Firming Regional Currencies and Revival of Carry Trades Bullish for the Phisix

``Asia’s riches and development, in fact, have been argued by historians to have been the basis for the growth and concentration of wealth and trade in Europe, particularly in Venice and Genoa.”- George Magnus, Senior Economic Advisor to UBS Investment Bank, quoted from the article, Sovereign Wealth Funds and the Rise of the "Global South"

In all, so far with global equity markets as the apparent beneficiaries of a struggling US dollar and a levered play on global growth, seasonal strength going to the yearend, aside expectations of continued global economic and financial buoyancy, liquidity inspired resumption of carry trades and heightened signs of inflation among key Asian economies as China, India and Singapore highlights the prospects for further currency appreciation or a liquidity spillover from unsterilized actions by central banks to limit currency movements.

In addition, even if the Bernanke’s FED were to pause from slashing of its interbank rates, economic growth prospects and interest rate spreads as well as interest rate expectations, are unlikely to be supportive of the US dollar, considering the intensifying losses in its real estate industry.

Except for the excessive investor sentiment against the US dollar, aside from its technically oversold position, the US dollar’s recently could be due to such transient factors.

Meanwhile, the Bangko Sentral ng Pilipinas (BSP) recently reduced overnight bank lending rates by 25 basis points in order to neutralize the implied tightening seen by the streak of the appreciating Peso aside from the possibly reducing the currency’s appeal for carry trade arbitrages, in our view.

Carry trades, or borrowing or shorting currencies with low yields and investing the proceeds into high yielding assets have been reignited on a global scale as the major funding currencies of the Japanese Yen and the Swiss franc has drifted lower amidst the appearance of stabilizing financial markets.

Surging emerging assets, global equities and commodities coincidental to the decline of the funding currencies could be empirical indications of the renewed activities in such specialized highly speculative trades.

A rise in volatility frequently coincides with the rise of these funding currencies as the levered positions utilized by such cross currency arbitrage get closed alongside with the corresponding liquidations of the assets invested.

The Fed’s move to drop interest rates has likewise caused other central banks to procrastinate from normalizing interest rates such as the Bank of England, and European Central Bank. The Bank of Japan is expected to keep on hold its rates too. Remember, these four central banks control policy rates for about 95% of the world’s international bonds and nearly all of the financing for international trade and financial markets, according to Cumberland Advisors’ David Kotok.

So the combined policy accommodation seems to have restored the inflationary speculative cycle.

And our thinking is that instead of manipulating the currency movements, the BSP or the local central bank has lowered rates to reduce the yield spread to prevent further appreciation caused by mounting incidences of carry trades.

However, the backstop of liquidity signifying continued strength in the region is likely to diffuse into Philippine assets barring any further credit shocks or deterioration in the US economy.

The short term risk is the technically overbought conditions could lead to an interim correction which should provide us ample opportunities to reposition or reenter.

While we maybe cautiously bullish on the markets over the interim for the abovestated reasons, don’t forget to invest only the amounts of risk you are willing to absorb.

Present conditions, such as a potential hard landing in the US or another bout of credit seizure or ripple effects from a violent US dollar unraveling or a sudden bust in China’s markets, are prone to shocks, whose risks should not be taken for granted.

Present conditions likewise allow us to position to take advantage of short-term trades as well as to position for a longer horizon. Invest prudently.