Morgan Stanley Projects Asian Currency Appreciation in 2006

by: SA Editors

Morgan Stanley economists Stephen L. Jen, Luca Bindelli, and Charles St-Arnaud expect Asian currencies to be higher in 2006 for the following reasons:

The Chinese Yuan RMB and Japanese Yen remain undervalued: "We believe the fair value of USD/JPY is around 101, while that of the CNY index is around 5-10% below the current value. If either one of these currencies strengthens meaningfully against the USD, we believe many of the AXJ currencies will also be propelled higher."

Strong global growth: "2006 is likely to turn out to be the fourth consecutive year with global growth at 4% or above...a buoyant global backdrop with modest risk of aggressive monetary tightening should be a favorable environment for the Asian economies."

Official reserves in several Asian countries approach saturation: "Japan has not intervened in the currency markets since March 2004; and both Korea and Taiwan drastically slowed down the pace of their reserve accumulation since the beginning of 2005...While it is difficult to conclude with certainty the ‘saturation point’ of China’s investment tranche, our own guess is that the US$1 trillion mark will be quite important, as it will be difficult to justify higher reserves."

US Currency Politics: "There have been indications that, if Beijing does not ‘do more’, the US Treasury may have to name China as a currency manipulator in its next report, due out in April. Beijing’s choice is now between letting the CNY appreciate some more or facing closure of some of its lucrative foreign markets."

China Wants Greater Currency Variability: "Now that USD/CNY has been variable for seven months, we are of the view that the whole process of establishing an on-shore CNY market has come to a point where a little more currency volatility will help...We expect to see a visible increase in the de facto daily variability of USD/CNY, and a sharper rate of decline in USD/CNY."

See Jen, Bindelli, and St-Arnaud's full analysis.