Asian currencies have appreciated against the U.S. dollar (USD) somewhere between 2% and 9% since the USD index peaked in late March, yet this was short of the 10%-25% gain in G7 and European currencies.
Although we believe the USD still has room to depreciate in the medium to long term, Asian currencies’ strength may be limited by their valuations. The following chart shows many Asian economies’ exchange rates are currently above their long-term averages, based on their real effective exchange rates (REERs).
Exhibit 1: Most asian currencies are in line with, or above, their long-term averages based on REER
We believe this either reflects their consistent current account surpluses, for economies such as China, Korea and Thailand, or their attractive yields, in markets such as India and Indonesia. Better control of the COVID-19 pandemic in most of the economies within the region, reflecting more effective governance, could also be a factor in supporting their currencies.
More moderate currency appreciation is also good news for Asian exporters, who would experience a smaller erosion of their profit margins. Traditionally, stronger Asian currencies typically take place when global growth is strong, and hence margin pressure would be offset by strong global demand. However, as we are still at an early stage of recovery from the pandemic, export volume may not recover until late 2020 or 2021.
Even though Asian currencies’ room to appreciate may be limited by their valuations, broad USD weakness should be sufficient to attract capital into Asian assets, both in equities and fixed income. More importantly, USD weakness typically coincides with solid global growth and more robust risk appetite. Both of these factors are positive for Asian equities and fixed income, especially when low risk free rates would attract international capital to their regions to generate income. The structural growth stories in Asia, such as consumption and infrastructure investment, should also appeal to long-term investors globally.