NN IP: Unsettling signs in the Asian currency markets

NN IP: Unsettling signs in the Asian currency markets

Asia Currency

With inflationary pressures failing to abate and central banks preparing for more rapid policy normalisation, concerns about global growth are intensifying. Over the past week, weak consumer confidence surveys in the Eurozone and fears of more large-scale lockdowns in China added to the concerns.

Meanwhile, increased volatility in the global currency markets suggests that the combination of tighter monetary policy and increasing pressure on economic growth is starting to create major shifts in capital flows. Against this backdrop we are maintaining our cautious asset allocation stance, with an underweight in Eurozone equities. In fixed income, we took profit on our large underweight in US Treasuries and reopened an underweight in Eurozone high-yield credit.

The renminbi and yen depreciate

The recent depreciation of the Japanese yen reflects a widening divergence in monetary policy between the US and Japan, and tells us that the yen is once again becoming more attractive as a funding currency for investments in higher-yielding currencies.

Meanwhile, the serious problems in domestic demand growth and regulatory uncertainty in China, coupled with the troublesome outlook for the global goods trade and widening interest rate differentials with the US and Europe, are causing capital outflows from China to accelerate. The 3% depreciation of the renminbi over the past week reflects these effects.

Further weakening of the currency would probably be welcomed by the authorities, but such rapid moves always risk a further deterioration in confidence. This is why the Chinese central bank reduced the reserve requirement ratio for foreign exchange deposits on Monday. Whether measures like this will stabilise the renminbi remains to be seen: in the end, clarity about the government’s exit strategy from its zero-Covid policy will be required for there to be a meaningful recovery in confidence.

Since last summer, capital outflows from China have increased (see figure). This can probably be attributed to the real estate crisis and regulatory tightening affecting business confidence. The government’s struggle with the pandemic has clearly not helped either: restrictions on mobility and full lockdowns have had a serious impact on demand, and have also led to production and logistics disruptions.

On top of this, the complicated geopolitical situation has added new dimensions to China’s already troubled relationship with the West. So far, Chinese export growth has held up well, but a substantial slowdown looks inevitable, if only because of the worsening outlook for global growth and the post-pandemic shift in global demand from goods to services.