes Unwound:

  • Have US monetary and fiscal policy start to perpetuate expectations for a sustainably strong USD (Reagan/Volcker in the early 80s or Clinton/Gingrich in the mid-90s) or have the rest of the G3 basket (i.e. Europe and Japan) get perpetually more dovish than the US. TBD.
  • On the expectation of tighter USD policies (both domestically and abroad), foreign capital is drained out of EMs and back into better-performing domestic markets. TBD.

For our previous discussion on this long-term asset allocation topic, please refer to our 6/8/12 note titled: “TWO SCHOOLS OF THOUGHT PART II” for more details.

New Zealand: Per RBNZ Governor Graeme Wheeler, “When the New Zealand dollar is coming under upward pressure, we want investors to know that the kiwi is not a one- way bet… The Reserve Bank is prepared to intervene to influence the kiwi. But given the strength of recent capital flows, we can only attempt to smooth the peaks.”

 

With this statement of intentions, New Zealand has become the latest economy to join the international Currency War. Their threat to combat recent gains comes as the spread between the AUD/USD and NZD/USD is as narrow as it’s been since 3Q10 (-$0.19), suggesting some degree of excess gain in the kiwi as the RBNZ hasn’t been quite as aggressive as the RBA in combating currency strength (0bps of cuts for the former over the LTM vs. -125bps for the latter).

CURRENCY WAR UPDATE: THAILAND AND NEW ZEALAND SOUND THE ALARM BELL - 2

 

CURRENCY WAR UPDATE: THAILAND AND NEW ZEALAND SOUND THE ALARM BELL - New Zealand Macro Factor Model

 

CURRENCY WAR UPDATE: THAILAND AND NEW ZEALAND SOUND THE ALARM BELL - Australia Macro Factor Model

With New Zealand’s recent inflation data  coming in-line with our forward projections for 1H13 (Quad #1), and Australia’s doing the same w/ respect to our GIP outlook (#Quads 2 & 3), there’s a more than fair chance the NZD/AUD cross has put in its short-cycle top on 2/14 ($0.82) and is poised to return to the mid-70 cent range over the intermediate term.

 

CURRENCY WAR UPDATE: THAILAND AND NEW ZEALAND SOUND THE ALARM BELL - NEW ZEALAND

 

CURRENCY WAR UPDATE: THAILAND AND NEW ZEALAND SOUND THE ALARM BELL - AUSTRALIA

Simply put, in an economic scenario where the RBA stops easing aggressively and the RBNZ has no bias to tighten amid a particularly dovish inflation outlook and concerns about excess currency strength, one could easily see the kiwi give up a decent amount of recent gains vs. its aussie counterpart over the next few months. That same central bank commentary can also be applied to the NZD/USD cross, which is down over a full percent on the day.

CURRENCY WAR UPDATE: THAILAND AND NEW ZEALAND SOUND THE ALARM BELL - UNITED STATES

Darius Dale

Senior Analyst