Ever since the Brexit Referendum results back in June, global money has flowed more into emerging market currencies.
The divergence is clear: The pound, along with the euro and pretty much all European currencies, have fallen against the U.S. dollar. Meanwhile, most of the Asian currencies – starting with the Japanese yen, the South Korean won, Taiwanese dollar, Malaysian ringgit and the Singapore dollar – have all gained against the U.S. dollar and continue to do so.
Money is flowing from the West to the East.
Here are some reasons why:
- The search for yield continues amid a heavily cash-infused environment as more than 20 developed countries are now experiencing negative interest rates. The average bond yield among the emerging markets is still above 4 percent and as long as a country has a liquid capital market and relatively stable inflation, investors feel comfortable pooling their money in these currencies now.
- We are currently in a low volatility environment. Buying a higher-yielding currency while selling a lower-yielding one is called “carry trade.” These potentially risky trades work when the market is stuck in a narrow range where we are right now.
- Ironically, the strong Japanese yen results in part from the unwinding of losses on investors’ long-term carry trade positions. While investors originally went back into the yen, some investors are now switching to other Asian currencies as a means of diversification and also as an additional caution against a furthering strengthening of the yen.
- There is no particular direction for the U.S. dollar right now as investors continue to defer the odds of a Federal Reserve rate hike, giving it a less than 50 percent chance of taking place by year-end.
My View: The current flow clearly reflects money coming out of mature economies where monetary policies have hit their limits. This is not only confined to Europe but also to the Americas where neither the U.S. nor the Canadian dollar is strengthening further despite good reasons to be doing so. Currently this trend of money moving from the West to the East looks temporary. While it’s premature to decide now, my intuition is that the key lies in the fiscal policies of the advanced nations going ahead.
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