Friday, January 24, 2014

Limits to Singapore Dollar Weakness

The US dollar hit an intra-day high of S$1.2830 Thursday. This was close to the S$1.2859 high seen during the emerging market volatility during the middle of last year. Like last year, the market is once again wondering if the US dollar can extend its rise to S$1.30. This can be achieved in several ways, but the odds of these outcomes materialising are low at this point.

The first scenario would require the Singapore dollar nominal effective exchange rate to fall through its mid-point to the bottom of its appreciating policy band. The only time this happened was in September 2011 when the Eurozone crisis erupted. This was considered a shock because it came immediately after the US lost one of its triple-A debt ratings in the previous month. The market was very short of US dollars then.
Today, there are no such positions to unwind. The market believes that the Fed policy to taper asset purchases will support the US dollar. The Eurozone is also exiting and not entering into a crisis, and US dollar bulls have been frustrated with the euro’s strength.
Against a more constructive outlook for the advanced economies, Singapore’s growth bottomed last year, and has been recovering back to the level seen in the September quarter of 2011. Unless the central bank materially downgrades its 2%-3% inflation outlook for 2014, policy should continue to favour the Singapore dollar NEER policy band appreciating at a modest and gradual appreciation pace of 2% a year.
The second scenario would require broad-based US dollar strength against the trade-weighted basket of currencies. The US dollar rose after the Fed first tapered asset purchases on December 18, but its trade-weighted policy band remained flattish. In fact, the latest peak in the band was also lower than the one seen during last summer’s volatility. Unlike last year, US dollar strength was more selective and balanced, than broad-based.
Within Asia, weaker domestic-led Southeast Asian currencies were balanced by stronger Northeast Asian export-led currencies. Policy divergences pitted a weak Japanese yen against an appreciating Chinese yuan. While the hard-hit Indian rupee recovered some lost ground and stabilised, the Indonesian rupiah extended its decline, while the Malaysian ringgit returned to its lows last summer. Outside Asia, stronger European currencies helped offset the weaker commodity currencies.
For now, we expect the Singapore dollar to hold above the mid-point of its policy band. This suggests that the upside in US dollar will be currently limited to the mid-point of the band, which has eased to S$1.2840 Friday from its S$1.2850-S$1.2860 high this week. As for the expected Federal Reserve taper next week, US dollar bulls are also disturbed by the resurgence of the European currencies and the US ten-year bond yield retreating further from 3.00% to below 2.80% Thursday.