JPMorgan Cuts Ringgit Forecast, Recommends Range Binary Option

By David Yong

July 29 (Bloomberg) -- JPMorgan Chase & Co. strategists say Malaysia's ringgit will decline in the third quarter after the central bank unexpectedly refrained from raising interest rates and because of ``heightened political risk.''

The bank reversed its forecast for a gain in the ringgit as the ``dovish'' statement from Bank Negara Malaysia following the July 25 rate decision signaled a bias toward sustaining economic growth at the expense of inflation. JPMorgan expects the currency to appreciate beyond the third quarter, albeit at a slower pace, given the current-account surplus and because the central bank will defend the ringgit to avoid a drop in investor confidence.

``The inflation profile will be key to the central bank's credibility and stability of capital outflows,'' Singapore-based currency strategists Claudio Piron and Yen Ping Ho wrote in a research note yesterday. Bank Negara will likely succeed in targeting the ringgit between 3.20 and 3.28 in the short-term, they said.

JPMorgan, the biggest U.S. bank by market value, cut its end-September ringgit forecast to 3.28 per dollar from 3.15 previously. The bank recommends investors buy a one-month range binary option to profit from the likelihood that the currency will trade between 3.2050 and 3.2850 over the next month.

The ringgit fell yesterday by the most in more than five weeks after the central bank kept its overnight policy rate at 3.5 percent, unchanged since April 2006, citing increased risks to the economy and unemployment. Consumer prices rose 7.7 percent last month, the most since January 1982, after the government raised fuel prices to cut its subsidies.

`Line in the Sand'

Malaysia's currency was at 3.2590 as of 12:20 p.m. in Kuala Lumpur and is up 1.5 percent this year, according to data compiled by Bloomberg. JPMorgan forecast the currency to trade at 3.20 in the fourth quarter rather than a prior estimate of 3.08, and 3.10 for the first quarter of 2009 from 3.00. The 3.28 level is a ``line in the sand'' for the central bank, the U.S. bank said.

JPMorgan said price increases may still accelerate, peaking in the third quarter. Policy makers switch in emphasis to the exchange rate rather than interest rates demonstrates the central bank's perception that inflation is a ``temporary phenomenon,'' according to JPMorgan.

Malaysia's ruling National Front coalition is trying to woo public support even as Prime Minister Abdullah Ahmad Badawi is facing calls to step down after a March election debacle. The ringgit plunged the most in nine months and stocks had the biggest loss in a decade after the poll showed the Front lost its two-thirds majority in parliament and ceded control in five of 13 states.

There continued to be a ``lack of visibility in Malaysia's political outlook,'' the JPMorgan report said.

Capital Flight

Malaysia's decision to hold interest rates suggests the central bank is employing the same tactic as Bank Indonesia and the Bank of Korea by switching the policy emphasis from interest- rate to foreign exchange, where central bankers have stepped into the market to support their currencies to fight inflation, JPMorgan said.

The tactical switch may add to the risk that foreign investors will pull money out, according to the bank. Global funds owned about 25 percent of Malaysian government bonds and 60 percent of short-term central bank bills and notes as of the end of April, the U.S. bank said.

There's also some ``tentative sign of domestic capital flight'' as foreign-currency deposits surged to 32.9 billion ringgit ($10.1 billion) in May to the highest since the Asian financial crisis, the strategists said.

``The issue is whether Bank Negara has the ability and wherewithal to defend the ringgit and maintain foreign-exchange stability and credibility,'' they said. ``The answer is yes.''

Binary Option

Malaysia's foreign-exchange reserves stood at $125.1 billion on July 15, enough to pay for 8.9 months of imports, compared with 6.7 months for South Korea and 4.9 months for Indonesia, JPMorgan said.

Apart from preventing currency weakness, capital outflows and inflation pass-through, Bank Negara's intervention should also be motivated by the fact that the ringgit is near post- crisis lows, according to JPMorgan's estimate.

The country's current-account surplus, forecasted at 10.9 percent of gross domestic product in 2008 versus 15.5 percent in 2007, remains sizeable, JPMorgan said. That should support the ringgit's long-term appreciation trend to 2.9 per dollar by September of next year, the bank forecast.

The one-month binary option recommended by JPMorgan costs 25 percent of the notional amount that will pay out as long as the currency stays within the 3.2050 to 3.2850 range, the bank said.

An investor paying $250,000 to enter the trade to receive a gearing factor of four-to-one will get a $1 million payout so long as the ringgit trades within the range in a month's time, Piron said in an e-mail today. The investor receives nothing if the currency trades at, or outside, the stipulated range.

A range binary is a barrier option, with the most common usage in the form of a specified range defined within a given period where a customer selects a premium amount and is assigned a gearing or payoff ratio.

To contact the reporter on this story: David Yong in Singapore at dyong@bloomberg.net