Asian FX focus: The Start of Q4
Bulls in charge but we can still find reasons not to chase
Asia FX has started Q4 much like how it traded the majority of Q3, rallying against the USD. With several markets closed at the beginning of the month (South Korea, Hong Kong and China), some caution is warranted in terms of the moves seen, as liquidity is probably affected. Nevertheless, it's hard not to come away with the impression that the bulls are very much in charge. Our sense had been we would enter a consolidation phase into October rather than see further sharp USD weakness. In this piece we present a series of charts to assess the bullish versus consolidation case for EM Asia FX.
We conclude that the medium-term bullish outlook is intact but we present a number of reasons not to chase recent momentum. Uncertainty around the longevity of the economic pick up, absent additional fiscal stimulus, and the US election outcome, are key considerations. These potential headwinds leave us reluctant to chase the likes of CNH or growth sensitive currencies such as KRW, SGD and TWD higher against the USD at the current juncture. We also maintain a short AUD/IDR recommendation as we continue to believe this offers an attractive hedge to some of the short-term risks outlined in this piece.
Near term global growth backdrop very supportive…
Data momentum in the major economies remains quite supportive. Economic surprise indices, taken from Bloomberg, for the US and Europe are around multi year highs (see the first chart). This compliments the continued positive run of China data, with Industrial profits and PMI prints this week suggesting the recovery remains firmly on track.
Market expectations for economic growth in Q3 have also been trending higher or remained elevated (see the second chart). This is less evident for China, although it rebounded very strongly in Q2 after a sharp slump in Q1, so this shouldn't be a huge surprise. In any case, China aggregate funding support continues to trend higher, which historically has tended to lead moves in EM Asia FX (see the third chart). This is likely to reflect the fact that higher funding support is good for China growth, which is typically good for other countries in the region.
Chart 1: US and EU economic surprise indices at multi year highs
Chart 2: US and EU Q3 growth forecasts revised higher
Chart 3: China aggregate funding support for growth and regional FX
...but some question marks for medium term
Interestingly though, if we look at market expectations for growth in Q4 of this year and into Q1 next year, a less optimistic picture emerges. The fourth chart below averages Q4 and Q1 next year growth forecasts, with the US and EU generally drifting lower, whilst China's growth forecasts have stayed fairly resilient. Uncertainty around the growth path for the US and EU is not surprising. COVID second wave fears in the EU cloud the outlook, whilst in the US the Fed has been at pains to point out the need for additional fiscal stimulus but we still remain at an impasse at the time of writing. Politics may also be creating uncertainty in terms of who will be the next US President and will there be a smooth transition.
Chart 4: Less upgrades for Q4 and Q1 next year though in US and the EU
Equities uncertainty in the near term as well
Political uncertainty can spill over into equities as well. The fifth chart below overlays a 1 month change in Trump's election probability (taken from Bloomberg, which sources PredictIt), against the 1 month change in global equities. The correlation is running at just under 50% since the beginning of the year. Of course there are many drivers to global equity performance over the medium term but a Trump loss can seen as negative for the equities via likely less friendly tax policies from a Biden administration and the potential for a disputed election result.
Given that equities and the USD have shown a firm inverse correlation recently (see chart 6 below), weaker equities may in turn give the USD a boost. This comes as EM Asia FX is already looking too strong relative to regional equity market momentum, see chart 7 below.
Chart 5: Trumps election odds and global equities performance
Chart 6: Equities and USD, a firm inverse relationship
Chart 7: A modest disconnect between Asian FX and local equities
Longer term support from easy central bank policy
An important offset from a medium term perspective is easier central bank policy settings. Chart 8 plots a proxy for global money supply against global equity market performance over the last decade. Again there are many drivers of equity market performance but periods of rising global money supply are typically supportive of equity market sentiment. It's also important to note that equity inflows into EM Asia remain on a positive trend and we are well below previous peak points from a sequential 3 month momentum stand point, see chart 9. Hence further supportive inflows can occur over the medium term.
One caveat we are mindful of is that the rate of change in global money supply is slowing down, which is painting a less positive picture (Chart 10). This arguably reinforces the point made above about the importance of fiscal policy as a key driver of sentiment, at least in the near term. If we overlay commodity prices with global money supply momentum a similar picture emerges. Demand sensitive commodities slumped overnight, although positioning may have been the dominant driver of these shifts.
Chart 8: Global money supply and equity market performance
Chart 9: More upside for EM Asia equity inflows
Chart 10: Momentum in global money supply impulse is waning
Strategy: The medium-term bullish outlook is intact but we find enough reasons not to chase recent momentum. Uncertainty around the longevity of the economic pick up, absent additional fiscal stimulus, and the US election outcome, are key considerations. These potential headwinds leave us reluctant to chase the likes of CNH or growth sensitive currencies such as KRW, SGD and TWD higher against the USD at the current juncture. We also maintain a short AUD/IDR recommendation as we continue to believe this offers an attractive hedge to some of the short-term risks outlined in this piece.