According to some analysts, 2015 should be a year of roller coaster activity for Asian currencies as the Federal Reserve in Washington makes arrangements to raise interest rates.
"The U.S. Federal Reserve will be hiking interest rates next year, while some Asian central banks will be acting in the opposite direction. Growth momentum is firmly in favor of the U.S., while structural and cyclical slowdowns in certain parts of Asia will see growth differentials narrow," one economist predicted last week.
All eyes are on the Federal Reserve, which is widely expected to raise interest rates in July after winding down on the easing program it put into place during the last recession.
In contrast to the U.S. move, most of Asia's central banks are easing. The People's Bank of China cut interest rates for the first time in two years in October, while the Bank of Korea cut rates to a record low the same month. Meanwhile, the Bank of Japan remains committed to its massive stimulus effort, while calls for rate cuts in Thailand and Australia are growing.
Forecasts of a three percent depreciation in Asian currencies over 2015 is being noted, similar to the decline in 2014. However, risks of greater depreciation exist should a tighter U.S. monetary policy lead to larger portfolio outflows from the region.
According to Saxo Capital Markets, "The world's major central banks and economies are entirely out of sync and the oil price collapse has added a dramatic new geopolitical and economic twist to global markets." Saxo's head of foreign-exchange strategy, John Hardy, said in a note last week that he anticipates "U.S. dollar strength on U.S. outperformance" next year.
Volatility
Hardy views the situation as one where four potential 'what if' catalysts exist that can create currency volatility next year. These include U.S. junk bond outflows, the resignation of European Central Bank (ECB) president Mario Draghi, Chinese yuan devaluation and a substantial weakening in the Japanese yen.
"There are already signs that the junk bond market in the U.S. is under severe strain here late in 2014. Liquidity is terrible in these bonds," Hardy said. "Junk bonds related to the U.S. shale oil are the most clearly in the danger zone and investor flow out of bonds could see mayhem and see the Fed ceasing all thoughts of hiking rates," which would see the dollar weaken sharply.
With the risk of deflation in China increasing amid the unwinding of its credit bubble, there's a risk that China will follow in the footsteps of the Bank of Japan with their devaluation of the yuan. According to Hardy, this would export a wave of deflation to the rest of the world, “launching a whole new and dangerous chapter of the currency wars."
Economists see the yuan and the Malaysian ringgit as the only two Asian currencies that are expected to appreciate against the dollar next year.
The December selloff in on the back of the slump in oil prices looks like signs that the ringgit will correct slightly from its oversold levels. Meanwhile, the U.S. dollar is up around 1.6 percent against the ringgit month-to-date.
At the bottom of the list is the Korean won which looks like next year's worst performer in the Asian currency arena. "Korea's export competitiveness is being severely eroded from a weak and increased competition from China. The won's real effective exchange rate against the yen is getting close to all-time highs, and a weaker currency is needed," noted one financial analyst.