Asia FX: Resilience at risk as US yields climb – MUFG

MUFG’s Michael Wan notes that Asia FX and rates have stayed relatively stable despite sharply higher US Treasury yields, but he warns this resilience may not last in the near term. He highlights divergences between Asia FX and US yields, low USD/CNH volatility, and stresses that rising US yields driven by tighter policy and higher risk premia are concerning for Asia.

Asia FX resilience faces growing headwinds

"Linking this to our region, Asia FX and rates markets have been quite benign so far despite the rise in US Treasury yields, but given the drivers of markets more recently we think the probabilities are that this resilience may not continue at least in the near-term."

"We can see this resilience thus far in Asia across multiple measures including the divergence between Asia FX with both yield spreads and absolute yields in the US, a general compression in Asia rates with US Treasury yields, coupled with strength and outperformance in certain currencies such as KRW, TWD, and CNY."

"In addition, implied FX volatility in a pair like USD/CNH has hit multi-decade lows, and while this may certainly be for good reasons, is another indication of how the market is probably positioned right now."

"Ultimately, it’s not just whether US yields are rising, but why they are rising which matters for the spillover impact including to Asia, as our previous analysis and framework shows (see Asia – why US yields rise matter for Asia)."

"As such, the fact market moves have been increasingly driven by tighter policy and importantly higher risk premia with some initial signs of risk-off is concerning."