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EM Asian Currencies Set to Lose Support From Hedging Costs

(Bloomberg)

(Bloomberg) -- The cost of hedging Asian investments for dollar-funded investors is set to drop from a two-year high, a shift that could lead to reduced support for the region’s currencies.

A Bloomberg-compiled gauge of three-month hedging costs in Asia jumped at the end of the year to the highest since October 2022 due to dollar gains, discouraging hedged portfolio inflows into the region. That may change with hedging costs expected to decline this year due to signs US rates would stay elevated relative to Asia.

Hedged investment flows are less supportive of currencies compared with unhedged ones as the former involves shorting of local exchange rates. 

“This increase in hedging costs is temporary, and should fall this year if the Federal Reserve doesn’t cut rates rapidly and doesn’t cut by a larger extent compared with Asia,” said Stephen Chiu, chief Asia FX and rates strategist at Bloomberg Intelligence in Hong Kong. “This will offer cheaper hedging costs or even yield pickups for dollar-funded investors that have Asian-currency exposure.”

READ: Bearish Rupee Bets Drive Hedging Costs to Highest Since 2022

Hedging works like this: Dollar-based investors seeking to hedge their baht investments, for example, would typically short the baht while being long the greenback. This would then mean receiving dollar rates while paying baht rates. A falling three-month dollar-baht forward would reduce hedging costs for dollar-funded investors.

Investors have turned less dovish on the Fed due to a resilient economy and concern that US President-elect Donald Trump’s policies will be inflationary. US Fed fund futures are now pricing around 40 basis points of easing this year, half of what was expected in September for the same period.

While the recent hawkish pivot from the Fed prompted Indonesia’s central bank to refrain from cutting rates in December for fear of heaping additional selling pressure on its currency, monetary authorities in Korea and Philippines have lowered rates in the final quarter. 

The Philippine central bank Governor Eli Remolona said on Thursday that there is still room to ease policy, with tariff threats from the incoming US President Donald Trump posing challenges to the Philippine economy.

A median estimate of a Bloomberg survey of economists shows expectations of 75 basis points of rate cuts each this year in Indonesia, Philippines and South Korea. Policymakers in the region are striving to prop up growth as the prospect of renewed trade tensions and a slowdown in the Chinese economy hurt the outlook.

(Updates with comments from the BSP governor in the second last paragraph)

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