This year, the cost of hedging in Asia is expected to decline, and emerging market currencies may lose support
Due to relatively high interest rates in the United States, it is expected that hedging costs in Asia will decrease this year. Bloomberg data shows that the three-month hedging cost index in Asia reached its highest level since October 2022 at the end of last year, suppressing inflows of hedging investments. Experts point out that if the Federal Reserve does not quickly cut interest rates, hedging costs are expected to decrease, providing dollar investors with lower hedging costs. Despite the Federal Reserve's policy turning hawkish, Indonesia, the Philippines, and South Korea are expected to cut interest rates by 75 basis points each to address economic growth pressures
According to the Zhitong Finance APP, due to the rise of the US dollar, the three-month hedging cost index for Asia compiled by Bloomberg surged to its highest level since October 2022 at the end of last year, suppressing the inflow of hedged investment portfolios into the region. There are signs that this situation may change, as US interest rates are expected to remain high relative to Asia, and hedging costs are projected to decline this year. The support for currency from hedged investments is smaller compared to unhedged investments due to the shorting of local currencies.
Stephen Chiu, Chief Asian Foreign Exchange and Rates Strategist at Bloomberg Intelligence in Hong Kong, stated, "The increase in hedging costs is temporary, and if the Federal Reserve does not cut interest rates quickly and the magnitude of the cuts is not significant compared to Asia, this situation should decrease this year." "This will provide US dollar investors with exposure to Asian currencies with lower hedging costs, potentially even increasing yields."
To illustrate how hedging works, if a US dollar-based investor wishes to hedge their investment in Thai Baht, they would typically short the Baht while going long on the dollar. This means they gain the dollar exchange rate while paying the Baht exchange rate; a decline in the three-month forward exchange rate of the dollar against the Baht will reduce the hedging costs for dollar investors.
Due to economic resilience and concerns that the policies of US President-elect Donald Trump will lead to inflation, investors' attitudes towards the Federal Reserve are no longer as dovish as before. Currently, the Fed fund futures market expects about a 40 basis point monetary easing this year, which is only half of what was expected for the same period last September.
Despite the recent hawkish policy shift by the Federal Reserve prompting the Bank of Indonesia to avoid rate cuts in December last year to prevent further selling pressure on its currency, the monetary authorities in South Korea and the Philippines both lowered interest rates in the last quarter.
The median estimates from a Bloomberg survey of economists indicate that Indonesia, the Philippines, and South Korea are expected to cut rates by 75 basis points this year. As the outlook for trade tensions resurfaces, damaging economic prospects, policymakers in the region are striving to boost economic growth