FX-Insights. USD/MYR: A Tempered Rise MACRO FX RESEARCH MYR. September 16, 2014

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MACRO FX RESEARCH MYR FX-Insights September 16, 2014 USD/MYR: A Tempered Rise MYR reversed out much of its 3Q gains against the USD by 15 Sep and was last seen around the 3.23-figure.

Yesterday s 300pip upward move could largely be attributed to China s weak Aug data over the weekend and closing of long positions ahead of the Malaysia Day holiday.

Whilst the global financial environment turns against the MYR, we expect subdued bond inflows, ongoing fiscal consolidation efforts, positive trade cues thus far, and possibly BNM rate hike to

1 MACRO FX RESEARCH MYR FX-Insights September 16, 2014 USD/MYR: A Tempered Rise MYR reversed out much of its 3Q gains against the USD by 15 Sep and was last seen around the 3.23-figure. The pair has been underpinned generally by external factors, i.e. broad dollar strength, rise in global currency volatility as well as the rise in UST rates that could possibly mean the end of conducive carry trade. Yesterday s 300pip upward move could largely be attributed to China s weak Aug data over the weekend and closing of long positions ahead of the Malaysia Day holiday. We anticipate choppy USD/MYR action, torn by opposing forces. Whilst the global financial environment turns against the MYR, we expect subdued bond inflows, ongoing fiscal consolidation efforts, positive trade cues thus far, and possibly BNM rate hike to underpin the MYR. Our economic team anticipates a 25bps hike on 18 th Sep, the last for the year before standing pat thereafter until end 1H Our MYR model that takes into consideration fundamentals and market indicators, projects a USD/MYR forecast of around 3.13 towards the end of the year. Our fair value model estimates USD/MYR at 3.08 on the longer 5-year horizon. However, taking into consideration global currency risk premiums, we favour the upper end of the range seen at the end of the year. Analysts Saktiandi Supaat saktiandi@maybank.com.sg (+65) Leslie Tang leslietang@maybank.com.sg (+65) Fiona Lim Fionalim@maybank.com.sg (+65) Chart 1: USD/MYR Daily, Violating the Trend Channel Source: Bloomberg; Maybank FX Research SEE PAGE 6 FOR IMPORTANT DISCLOSURES

2 Our Full Story MYR weakened 1.7% since 8-Sep against the USD, one of the worst performers among its peers. The currency was hit exceptionally hard after China s industrial production came in shockingly soft for Aug. USD/MYR has bounced above the 3.23-figure in a swift upmove from low-3.14 levels around end Aug. The first trigger stemmed from the rise in UST rates after Fed San Francisco released a report that suggests that the markets have been under-estimating the possibility of an earlier-than anticipated rate hike by the Fed. Chart 2 reveals that MYR has actually weathered the dollar strength pretty well until recently. USD/MYR remained relatively stable even as the DXY surpassed its 2014 high in Aug, only making a significant bounce within the past two weeks. Risk-off exacerbated the USD/MYR rally as Asian investors digest the weak China data. Chart 2: USD/MYR vs DXY Sources: Bloomberg LP, Maybank FX Research The inevitable must come as US economic recovery becomes more entrenched. The carry trade environment had a good run and MYR players would have to brace for a change in environment where the USD could no longer be a funding currency. China weakness at this point could drag on the currency. However, we are unlikely to see the dramatic rally in the pair that was observed in Rather, we anticipate choppy action where a myriad of factors could pull USD/MYR in opposite direction. Besides, the further ECB and BoJ easing measures could lead to some support as euro and JPY funding for carry trades remain to some extent. We should continue to see some level of eurozone real money funds interest in regional currencies on the back of better fundamentals. Strong Fundamentals Put MYR on good footing Fiscal Consolidation Efforts to Pay off. As we have noted repeatedly in our previous notes, the Malaysian government has demonstrated commitment to straighten out its fiscal accounts by cutting subsidies in the past year. Subsidies of gas, electricity and sugar were cut one after another. As a result, budget deficit in 1H 2014 slipped to MYR 19.1bn which is 3.7% of GDP. Malaysia s budget deficit target of 3.5% of GDP by end 2014 is still on track but not without risks of deterioration. The fuel subsidy mechanism is under review as the government intends for only a specific group to be eligible for subsidized fuels, via means-testing, 16 September

quota and smart-card technology. We view its implementation and execution to be administratively challenging with potential loopholes for leakage. That said, any slippages should not derail efforts.

3 quota and smart-card technology. We view its implementation and execution to be administratively challenging with potential loopholes for leakage. That said, any slippages should not derail efforts. Looking forward, Budget 2015 will be eyed closely for a follow-through in the government s fiscal consolidation effort thus far. Crucial in the coming year is the GST implementation in Apr. We expect the government to stand by its commitment as Malaysia remains under negative watch by Fitch Rating Agency. In addition, domestic demand has weathered the subsidy rationalization program rather well so far and would likely boost the government s confidence to straighten out its fiscal bill. A temporary surge in demand to offset expected eventual bond outflows. Assuming that Malaysia will lower budget deficit, our fixed income analyst also expects lower gross debt issuance by the government next year given the lower financing needs. More debt switches are expected. A surge in demand is thus, anticipated before the end of the year which could be positive for MYR. Nonetheless, the high composition of foreign debt holdings could see an outflow once Fed signals a rate hike and yield spreads start to compress. That phenomenon is already being played out. As such, we look for subdued bond inflows towards the end of the year. External demand exceeded expectations this year, prompting our economic team to bump up the full year forecast of trade balance to a wider surplus of MYR87.9bn. Near-term global trade conditions remain positive as global manufacturing PMI (as monitored by our economic team on 32 countries) improved to 52.6 in Aug from 52.4 reported in the month prior. We expect steady trade surplus to lend support to the MYR. External Headwinds and Tailwinds The US Fed will exit QE soon and rate hikes are on the cards as economic indicators signal stronger growth. Regardless of when Fed will shift its rhetoric, we expect the inevitable to happen as mentioned in the earlier part of this report. On the other hand, BOJ and ECB are expected to ease further. The policy divergences between the developed economies open up new regional search for yield opportunities that could support emerging market FX, including the MYR. In fact, flows from Europe makes up a generally sustained 30% of total direct investment liabilities into Malaysia (i.e. this includes portfolio investment (equity and debt) + direct fdi) in 2013 as shown in Chart 3 while that from Japan makes 10%. Further easing from both central banks should temper the USD/MYR rise. Chart 3: Europe Makes 30% of Direct Investment Liabilities as of 2013 Chart 4: Bond Inflows Expected To Rise Sources: Dept of Statistics, Maybank FX Research Source: CEIC, Maybank FX Research 16 September

Mar-07 Nov-07 Jul-08 Mar-09 Nov-09 Jul-10 Mar-11 Nov-11 Jul-12 Mar-13 Nov-13 Jul-14 Mar-15 Nov-15 Sep-2014 Mar-2015 Sep-2015 Mar-2016 Sep-2016 Mar-2017 Sep-2017 Mar-2018 Sep-2018 Mar-2019 Sep-2019

4 Mar-07 Nov-07 Jul-08 Mar-09 Nov-09 Jul-10 Mar-11 Nov-11 Jul-12 Mar-13 Nov-13 Jul-14 Mar-15 Nov-15 Sep-2014 Mar-2015 Sep-2015 Mar-2016 Sep-2016 Mar-2017 Sep-2017 Mar-2018 Sep-2018 Mar-2019 Sep-2019 Mar-2020 USD/MYR: A Tempered Rise Net bond flows year-to-date have been generally supportive of the MYR and within the next 3 months we do not expect any major net outflows similar to that in the middle of In addition, with lower gross debt issuance by the Malaysian government next year, given lower financing needs, we expect mild support for the Malaysian debt markets. This suggests that the MYR may remain somewhat constrained in its push up towards the range, unless we see significant dollar strength driven by extremely hawkish signals by the Fed, strong euro declines driven by weaker fundamentals and significantly negative Chinese data coming onstream. USD/MYR Models Chart 5: USD/MYR Model Chart 6: USD/MYR Fair Value Projection Myr forecast USDMYR (Actual) +1 std dev -1 std dev Implied USD/MYR 4 per. Mov. Avg. (Implied USD/MYR) Sources: CEIC, Bloomberg LP, Maybank FX Research Using our MYR model and a base scenario of stronger fiscal position, concomitant lower credit default swap points, steady trade surplus and subdued bond inflows, USD/MYR is projected to trend lower towards 3.13 by the end of this year as seen in Chart 5 while that of the fair value trends towards 3.08 for Despite the bullish MYR picture depicted by our models, we also have to take into account the risk premium of US Fed s rate hike and other event risk. This is supported by the USD/MYR options market which seems to be showing further skew upwards for the USD/MYR albeit mildly in the near term. Chart 7: USD Call MYR Put Forward Delta without premium adjustment (as at 16 Sep 2014) Source: Bloomberg 16 September

5 More recently, the USD/MYR forward implied yields (see Chart 8 proxy indicator for carry trade) have fallen onshore as the UST rates bounced off their lows and global currency volatility rises. The 3-mth implied yields have been rising since early this year, suggesting MYR benefitted from the carry trade run for the most part of But with the rise in recent global currency volatility, higher expectations of a US rate increase, unraveling the carry trade plays, MYR may have weakened in tandem, playing out the scenario that we have envisioned since the start of the year. However, we do not expect an exodus given still significant liquidity in the system out of the eurozone and Japan. Chart 8: 3M Forward Implied Yields Source: Bloomberg, Maybank FX Research Strong fundamentals also still underpin MYR-denominated assets and we continue to hold our year-end forecast at 3.20 for now. We continue to assess the developments out of the US with the FOMC statement and press conference this Thurs a significant factor in determining the USD/MYR level over the next 3-6 months. The dollar trajectory is expected to see strong upward pressure in our view. Currently our baseline for the dollar index is for end year at around 84.00, but there is very strong possibility it could end the year at around 86 or more especially after the Sep FOMC. Taking that into consideration, we would favour the upper end of the range seen at the end 4Q 2014 and towards 3.30 again in 1Q September

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