Master Rider Blog

Cross Junction

October 5th, 2007 NW Teong

US dollar is weak against almost all major currencies in the world. Please see the charts for Singapore $ per US$ and Euro per US$, the US$ is at historical low vis-à-vis these currencies.

Courtesy of Yahoo Finance 

This weakness of US$ is exacerbated by the aggressive cut in interest rates by the US Fed on the 18 of Sept 2007. The repercussion of a weak US$ could prompt more capital flights out of USA. All things being equal, investors do not wish to invest in a market where the currency is weakening against its home or base currency, let alone US economy is slowing down. This is in sharp contrast as compared to markets in the Asia Pacific region such as China, India, Hong Kong, Korea, Singapore, Vietnam, Malaysia and so on. These economies in Asia are enjoying respectable growth with robust domestic demand as well as higher intra-regional trades. This has already translated into higher returns in the stock markets in these countries. In fact, many of these stock markets as represented by their respective indices have already reached historical records. The added bonus is the strengthening of local currencies vis-à-vis the US$. Hence for investors with US$ as base currency, it will register added return due to the forex gain.

However, the caveat here is that so long as the weakening process is gradual then it is fine. A sudden collapse of US$ would be disastrous to world financial system and hence world economy. A report showed that foreigners now hold slightly more than US$2 trillion of US assets with the bulk of it in Treasurys held by central bankers in Asia. These powerful Asian central bankers are keen to diversify its portfolio away from US assets and they have more incentive to do so now that US$ is weakening and is slated to weaken more. In short, a capital flight away from US markets is already happening, it is a matter of degree. Thus, it pays to monitor how this is being played out in the next few months or even years.

We have to take note that a gradual weakening of US$ would be positive for emerging stock markets as the funds continue to flow into these region. However, a sharp fall in US$ will create panic among global investors that they will sell out their equity portfolios in favour of government bonds, i.e. a classical of fight to safety. With this as a backdrop, US Fed is really at a cross junction at the moment. A potential credit squeeze and a slow down in economy necessitate a cut in interest rates, however a weak US$ calls for a steady or a hike of interest rates. Personally, I feel that the US Fed does not need to cut its Fed funds rate at its next FOMC meeting which is scheduled on 30/31 Oct 2007. Investors who buy shares with the hope of further rates cut are likely to disappoint. Just like in a healthy diet, what one is looking for is a well balanced diet and I am sure the US Fed will try to seek the best possible balance in its interest rates policy.

Whatever the interest rates policy, the stock markets in the Asia Pacific region are likely to enjoy their bullish run, at least till the end of the year albeit unforeseen circumstances. (Caution: We are exactly two weeks away from the anniversary of Black Monday.) Cheers!

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Entry Filed under: Macro, Stocks, Singapore