EM Asian currencies likely to decline if US-China trade tensions intensify further, says Scotiabank

The emerging market Asian currencies are expected to decline if the US-China trade tensions intensify further. But if the trade disputes remain under control, the Fed’s future rate cuts/monetary easing will certainly prop up regional currencies, according to the latest research report from Scotiabank.

US factory activity shrank for the first time in three years in August, reinforcing our view that global economic slowdown is deepening. The Institute for Supply Management (ISM) said its index of national manufacturing activity dropped to 49.1 in August from 51.2 the prior month, below the 50 threshold that separates expansion from contraction on a monthly basis.

The ISM's forward-looking new orders sub-index dropped to a reading of 47.2 in August, the lowest level since June 2012, from 50.8 in July. In addition, the employment sub-index tumbled to 47.4 last month, the weakest reading since March 2016, from 51.7 in July.

US consumer confidence is anticipated to weaken finally in the months ahead amid falling ISM manufacturing PMI, particularly if the US-China trade disputes spark more selloff in US stock markets as US consumer confidence has been closely tracking the performance of S&P500 share index since the beginning of 2008.

Consumer spending accounts for more than two-thirds of the US economy. According to the St. Louis Fed chart, there has been a shift in income to capital (ownership of businesses, land and assets) from labor (hourly wages and salaries) in the US. More Fed monetary easing is needed to help weather the economic downturn as indicated by the flattened/inverted UST yield curve, the report added.

In addition, Fed rate cuts could reduce both risk-free interest rate and risk premium to bolster US stock markets, as the so-called wealth effect has a significant implication for US economic expansion. The PBoC keeps setting USD/CNY fixing below 7.09 to defend the yuan exchange rate, together with tightened CNH liquidity conditions.

"The dollar/yuan is anticipated to trade in a range of 7.1-7.2 at the moment and will move in a stepped way in response to developments in the renewed US-China trade negotiations. We bear in mind that the yuan exchange rate could be used as an automatic stabilizer to adjust macro economy and international balance of payments according to the PBoC," Scotiabank further commented in the report.