Asia's Anesthesia Could Wear Off – Deutsche Bank
Mallika Sachdeva, Strategist at Deutsche Bank, suggests that three
forces – beyond positioning and seasonality – have been at play in the
latest Asian FX rebound but the numbing relief from each could wear off.
“First, Fed pricing has disconnected from easier financial conditions. The S&P rebound would now be consistent with the market pricing over two hikes from the Fed this year, instead we are pricing less than one. Over the past few days, Fed pricing has begun to grind higher, putting a bid under the USD. Admittedly, Yellen could reinforce a dovish message this week pouring cold water on recent moves. But we doubt this would have the same positive impact on Asian FX as in March with positioning much lighter. While further extension of the dovish window could begin to embolden Asian central banks which have been tentative about cutting rates (Korea, Malaysia, Thailand).
Second, Asian data surprises have bounced led by Chinese stimulus. However, Asia data surprises are nearing cyclical peaks, and the stress in the Chinese credit/rates market is shedding light on the poor quality of data improvement. The best of the data bounce halo may be behind us. A longer-term picture makes the same point. Asian FX has moved with cumulative data surprises over long periods. Asian FX topped out in 2011 precisely when data began missing expectations. Asian FX weakened beyond data disappointments last year, but recent FX gains have corrected this gap. For currencies to head higher, data would need to start sustainably surprising.
Third, strength in the JPY, and stability in USD/CNY have been working together to create a benign environment for Asian FX. We have highlighted that this is a fragile balance, which renewed success in weakening the JPY could upset. Note that USD/CNY fixed back above 6.50 today for the first time this month after a 2% move higher in USD/JPY on Friday. While still at low levels, CNY is now the second most correlated Asian currency with the JPY, after SGD.
Going into a seasonally weak May, it will be a nervous week for Asian FX with markets watching three policy responses: Fed’s response to the market-dot divide, BoJ’s response to perceptions of narrower policy space, and China’s response to this more default-driven (rather than liquidity-driven) credit stress.”