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As Treasury Yields Surge, Funds Stick to Asian Currency Bets

Updated on
  • Ringgit, rupiah and Indian rupee among investors’ top picks
  • Dollar may still in cyclical decline, Aberdeen Standard says

Asian currencies are getting support from an unexpected development -- the weakening relationship between the two-year Treasury yield and the dollar.

As Treasury yields climb, expectations for the dollar to benefit and emerging Asian assets to decline may be dashed, according to PineBridge Investments. Money managers at Aberdeen Standard Investments Ltd. and Schroder Investment Management Ltd. say the greenback may even weaken.

The strength in Asian exchange rates this year is lending support to the argument, with the the Bloomberg-JPMorgan Asia Dollar Index stronger even as the two-year Treasury yield soared past 2 percent to touch a decade high last Friday. Strong economic and trade growth, regional central banks tightening, and buoyant commodity prices are prompting inflows into Asia.

“The correlation between rising U.S. two-year yields and a stronger U.S. dollar has clearly broken down,” said Anders Faergemann, a senior fund manager in London at PineBridge Investments, which oversees about $88 billion globally. “On the other hand, Asian currencies should benefit from current-account surpluses, stronger economic growth and any signs of central banks turning more hawkish.”

Unraveling Knot

Asian currencies' inverted correlation with U.S. 2-year yield has been weakening

Sources: Bloomberg

Note: Correlation is measured based on changes in Bloomberg-JPMorgan Asia Dollar Index and 2-year Treasury yield on a rolling 60-day basis

The Bloomberg-JPMorgan Asia Dollar Index, which tracks the region’s 10 most active currencies, has gained 1.6 percent this year, while the greenback lost around 3 percent. While the two-year Treasury yield has advanced 26 basis points since the start of 2018 and the 10-year has soared 45 basis points, that hasn’t increased the allure of U.S. bonds compared with emerging-market assets for some money managers.

In the past, higher Treasury yields have led to a stronger dollar against Asian currencies, as happened during 2008, 2013 and 2016. While rising Treasury yields could pose a risk, doubts remain about an expanding U.S. deficit and the ability of the Federal Reserve to push through with its rate hikes, said Dwyfor Evans, head of Asia Pacific macro strategy with State Street Global Markets in Hong Kong.

Picks from fund managers who spoke to Bloomberg about Asia’s emerging markets range from the Malaysian ringgit and the Chinese yuan, to the high-yielding currencies of India’s rupee and Indonesia’s rupiah. The ringgit is Asia’s top performer this year, rising around 3.8 percent, while the yuan has gained 3.3 percent.

“I’m generally positive on EM FX for 2018 as I believe the dollar remains in the midst of a cyclical decline,” said Edwin Gutierrez, head of emerging-markets sovereign debt at Aberdeen Standard Investments, which oversees £569.7 billion ($803 billion) globally. “We’re now two years through that cycle and historically these cycles have tended to last five to seven years. It’s not a case of anything bad happening to the U.S. economy, but rather a case of the rest of the world, e.g. Europe and EM looking better.”

The money managers also cited risk factors for Asian assets including an improvement in U.S. economic data, a rise in trade protectionism, and a slowdown in demand for commodities.

Here are other comments from the managers:

Gutierrez, head of emerging-markets sovereign debt at Aberdeen Standard Investments

  • Biggest risks are a China-induced slowdown in commodities and a rise in U.S. protectionism, although impact from latter would be offset by inflows into emerging market equities and bonds
  • “It’s also a case of how much central banks will lean into that appreciation and mitigate those pressures as we’ll continue to see in the likes of Indonesia, India, Korea and Thailand, to name a few”
  • Likes the Mongolian tugrik, Sri Lanka rupee and high-carry frontier currencies
  • Expects Philippine peso to be a laggard due to the rise in imports as growth remains strong

Hakan Aksoy, senior portfolio manager for EM local currencies at Amundi Asset Management which manages 1.4 trillion euros ($1.73 trillion):

  • “We still believe in the carry trade story in 2018 from the local currency performance window because we forecast commodities will be stable and the dollar not very strong. Without taking too much duration risk, we like to take currency plus carry risk in our local currency markets”
  • Has been overweight India and Indonesia for more than two years, and plans to keep this stance with both countries having a better growth outlook and political stability after elections; currently hedged Indian rupee tactically
  • Also overweight in onshore Chinese yuan and Malaysian ringgit
  • Low-yielding Asian currencies are more sensitive to widening U.S. yields and Amundi is of the view that on the rates side, there’s not much value in low-yielding countries such as Thailand

Anders Faergemann, a senior fund manager in London at PineBridge Investments:

  • Expects 10-year Treasury yield to rise slightly in early 2018 but be capped around 2.75% thereafter with continued curve flattening as long as core inflation remains benign
  • “The correlation between rising U.S. 2-year yields and a stronger U.S. dollar has clearly broken down and we are trying to establish whether that convention has been replaced by a newfound correlation between flattening of the 2-year and 30-year UST curve and a weaker US dollar”
  • Key risks to Asian FX include a jump in U.S. wages and inflation, as well as a reversal in the weak dollar trend
  • Likes the Malaysian ringgit due to attractive valuations and possibility that the central bank may be leading Asian peers in tightening policy

Manu George, fixed-income director at Schroder Investment Management Ltd. which manages $577.3 billion:

  • Sees a partial strengthening in the dollar in the short term as the currency has sold off too aggressively
  • Still, USD remains relatively expensive versus the other major currencies and so may trend lower
  • EM Asian FX trade “appears to be a carry game with Asian central banks resisting the rise of their currencies”
  • Biggest risks to trade are the political standoff in the U.S. and whether the U.S. govt will engage in tariffs against China
  • Favors China’s onshore yuan, Indonesia’s rupiah and India’s rupee

Dwyfor Evans, head of Asia Pacific macro strategy with State Street Global Markets:

  • Rising U.S. yields have only had a tangential impact on EM and traditional pro-growth and pro-carry strategies remain broadly in favor
  • Whether U.S. yields rise depends on price trends; evidence in the first few weeks of January is that the inflation trend is robust, so, rising U.S. yields are a risk at this point
  • “We don’t see this as a stellar USD year unless the Fed surprises on rate hikes, and while there is some support for that in our online prices series, we would still question the commitment of the Fed to turn hawkish,” says Evans. “History tells us that hiking cycles tend to not be USD supportive in the main, and we expect that budgetary and twin deficit concerns will continue to weigh”
  • Likes Malaysian ringgit given its strong out-performance in 2017 and this can continue as commodities are supportive and the currency remains very cheap on a long-term REER basis
  • Thailand’s baht is potentially interesting although State Street remains wary about whether elections will take place

— With assistance by Masaki Kondo

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