Heading into 2021, markets continue to price in a positive outlook for the real economy. Continued positive developments on a COVID-19 vaccine support the narrative that inoculations could start this year. While it will take time to build a critical mass of vaccinated people, vaccine progress reduces virus tail risks that could lead to a double-dip recession.
Policy support should also aid in the recovery. On the fiscal side, additional aid may not be coming in the near term, but countries are also not expected to start tightening policy or address debt sustainability concerns early in the recovery. On the monetary side, most of the tools have already been used, but central banks should keep policies loose during the early stages of the recovery.
Given these factors, Asian FX appears in position to be a currency winner in 2021, although current positioning likely constrains the pace of near-term gains. Here are three key themes that will determine whether or not Asian FX can realize its optimistic outlook. - COVID-19 normalization: Like the rest of the world, Asia’s recovery is contingent on the successful introduction of a COVID-19 vaccine. This is especially relevant for Indonesia, India and the Philippines, as these countries have struggled with controlling the virus. Balance of payments also matter, meaning Thailand could benefit from a resumption of tourism, while China’s services deficit is likely to grow.
- Policy mix: Western economies are likely to remain heavily dependent on monetary stimulus as fiscal policy is constrained by gridlock in the U.S. and bureaucracy in Europe. This lower-for-longer interest rate outlook in the developed markets should support Asian markets where higher nominal yields will be attractive to foreign investors. China stands out as a country that will benefit from the search for yield.
- Tolerance for FX appreciation: As the global economy recovers, U.S. dollar selling from exporters should provide a tailwind for local currencies. The key question is whether Asian policymakers will be tolerant of further appreciation. This is particularly relevant in countries such as India, Singapore and Thailand, which intervened aggressively in 2020.
Finally, the biggest wildcard in the market’s positive outlook is the assumption that a Biden administration will be positive for U.S.–China relations. While expectations for de-escalation under a Biden administration is reasonable, there are reasons to be cautious. Near term, the current administration could still take more aggressive actions. Longer term, the White House is likely to face provocations to test the boundaries of the Biden administration. | |
| HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT: | |
- The General Services Administration (GSA) will start providing President-elect Biden with federal resources intended to assist in a smooth transition of power. In a tweet late Monday, President Trump said that the GSA was “being allowed to preliminarily work with the Dems” but that his legal fight wasn’t over and that he would “never concede” to the election fraud he has baselessly alleged.
- President-elect Biden has started to name his cabinet picks after reports emerged yesterday that he will nominate former Fed Chair Janet Yellen to be the next Treasury secretary. If confirmed, Yellen will be the first female to hold the position. Additionally, it has been reported that Biden asked Lael Brainard to remain at the Fed, raising speculation that she could be in line to be the next Fed chair when Jay Powell’s term expires.
- Commodity trading levels have returned back to pre-virus levels. The estimated value of open interest has climbed to $937 billion as investors look past near-term growth risks.
- German IFO survey data came in mixed, with the business climate and current assessment components beating expectations but the expectations component disappointing. While it appears that we are headed for a downturn, the hope is that positive vaccine news will make the drop in sentiment less steep.
- U.K. Prime Minister (PM) Boris Johnson confirmed that the country’s national lockdown will end next week and be replaced by a three-tier system of regional restrictions that will last until spring. In response, the British Medical Association has warned that the PM’s plan was not tough enough to control the virus.
- The New Zealand dollar is up on the day as the country’s central bank is considering adding house price inflation to monetary policymaking after a request to do so came from the government. Should this happen, the chances of negative rates will fall even further, as housing prices have surged during the pandemic.
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