Asia may rise but be careful of the dragon

The Thai government attempted to pull on the reins of its rapidly appreciating currency yesterday. This should be a warning sign for traders putting their cash into emerging market currencies. Capital controls are one of the few weapons available to governments who need to keep their currency weak to compete with China in the export market.

When money is flowing out of the dollar, the rapid appreciation of emerging market currencies is certainly tempting. Indeed the Thai baht has gained 2.9 per cent against the dollar since August this year.

But this flood of action is making the Asian authorities nervous. It is no secret that the Chinese are determined to keep their currency weak. The trouble is that export-led growth is equally important to the rest of developing Asia.

This is exacerbated by the fact that China pulls out all the stops to maintain its currency position. A point proved on the weekend when China reacted to tensions at the IMF meeting by raising reserve requirements for six large commercial banks in an effort to drain cash from the economy.

China’s weak yuan will eventually prompt other Asian countries to act. The battle for cheap exports is fierce and vital for countries such as Thailand. It is easy to connect China’s action on the weekend to Thailand’s yesterday, which could mark the onset of further action across developing Asia to keep currencies in check. The chart below demonstrates quite how quickly the baht has appreciated against the yuan.

Societe Generale’s head of foreign exchange Kit Juckes warns that this could be exceptionally bad news for the trader: “It would be foolish to put money into one of these currencies without a very detailed understanding of the country involved.”
Likewise, Neil Mellor of the Bank of New York Mellon warns: “Never forget that if things go wrong, the shallower the market the greater the risk that you might not be able to sell if things take a turn for the worse.”

Even when intervention is in line with market expectations traders can still be at risk. Yesterday’s experience with the Thai baht is a fine example: the dollar still weakened falling from 30.05 to 29.99 Thai baht despite the fact the announcement was expected by the market.

This reaction is typical of the market, Mellor explains: “In that immediate uncertainty after an announcement, even longer term traders sometimes just sell or liquidate their position to minimise damage. Just in case.”

Traders should be warned that a currency devaluing “race to the bottom” is a global problem. The battle to stay cheap will be waged across the Far East and this is likely to be done using capital controls. Unless you have an expert understanding of the country involved, approach with caution as illiquid markets can expose you to the risk of being unable to get out.