Report by Standard Chartered Global Research on Tuesday, Oct 12
KUALA LUMPUR: Malaysia's central bank allowed the Malaysian ringgit nominal effective exchange rate (MYR NEER) to appreciate sharply in H1-2010, reflecting strong economic fundamentals.
In line with this, Malaysia's FX reserves were roughly stable from mid-September 2009 to mid-September 2010. However, since then, the reserves have risen sharply. In our view, this may reflect a subtle new change in Malaysia's FX policy.
To analyse the MYR against its trade-weighted basket, we have updated the Standard Chartered MYR NEER to reflect the change in Malaysia's trading patterns. The MYR NEER has depreciated since mid-September.
While Bank Negara Malaysia (BNM) remains broadly confident in economic fundamentals, the central bank may have become more concerned that sharp MYR appreciation was out of line with economic fundamentals.
We expect USD-MYR to grind lower into year-end on broad US dollar (USD) weakness, widening US- Malaysian rate expectations, and seasonal factors. In H1-2011, USD-MYR should bounce on slowing growth expectations.
Over the coming three to six months, we expect the MYR NEER to be roughly stable, supported by the subtle change in BNM's FX policy, and as most of the positives appear to be in the price. In line with this, we maintain our short-term Neutral FX rating on the MYR.
The sharp rise in the FX reserves in September can partly be explained by valuations, as the USD has fallen broadly, particularly against the euro (EUR). However, we believe that it may also reflect a subtle change in Malaysia's FX policy.
When Malaysia de-pegged the MYR from the USD on 21 July 2005, BNM provided the following explanation of the change in the exchange rate system:
'Bank Negara Malaysia announces today that the exchange rate of the ringgit with immediate effect will be allowed to operate in a managed float, with its value being determined by economic fundamentals. Bank Negara Malaysia will monitor the exchange rate against a currency basket to ensure that the exchange rate remains close to its fair value. Promoting stability of the exchange rate continues to be a primary objective of policy. Changes in the international and regional financial and economic environment have made it important for Malaysia to have a stable exchange rate against its major trading partners, in particular, the regional countries. Consequently, the stability of the ringgit exchange rate against the regional currencies will become increasingly important. Such stability can best be achieved by maintaining the value of the ringgit against a trade-weighted index of Malaysia's major trading partners.'
This explanation highlights the fact that Malaysia operates a managed float in which the value of the MYR is determined by economic fundamentals, but also that the central bank monitors the MYR against a trade-weighted basket.
While BNM does not have an explicit policy band for the MYR, the central bank has always emphasised the orderly movement of the currency. To analyse the MYR against a trade-weighted basket, we have made some adjustments to the Standard Chartered MYR NEER, which we introduced in November 2008.
Notably, we have assumed the same weightings from the de-pegging in July 2005 to December 2007, and changed the weightings in January 2008 to reflect the change in Malaysia's trading patterns.
We have spliced the index at 1 January 2008 (in line with the method outlined in 'Measuring the Real Effective Rate: Pitfalls and Practicalities', Reserve Bank of Australia Research Discussion Paper No. 2001-04, Luci Ellis, 2001). The change in trade weights from July 2005-December 2007 to January 2008-October 2010 period is based on the following factors:
1. Malaysia's trade with the US as a percentage of its total trade is decreasing.
2. Malaysia's trade with China as a percentage of its total trade is increasing.
3. Malaysia's trade with emerging Asia as a percentage of its total trade is increasing.
Chart 2 illustrates the adjusted Standard Chartered MYR NEER. From July 2009 to July 2010, the MYR NEER appreciated.
In our view, this reflected a silent policy change by BNM ' the MYR NEER was allowed to appreciate sharply as the authorities became more confident in improving fundamentals. Malaysian fundamentals improved from mid-2009 to mid-2010, with Q2-2010 GDP rising 8.9% y/y after contracting 3.9% y/y in Q2-2009. The Standard Chartered MYR NEER peaked on 9 September 2010 at 109.50.
Since 10 September, the MYR NEER has depreciated around 2.85%, to 106.38 as of today. In our view, this may reflect a silent policy change. While BNM remains broadly confident in Malaysia's economic fundamentals, it may have become concerned that the sharp MYR NEER appreciation was out of line with economic fundamentals.
FX outlook
We forecast that Malaysia's GDP growth will slow to 3.5% y/y in Q3-2010, 2.8% y/y in Q4-2010, 2.3% y/y in Q1-2011 and 2.4% y/y in Q2-2011, from 8.9% y/y in Q2-2010. For the whole of 2011, we expect GDP growth to slow to 4.5% from 6.2% in 2009.
This is in line with the slowdown expected in other small, open Asia ex-Japan (AXJ) economies such as Singapore, Thailand and Taiwan, given slowing growth in the US and China.
While we expect Malaysia's current account surplus to improve to 17.0% of GDP in 2010 from 16.7% in 2009, the risk appears to be on the downside given the sharp narrowing of the trade surplus.
Meanwhile, we expect BNM to raise interest rates to 3.00% in Q1-2011 and to 3.50% in Q2-2011, from 2.75% currently.
Hence, we expect interest rate expectations to continue to support the MYR in the coming quarters.
Finally, we note the strong seasonality of the MYR, which, in line with several other AXJ currencies, tends to perform strongly in Q4 and Q1 and underperform in Q2 and Q3 (see FX Alert, 23 July 2010, 'The outlook for AXJ currencies in H2').
In sum, we expect USD-MYR to grind lower into year-end on broad USD weakness, a widening differential between US and Malaysian rate expectations, and seasonal factors. In H1-2011, USD-MYR should bounce on slowing growth expectations.
Over the coming three to six months, we expect the Standard Chartered MYR NEER to be roughly stable, supported by the subtle change in BNM FX policy, and as most of the positives appear to be in the price.
FX strategy
Leveraged funds
Short-term technicals for USD-MYR are bullish, as the 14-day RSI, stochastics and the MACD are pointing higher in neutral territory. The next key resistance level comes in at 3.1750, whereas support remains at the low of 3.0815 from 29 September.
Weekly charts are mixed ' stochastics are pointing higher in oversold territory, whereas the RSI and the MACD are pointing sideways. The daily reading of our risk appetite measure is edging higher, in Risk seeking territory.
This is a bullish signal for the MYR given its usual correlation with global risk sentiment. We believe that the offshore community is short USD-MYR, but less so than a month ago given the recent choppy trading pattern.
Hence, based on technicals, risk appetite and positioning, the short-term outlook for USD-MYR is mixed. We recommend that leveraged funds stand aside for now, but look to re-establish short positions ahead of resistance at 3.1750.
Real money funds
Asset managers who manage their currency risk actively and separately from their underlying exposure tend to take a more qualitative, or 'fundamental', rather than a quantitative, or technical, approach. We suggest that such asset managers maintain a Neutral position, as the MYR NEER is likely to remain stable given BNM's subtle policy shift and the fact that most of the positives appear to be in the price.
Currency overlay managers, by contrast, tend to take a more qualitative, or technical approach. Granted, this is a generalisation, but it does seem to be the case that the majority of currency overlay managers adopt a quantitative approach to currency management.
Key USD-MYR MAs have bottomed out and are edging higher. This suggests that currency overlay managers will be cutting short USD-MYR positions and moving to a long position.
Corporates
Transaction risk
Our USD-MYR forecasts are below onshore forwards on a three-month horizon, but above onshore forwards into Q2-2011. Hence, Malaysian exporters with short-term USD receivables should maintain high hedge ratios on short-term USD receivables.
However, over the coming three to six months, Malaysian exporters should lower their hedge ratios on short-term USD receivables.
Malaysian exporters with short-term and medium-term EUR and Japanese yean (JPY) receivables should maintain high hedge ratios, as the MYR should outperform the EUR and the JPY over the medium to long term.
Translation risk
With respect to translation risk, we expect the MYR to gradually appreciate versus the USD on a medium- to long-term basis.
As such, we advise USD-based clients to lower their hedge ratios for MYR-denominated assets. EUR-, GBP-, AUD-, NZD- and JPY-based corporates should also consider lowering their balance-sheet hedges of MYR-denominated assets, as these currencies should underperform the MYR over the longer term.
Similarly, Malaysian corporates with G10 subsidiaries should maintain high balance-sheet hedges on G10 currencies.
''
KUALA LUMPUR: Malaysia's central bank allowed the Malaysian ringgit nominal effective exchange rate (MYR NEER) to appreciate sharply in H1-2010, reflecting strong economic fundamentals.
In line with this, Malaysia's FX reserves were roughly stable from mid-September 2009 to mid-September 2010. However, since then, the reserves have risen sharply. In our view, this may reflect a subtle new change in Malaysia's FX policy.
To analyse the MYR against its trade-weighted basket, we have updated the Standard Chartered MYR NEER to reflect the change in Malaysia's trading patterns. The MYR NEER has depreciated since mid-September.
While Bank Negara Malaysia (BNM) remains broadly confident in economic fundamentals, the central bank may have become more concerned that sharp MYR appreciation was out of line with economic fundamentals.
We expect USD-MYR to grind lower into year-end on broad US dollar (USD) weakness, widening US- Malaysian rate expectations, and seasonal factors. In H1-2011, USD-MYR should bounce on slowing growth expectations.
Over the coming three to six months, we expect the MYR NEER to be roughly stable, supported by the subtle change in BNM's FX policy, and as most of the positives appear to be in the price. In line with this, we maintain our short-term Neutral FX rating on the MYR.
The sharp rise in the FX reserves in September can partly be explained by valuations, as the USD has fallen broadly, particularly against the euro (EUR). However, we believe that it may also reflect a subtle change in Malaysia's FX policy.
When Malaysia de-pegged the MYR from the USD on 21 July 2005, BNM provided the following explanation of the change in the exchange rate system:
'Bank Negara Malaysia announces today that the exchange rate of the ringgit with immediate effect will be allowed to operate in a managed float, with its value being determined by economic fundamentals. Bank Negara Malaysia will monitor the exchange rate against a currency basket to ensure that the exchange rate remains close to its fair value. Promoting stability of the exchange rate continues to be a primary objective of policy. Changes in the international and regional financial and economic environment have made it important for Malaysia to have a stable exchange rate against its major trading partners, in particular, the regional countries. Consequently, the stability of the ringgit exchange rate against the regional currencies will become increasingly important. Such stability can best be achieved by maintaining the value of the ringgit against a trade-weighted index of Malaysia's major trading partners.'
This explanation highlights the fact that Malaysia operates a managed float in which the value of the MYR is determined by economic fundamentals, but also that the central bank monitors the MYR against a trade-weighted basket.
While BNM does not have an explicit policy band for the MYR, the central bank has always emphasised the orderly movement of the currency. To analyse the MYR against a trade-weighted basket, we have made some adjustments to the Standard Chartered MYR NEER, which we introduced in November 2008.
Notably, we have assumed the same weightings from the de-pegging in July 2005 to December 2007, and changed the weightings in January 2008 to reflect the change in Malaysia's trading patterns.
We have spliced the index at 1 January 2008 (in line with the method outlined in 'Measuring the Real Effective Rate: Pitfalls and Practicalities', Reserve Bank of Australia Research Discussion Paper No. 2001-04, Luci Ellis, 2001). The change in trade weights from July 2005-December 2007 to January 2008-October 2010 period is based on the following factors:
1. Malaysia's trade with the US as a percentage of its total trade is decreasing.
2. Malaysia's trade with China as a percentage of its total trade is increasing.
3. Malaysia's trade with emerging Asia as a percentage of its total trade is increasing.
Chart 2 illustrates the adjusted Standard Chartered MYR NEER. From July 2009 to July 2010, the MYR NEER appreciated.
In our view, this reflected a silent policy change by BNM ' the MYR NEER was allowed to appreciate sharply as the authorities became more confident in improving fundamentals. Malaysian fundamentals improved from mid-2009 to mid-2010, with Q2-2010 GDP rising 8.9% y/y after contracting 3.9% y/y in Q2-2009. The Standard Chartered MYR NEER peaked on 9 September 2010 at 109.50.
Since 10 September, the MYR NEER has depreciated around 2.85%, to 106.38 as of today. In our view, this may reflect a silent policy change. While BNM remains broadly confident in Malaysia's economic fundamentals, it may have become concerned that the sharp MYR NEER appreciation was out of line with economic fundamentals.
FX outlook
We forecast that Malaysia's GDP growth will slow to 3.5% y/y in Q3-2010, 2.8% y/y in Q4-2010, 2.3% y/y in Q1-2011 and 2.4% y/y in Q2-2011, from 8.9% y/y in Q2-2010. For the whole of 2011, we expect GDP growth to slow to 4.5% from 6.2% in 2009.
This is in line with the slowdown expected in other small, open Asia ex-Japan (AXJ) economies such as Singapore, Thailand and Taiwan, given slowing growth in the US and China.
While we expect Malaysia's current account surplus to improve to 17.0% of GDP in 2010 from 16.7% in 2009, the risk appears to be on the downside given the sharp narrowing of the trade surplus.
Meanwhile, we expect BNM to raise interest rates to 3.00% in Q1-2011 and to 3.50% in Q2-2011, from 2.75% currently.
Hence, we expect interest rate expectations to continue to support the MYR in the coming quarters.
Finally, we note the strong seasonality of the MYR, which, in line with several other AXJ currencies, tends to perform strongly in Q4 and Q1 and underperform in Q2 and Q3 (see FX Alert, 23 July 2010, 'The outlook for AXJ currencies in H2').
In sum, we expect USD-MYR to grind lower into year-end on broad USD weakness, a widening differential between US and Malaysian rate expectations, and seasonal factors. In H1-2011, USD-MYR should bounce on slowing growth expectations.
Over the coming three to six months, we expect the Standard Chartered MYR NEER to be roughly stable, supported by the subtle change in BNM FX policy, and as most of the positives appear to be in the price.
FX strategy
Leveraged funds
Short-term technicals for USD-MYR are bullish, as the 14-day RSI, stochastics and the MACD are pointing higher in neutral territory. The next key resistance level comes in at 3.1750, whereas support remains at the low of 3.0815 from 29 September.
Weekly charts are mixed ' stochastics are pointing higher in oversold territory, whereas the RSI and the MACD are pointing sideways. The daily reading of our risk appetite measure is edging higher, in Risk seeking territory.
This is a bullish signal for the MYR given its usual correlation with global risk sentiment. We believe that the offshore community is short USD-MYR, but less so than a month ago given the recent choppy trading pattern.
Hence, based on technicals, risk appetite and positioning, the short-term outlook for USD-MYR is mixed. We recommend that leveraged funds stand aside for now, but look to re-establish short positions ahead of resistance at 3.1750.
Real money funds
Asset managers who manage their currency risk actively and separately from their underlying exposure tend to take a more qualitative, or 'fundamental', rather than a quantitative, or technical, approach. We suggest that such asset managers maintain a Neutral position, as the MYR NEER is likely to remain stable given BNM's subtle policy shift and the fact that most of the positives appear to be in the price.
Currency overlay managers, by contrast, tend to take a more qualitative, or technical approach. Granted, this is a generalisation, but it does seem to be the case that the majority of currency overlay managers adopt a quantitative approach to currency management.
Key USD-MYR MAs have bottomed out and are edging higher. This suggests that currency overlay managers will be cutting short USD-MYR positions and moving to a long position.
Corporates
Transaction risk
Our USD-MYR forecasts are below onshore forwards on a three-month horizon, but above onshore forwards into Q2-2011. Hence, Malaysian exporters with short-term USD receivables should maintain high hedge ratios on short-term USD receivables.
However, over the coming three to six months, Malaysian exporters should lower their hedge ratios on short-term USD receivables.
Malaysian exporters with short-term and medium-term EUR and Japanese yean (JPY) receivables should maintain high hedge ratios, as the MYR should outperform the EUR and the JPY over the medium to long term.
Translation risk
With respect to translation risk, we expect the MYR to gradually appreciate versus the USD on a medium- to long-term basis.
As such, we advise USD-based clients to lower their hedge ratios for MYR-denominated assets. EUR-, GBP-, AUD-, NZD- and JPY-based corporates should also consider lowering their balance-sheet hedges of MYR-denominated assets, as these currencies should underperform the MYR over the longer term.
Similarly, Malaysian corporates with G10 subsidiaries should maintain high balance-sheet hedges on G10 currencies.
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