There has been an important shift in Asian currencies over the first half of September with a notable weakening trend after months of almost uninterrupted gains. And this will have important wider dollar implications as one key source of vulnerability is kept in abeyance. There is also the possibility of a much more important shift if key Asian economies are at risk of recession.
The Korean won, for example, has retreated to lows near 1110 against the dollar from 1065 at the beginning of the month while the Taiwan dollar has weakened to 29.55 from around 29 with losses for all major regional currencies. The Chinese yuan juggernaut has been halted, at least temporarily, and even the ultra-safe Singapore dollar has weakened to around 1.24 from a historic peak just beyond the 1.20 level.
Confidence in the Asian growth outlook has deteriorated as export prospects have weakened and there is also some nervousness that the Asian economies could be at risk of a repeat of the 1997 crisis. There has certainly been a build-up of excess liquidity as central banks have been forced to follow excessively-loose monetary polices given the U.S. Federal Reserve policies even though domestic inflation profiles have deteriorated. Misaligned monetary policy increases the risk of speculative bubbles in areas such as property and the risk of bad lending practices. For now, these fears are still well-contained, but confidence is liable to falter and there are straws in the wind of a much more serious cyclical downturn. Asian doubts will have an important currency-market impact, especially if there is convincing evidence of a downturn in the property sector.
During the first eight months of 2011, there was persistent intervention by Asian central banks to prevent their currencies from appreciating against the dollar. As a function of their reserve management operations, there was also an important and steady flow of dollar selling as part of these sales were translated into euros. This central bank euro buying against the dollar was an extremely important source both of US currency vulnerability and euro resilience.
With Asian currencies suddenly hitting reverse, the pressure for intervention to cap gains has certainly eased. Indeed, there has been some small-scale intervention to prevent further losses for local currencies.
While this trend continues, an important source of dollar vulnerability against the euro will be effectively removed. This may only be short-term relief, but there are certainly important risks of much more substantial reassessment of the Asian outlook given the global economic risk profile which would also provide crucial dollar protection over the next few months.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
