Crouching currencies pounce

The recent political dramas that gripped the US have put rival currencies, such as China’s yuan, firmly in the spotlight as the credibility of the world’s reserve currency is questioned. This, in conjunction with a perception quantitative easing will continue for some time yet, has encouraged Asian currencies to improve.

Markets have established the expectation quantitative easing will continue in its current form for some time yet, pushing the S&P 500 to all-time highs and engineering Asian currencies to be at the forefront for those with an appetite for risk.

Quantitative easing has convincingly dislodged the traditional risk starting points and historical relationships between asset classes.

A basket of Asian currencies have comfortably returned to trade in tandem with the US-based S&P 500, concluding risk is once again back on the table for countries engulfed by the threat of tapering.

After reaching a three-year low in August, the JP Morgan Asia Dollar Index has rebounded in a compelling fashion. The Chinese yuan and Hong Kong dollar make up nearly half of the trade-weighted index, which has been pulled higher amid improving economic data from China.

Also bringing a meaningful contribution to the index is the Indian rupee which has lost over 12 per cent against the US dollar in this year alone as the country battled a change of capital flows on the prospect of the withdrawal of quantitative easing. Since August lows. the currency has recovered over 10 per cent.

In a move to internationalise the yuan, China has made currency swap agreements with trading partners to eliminate the dependence of converting currencies into the US dollar, resulting in less US dollars being used in trade. China’s move to open up the capital market for its currency has seen the yuan climb to be the ninth most-traded currency, according to the Bank for International Settlements.

We have long known the US Federal Reserve has the Australian dollar on a string, due in part to the large interest-rates differential. In contrast, the basket of Asian currencies has slightly different fundamentals, resulting in different trading relationships. 

With clean data following the US government shutdown not expected until early next year, the market is not expecting the Federal Reserve to taper anytime soon. For now, the relationship between strengthening Asian currencies and the S&P 500 looks like a lasting romance.