Discomfort over FX strength in NE Asia

Philip Wee, FX Strategist, DBS Bank and Eugene Leow, Rates Strategist, DBS Bank

There is discomfort in Northeast Asia regarding further currency appreciation. China's State Administration of Foreign Exchange (SAFE) reminded citizens and corporations on the mainland that the Chinese yuan has become a two-way exchange rate based on real demand and not on speculative activities betting on its future value. SAFE's warning came ahead of China's announcement to slap additional tariffs of 25% on 128 kinds of US imports including pork. Against looming US-China trade tensions, China has probably become uncomfortable with the yuan's strong 3.7% appreciation in Q1 after its 6.7% rally for the whole of 2017.

Japan's large manufacturers have also turned less optimistic because of the strong Japanese yen, which has appreciated 6% in Q1, more than the 3.8% seen last year. The Bank of Japan's Tankan Survey for Large Manufacturers fell, for the first time in eight quarters, to 24 in Q1 from 26 in the final quarter of last year. Many Japanese manufacturers have complained about profit squeezes from the yen's appreciation.

Similarly, Korean exporters expect worsening profitability despite expectations for a pick-up in export activities in Q2 from Q1. The drags are likely to come from the won's lingering strength last year and the risk of more import regulations from major trading partners. Seoul has also refuted claims that the exchange rate was included in the latest Korean-US Foreign Trade Agreement discussions. Against this background, the US Treasury Department's semi-annual currency report due in mid-April has come into focus. It remains a low probability for the US to name any major trading partner as a currency manipulator.

10Y and 30Y US Treasury yields closed last week at 2.74% and 2.97% respectively. Fears of runaway inflation, a much more aggressive Fed and spiking long-term yields appear to have recededover the past month. Instead, concerns appear to have shifted towards still-heightened trade tensions and the lacklustre performance of the stock market. Notably, the VIX, at 20, is still elevated by recent standards (this figure was hovering around 10 before the sharp spike in volatility in February). Implied volatility in swaptions also climbed modestly.

The heavy net short positions in the Treasury futures market (especially in the 5Y and 10Y tenors) may lead to increased volatility in yields. While we think that the back of the UST curve looks rich after the sizable rally over the past few weeks, large short positions may serve as a short-term overhang on yields. Yields may also be more vulnerable to downside pressures if US data disappoints. For now, we see 10Y US yields in the 2.70-3.00% range.

Source : Equity Bulls

Keywords