This article first appeared in Personal Wealth, The Edge Malaysia Weekly on May 21, 2018 - May 27, 2018

The ringgit is still poised to perform well towards the end of the year as international investors are seeing encouraging post-election developments, according to market observers.

Sergei Strigo, head of emerging market debt and currency at Amundi Asset Management in London, says the company remains positive on the ringgit following the announcements of reforms and new policies after the 14th general election, although there are some concerns over the campaign promises of the Pakatan Harapan (PH) coalition.

“The key areas to watch would be potential changes to the taxation system and fuel subsidies, but the latest discussions regarding the Council of Elders [Team of Eminent Persons], independence of the central bank and Prime Minister Tun Dr Mahathir Mohamad’s anti-corruption [policy] are very positive and should improve the image of Malaysia in the eyes of the international community,” says Strigo.

Stephen Innes, Asia-Pacific head of trading at Oanda, concurs, adding that the market reaction to PH’s surprise win was relatively calm. “The bond market, for example, was predicted to experience anywhere between 0.20% to 0.25% pullback, but it opened at around 0.05% to 0.10%.

“We will probably have a better sense of the currency’s direction in the next two weeks, but the opening salvo is relatively positive in my view. There is no panic in the market, the Asian market still looks fine and we are not looking at any serious negative fallout on equities or bonds so far,” says Innes.

The wildcard to the currency’s performance, he adds, would be the Goods and Services Tax (GST) and how the debt agencies react to Mahathir’s pledge to scrap the unpopular tax within 100 days. Moody’s Investors Service and Fitch Ratings have recently raised concerns that abolishing GST could dent the government coffers if it is not offset by any other revenue-raising measures.

However, Mahathir has announced that the country has enough revenue to remove the value-added tax. Innes says that he views GST as a double-edged sword — while it could put the budget at risk, more money in people’s pockets will lead to more spending, which is positive for the economy in the long term.

“The current Malaysian government also proposed to bring back the fuel subsidy, which could be viewed as inflationary. This could be good for the ringgit as it could lead to Bank Negara Malaysia taking a more hawkish stance later in the year, compared with its current neutral stance,” says Innes.

On May 12, Mahathir announced the formation of the Team of Eminent Persons, tasked with, among others, advising the new government on economic and financial matters during the transition of power. Innes says this is also seen as a positive move for the performance of the currency, especially as the team comprises very experienced and prominent individuals.

“The highlight is the appointment of former Bank Negara governer Tan Sri Dr Zeti Akhtar Aziz to the team. This is very favourable as she is the one responsible for bringing Malaysia out of past financial crises. I think there will be better collaboration between the government and Bank Negara going forward,” says Innes.

“I think it is interesting that the appointments are based on merit and not patronage. We are also looking at a smaller Cabinet, no bigger than 30, as announced by the prime minister, so we think policy decision-making should be quicker.”

Aside from the post-election factors, Strigo says the ringgit is the most attractive Asian currency to Amundi because the position seems to be very clean due to the measures that Bank Negara has taken to curb currency speculation.

“Ultimately, the economy is rebounding, so growth is improving. The rate hike in January helps too, and the country’s current account surplus is still very strong. Looking at the performance of the ringgit in the past 12 months, we definitely see more room for it to appreciate, so we are very constructive on the currency.”

Innes says the currency is also poised to outperform due to high internal and external demand. “Malaysia is one of the major beneficiaries of China’s Belt and Road Initiative and once it kicks in, it is going to provide and stir more capital inflows to Malaysia. Oil prices will continue to rise and while it is considered inflationary in Malaysia, it will also be supportive because Malaysia is one of the largest exporters of oil and gas in the region. To top it off, I think Bank Negara is quite welcoming to a stronger ringgit, simply because it does not want to raise rates further and a stronger ringgit will theoretically act as an inflationary buffer.

“The market also does not fear the political risk in Malaysia. Despite some scandals that have happened over the past couple of years, at the heart of the matter is that it is hard to ignore Malaysia’s performance, exports and current accounts. As the economy starts to get more sophisticated and mature, I think the country stands to be one of the go-to places for foreign investors,” says Innes.

EM currencies spell opportunities

Aside from the ringgit, other selected Asian and emerging market (EM) currencies remain attractive this year, despite the risk of an escalating trade war between the US and China, says Strigo. “The overall risk environment today is supportive for risky assets. By and large, the global economy is recovering in both the developed markets (DM) and EM and commodity prices have rebounded and stabilised at the current levels.

“Against the backdrop of the political noise coming from DMs, EM bonds and currencies remain relatively higher-yielding assets compared with [those in] DM. Obviously, there is a market time and element involved as well but ultimately, having a basket of EM currencies that are undervalued, or have a very strong momentum, is a good idea because it has significant room to perform,” says Strigo.

Over the past few months, the risk of an escalating trade war between the US and China has hogged the headlines, making currency investors nervous about their investments across different asset classes.

Among the EM currencies that Amundi favours at the moment are the Mexican peso, the ruble, Turkish lira and the rand. Meanwhile, within Asia, the currencies that the company is “overweight” in are the ringgit, rupiah and Indian rupee.

According to Strigo, an allocation of 10% to 20% in EM local currency or hard currency bonds would be ideal for a global fixed income portfolio in order to take advantage of the potential EM currency outperformance. He adds that aside from the risk of a significant sell-off in global equity markets, political risk in the EM can still have a big impact on EM currencies.

“This year is a very busy election year, starting with Russia on March 18, then Mexico in early July and Brazil in autumn, so the period running up to the elections and the outcomes will influence the assets in the countries to some extent. For example, in early February South Africa changed presidents and the rand rallied quite significantly,” says Strigo.

The trade war risk, which has been widely discussed among market players, has yet to elicit any strong reaction from the currency markets relative to how it has impacted trading in the equity markets. According to Innes, this is due to the uncertainty in currency markets of how the trading market is going to play out versus in the equity markets, where fear has been a recurring theme in the past few months.

“Equity investors are worried that the trade war could erode some of their long-term positions so they got out of equities very quickly. Currency markets, however, are a mixed bag. For instance, when the trade war rhetoric was easing recently, US president Donald Trump suddenly announced a plan to slap another US$100 billion in tariffs on Chinese imports, so the markets are very confused.

“If a full-blown trade war does take place, commodity markets will weaken, so currencies that are susceptible to oil prices, such as the Australian dollar and Canadian dollar, will be the nearest victims,” says Innes.

The Australian dollar and Canadian dollar, part of the commodity block of the G10 currencies, are exceptionally prone to increasing tariffs due to their proximity in the global supply chain and proximity to iron ore exports to China. The increase in tariffs could dent China’s demand, hurting the currencies.

Asian currencies had a strong run last year, completing one of the best years in the past two decades. The Bloomberg JPMorgan Asia Dollar Index, which measures 10 of the region’s currencies against the greenback, even recorded its biggest annual advance since it started in 1994, climbing 6.7% last year.

Despite hitting a two year-low in early March, the rupiah is still considered an interesting opportunity, says Strigo. After hitting 13,800 against the greenback on March 1, Bank Indonesia is said to have intervened in the market to support the currency. “The central bank has been very vocal in limiting the appreciation of the rupiah and that potentially was what is preventing the currency from going strong, but now there is pullback, and we are looking at more interesting levels,” says Strigo.

According to Khoo Hsien Liang, portfolio manager at Affin Hwang Asset Management Bhd, the rupiah and Philippine peso are the worst-performing currencies against the US dollar from the beginning of the year to April 30. He explains that this is the result of the two countries’ twin deficits (fiscal and current account) in a tighter global monetary policy environment.

“The peso and rupiah would face continued pressure until the end of this year due to continued current account deficits. This position would be further pressured due to increasing oil prices as both economies are net importers of energy,” says Khoo.

Meanwhile, the baht has done well, strengthening 3.3% against the US dollar from the beginning of the year to April 30, as the country is running a large current account surplus of 8% to 10% of its gross domestic product. However, Khoo says that it would be difficult for the currency to strengthen further, as the US Federal Reserve is expected to hike rates while the Bank of Thailand is unlikely to raise rates due to low inflation.

Greenback expected to underperform

Looking at the longer-term view, Oanda’s Innes says that once the trade war rhetoric is out of the way, the market will start to readdress central bank policy decisions. The Fed is expected to continue to raise rates moving towards 2019, which will be supportive of the US dollar. However, his view on the greenback is negative due to overhang risks, which include the Mueller investigation and uncertainty surrounding what Trump’s administration wishes to achieve.

“Right now, the market is in a little bit of fluctuation because the US dollar is oversold. Everybody is short on the US dollar, euro and yen. I think the reason why the market is holding these positions is because of the expectations of the central banks — the European Central Bank (ECB) and Bank of Japan (BoJ) — to change policy, within the dialogue of rising interest rates and quantitative easing in the relative countries,” says Innes.

While he says it is quite clear that the Fed is raising interest rates four times this year, there might be surprises from ECB and BoJ. “With that in the background, there is one elephant in the room, which in my view will keep the US dollar in the tank — and that is the expanding US budget deficit. That deficit is going to be enormous because there is no way to pay for it. The only way they can pay for it is to sell US bonds in the market, and nobody wants to buy US bonds for fear the yield is going to go higher.

“With no demand for US dollar bonds, interest rates become less sensitive over the long run and therefore the US dollar continues this gradual increase going down the road. So I think there is still a structural change to a longer-term bias for the weaker dollar heading to 2019,” says Innes.

Meanwhile, Strigo says that there is improvement in the eurozone economies and the ECB is becoming more hawkish from the point of view of reducing the quantitative easing and to hike interest rates. “With the political noise of the elections in France, Germany and Italy out of the way, there is a general consensus that Europe is becoming attractive as an investment destination.

“We are seeing significant inflows into European assets. Combined with a very strong current account surplus, the euro basically has all the support and probably has more room to appreciate versus the greenback but it will not be in a straight line,” says Strigo.

With the assumption of a weaker US dollar, Innes says that heading to 2019, the exchange rates against the US dollar are 1.30 for the euro, 100 for the yen, 3.80 for the ringgit, 1,000 for the won, and 6.20 for the renminbi.

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