EconWatch. Qualms of forex volatility; strong USD prior to policy tightening in the US. 21 August 2015

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EconWatch 21 August 2015 Patricia Oh Swee Ling patricia-oh@ambankgroup.com 603-2036 2240 Qualms of forex volatility; strong USD prior to policy tightening in the US Investment Highlights Qualms of currency movements persisted in the recent weeks due to the devaluation of CNY. Since 10 August, CNY has depreciated 3.1% vs. the USD to close at CNY6.40 per USD on 19 August 2015. The shift in forex regime by China could trigger further easing for Europe and Japan as global economies begin to streamline economic policies ahead of the potential rate increase in the US during 2H15. Empirical analysis suggests that regional currencies are positively correlated with CNY, except for GBP and EUR. Within the ASEAN basin, the correlation coefficients for CNY vs. MYR and SGD are relatively higher compared to THB, IDR and PHP. The coefficients correlation for MYR-CNY and SGD-CNY are 0.40 and 0.58, respectively. Meanwhile, THB/ IDR/ PHP are positively correlated with the CNY currency, with coefficients of 7/ 8/ 8, respectively. Based on the recent currency trend for data series since January 2015, GBP is inversely correlated with most regional currencies except HKD and SGD, respectively. Ringgit is relatively weaker compared to regional counterparts. As seen in the correlation matrix, Ringgit is positively correlated with regional currencies, except GBP. The coefficient correlation of MYR-GBP is -0.39. As such, weak Ringgit tends to coincide with weak regional currencies. That said, Ringgit had deteriorated sharply against its regional counterparts in recent months (see Chart 4). Also, compared to regional currencies, Ringgit led the pact as the steepest deterioration against the USD as at YTD (see Chart 5). Foreign holdings of MGS fell by 0.8% MoM in July. Global holdings of Malaysia s government bonds remain above 30% for the fifth consecutive month in July. When included both conventional and Islamic sovereign bonds, global holdings stood at 31.5% of total outstanding government bonds (vs. 32.1% in June). In terms of segment, foreign holdings of MGS stood at RM165.4bil (or -0.8% MoM). That accounted for 47.8% of total outstanding MGS in July vs. 48.5% in June. Meanwhile, Government Investment Issues (GII) slipped by 16% MoM to RM8.2bil in June. It rose to an all-time high of RM10.9bil in May. Prior to the forex devaluation by China, investors were convinced of a September rate hike. Key indicators showed that the economy has gathered traction. According to the FOMC s quarterly Summary of Economic Projections in June 2015, the Fed s median estimates for interest rate at the end of 2015 and 2016 are 0.625% and 1.625%, respectively. The remaining FOMC meetings for the year are scheduled for 16-17 September, 27-28 October and 15-16 December 2015. The question remains as to whether the Fed could persist with policy tightening in September. Cliffhanger for the Fed with global developments since July. Since the July meeting, conflicting signals of a rate hike in September have emerged. A report on US employment in July showed job gains, bringing the economy closer to the point of recovery. However, other global developments are likely new reason for caution of an initial rate hike for the US in September. At the FOMC meeting in July, the committee noted the decline in China s stock market. Since then, Chinese officials devalued the CNY to spur exports growth. Crude oil prices hit a six-year low this week. The low global crude oil prices have triggered further uncertainties for sustainable inflation in the US and price increases towards the Fed s long-term inflation target of 2.0%. Based on Wednesday s close of USD47.16 per barrel, the Brent crude oil has fallen by 18% YTD. Meanwhile, WTI fell by 23.4% YTD to close at USD40.80 per barrel. As at year-end 2014, the Brent crude oil closed at USD57.33 per barrel and WTI stood at USD53.27 per barrel. YTD averages as at 19 August 2015 for Brent and WTI are USD58.18 and USD52.13 per barrel, respectively. PP 17843/09/2013 (032994)

01-15- 29-12- 26-12- 26-09- 23-07- 21-04- 18-02- 16-30- 13-Aug-15 CHART 1: FLUCTUATION OF CNY CURRENCY (CNY/ USD) 6.45 6.40 6.35 6.30 6.25 6.20 6.15 OVERVIEW Qualms of currency movements have persisted in recent weeks due to the devaluation of CNY. Since 10 August, CNY depreciated 3.1% vs. the USD to close at CNY6.40 per USD on 19 August 2015. The shift in forex regime by China could trigger further easing for Europe and Japan as global economies begin to streamline economic policies ahead of the potential rate increase in the US during 2H15. Empirical analysis suggests that regional currencies are positively correlated with CNY, except for GBP and EUR. As for Malaysia, Ringgit has been undervalued considering its weaker stance against regional currencies as at YTD. Generally, Ringgit is positively correlated with most currencies, except GBP. At this juncture, Ringgit has deteriorated more significantly against the greenback compared to the decline of regional currencies vis-à-vis the greenback. Elsewhere, global holdings of Malaysia s government bonds remain above 30% for the fifth consecutive month in July. When included both conventional and Islamic sovereign bonds, global holdings stood at 31.5% of total outstanding government bonds (vs. 32.1% in June). CHART 2: REGIONAL CPI AND INTEREST RATE (%) Inflation Interest rate Indonesia Malaysia % Key central bank rate 7.25% 7.50% China Korea Japan* EURO UK US* Singapore* Taiwan Thailand (2.0) 2.0 4.0 6.0 8.0 5% 0% Euro Japan 0.25% 0.50% 0.50% Hong Kong UK US 1.50% Thailand 2.00% Australia 3.25% Malaysia 4.00% Philippines 4.85% China India Indonesia AmResearch Sdn Bhd 2

CHART 3: CORRELATION MATRIX BETWEEN REGIONAL CURRENCIES Correlation Matrix CNY HKD KRW JPY MYR SGD THB IDR PHP AUD GBP EUR CNY 0.440 0.382 54 0.404 0.579 71 79 77 0.232-86 -17 HKD 0.440 92-07 44 0.494-40 20-18 25 0.239 47 KRW 0.382 92 0.759 0.903 0.733 0.836 0.796 0.826 0.841-0.414 0.279 JPY 54-07 0.759 0.778 0.427 0.833 0.886 0.749 0.733-0.526 0.326 MYR 0.404 44 0.903 0.778 0.688 0.811 0.853 0.854 0.829-0.389 0.349 SGD 0.579 0.494 0.733 0.427 0.688 0.351 0.490 0.398 0.722 53 0.572 THB 71-40 0.836 0.833 0.811 0.351 0.841 0.890 0.690-0.670 97 IDR 79 20 0.796 0.886 0.853 0.490 0.841 0.787 0.765-0.525 0.437 PHP 77-18 0.826 0.749 0.854 0.398 0.890 0.787 0.611-0.503 44 AUD 0.232 25 0.841 0.733 0.829 0.722 0.690 0.765 0.611-0.235 0.592 GBP -86 0.239-0.414-0.526-0.389 53-0.670-0.525-0.503-0.235 0.347 EUR -17 47 0.279 0.326 0.349 0.572 97 0.437 44 0.592 0.347 EMPIRICAL ANALYSIS Positive correlation between most regional currencies and CNY Based on the recent currency trend for data series since January 2015, GBP is inversely correlated with most regional currencies except HKD and SGD, respectively. Based on the correlation matrix, regional currencies are positively correlated with CNY, except for GBP and EUR. Ringgit is relatively weaker than regional counterparts Within the ASEAN basin, the correlation coefficients for CNY vs. MYR and SGD are relatively higher compared to THB, IDR and PHP. The coefficients correlation for MYR-CNY and SGD-CNY are 0.40 and 0.58, respectively. Meanwhile, THB/ IDR/ PHP are positively correlated with the CNY currency, with coefficients of 7/ 8/ 8, respectively. As seen in the correlation matrix, Ringgit is positively correlated with regional currencies, except GBP. The coefficient correlation of MYR-GBP is -0.39. As such, weak Ringgit tends to coincide with weak regional currencies. That said, Ringgit has deteriorated sharply against its regional counterparts in the recent months (see Chart 4). Also, compared to regional currencies, Ringgit led the pact with the steepest deterioration against the USD as at YTD (see Chart 5). CHART 4: PERFORMANCE OF RINGGIT AS AT 19 AUGUST 2015 (% CHANGE YTD) IDR AUD EUR KRW THB SGD JPY PHP CNY USD HKD GBP -2-15.0-1 -5.0 Notes: Positive territory indicates the appreciation of the Ringgit, while negative territory shows the depreciation of the Ringgit. Sources: Bank Negara Malaysia / AmResearch AmResearch Sdn Bhd 3

Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Apr-14 Jul-14 Oct-14 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Sep-14 CHART 5: REGIONAL CURRENCIES VS. USD AS AT 19 AUGUST 2015 (% CHANGE YTD) GBP HKD CNY JPY INR PHP SGD THB KRW EUR AUD IDR MYR -2-15.0-1 -5.0 5.0 Notes: Positive territory indicates the appreciation of regional currencies against USD, while negative territory shows the depreciation of regional currencies. Sources: Bank Negara Malaysia / AmResearch FOREIGN HOLDINGS OF MGS FELL BY 0.8% MOM IN JULY Global holdings of Malaysia s government bonds remained above 30% for the fifth consecutive month in July. When included both conventional and Islamic sovereign bonds, global holdings stood at 31.5% of total outstanding government bonds (vs. 32.1% in June). In terms of segment, foreign holdings of MGS stood at RM165.4bil (or -0.8% MoM). That accounted for 47.8% of total outstanding MGS in July vs. 48.5% in June. Meanwhile, Government Investment Issues (GII) slipped by 16% MoM to RM8.2bil in June. It rose to an all-time high of RM10.9bil in May. INTERNATIONAL RESERVES AT BNM PROBABLY DECLINED FURTHER DURING 1H AUGUST BNM has probably mediated in the forex market on the back of further depreciation of the Ringgit during 1H August. As such, the weak currency exerted further downward pressure on the forex reserves recently, which had already deteriorated sharply as at YTD July 2015. As at end-july, reserves dipped by 8.3% MoM (or -USD8.8bil) to USD96.7bil. On a YTD basis, reserves fell by USD19.2bil (or -16.6%) due to lower trade surplus while BNM intervened to ensure an orderly fluctuation of the Ringgit. Cumulative trade balance fell by 7.0% YTD (or -RM3.1bil) to RM41.7bil as at end-1h15. CHART 6: FOREIGN HOLDINGS OF MALAYSIAN GOVERNMENT BONDS (% OF TOTAL) Government Bonds MGS 34 60 32 30 28 26 24 22 50 40 30 20 10 20 0 Sources: Department of Statistics / AmResearch AmResearch Sdn Bhd 4

Jan-05 Aug-05 Mar-06 Oct-06 May-07 Dec-07 Jul-08 Feb-09 Sep-09 Apr-10 Nov-10 Jun-11 Jan-12 Aug-12 Mar-13 Dec-14 Jan-05 Sep-05 May-06 Jan-07 Sep-07 May-08 Jan-09 Sep-09 May-10 Jan-11 Sep-11 May-12 Jan-13 Sep-13 CHART 7: US ECONOMIC PROJECTIONS BY THE FED IN JUNE 2015 Variable 2015 2016 2017 Longer run Change in real GDP 1.8 to 2.0 2.4 to 2.7 2.1 to 2.5 2.0 to 2.3 March projection 2.3 to 2.7 2.3 to 2.7 2.0 to 2.4 2.0 to 2.3 Unemployment rate 5.2 to 5.3 4.9 to 5.1 4.9 to 5.1 5.0 to 5.2 March projection 5.0 to 5.2 4.9 to 5.1 4.8 to 5.1 5.0 to 5.2 PCE inflation 0.6 to 0.8 1.6 to 1.9 1.9 to 2.0 2.0 March projection 0.6 to 0.8 1.7 to 1.9 1.9 to 2.0 2.0 Core PCE inflation 1.3 to 1.4 1.6 to 1.9 1.9 to 2.0 March projection 1.3 to 1.4 1.5 to 1.9 1.8 to 2.0 Sources: Federal Reserve / AmResearch TIGHTER MONETARY POLICY FOR THE US BY END- 2015 According to the FOMC s quarterly Summary of Economic Projections in June 2015, the Fed s median estimates for interest rate at the end of 2015 and 2016 are 0.625% and 1.625%, respectively. Hence, the Fed is likely to initiate the first interest rate hike during one of the upcoming monetary policy meeting in 2015. The remaining FOMC meetings for the year are scheduled on 16-17 September, 27-28 October and 15-16 December 2015. The Fed has held its target for the fed funds rate at virtually zero since December 2008 to bolster growth. Prior to the forex devaluation by China, investors were convinced of a September rate hike based on a survey by Bloomberg. Key indicators showed that the economy gathered traction. In particular, steady job gains in July spur confidence that the Fed could raise rates in September 2015. Mostly, non-farm payrolls increased by at least 200,000 per month since March 2014, except for March 2015. Unemployment rate remained unchanged at 5.3% in July, which is not far above the Fed s long-term target of a 5.0%- 5.2% range. As a recap, the unemployment rate in the US tapered from the high of 1% seen in October 2009. That said, the question remains as to whether the Fed could persist with policy tightening in September. With the current policy stance in China and weak global crude oil market, the Fed is probably facing a potential dilemma about raising interest rates at its September meeting. CHART 8: LABOUR MARKET IN THE US 600 400 200 0-200 -400 Non-farm payrolls (% MoM/ '000) 11 10 9 8 7 Unemployment rate (%) -600-800 -1000 6 5 4 AmResearch Sdn Bhd 5

Sep-13 Nov-13 Dec-13 Feb-14 Mar-14 Apr-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Aug-15 Sep-13 Nov-13 Dec-13 Feb-14 Mar-14 Apr-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Aug-15 CHART 9: BRENT CRUDE OIL PRICE 140 120 100 80 Price fluctuation (USD/ barrel) Annual comparison of monthly averages (% YOY) 60 40 20 0-55 -53-51 -49-47 -45-43 -41-39 -37-35 CLIFFHANGER FOR THE FED WITH GLOBAL DEVELOPMENTS SINCE JULY Since the July meeting, conflicting signals of a rate hike in September have emerged. A report on US employment in July showed job gains, bringing the economy closer to the point of recovery. However, other global developments are likely new reasons for caution of an initial rate hike for the US in September. At the FOMC meeting in July, the committee noted the decline in China s stock market. Since then, Chinese officials have devalued the CNY to spur exports growth. Elsewhere, crude oil prices hit a six-year low this week which triggers further uncertainties for sustainable price increase towards the Fed s long-term inflation target of 2.0%. Based on Wednesday s close of USD47.16 per barrel, the Brent crude oil has fallen by 18% YTD. Meanwhile, WTI fell by 23.4% YTD to close at USD40.80 per barrel. As at year-end 2014, the Brent crude oil closed at USD57.33 per barrel and WTI stood at USD53.27 per barrel. YTD averages as at 19 August 2015 for Brent and WTI are USD58.18 and USD52.13 per barrel, respectively. 120 110 100 90 80 70 60 Price fluctuation (USD/ barrel) CHART 10: WTI CRUDE OIL PRICE Annual comparison of monthly averages (% YOY) 50 40-55 -53-51 -49-47 -45-43 -41-39 -37-35 AmResearch Sdn Bhd 6

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