In February 2014 Stratton Street highlighted a list of countries likely to suffer a ‘dip’ in fortunes, these are countries where weak fundamentals have been ‘brushed’ aside or ignored, but are nonetheless vulnerable. A backdrop of deleveraging, with the Fed normalising rates and tapering bond purchases, ‘paints’ a very negative view for countries with large net foreign liabilities, otherwise collectively known as "PAINTBRUSH". These “PAINTBRUSH” countries, in no particular order of level of concern, are Poland, Australia, Indonesia, New Zealand, Turkey, Brazil, Romania, Ukraine, South Africa and Hungary. As a guide, since the end of January 2014 none of these countries’ currencies (spot rate) are showing a positive return against the US dollar: not surprisingly the Ukraine is the worst with the hryvnia down ~67%, followed by the Turkish lira down ~52% (at the time of writing). Even South Africa, the best performer, is down 10.9% on a spot basis. In contrast, the currencies of creditor nations such as Singapore, China, Japan and Switzerland have performed better although over this time period the US dollar index (DXY) has appreciated.
Countries with net foreign assets balances are less reliant on foreign inflows than those with net foreign liabilities and over the longer term creditors’ currencies tend to appreciate while those of heavy debtors tend to depreciate. It follows that the Chinese renminbi remains one of Stratton’s Street’s favoured currencies: China has a positive NFA position which is helped by a persistent, albeit smaller, current account surplus. Amidst all the volatility besetting more vulnerable emerging markets’ currencies this year the renminbi is an attractive place to be positioned. When the positive carry is factored in (Chinese rates are higher than US rates) the return from holding renminbi is further enhanced: YTD the renminbi (CNH) total return is 3.8 percent compared to 2 percent on a spot basis.
We expect the renminbi to continue to appreciate ~4% per annum based on China’s strong fundamentals, persistent current account surplus and strong net foreign assets position but as importantly the recent opening up of China’s bond markets via schemes like Bond Connect. These inflows will boost overseas holdings of renminbi which currently stand at a paltry 2%, far lower than the importance of China in the world economy. That will change.