FxWirePro: Fed’s move and Chinese slowdown hamper EM pairs – MYR, KRW and BRL vulnerable

With a Fed hike around the corner is likely to prolong for another 2-3 months, the spotlight shifts back to the spillover effects on some of the emerging economies. This time, however, we expect a Fed rate hike to have a very different impact on the relative performance of Asian FX. MYR, IDR, TWD, and KRW are the most vulnerable to higher US rates and a higher USD. On the other end of the spectrum, RMB, INR, and PHP appear to be in the strongest positions.

MYR the most worrying among Asian currency crosses, bear monitoring metrics such as short-term external debt to GDP and short-term external debt to FX reserves are key indicators of an economy's resilience to external shocks. Malaysia stands out as having the weakest among evolution of these debt metrics since 2012. Korea is also one of the most vulnerable Asian economies to a slowing China, and authorities are adopting an easing bias, including measures to help recycle the current account surplus.

Currency strategies:

Long USDCNH forwards and long USDKRW NDFs Slower growth, increasing risk of capital outflows and CNY overvaluation would likely steer China away from pegging to the rising dollar. We see this happening in reaction to a stronger USD environment as well as the need to stabilize outflows.

Long USDBRL 3-month 1x1 call spread on worsening fiscal outcomes amid slowing growth is being perceived as implying tolerance for higher inflation. BRL weakness has happened alongside higher breakevens, but it still looks expensive adjusted for credit quality. Risk premium is likely to rise further.