MA XUEJING/CHINA DAILY

The stress in the global banking system is leading some to draw parallels with the last banking crisis. There are, of course, clear differences around the nature of the banking stress itself. While the 2006-08 crisis was more explicitly a credit crisis, this time it has been more an interest rate risk crisis.

Smaller banks are struggling to compete on deposits, with front-end rates having been hiked sharply, and are also facing sharp losses on their fixed-income assets, which the withdrawal of deposits is exposing.

The 2008 Global Financial Crisis built slowly, with housing prices beginning to fall in 2006, hedge funds saddled with subprime investments beginning to fail in 2007, and full-blown banking failures in 2008. Despite clear signs of stress by mid-2007, Asian currencies actually continued to rally for a few quarters, with over 5 percent gains on an average Asian foreign exchange index from July 2007-Mar 2008, before a sharp turn and over 15 percent losses in the year thereafter.

There was of course variation in how Asian currencies performed even in the midst of the crisis. We note that from Summer 2007-End 2008, the Japanese yen, Chinese yuan and Singapore dollar actually managed to deliver net positive gains, while the Republic of Korea won, Indian rupee and the Indonesian rupiah lost the most ground.

Crucial differences in the Asian FX backdrop

There are a lot of areas to mine when it comes to parallels with history. We identify a number of crucial differences between 2007-08 and today that suggest that Asian currencies are likely to fare much better this time:

1. Foreign positioning in Asian assets is much lighter, with considerable outflows from Asian equities in recent years in contrast to the years of inflows from 2002-07.

In the five years before Summer 2007, Asian equities had attracted $136 billion of inflows, or over 1 percent of the GDP of the countries covered, while over the past 5 years, Asian equities have lost $120 billion, or 0.3 percent of GDP. Foreign investors are simply far less invested and exposed, having refrained from building positions in the last few years.

2. Corporate positioning is also long US dollar now, unlike short US dollar in 2007.

Asian corporates have hoarded US dollar deposits in recent years, in contrast to the heavy short US dollar forward positions in 2007. The year preceding 2007 had seen a consistent downtrend in US dollar/Asia, with domestic corporates actively positioned short US dollar.

3. Less risks of US dollar funding stress.

The emergence of banking system risks have been accompanied by far less US dollar stress this time. While US dollar funding premiums have risen, it is well below levels seen in 2020, and just a fraction of what occurred in 2008. This is partly because foreign investors and corporates are much less short US dollar to begin with and thus the scramble for US dollar has also been more limited. But it is also partly due to higher levels of foreign exchange reserves, and access to emergency US dollar liquidity from the Fed via the foreign and international monetary authorities' repo facility, which appears to have been tapped recently for up to $60 billion, albeit it is unclear how much Asian central banks have played a role.

4. China's expected strong recovery this year and next will provide an offset, particularly for ASEAN where some countries are more leveraged to China over US growth now, especially service exporters.

The Chinese economy is expected to accelerate from this year itself, given the reopening and property market reversal, with Deutsche Bank House View expecting 6.0 percent and 6.3 percent growth in 2023 and 2024. This should provide a helpful offset, particularly to Asian economies that are more leveraged to Chinese than US growth.

We look at a simple correlation between domestic manufacturing PMIs and China versus US PMIs. We find that a number of ASEAN economies-Malaysia, the Philippines, Thailand and Vietnam — are all more correlated to China than US growth now, while North Asian economies could face a bigger drag from the US than lift from China. While there are clear relative implications for manufacturing strength, we think the bright spot of the Chinese recovery will be in services consumption, with Thailand set to benefit the most from this trend as Chinese tourism spending resumes.

5. Asian currencies are much more attractively valued.

In Summer 2007, Asian currencies were decidedly overvalued by an average of 13 percent on our Trade Weighted Index trade-based models. In comparison, Asian currencies on average are now slightly undervalued.

6. Most striking similarity between then and now will be around Japan and yen's strength.

Even in 2006, the Bank of Japan tightened after the Fed had delivered its last hike and cracks were beginning to appear. But while the last BoJ tightening cycle was very short-lived, and quickly reversed, we think this one will have more virtuous and sustainable domestic drivers. In 2006, when the BoJ lifted rates, core inflation was still negative and headline inflation less than 1 percent. In contrast, Japan appears to have made a more meaningful exit from its low inflation regime this time, with Shunto wage increases the largest since the early 1990s in March 2023.

Taking the above factors together, we would note a weaker case to play this banking crisis via long US dollar/Asia positions compared with 2007-08. In contrast to then, real positioning appears very light with domestic corporates sitting on long US dollar and foreign investors having avoided building Asian exposure in recent years. Asian currencies are also mostly cheap, the risk of US dollar funding stress is much lower, and China is recovering strongly.

Our relative currency preferences mostly reflect the drivers discussed above. We note that exports from markets such as the Republic of Korea have been very poor, and a slowing US economy could add to the drag; Malaysia is meanwhile more leveraged to China's growth recovery. We see Thailand getting a boost later in the year from a greater return of Chinese tourism. We also see growth and monetary policy divergence leading to strength in the Chinese yuan against the US dollar this year.