Singapore, an economy known for its disciplined monetary and fiscal policy, has managed to get caught in the crossfire of a currency war with no easy way out.
Ever since Abenomics, Asian currency wars have been a dominant theme for macro investors. A currency war begins when one country decides to devalue their currency in order to stimulate export demand. But neighboring countries with stronger currencies have a harder time competing for exports so they begin to devalue as well. What ends up happening is a "race to the bottom" where both countries end up devaluing their currencies into oblivion in order to stay competitive in the global marketplace.
China is the last player to fire off a fresh round of devaluation. They want to remove the yuan's de facto peg with the US dollar in an effort to stymie decreasing growth and debt problems. Singapore will need to follow in the footsteps of China if they wish to re-energize their economy and prevent a real slowdown. This will create upward pressure on USD/SGD, our trade of interest, as the Singapore dollar depreciates against the US dollar.
Due to China's recent actions the Monetary Authority of Singapore, MAS, has had to take an easier stance on their own currency. Like many Asian countries, growth in Singapore has been stagnating at 2% per year and the MAS has had to lower their expectations for 2016.
Inflation has been falling for some time and since 2015 has been negative (deflation). The most recent print was -0.8%.
And finally exports have begun to decelerate.
"Yes, we have many more opportunities in the globalised world, but we also face fiercer competition."
"Our economy is slowing down and undergoing transition. We cannot expect an easy journey ahead."
-Prime Minister Lee Hsien Loong's 2016 New Year Message
Singapore's MAS operates differently than your standard issue central bank. For starters, it does not control interest rates at all, it instead, lets the market set rates.
The MAS chooses to center their monetary policy solely around management of the exchange rate. The Singapore dollar is managed around a basket of currencies which are weighted based on their influence to Singapore's export and import markets. This basket is called S$NEER.
The default setting of the band is upward sloping to promote the "modest and gradual appreciation" of S$NEER. MAS can manipulate their currency by changing the slope, location, or width of the band.
Click to enlargeThe examples above demonstrate the different ways that Singapore can depreciate their currency. The first graph, a flattening of the band, slows the rate at which the SGD can appreciate. The second graph, a re-centering of the band is basically equivalent to a one-off devaluation of the SGD. And finally the third graph, shows a widening of the band which would increase currency volatility but allow more room for the SGD to depreciate.
The MAS typically produces two statements a year detailing their stance on the currency band and their macroeconomic outlook. But last year, in January 2015, they held a special meeting to announce a flattening of the band citing a falling global and domestic inflation environment.
As noted at the beginning of the statement:
"Since the last Monetary Policy Statement in October, developments in the global and domestic inflation environment have led to a significant shift in Singapore's CPI inflation outlook for 2015. As part of its ongoing economic surveillance, MAS has assessed that it is appropriate to adjust the prevailing monetary policy stance."
This special meeting signaled to us that Singapore has entered the "race to the bottom." The MAS further confirmed intentions by decreasing the slope of the band again in their latest policy statement which was released in October of 2015 citing "growth slightly weaker than earlier envisaged."
Singapore is the most vulnerable to a currency war among the Asian nations. As a small island nation, it relies heavily on imports and exports to grease the wheels of the economy. The World Bank's data shows that Singapore's exports account for 187.6% of their GDP.* To put that into context, China's exports are only 22.6% of their GDP.
*(Exports can be larger than total GDP if imports are large as well. For example if GDP=C+G+I+(X-M), a large exporting/importing nation like Singapore could look like 300=50+50+100+(600-500). Exports, 600, are twice as large as GDP, 300.)
A stronger Singapore dollar would destroy the country's competitiveness in the export market and put a huge dent into their bottom line. To make matters worse, one of Singapore's top export destinations is China, the country devaluing the most aggressively.
Now the MAS has a peculiar problem to solve:
Singapore largely relies on exports to generate income.
Singapore's largest trading partner is China.
The yuan is undergoing a massive devaluation.
Singapore faces a major decision. Either let their currency appreciate against their largest trading partner and take a huge hit on exports or ease with China and the rest of the Asian nations to prop up export demand.
As is the norm with sovereign governments, we think Singapore decides to ease now and kick the can further down the road.
USD/SGD is the cheapest way to play a broad based Chinese lead currency depreciation against the US dollar. Borrowing costs for the currency are among the lowest in the Asian area, the pair tracks USD/CNY quite well.
Disclosure: I am/we are long USD/SGD.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.