With a still challenging global growth environment, central banks in the developed world have stepped up a range of unconventional and quantitative easing (QE) policies. One of the (un)intended consequences is a weaker currency to help stimulate growth. The substantial weakening of the Japanese Yen following the recent election has also given renewed discussion to how countries should combat this currency war. From an investment standpoint, it is important not only to select what type of assets (be it fixed income, equities or real estate) you own, but also the currency denomination of these assets in order to preserve your purchasing power. How do Asian currencies look in this regard? Although Asian countries vary widely in terms of their individual fundamentals, the common threads we can observe include:
1) Higher growth rate,
2) Relatively strong fiscal management, and
3) Healthy balance of payment situation.
These themes have been in place for some time. For this year we are getting additional catalysts both from valuation and technical angles.
Valuation wise, yields in Asian markets are now considerably higher than other major currencies. To the extent that income remains a key driver and collecting carry is encouraged by the policy intent of quantitative easing, Asia looks attractive in this regard. On a real yield comparison, while they are not high in Asia, at least they are positive, with most countries’ inflation currently stabilizing at the lower end of the central bank target range. Our internally developed forward looking inflation pressure gauge also shows lower than average readings.
From our technical assessment, our research shows that periods of QE had led to appreciation in Asian currencies. Global investors, including central bank FX reserves managers are increasingly interested in Asian bonds for the diversification benefit as well as other positive dynamics. Equity performance can also serve as another source of positive flow for Asian currencies as interest in the asset class increases from the so called “Great Rotation” – (even though recent flows and other evidence suggest the equity interest has been coming out of cash rather than fixed income). Equity valuation is not expensive from a historical perspective, with earnings momentum improving across Asia. Central banks also have room to cut interest rates given current inflation levels, which can also drive good performance for equities and local currency fixed income.
As for specific investment ideas, on the lower volatility side, we see the offshore Chinese Yuan (CNY) market growing further this year with more breadth in terms of government and corporate instrument selection. They can provide a sizable yield pickup vs. USD paper with generally shorter maturity and less interest rate risk. On the higher risk/higher reward spectrum, government securities in India can be considered with their yield in the high 7% area. Capital control in India was tighter than other regional countries but they have been progressively loosening. While bond quota to buy local debt used to be hard to come by, recent changes have enabled foreigners to participate via regular monthly quota auction. The Reserve Bank of India has begun cutting rates and inflation has started to recede from an elevated level. Its current account deficit is a risk, while its fiscal reforms also bear watching but policy steps announced so far have been encouraging.