Business Times Singapore
Making sense of the currency market turmoil
William R. Thomson
Aug 7, 2007
How far will the US$ fall?
Will yen 'carry trade' positions unwind swiftly? Experts give
their take on these and related concerns
OVERVIEW
THE combination of a sliding
dollar, an unwinding of yen 'carry trades' (whereby yen are used
to finance investment or speculation in higher- yielding currencies)
and a credit crunch in US markets has sent financial markets
reeling around the world. Volatility is back and global asset
valuations are looking shaky.
The Business Times gathered
together an impressive array of experts to discuss just how serious
the situation is - and where investors should look for refuge
in the storm.
PARTICIPANTS
Moderator:
Anthony Rowley, Tokyo correspondent of The Business
Times
Panellists:
Mark Cutis, chief investment officer at Shinsei Bank in
Tokyo.
Robert Lloyd George, chairman and CEO of Lloyd George
Management, Hong Kong
Rei Masunaga, an international economist and former senior
official of the Bank of Japan
Mark Mobius, president of Templeton Emerging Markets Fund
and director and executive vice-president of Templeton Worldwide
Tohru Sasaki, an executive director and chief foreign
exchange strategist, JPMorgan Chase Bank, Tokyo
William Thomson, chairman of Private Capital, Hong Kong
Anthony: Let me move straight to the point
and ask you first, Tohru-san (since you are in the thick of currency
market trading every day) - how far and how fast is the current
dollar slide likely to go, and are we looking at a technical
adjustment or a secular decline?
Tohru: I think the slide will stop sooner rather than
later. In the past, when risk aversion heightened among investors,
the dollar tended to be bought back. This is probably because
(at such times) US investors repatriate their overseas assets.
According to US Treasury data, the monthly average of US investors'
net foreign stock and bond purchases was just US$4.7 billion
in 2003. But the monthly average between January and May this
year has been US$26.5 billion. US investors have increased their
overseas investment and, therefore, once they start unwinding
these investments, dollar-buying demand should become relatively
large
Robert: There are some signs that the current dollar
slide is bottoming out. Clearly, it was oversold at US$1.38 to
the euro, US$2.06 to the pound and I think that the most undervalued
currency was clearly the yen.
Mark C: I think the current dollar sell-off is basically
over. I don't expect to see (it fall to) US$1.40 against the
euro.
Rei: The dollar slide is mainly a reflection of
market concern about the future of the US. The US economy will
regain growth around the fourth quarter of this year. If so,
the slide of the dollar will decelerate, although it may not
stop because the US current account deficit will continue. Concern
over the future of the American economy was primarily triggered
by the sub-prime house mortgage loan problem in the US. The excess
mortgage lending by banks reminds me of Japan's asset bubble
in the late 1980s.
However, I do not consider
that the present American problem is as serious as was the case
in Japan. The Federal Reserve is not excessively worried by the
sub-prime loan issue, because other parts of the economy are
resilient. However, it watches market development carefully and
will lower interest rates if there is a sign of recession. Fortunately,
inflation is already under control and the Fed has good room
for manoeuvre.
William: The dollar has been perched on a
precipice. It has recently been trading at 80 on the USDX index.
The trend of the dollar has been down since 2001 and most such
declines end in panic selling and policy changes. There is a
whiff of fear and panic. We are not, in my opinion, yet at the
bottom.
Mark M: How far the dollar will go depends on the state
of the current account deficit and the strength of the US economy.
How fast it will slide will depend on the confidence level of
the market towards the dollar. It will always be under scrutiny
due to its importance as a world currency, and always susceptible
to great volatility in times of market uncertainty.
Anthony: What about the impact on other major
currencies - and are we seeing the beginning of a major unwinding
in yen carry trade positions?
Mark C: I expect to see a savage unwinding of carry
trades with higher Japanese interest) rates, although I suspect
short-term you will see a new trading range of 115-125 (for the
dollar against the yen). I expect to see the euro/yen rate at
135 within five months. I also expect to see an equity markets
sell-off but the Japanese market will hold up, which, along with
higher rates, will encourage a repatriation of funds (to Japan)
and further increase volatility.
Tohru: No, I do not think so. Current yen appreciation
is being caused by yen buybacks by short-term speculative accounts.
However, Japanese retail investors, who are the major driver
of the yen carry trade, still continue to sell yen through investment
trusts and foreign exchange market margin trading. Once these
short-term speculators have finished buying back their yen-short
positions, yen appreciation will stop. Then, once the market
settles down, yen weakness should resume.
William: Because of the carry trade, the yen
has probably the largest short position against it of any currency
in history. It is a matter of when, not if, that gets reversed.
Rei: The unwinding in yen carry trade positions
which took place in recent days made the yen stronger. My view
is that this unwinding is a healthy correction of the excess
selling of yen over the past several months. At this moment,
Japanese political uncertainties will persist and investors both
at home and abroad will consider it unsafe to take any big position
in yen either way.
Therefore, I will not be surprised,
if the yen stays in a narrow range around the present level for
some time. People are interested in the outcome of the Policy
Board meetings of the Bank of Japan (BOJ) in coming months. Though
a 0.25 per cent hike of short-term interest rates is likely to
come in August-September, its effect on the yen exchange rate
will not be very large, as the market has already discounted
it.
Robert: In our view, the yen could easily go up to
100 and there are a number of factors which could tip the trend
over that: Japanese Government Bond (JGB) yields are now around
2 per cent and may rise further; and the attractions of high-yield
bond markets like the New Zealand dollar, Australian dollar and
others will quickly fade with corrections in those currencies.
Most Asian central banks are trying to stem the 'hot money' inflows.
It is the reverse of the summer of 1997 and we have instead of
a meltdown, a 'melt up' in Asian currencies.
As for the dollar, its retreat
has had geopolitical as well as economic consequences. Opec countries
seem to be willing to sell oil in euro and perhaps move towards
a commodity based 'dinar', which would leave them less at the
mercy of a falling dollar, in which oil is priced at present.
Since we believe that we are in the midst of a 20-year bull market
in commodities - not only energy and minerals but also food and
other soft commodities - it is clearly a critical element to
decide what course the dollar will take.
I tend to believe that the
Federal Reserve and (US Treasurer) Henry Paulson will be responsible
and take pre-emptive action to prevent a sudden slide. The Americans
are not going to give up their primary role in the world monetary
system easily or quickly. It is always a mistake to underestimate
the resilience and creative energy of the US economy, and I think
that both the trade deficit and the budget deficit will tend
to improve over the next two years, particularly if
there is a retreat from Iraq.
Anthony: Which currencies look safest to you,
in the light of widespread market turbulence?
Mark C: In Asia I think the Singapore dollar and probably
the Malaysian ringgit and probably the Thai baht, but they will
all depreciate during a US dollar rebound. In Europe, probably
the Swiss franc (is the safest).
Rei: Maybe the euro is safest, because at present
the euro area does not have big uncertainties both on the economic
and political front in comparison to the US and Japan.
Mark M: There could be a move into emerging market
currencies that offer higher yields - (those of) countries with
strong foreign exchange reserves and current account balances,
mainly in Asia.
William: Asian currencies as a group are still
inviting. The Singapore dollar is in some ways the new Swiss
franc. The Malaysian ringgit should move in line with the Chinese
yuan but it is easier to buy. Both on a value and a technical
basis, the Japanese yen is very undervalued.
Robert: Emerging market currencies have already made
huge gains - that is, the Brazilian real and others. I would
not counsel investors to chase them now
Anthony: Do you expect to see credit markets
and stock markets stabilise soon, and likewise equity markets.
What about bond markets and gold (or other commodities)?
Robert: My prediction is for equities to stabilise
in the next three months. Gold will continue towards US$1,000
an ounce in the next two years and oil will very likely break
up to US$100 over two years.
Mark C: No, I don't expect short-term stability. Maybe
in the month of August but when the 'boys' come back from the
beach, they will have to deal with the undigested LBO financings
and the continued spate of hedge fund mini blow-ups. Not only
were there sub-prime mortgage exposures in Australia but now
they have cropped up in Paris-based hedge funds. So, I expect
to see big turbulence - probably in October. Turbulence means
a 10 per cent plus sell- off.
The bull market is probably
intact as it is more of a global phenomenon than a localised
event or driven by something like a hi-tech boom. Interest rates
can fall periodically on some flight-to-quality concerns but
in general we are on an upward trajectory for rates. Many financial
strategies will come unglued with higher rates. This will precipitate
another crisis which essentially means that, with time, risk
gets re-priced. What does that imply? Credit spreads will normalise.
Gold should take out US$700 in the next three months and take
out the old 1980 high of US$800 plus. This repricing or normalisation
in credit spreads is not necessarily bad. It means simply that
many frivolous investments that have been powered by leverage
will no longer be viable.
William: The markets are getting an overdue
wake-up call. Risk is everywhere and it has been way under priced.
The risks of contagion from the sub-prime fiasco in the US are
just one example of the reckless use and misuse of leverage in
the ongoing financial bubble that dates back to late 2002/early
2003. If this situation unwinds further, as I expect, there will
shortly be increased pressure on the Fed to lower short-term
rates, the first 10 per cent correction in the Dow or the S&P
500 since the bull began in 2003 - an almost unprecedented interval.
Anthony: Is the decline in the dollar likely
to result in a significant shift of investment into emerging
market currencies and which ones are likely to be most favoured?
How great is their capacity to absorb potential large outflows
from the dollar?
William: As the euro appreciates above US$1.40,
we will be hearing louder and louder voices calling for intervention
and a curbing of the European Central Bank's independence. Total
reserves of developing economies, including those of sovereign
wealth funds, total around US$6 trillion - about equal to outstanding
US government debt. These reserves are growing at about US$700-800
billion a year and the US dollar element is disproportionate
to its share of global GDP. A relatively small diversion of new
flows (not stock) has the capability to move emerging market
currencies disproportionately as well.
Tohru: Considering the size of US dollar markets,
the impact from flows into emerging markets should be minimal
for the entire dollar market.
Rei: My forecast is that the magnitude of the decline
of the dollar value will be rather limited. Under these conditions,
I don't expect any big shift of investment into emerging market
currencies from dollar assets. Even when volatility in the world
stock market starts again from New York, the 'safe haven' role
of the dollar will not be lost easily.
Anthony: Which are the best vehicles for investing
in emerging market currencies - equity or bond investment trusts
in the appropriate currencies, or specialised currency funds?
Mark M: Equity investment trusts that are well diversified.
Robert: I would say that the best vehicles are general
emerging market (GEM) funds. They have exposure to emerging market
currencies and the best stock selection as well as high earnings
growth. They normally diversify risk by owning 12-15 different
markets. There are (also) some interesting new asset classes,
like Asian Reits and other property funds which have good yields
and may be appealing for private investors. Plus, buying property
in an area of appreciating currency achieves a double gain -
investors in Singapore know this better than anyone else.
6 August 2007
Business Times Singapore
321gold Ltd
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