Fed rate hikes to benefit VND in 2019

Fed rate hikes to benefit VND in 2019, illustration photo

Expected hike

The Federal Reserve (Fed) raised its benchmark interest rate by 25 basic points last Wednesday, bringing the target range for the federal funds rate to 2-2.25 per cent. Along with the rate increase, the Federal Open Market Committee (FOMC) continued to project one more hike towards the end of 2018 and lifted the probability of three more hikes in the following year.

Ngo Dang Khoa, head of global markets at HSBC Vietnam, noted that the FOMC statement would not necessarily make much of a change in investors’ risk appetite at present, as the result of the policy meeting had been expected by most markets around the globe.

“The 25-basic-point increase has been reflected in the price, so the reaction of the FX markets will chiefly come from the specific content in the minutes of the meeting, as well as the future interest rate hike projection of the Fed. The change in the language of the statement with the drop of the word ‘accommodative’ is seen as a ‘dovish’ movement; the dot plot, however, pointed to a stronger dollar in the future,” said Khoa.

The USD, according to Eddie Cheung, Asia FX strategist at Standard Chartered, has actually been quite flat for the past two to three weeks and people were wondering if the Fed raising its rate may provide a catalyst for the USD to turn around. “We don’t think that’s the case. Because for the USD to turn around, two key conditions have to be met: Firstly, the Fed needs to stop signalling more rate hikes, and we don’t think that is happening yet. Secondly, we have to think about what’s happening in emerging markets (EM). EM currencies have definitely come under pressure, there has been especially big depreciation in countries with account deficits, and just given the sentiment surrounding the US-China trade war, sentiments have been very weak and we don’t expect that to turn around yet,” Cheung explained.

Meanwhile, the pressure the rate hike would have on the VND/USD exchange rate, according to Khoa, is still there, on the back of the projection for further gradual increases in the target range for the federal funds rate. “Such pressure [on the VND] could be on the rise or on the wane depending on the fluctuation of the Chinese yuan (CNY), since China is one of the largest trading partners of Vietnam, accounting for over 20 per cent of the country’s import-export turnover, and Vietnam currently has its largest trade deficit with China,” stressed Khoa.

A stable CNY could help maintain the overall stability of FX rates within the region, including the stability of the VND. An unstable CNY, according to Khoa, could impose FX risk on the currency.

Impact of CNY

This means that the VND cannot rest easy with the Fed’s projection of additional rate hikes, but ought to watch out for the movement of the CNY in the near future. Cheung said that if the USD/CNY edges up, there will be some depreciation of the VND.

“People are wondering if the USD/CNY price will break the 7.0 level. We don’t think that will happen this year, but next year. Right now, the People’s Bank of China (PBOC) is becoming less tolerant of currency weakness and they’re trying to slow down the depreciation,” Cheung said. “We think they want to be very careful because the situation is different from two years ago. Two years ago, they devalued the currency (and Vietnam, of course, followed) and a lot of money left China and FX reserves fell. So this time, the PBOC is very careful.”

In 2019, according to the FX strategist, there will be more drivers for CNY depreciation. “First is USD strength (especially in the first half of the year) – the Fed is expected to hike rates, which means there’s more room for the USD to appreciate. Secondly, China may see a current account deficit in 2019, which is very important because previously, China has been saying, “We have an account surplus, so our currency doesn’t need to depreciate.” But under the trade war scenario, we expect the trade surplus to shrink and cause depreciation pressures.”

“For the second half of 2019, the USD will soften because markets will start pricing in Fed hikes,” he added.

Time for the VND to shine

With markets pricing in the impact of the Fed rate hikes next year, the VND could be presented with a possibility for appreciation. “We’re positive about Vietnam’s fundamentals and we’re seeing a trade surplus this year – that’s basically the reason why the VND has been quite resilient compared to other Asian currencies,” said Cheung. “However, the VND could still experience some depreciation, especially if USD/CNY moves higher.”

“Our view for the end of this year is the USD/VND price standing at 23,400, then 23,500 and 23,600 early in the first half of next year,” he said.

The prospects for the VND to gain strength come from the fact that the VND is in a good spot right now, according to Cheung, as the dong has appreciated against the CNY and Korean won, which represent Vietnam’s two biggest import partners China and South Korea. However, the VND has depreciated against USD and EUR, which represent Vietnam’s two biggest export partners, the US and the EU.

So on a trade basis, this is perfect for Vietnam, because Vietnam is buying goods at a cheaper price while exporting at a higher one.

“That’s a very strong advantage for the VND. Especially in the second half of 2019, as the USD softens, the VND may have an opportunity to appreciate,” Cheung said.