Carry traders in Asia, having survived the initial jitters from the US subprime mortgage crisis, are now looking for funding currencies with less risk.
While the Japanese yen and the Taiwanese dollar remain the vehicles of choice for financing purchases of the New Zealand dollar and other high-yielding currencies, the risk of a reversal in these trades is prompting the search for alternatives.
The cost of money in Taiwan is rising, partly because the central bank wants to kill the carry trade and arrest capital outflows. Although the yen remains very much in play, no one knows for how long. The Bank of Japan may signal higher interest rates as early as next month. And that makes funding positions in yen very profitable, but dangerous.
Amid these threats, the Singapore dollar may fit the bill nicely as a low-risk funding currency.
Singapore’s economic growth has accelerated for three straight quarters, reaching an annualized two-year high of 12.8% in the quarter ended 30 June.
Yet, consumer-price inflation is subdued and the one month interbank interest rate on the island is, thanks to a glut of capital, just 2.4%, almost 1 percentage point lower than at the beginning of the year. The implied cost of borrowing Taiwan dollars using the forward market is 2.6% for a month.
The liquidity overhang in Singapore is unlikely to disappear soon and that may be a reason for the nation’s currency to replace the Taiwan dollar as a funding option.
“The Singapore dollar is also attractive as a funding currency because of its lower volatility, slightly below that of the Taiwan dollar and significantly below that of the Japanese yen,” Citigroup Inc. economist Chua Hak Bin wrote in a note to clients Sunday.
Using the currency of a fast-growing economy for funding a carry trade isn’t conventional advice, though it’s not unheard of. In a 22 January research note, ABN Amro Holding NV economists, led by Irene Cheung in Singapore, had suggested borrowing in Chinese yuan to buy the Indian rupee. The ABN Amro analysts had, at the time, proposed selling the yuan forward to buy the Korean won and the Indonesian rupiah, too. At an implied cost of less than 1%, it’s cheap to borrow yuan for a year in the offshore, non-deliverable forward market. Yet, the Singapore dollar may be more suitable for financing carry trades.
For one, the offshore yuan market isn’t very deep. Besides, the pace of appreciation in the yuan is something of a lightning rod in the politics of world trade. It is also a key variable that’s going to determine whether the overextended Chinese economy lands softly, or with a thud.
There are no such pressures on the Singapore dollar. The country’s monetary authority manages the trade-weighted exchange rate against an undisclosed basket of currencies. The Singapore dollar is in the upper half of its trading band, according to Chua’s calculations. That limits the potential for further gains in the currency, providing “free insurance” to carry traders, according to the Citigroup economist.
With annual consumer price inflation of 1% in May, little changed from a year earlier, the Monetary Authority of Singapore doesn’t have a pressing reason to make its existing stance of seeking a “modest and gradual appreciation” more hawkish.
Sure, the city-state’s property market is in a frenzy; stocks, too, are getting as pricey as they last were in 1993. Yet, it’s difficult to envision Singapore using monetary policy to control asset-price bubbles.
That makes the Singapore dollar a good option for speculators looking to bet, say, on the New Zealand dollar.
With carry trades alive and well, there is no respite in sight for Reserve Bank of New Zealand governor Alan Bollard.
The central bank of New Zealand has raised the official cash rate three times this year to a record 8%.
An inflation report on Sunday boosted expectations of another 25 basis-point increase on 26 July. The juicy yield is drawing in speculators, whose leveraged bets have already pushed the kiwi to a 22-year high. Meanwhile, New Zealand exporters are complaining bitterly.
If the recipients of carry trades are smarting, at least one sender of capital—Taiwan—isn’t too happy, either.
Taiwanese residents sent more than $11 billion overseas in the first quarter, prompting the monetary authority to ask mutual funds to invest more in local stocks.
In a further move to prevent capital flight, the central bank also urged banks last month not to reject time deposits, thus giving savers a reason to keep their money in Taiwan. It repeated the call on 3 July.
The monetary authority also raised the benchmark interest rate last month by a more-than-expected quarter-percentage point to 3.125%. Taiwan will welcome it if the speculative fervour now shifts to the Singapore dollar.
A big dose of global risk aversion may yet cool the ardour of carry traders, though for now it looks like the soap opera will continue with new actors replacing old ones.
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