With concerns over a possible further correction in the US equity market (~9% lower from 19 February to 18 March), we look at FX performance in historical periods, when the US S&P 500 equity index entered a bear market and declined by more than 20%. Specifically, we looked at the Dotcom bubble crash of the early 2000s, the Global Financial Crisis in the late 2000s, the Covid-19 pandemic crash in 2020, and the high US inflation and aggressive Fed hike period in 2022. During those periods, the most significant underperformance (and consistent) was in KRW , IDR, NZD, and AUD, depreciating on average by 26.5%, 20.5%, 16.3%, and 16.2%, respectively against the USD. The relative outperformers in Asia FX and the G10 (ex- USD) were RMB and CHF. JPY saw mixed performance (Figure 1).
Although we would expect similar performance in global FX if US equities correct substantially further from here, we believe there are a few key differences this time:
USD/JPY’s reaction has been mixed in the past significant S&P sell-offs. The Dotcom bubble burst and the January-to-October 2022 periods were two examples of when USD/JPY actually rose (rather than JPY strength). During the Dotcom-related equity sell-off, the BOJ introduced QE (January 2001), while the move up in USD/JPY in 2022 was due to the aggressive US Fed hikes. Owing to the current environment of weakening US growth expectations (i.e., the questioning of the US exceptionalism), which compares with the strengthening in Japan’s macro situation, underlying inflation, and BOJ policy divergence (rate hikes), we believe this could see strong JPY outperformance if US equities correct sharply lower.
EUR general underperformance (vs. USD) in past equity bear markets may not be the case this time. Europe will still be affected by possible tariffs and the slowing in the US economy, but there is numerous support for EUR. These include increased European fiscal spending /a stronger macro, a possible unwind in elevated US asset holdings, scope for further pricing out of ECB cuts, and some scope for a US-led Russia-Ukraine peace deal.
On RMB, we believe market hopes on stimulus, the tech theme, and some positive China growth expectations might provide some support for RMB. However, we are still cautious about RMB depreciation risk with Trump’s actions against China – possibly intensifying in April. Our concern is that China may allow for some RMB adjustment/depreciation if Trump continues to impose more tariffs on China (our economics team expects a further 15pp tariff on China ahead).
INR should be relatively resilient, as experienced during the Covid-19 pandemic and recent aggressive Fed hike periods. Although some FX flexibility is likely to be allowed, there is ample space for the RBI to control FX because of India’s high level of FX reserves and its ability/experience to garner external sources of financing (greater financing also applicable to most of the region).
