Philip Wee, FX Strategist

Eugene Leow, Rates Strategist

DBS Group Research

FX: Breather for Asian FX, especially against EUR and GBP

Recent economic and political developments have set the stage for Asian currencies to extend their appreciation against their weaker European counterparts.

The pound is at risk of capitulating after Thursday’s resignation of three UK ministers over the draft Brexit withdrawal agreement that Prime Minister Theresa May negotiated with the European Union. With the narrative for a leadership challenge stepping up, PM May (and her potential successor, if any) risks losing the support of the Democratic Unionist Party (DUP) that provides her government its majority in parliament. Apart from Northern Ireland, Scotland has also thrown its hat into the ring that the Brexit deal was unacceptable. It was only a month ago that former prime minister John Major warned that Brexit was “a colossal misjudgement that will diminish” the UK. For the pound, Brexit is no longer simply about a deal or no deal but evolving into an existential crisis regarding the kingdom’s unity.

In Europe, the disappointing growth story weighing on the euro just got heavier. Eurozone’s preliminary sub-2% growth for 3Q18 is likely to be downgraded after Germany reported its first quarterly decline since 1Q15. Italy’s economy reported zero growth which will steel Rome’s resolve to defend its expansionary fiscal spending plans against pressure from Brussels to return to its previous commitment to rein in its budget deficit.

Conversely, the resilience in Asian currencies is best reflected by their weakest members. The Indonesian rupiah and the Philippine peso have appreciated on their rate hikes on November 15. Amidst slower growth and lower oil prices, investors have started to give the peso the doubt that the five hikes totalling 175 bps since May could anchor inflation expectations. The Indian rupee was the clear beneficiary of the 20-25% decline in crude oil prices in the past six weeks. Given the circumstances, markets appear inclined to give Trump-Xi the benefit of the doubt for now to (no matter how unlikely) strike a truce on trade at the G20 Summit a fortnight from today.

Rates: Two hikes & a hold in Asia

This week, Bank Indonesia (BI) and Bangko Sentral ng Pilipinas (BSP) hiked rates by 25bps while the Bank of Thailand (BoT) kept rates on hold (voting patterns suggest that a hike is imminent). The decision by BI was a surprise. Consensus (and DBS) were in the hold camp. With multiple hikes already delivered for the year and the rupiah showing signs of stabilisation, we thought that the next hike would only come in December (broadly tracking the Fed). Now that this hike has been brought forward, we think that another two hikes can be delivered in 1H19.

For BSP and BoT, consensus was mixed. To be sure, policy settings in the Philippines are still too accommodative given where headline CPI (6.7% YoY) is and the rate hike is justified. However, given the BSP’s focus on growth (and that inflation is peaking) and relatively dovish slant, a fifth consecutive hike suggests that the governor is more hawkish than previously thought. We think that another 75bps of hikes would take place by mid-2019. Thailand is not facing overheating risks and firm external account balances have resulted in a resilient THB despite multiple bouts of market volatility this year. Worries about a prolonged period of low rates and widening USD-THB rate differentials are the more likely motivations behind the desire to raise rates. We think BoT policy normalisation is imminent, but it will likely be a very shallow cycle.

The upshot is that financial conditions in Asia (and across EMs) are tightening in line with the US. The rate increases in the current account deficit economies have been significant but on balance, these adjustments are orderly. As the Fed takes monetary policy into restrictive territory, we would reasonably expect EM central banks to be dragged along.

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