number DBS Asian Insights DBS Group Research March 2015 The Mighty US Dollar Foreign Exchange 2Q 2015

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1 06 number economics BRIEFING DBS Group Research March 2015 The Mighty US Dollar Foreign Exchange 2Q 2015

2 02 The Mighty US Dollar Foreign Exchange 2Q 2015 Philip Wee Senior Currency Economist Group Research DBS Bank Produced by: Asian Insights Office DBS Group Research

3 Introduction G3 Currencies Mighty US Dollar Against Euro and Yen Commodity Currencies More Payback Asia ex Japan Currencies Down Versus USD, Up on NEER Realigning to Higher USD US Dollar Euro Japanese Yen Chinese Yuan Hong Kong Dollar Taiwan Dollar Korean Won Singapore Dollar Malaysian Ringgit Thai Baht Indonesian Rupiah Philippine Peso Indian Rupee Vietnam Dong Australian Dollar New Zealand Dollar

4 04 1 Currency forecasts EUR/usd usd/jpy usd/cny usd/hkd usd/twd usd/krw usd/sgd usd/myr usd/thb usd/idr usd/php usd/inr usd/vnd AUD/usd NZD/usd DBS forecasts in red. are median forecasts collated by Bloomberg as at 11 Mar 2015

5 05 Introduction W e live in interesting times when it comes to the world s currencies. Foreign exchange markets have seen massive, sometimes volatile, shifts in the values of the US dollar, the euro and the Japanese yen. Elsewhere in commoditybased economies, boom times have turn into hard times and their oncesoaring currencies had fallen fast. From Washington to Tokyo to Frankfurt and beyond, central bankers and policymakers are making daily headlines as they try to come to grips with the effects of low oil prices and stubborn deflation. Standing out in this landscape of challenges and crises has been the rise and rise of the greenback. Now that the US Federal Reserve has ended years of quantitative easing (QE) and is eyeing rate hikes, the US dollar s fortunes seem unstoppable, at least for a while. Meanwhile, the Eurozone and Japan are hoping their own versions of QE will eventually nudge their moribund economies back to recovery and growth. And, in China, authorities are trying to manage its inevitable slowdown. As for the rest of Asia, most of their exchange rates are actually stable to firm on a trade-weighted basis, even as they cope with currency depreciation against the dollar. This report attempts to explain what has happened, why it happened, and what could be ahead. 2 DXY (USD) index - from crisis to recovery 3 Are markets underestimating Fed hikes?

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7 07 G3 Currencies Mighty US Dollar Against Euro and Yen Quantitative easing...the markets risk underestimating the Fed s intentions to return real interest rates to positive territory 4 The US dollar (USD) is expected to sustain its uptrend over the next couple of years on divergent monetary policies. The most significant development in the 2015 March quarter was the European Central Bank s (ECB) success in pushing through QE to fight deflation. Lasting from March 2015 to September 2016, the program is to expand the ECB s balance sheet to a new high. The Bank of Japan (BOJ) had earlier launched a second round of QE last October and is likely to keep expanding its balance sheet to record highs into its scheduled second sales tax hike in April Conversely, the US Federal Reserve s balance sheet has stopped expanding after its last taper in October, which effectively ended QE3. Exiting its crisis, the Fed is keen to further normalise monetary policy by hiking interest rates later this year. It is here that the markets risk underestimating the Fed s intentions to return real interest rates to positive territory. According to the Fed s optimal study, the Fed Funds Rate should return to 3-4% by 2017, above the Fed s 2-2.5% inflation target. In summary, QEs in Japan and the Eurozone were mostly responsible for leading the benchmark DXY (US dollar) index out of its post-crisis range. Having recovered more than half of its losses from the last weak USD cycle in , the DXY has scope to extend its recovery on the approaching Fed hike cycle. ECB s balance sheet to expand until Sep BOJ s monetary base to expand until April 2017

8 08 6 Black gold slides, yellow gold lacking lustre Currencies 7 NZD & AUD - room to catch-up with CAD Commodity Currencies More Payback Most overvalued Demand for commodities was dampened by the lopsided world economy. The outlook for commodities and commodity currencies first turned negative when the USD started to recover its status as the world s leading reserve currency. America s exit from its crisis was first heralded by the Fed tapering asset purchases to end QE3. This first sell-off in commodity currencies in 2013 was led by the plunge in gold prices during the Fed taper tantrums. Demand for commodities was, meanwhile, dampened by the lopsided world economy. Before Abenomics turned up, Japan was mired in deflation. The Eurozone twice entered into crisis. And, China slowed down from its economic restructuring. Against this background, oil prices collapsed in the second half of 2014 from an oversupply in crude. This led Canada and Australia to cut rates, and New Zealand to abandon its rate hike bias. Not surprisingly, the New Zealand dollar (NZD) is considered the most overvalued on an indexed basis, compared with the Australian dollar (AUD) and Canadian dollar (CAD). On a relative value basis, the AUD lost its premium against the USD when the US jobless rate fell below 6%, even as Australia s rose above 6%. With the USD strong globally, Australia and New Zealand consider their exchange rates overvalued. Both central banks have become more vocal and pro-active in seeking more depreciation in their currencies, not only against the USD, but also on a trade-weighted basis.

9 09 8 Relative value - US jobless rate <6% vs AU >6% 9 Why RBA thinks AUD is overvalued 10 Asian currencies - down vs USD but up on NEER 11 MYR - weaker than Southeast Asian peers

10 10 Asia ex Japan Currencies Down Versus USD, Up on NEER Although Asia ex Japan (AXJ) currencies have depreciated against the USD, most have actually appreciated on a nominal effective exchange rate (NEER) basis. This was attributed to the sharp depreciation in major currencies, namely the euro (EUR) and the Japanese yen (JPY) since mid2014. The Malaysian ringgit (MYR) stood out as the weakest AXJ currency which was best reflected by the break in its tight correlation with Southeast Asian currencies. The shock on the MYR from the plunge in oil prices was worse than the 12% depreciation experienced during emerging market (EM) volatility from May 2013 to January By early March 2015, the USD/MYR was more than 10% above the peak hit during EM volatility. To a lesser extent, the same was also seen for USD/IDR, which rose to new highs not seen since the 1997/98 Asian crisis. Despite record high stock markets on reform hopes from newly-elected leaders, the Indonesian rupiah (IDR) and the Indian rupee (INR) have not been able to buck the globally strong USD trend. Although India and Indonesia benefitted from lower oil import bills, both countries want to bring growth rates higher and have surprised with interest rate cuts. With the US expected to hike rates later this year, this should continue to keep the USD on its upward trajectory, not only against these RRR currencies, but also other AXJ currencies. 12 USD/IDR broke above post-asian crisis highs 13 RRR currencies - bracing for US rate hikes

11 11 Realigning to Higher USD To gauge how the strong USD impacted AXJ currencies, we can compare their performances against the benchmark Major (DXY) and Asian (ADXY) currency indices. During the last weak USD cycle in , it was clear that on an indexed basis, major currencies appreciated more than their AXJ counterparts. Hence, the QE policies of Japan and the Eurozone could be viewed as correcting excessive strength in the yen and euro as opposed to targeting weaker exchange rates or promoting currency wars. After the 2008 global financial crisis, export-led Korea and Taiwan kept their exchange rates competitive and close to the ADXY, in spite of record-high foreign reserves and current account surpluses. Global rebalancing efforts were, instead, led by the Singapore dollar (SGD) and the Chinese yuan (CNY) via appreciating exchange rate policies. Unfortunately, this could not be sustained after the DXY reversed its downtrend in mid Since then, the DXY has been rising aggressively, and is set to converge with the ADXY. Singapore responded by slowing its appreciating exchange rate policy in January, ahead of its scheduled policy review in April. Since November, China has cut rates twice, lowered its reserve requirement ratio, and gradually lifted its USD/CNY parity rate. Despite efforts to let their currencies realign to a higher USD, these four countries have only succeeded in slowing the trade-weighted appreciation in their exchange rates. 14 KRW - watching DXY (JPN & EUR) closely 15 TWD - not overvalued for sure 120 Indexed: Feb 2002 = 100 stronger USD ADXY index (AXJ currencies) USD/KRW DXY index (Major currencies)

12 12 16 SGD - following USD higher 17 CNY - no incentive to appreciate 110 Indexed: Feb 2002 = 100 stronger USD 100 ADXY index (AXJ currencies) USD/SGD DXY index (Major currencies)

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14 14 US Dollar DXY Hits 12-Year High on G3 Monetary Policy Divergences US rate hike cycle Effectively, the DXY has recovered more than 50% of its losses The benchmark DXY index ascended to on March 6, its highest level since September Effectively, the DXY has recovered more than 50% of its losses incurred during the last weak USD cycle between 2002 and DXY was also well above the range seen during QE1, 2 and 3 under the Fed. This marked America s exit from the 2008 global financial crisis. Even so, the DXY s surge since mid-2014 was also attributed to monetary policy divergences in the G3 economies. Just as the Fed s last taper ended QE3 last October, Japan shocked with its second qualitative and quantitative easing (QQE2) in the same month in response to its technical recession, while the Eurozone started QE in March this year to fight deflation. Looking ahead, this trend is likely to endure over the next two years. The Eurozone s QE is scheduled to end by September 2016 while Japan s QQE2 is expected to last until its second sales tax hike due in April As for the US rate hike cycle (which is expected to start later this year), the Fed s goal is to normalise monetary policy by returning real rates to positive territory. Currently at %, and below the Fed s 2-2.5% inflation outlook target, Fed Funds Rate would only reach 3-4% by DXY index - emerged from 2008 crisis DXY Policy, %

15 15 Euro EUR/USD Moving Towards Parity on ECB QE and Fed Rate Hike Expectations Divergence The EUR/USD started 2015 below 1.20 on signs that the ECB was moving closer towards QE. The EUR/USD fell below 1.15 on January 22 when the ECB announced it would implement QE in March. It broke below 1.10 just before QE was launched on March 9. Between May 8, 2014 and March 6, 2015, the EUR/USD depreciated 23% from a high of to More importantly, the currency pair is well below the low seen during the PIGS (Portugal-Italy-Greece-Spain) crisis in May 2010, and the low during the Eurozone crisis in July It is important to recognise that the weakness of the euro since May 2014 is not driven by another crisis, but the result of an intended policy decision to ease monetary conditions via a depreciation in the real exchange rate. Looking ahead, the next push for the EUR/USD to fall towards parity would need to come from US rate hikes expected to start later this year. The currency pair should remain weak over the medium-term from an ECB balance sheet expanding to a new record high versus a Fed balance sheet shrinking from its all-time high. This monetary policy divergence is scheduled to last into EUR/USD - moving towards parity EUR/USD Policy, %

16 16 Japanese Yen USD/JPY Eyes Fed Hike to Move Higher Again. But Upside May Be Limited at Around 124 Different challenges Japan s leaders and policymakers are facing new and different challenges today 20 The USD/JPY surged from 101 to 122 in the second half of 2014, into and after the BOJ s QQE2 on October 31. After the ruling Liberal Democratic Party led by PM Shinzo Abe won a snap election on December 14, the USD/JPY has been consolidating mostly between 116 and 121. The same price action was also witnessed in The USD/JPY raced to 103 from 77 in October 2013 to May 2014, into, and after, QQE1 in April Thereafter, it consolidated between 96 and 101, before it rose again to 105 in the 2013 December quarter ahead of the first Fed taper in December If history repeats itself, the USD/JPY is likely to rise again into the first Fed hike, which is expected later this year. This time around, most see the next ceiling for the USD/JPY around the 124 high set in mid Despite the similarities, Japan s leaders and policymakers are facing new and different challenges today. With Japan emerging slowly from a technical recession amid a rout in global oil prices, doubts remain over the BOJ s ability to meet its 2% inflation target. Fiscal reforms have been in doubt after the second sales tax hike was pushed out to April 2017 from October Finally, political scandals appear to have returned to plague Abe and his ministers. USD/JPY - back to 2007 high USD/JPY Policy, %

17 17 Chinese Yuan As China Turns Dovish on Monetary Policies, CNY Keeps Weak Tone Against USD Dovish policy For the first time since 2012, the People s Bank of China (PBOC) cut the one-year lending rate by 40 basis points (bps) to 5.60% on November 21, Less than a month later, the official parity rate for USD/CNY bottomed at on December 17. Since then, the PBOC has been guiding parity higher by 0.7% to as at March 3, During this period, the banks reserve requirement ratio (RRR) was lowered by 50 bps to 19.5% on February 4, while the lending rate was cut a second time on March 1 by 25bps to 5.35%. These dovish policy moves were supported by disappointing data. Consumer Price Index (CPI) inflation fell to 0.8% year-on-year in January 2015, below 1% for the first time since Export growth returned into negative territory in January 2015 after eight months of expansion. Despite a wider current account surplus last year, foreign reserves fell in the second half of The real economy expanded 7.4% in 2014, its slowest growth rate in 24 years. China lowered its 2015 growth target to 7% from 7.5%. Against this backdrop, markets have been keeping onshore USD/CNY rates and offshore USD/CNH rates at the upper side of the official trading band. Looking ahead, China is expected to ease rates and RRR again, and possibly widen the trading band too. 21 USD/CNY - not bucking globally strong USD USD/CNY Policy, %

18 18 Hong Kong Dollar USD/HKD to Rise When US Starts to Hike Rates Later This Year CNY depreciation There was no speculation that Hong Kong would shift its Hong Kong dollar (HKD) peg from the USD to the CNY, and understandably so. The USD is strong globally and also against Asian currencies, including the CNY. In reality, the foreign exchange market was preoccupied with the depreciation of the CNY in the offshore markets. By March 6, the USD/CNH and the oneyear outright non-deliverable forward (NDF) for the USD/CNY was respectively, 0.1% and 2.0% above the official trading band in the mainland. Unlike previous years, the Hong Kong Monetary Authority (HKMA) did not intervene to support the floor of the convertibility band for the USD/HKD. Instead, the central bank was probably more concerned about the health of its financial centre. Hong Kong is caught between rate cuts and more capital account convertibility in China, and liquidity and credit risk from the looming US rate hike cycle. With residential property prices having risen another 13% in 2014, the HKMA on February 24 announced more credit tightening measures to safeguard the financial system from the heated sector. During the last US rate hike cycle in , the USD/HKD rose to 7.80 or the mid of its convertibility band. 22 USD/HKD - moving off its floor USD/HKD Policy, %

19 19 Taiwan Dollar While Currently Favoured by Fundamentals, TWD is Uncertain About Its Political Future Outperforming...businesses have started to worry that an unfavourable outcome at the 2016 presidential elections may strain cross-strait relations 23 The Taiwan dollar (TWD) was the most resilient currency within the Asian NIEs (Newly Industrialised Economies). Since mid-october 2014, Taiwan equities have been consistently outperforming their peers too. Taiwan was the fastest-growing economy (3.5%) in 2014 compared with South Korea (3.3%), Singapore (3.0%), and Hong Kong (2.3%). This lead is likely to be preserved in The government, on February 16, upgraded its 2015 growth outlook to 3.78% from 3.50%. With export growth seen paltry at 1.02%, growth is expected to be driven by strong domestic demand. Ironically, this was not reflected in its dovish outlook for imports (minus 1.02%) and inflation (0.26%). Conversely, such growth optimism was not shared by businesses, which have started to worry that an unfavourable outcome at the 2016 presidential elections may strain cross-strait relations. According to a poll conducted by Want Want China Times Media Group in late February, 57% of the voters favoured the pro-independent opposition Democratic Progressive Party (DPP) to win the election. Hence, the TWD cannot afford to neglect its role of maintaining export competitiveness and price stability in a strong USD environment. USD/TWD - rising back to 2010 high USD/TWD Policy, %

20 20 Korean Won KRW is Facing Multiple Headwinds, Externally and Domestically JPY concerns Export-led Korea has been closely monitoring the Korean won (KRW) against the weak JPY after the BOJ shocked with QQE2 on October 31 last year. This year, Korea is also worried that the ECB s move to launch QE in the 2015 March quarter may weaken the euro and hurt its exports to the Eurozone. Neither did it help that GDP growth slowed for the third straight quarter to 2.7% year-on-year in the 2014 December quarter from 3.9% in the 2014 March quarter. Effectively, the economy was now performing below its potential growth rate, which the Bank of Korea (BOK) estimated to be 3.5%. This was probably why the BOK cut rates in August and October last year, and in March this year. Looking ahead, the BOK could once again lower its policy rate in the 2015 June quarter. CPI inflation fell to 0.5% year-on-year in February 2015, a 16-year low. At 2.3% year-onyear in February 2015, core inflation was also below the BOK s % inflation target. Even so, BOK was wary that the rate cuts may have led housing lending growth to exceed its expectations. During his report to parliament in February, BOK Governor Lee Ju-yeol told lawmakers that foreign reserves might be mobilised to address threats to financial stability from further falls in the JPY and commodity prices, as well as US rate hikes expected later in the year. 24 USD/KRW - tracking weaker JPY & EUR USD/KRW Policy, %

21 21 Singapore Dollar Tone Remains Strong for USD/SGD to Keep Rising Towards 1.40 Surprise decision...the risk of the appreciation policy turning neutral cannot be totally discounted 25 The Monetary Authority of Singapore (MAS), on January 28, eased the appreciation pace of the SGD NEER policy band. The decision took markets by surprise because it came ahead of the scheduled semi-annual policy review in April. Inflation was cited as the reason for the policy change. The central bank downgraded its 2015 inflation outlook to between minus 0.5% and 0.5% from % previously. CPI inflation first turned negative in November 2014 and was last at minus 0.4% year-on-year in January Overall, the 2015 March quarter was best characterised by the SGD NEER depreciating from the mid to the floor of its policy band. According to our model, this represented a 2% depreciation in the SGD on a tradeweighted basis. With the market looking for the MAS to ease again in April, the USD/SGD has been above 1.35 since early February. We reckon the policy band could be re-centred lower (our base scenario) or widened to manage volatility from Fed hikes later in the year, propelling the USD higher globally. That said, the risk of the appreciation policy turning neutral cannot be totally discounted, especially if deflation starts to rear its ugly head and force another downgrade in the inflation outlook. USD/SGD - rising back to 2101 high USD/SGD Policy, %

22 22 Malaysian Ringgit Having Slipped on Oil in 2014, MYR is Vulnerable to Fed Hikes Expected in 2015 Worst performing As a net oil exporter, Malaysia suffered from lower oil and gas revenues 26 The MYR was the worst performing emerging Asian currency in 2014, and the second weakest in the 2015 March quarter. The sharp sell-off in the MYR started in August 2014 on the global oil rout. As a net oil exporter, Malaysia suffered from lower oil and gas revenues. The government, on January 20, downgraded its budget targets announced last October, which assumed an oil price of US$100/barrel. With oil prices halved today, the 2015 growth outlook was lowered to % from its previous estimate of 5-6%. The goal to further narrow its fiscal deficit to 3% of GDP was abandoned with the target raised to 3.2%. Linking its sovereign credit worthiness to public finances, Fitch warned that it may downgrade Malaysia s debt rating during its review in the first half of Another concern is external debt, which was redefined to include holdings of MYR-denominated debt by foreigners. Over the past few years, short-term external debt has been rising and converging with falling foreign reserves, amid narrowing current account surpluses. Against this backdrop, the MYR is not immune to US rate hikes, which are expected to start later this year. The risk remains for the USD/MYR to trend higher to and above USD/MYR - back to 2009 high USD/MYR Policy, %

23 23 Thai Baht THB is Not as Resilient as It Looks; USD/THB is Likely to Return Above 33 Eventually Benefitted The Thai baht (THB) has been the top performing Asian currency in As of March 4, the THB appreciated 1.6% year-to-date against the USD, while other emerging Asian currencies depreciated by an average 3.8%. Real GDP growth rebounded to 2.3% yearon-year in the 2014 December quarter from minus 0.5% in the 2014 March quarter. In turn, Thai stocks rose towards the record highs seen in early As a net oil importer, Thailand benefitted from lower oil prices. Current account deficits have, since October 2014, reversed into strong surpluses with a record high ofus$5.5 billion posted in December While this was attributed to a smaller oil import bill, exports continued to languish. In the first two months of 2015, the fall in inflation into negative territory was also accompanied by a retreat in consumer sentiment. Not surprisingly, business sentiment remained cautious because of worries about low domestic spending and the lacklustre global economy. Against this uninspiring backdrop, the THB, on a NEER basis, would need to shed some of its sharp 9.3% appreciation accumulated between May 2014 and February The central bank may also need to consider lowering interest rates to augment efforts to meet the 4% growth target set for this year. 27 USD/THB - uptrend still intact USD/THB Policy, %

24 24 Indonesian Rupiah USD/IDR Above 13000, Uptrend Intact Revive growth President Joko Widodo wants to lift growth to 7% during his five-year term 28 Indonesia s aspiration to achieve its growth targets would probably eclipse its desire for exchange rate stability. President Joko Widodo wants to lift growth to 7% during his five-year term. The immediate challenge this year will be to revive growth to 5.7% from a five-year low of 5.03% last year. On the fiscal front, fuel subsidies were cut to free up funds for more spending in infrastructure. On the monetary front, Bank Indonesia (BI) surprised with a rate cut on February 2014 after CPI inflation fell to 6.29% year-on-year in February 2015 from a high of 8.36% in December The president signalled a desire for another rate cut if inflation falls further below 5%. This has weakened the IDR on two counts. First, global currency markets favour a strong USD because Fed hikes are seen starting later this year. Second, no thanks to the Eurozone and Japan, countries with dovish monetary policies are seen favouring weaker currencies. Neither does it help that the current account deficit is expected to widen to % of GDP this year. During the EM volatility of May 2013 to January 2014, the IDR only stabilised after the deficit narrowed to less than 2%. With the private sector discouraged from accumulating more external debt, this presents a challenge to deliver a stable IDR to attract investments. USD/IDR - new post-crisis highs USD/IDR Policy, %

25 25 Philippine Peso USD/PHP Stable Around 45 Despite Global Currency Volatility Rewarded The Philippine peso (PHP) remained one of Asia s most stable currencies, underpinned by favourable fundamentals. Since 2012, the Philippines had been the second-fastest growing Asian country after China. Ironically, the country also reported the highest jobless rate in the region. Fortunately, this turned out to be a blessing in disguise. Remittances by Philippine workers overseas have not only helped boost domestic demand at home, they have also ensured a healthy international liquidity position. In contrast to many Southeast Asian countries, the country s foreign reserves exceeded gross external debt while current account surpluses matched short-term external debt. For the third straight year, the Philippines was rewarded in 2014 with sovereign debt rating upgrades by all three international rating agencies Moody s, Standard & Poor s and Fitch. Not surprisingly, the Philippine markets found favour with foreign investors. Philippine stocks posted record highs this year and the PHP has been stable despite market volatility from unpredictable central banks in the rest of the world. Barring unforeseen shocks, the PHP is well-positioned to weather the US rate hike expected to start later in the year. The PHP remained one of Asia s most stable currencies, underpinned by favourable fundamentals USD/PHP - mild uptrend D B Sf USD/PHP Policy, %

26 26 Indian Rupee Optimism in INR is Reflected Via Trade-Weighted Appreciation and Not Against USD Make in India...the INR is still being held to ransom by external factors 30 The INR started 2015 on a firm note, but could not extend its appreciation beyond January. The USD/INR fell from to from January 6 to 28, but it has since been consolidating between and On the domestic front, sentiment has improved. Indian equities continued to rise to record highs on reform hopes and supportive policies to lift growth. On the former, there is optimism over the Make in India initiative to establish the country as a global manufacturing hub. The finance ministry and the Reserve Bank of India (RBI) signed a monetary policy framework to set an inflation target of 4% and keep it within 2% of either side of the target. The Budget 2015/16 announced on February 28 was aimed at boosting growth and infrastructure, which RBI Governor Raghuram Rajan believed would help India become a powerhouse in the world. RBI played its part with two surprise inter-meeting rate cuts on January 15 and March 4. As for the exchange rate, the INR is still being held to ransom by external factors. The USD/INR should continue to rise on the globally strong USD trend from QEs in the Eurozone/Japan versus Fed hikes later this year. Instead, optimism in the INR is best reflected, on a relative value basis, in its trade-weighted appreciation. USD/INR - still crawling higher USD/INR Policy, %

27 27 Vietnam Dong VND Stable in Strong USD Environment Upgraded The Vietnam Dong (VND) is stable. The USD/VND remained in the lower half of its official trading band after the VND was devalued on January 7. The State Bank of Vietnam (SBV) lifted the mid-point of the USD/VND trading band by 1% to The mid was previously lifted by 1% to in June. The devaluations do not imply weakness, but they are a recognition by policymakers of the need to keep the exchange rate aligned to the globally strong USD environment. In reality, Vietnam is no longer experiencing the macroeconomic imbalances doubledigit inflation and chronic trade deficits that plagued the VND after the 2008 global crisis. Instead, CPI inflation eased to 0.34% year-on-year in February 2014 while a trade surplus of US$2.14 billion was reported in In the second half of 2014, Moody s and Fitch upgraded Vietnam s sovereign debt rating by a notch to B1 and BB minus respectively. Against this favourable landscape, SBV sees room to lower interest rates by bps this year. This would complement the government s pro-investment policy and help the economy to return growth above 6% this year. Unlike most of its Asian peers, Vietnam s growth has improved in the past three years to 5.98% in 2014 from 5.42% in 2013 and 5.25% in USD/VND - stable despite devaluation USD/VND Policy, % n.a. n.a. n.a. n.a. 6.50

28 28 Australian Dollar AUD/USD to Fall Towards 0.70 Competitive headwinds The AUD remains fundamentally weak. The Reserve Bank of Australia (RBA) has not only abandoned its steady rate bias, but also cut its cash target rate by 25 bps to a record low of 2.25% on February 3. A week later, on February 10, the central bank downgraded its 2015 outlook for the Australian economy. Real GDP growth is now expected to average % this year instead of 2-3% previously. CPI inflation is expected to average 1.25% in the first half of 2015 instead of % before. RBA Governor Glenn Stevens told parliament on February 13 the economy was not expanding fast enough to stop the jobless rate from climbing. The unemployment rate has, after it bottomed at 4.9% in December 2010, been ascending over the past four years to 6.4% in January Externally, the AUD also faces competitive headwinds from a globally strong USD against Asian currencies the region buys more than 70% of Australia s exports. The plunge in oil prices since mid-2014 also hammered other commodity currencies such as the CAD and NZD. Canada surprised with a rate cut in January while New Zealand abandoned its rate hike bias in favour of a steady rate stance. Against this backdrop, the RBA still sees a need for the AUD to depreciate, not just against the USD, but also on a trade-weighted basis. 32 AUD/USD - still high relative to global trends AUD/USD Policy, %

29 29 New Zealand Dollar NZD is Unjustifiably High and Needs to Realign to Weaknesses of Its Peers Too optimistic Unlike its counterparts in Canada and Australia, the RBNZ did not cut rates this year 33 Unlike its counterparts in Canada and Australia, the Reserve Bank of New Zealand (RBNZ) did not cut rates this year. Even so, the RBNZ did abandon its rate hike bias in favour of a steady rate stance at its monetary policy meeting on January 29. The door was left open for the next move to be a cut as much as it was for a hike. The policy shift could be attributed to CPI inflation falling to 0.8% year-on-year in the 2014 December quarter, below the RBNZ s 1-3% target range for the first time since the 2013 June quarter. The RBNZ reckoned inflation could turn negative and stay below its target range throughout According to the latest RBNZ survey released on February 24, two-year inflation expectations eased to 1.80% from its previous 2.06% reading last November. Not surprisingly, both the two-year and ten-year government bond yields are below the 3.50% policy rate. Hence, consensus may be too optimistic in expecting the RBNZ to hike rates in the 2016 March quarter. With rates on hold for an extended period of time, the RBNZ is likely to focus on the value of the NZD, which it considers unjustifiably high. The AUD and the CAD have respectively returned 72% and 95% of their post-2008 crisis gains. Put simply, the NZD/USD should be below and not above 0.70 and closer to its peers on an indexed basis. NZD/USD - too high relative to peers NZD/USD Policy, %

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