Asian currencies and bonds: A decoupling relationship

Investing.com - There is a notable change occurring in the longstanding connection between the currencies of developing Asian markets and domestic bonds. This change is being driven by a growing number of investors who are choosing to protect themselves against the risks associated with foreign exchange fluctuations, and this choice has been motivated by the declining expenses involved in such hedging measures.

The increasing disengagement is additionally pushed forward by the grim economic prediction for China, which keeps applying stress on Asian currencies but has minimal impact on local bond markets.

According to information gathered by Bloomberg, the average correlation between government bond yields and a variety of emerging Asian currencies over a 90-day period has decreased from 0.42 at the end of last year to a mere 0.1 recently. A correlation of 1 would indicate that the two elements move perfectly in sync.

This pattern reveals why, even though there has been a rise in investments in Asian bonds this year, the impact on currency markets in the region remains minimal. The possibility of interest rate reductions in Asia and lower expenses for protecting against currency risks implies that these local currencies may continue to experience strain throughout this year.

Galvin Chia, a rising market strategist at NatWest Markets stationed in Singapore clarified, "The scenario can be summarized as the comparison of interest rates." He further stated, "As interest rates in the US continue to rise because the Federal Reserve has not been able to achieve its disinflationary targets, the rates in most Asian economies remain low, resulting in lower costs for safeguarding against risks."

The decreased expense for protecting against risk makes it attractive for global funds that are contemplating providing dollars in exchange for Asian currencies. For example, the value of three-month non-deliverable won forwards has drastically decreased, reaching around 1.7 times below their average for the past five years, a significant drop from the 2.9 basis points observed at the end of December.

There is a clear difference between the value of regional currencies and the yields of Asian bonds, as observed in Malaysia. In May, foreign investors bought Malaysian debt amounting to $842 million, which is higher than the average net inflow of $388 million over the past six months, as reported by the central bank. However, the Malaysian ringgit depreciated by over 3% against the US dollar, making it the worst-performing Asian currency in May.

According to the current pattern, a noticeable decrease was observed in the comparison of indices related to the yields of Malaysian bonds and the exchange rate of the dollar against the ringgit. This decrease was around .3, which is lower than the decrease of .5 seen in December. A similar trend was also observed in Thailand, where the gauge only decreased by .04, compared to the earlier decrease of .4.

The declining growth prospects in China also have an impact on the connections between local interest rates and the currencies of other countries. The Chinese economy has a significant influence on trading relationships, particularly with South Korea, Taiwan, Thailand, and Malaysia. However, the effect is not as noticeable when it comes to regional bonds, as their direction is currently influenced by inflation patterns.

Meanwhile, traders have been increasing their wagers on interest rate reductions in the emerging Asian region as inflation shows signs of deceleration. These anticipations of monetary easing could potentially assist in reducing bond yields, while also making carry-trade targets in these countries less attractive.