Central banks have been cutting interest rates, with the latest moves by Japan and Sweden. The deliberate moves result in planned devaluation of their currencies. So, where is “hot money” going?
How will real interest rate affect currency?
Higher real interest rates tend to lead to an appreciation in the currency. This is because high interest rates means saving in that country gives a better return. Therefore investors often move funds to countries with higher interest rates. (this is known as hot money flows) http://www.economicshelp.org/blog/5394/interest-rates/interest-rates-and-exchange-rate/
The following graph depicts current position of real interest rate for respective countries:
Hot money going into Brazil?
With the highest relative real interest rate (at this point in time), the Brazilian real should be able to appreciate. Nevertheless, there are many economic issues with the country as well as falling crude oil prices have impacted on Brazil.
Indonesia appears attractive in terms of real interest rate (highest among the ASEAN countries). However, Indonesia has now run both current-account and fiscal deficits for three years in a row, a gnawing problem that is undermining its currency and could upset a high-spirited stock market.
Second on the list – Philippines looks like a promising destination to attract hot money
Singapore is the developed country with the highest real interest rate, not because it has a high nominal interest rate but due to its current deflationary trend. Will it be the next Japan, suffering long term deflation?
Key implications :
- Foreign exchange movements are subject to numerous macro factors. Nevertheless, differential real interest rate may provide guidance as to the direction of hot money and carry trade pairs
- Will we see a reversal of capital flows back to emerging markets (due to higher real interest rates)?
- However, when there is economic turmoil, capital will flow into “safe haven” assets
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