New funding currency?

Inflation in New Zealand in the June quarter turned out to be higher than expected, with consumer prices rising 1 percent. This means that the central bank will continue to raise interest rates. It also means that the New Zealand dollar will continue to attract carry traders.

Andy Mukherjee thinks the Singapore dollar could become the new funding currency for carry trades in Asia.

While the Japanese yen and the Taiwanese dollar remain the vehicles of choice for financing purchases of the New Zealand dollar and other high-yielding currencies, the risk of a reversal in these trades is prompting the search for alternatives.

The cost of money in Taiwan is rising, partly because the central bank wants to kill the carry trade and arrest capital outflows. Although the yen remains very much in play, no one knows for how long. The Bank of Japan may signal higher interest rates as early as next month. And that makes funding positions in yen very profitable, but dangerous.

Amid these threats, the Singapore dollar may fit the bill nicely as a low-risk funding currency...

[C]onsumer-price inflation is subdued and the one-month interbank interest rate on the island is, thanks to a glut of capital, just 2.4 percent, almost 1 percentage point lower than at the beginning of the year. The implied cost of borrowing Taiwan dollars using the forward market is 2.6 percent for a month.

The liquidity overhang in Singapore is unlikely to disappear soon and that may be a reason for the nation's currency to replace the Taiwan dollar as a funding option.

"The Singapore dollar is also attractive as a funding currency because of its lower volatility, slightly below that of the Taiwan dollar and significantly below that of the Japanese yen," Citigroup Inc. economist Chua Hak Bin wrote in a note to clients yesterday...

With annual consumer-price inflation of 1 percent in May, little changed from a year earlier, the Monetary Authority of Singapore doesn't have a pressing reason to make its existing stance of seeking a "modest and gradual appreciation" more hawkish.