UBS interprets "New Taiwan Dollar surge": What is the real reason? Is the hundred billion dollar sell-off still on the way?

Author: Zhang Yaqi

On Monday, the New Taiwan Dollar (NTD) rose 4% against the US Dollar (USD) at the beginning of trading, breaking the 30 mark and reaching 29.835 NTD per USD, the highest level since February 2023, marking the sixth consecutive trading day of gains. Today's increase also set a record for the largest gain since 1988. Last Friday, the NTD appreciated more than 3% against the USD in a single day.

According to news from the Chasing Wind Trading Desk, UBS's research on the 5th pointed out that this phenomenon cannot be fully explained by traditional indicators. In addition to stock inflows, the main drivers of this round of NTD appreciation are the currency hedging activities by insurance companies and enterprises, as well as the stop-loss from previous NTD financing arbitrage trades.

Despite the intervention by the Central Bank of the Republic of China (Taiwan) last Friday, market equilibrium has been disrupted. UBS predicts that insurance companies and exporters may increase their hedging ratios when the NTD corrects, and merely restoring foreign exchange hedging/deposits to trend levels could lead to a sell-off of up to USD 100 billion (equivalent to 14% of Taiwan's GDP). UBS expects that the NTD still has room for appreciation in the future, which may trigger a regional (South Korea, Singapore, etc.) currency response.

Equilibrium Disrupted: A USD 100 Billion Sell-off May Be Coming

UBS pointed out that on May 2, the NTD/USD exchange rate surged 5%, marking the largest single-day increase in 40 years, and this abnormal volatility cannot be explained by traditional indicators. While the recovery of the stock market played a certain role, it cannot fully account for the drastic changes in the exchange rate.

The report believes that beyond this catalyst, currency hedging (driven by insurance companies and enterprises) and the stop-loss from NTD financing arbitrage trades have jointly contributed to this exchange rate anomaly. The report states that this unusual response of the NTD has raised many questions in the market regarding the lack of intervention by the Central Bank of the Republic of China (Taiwan).

The report argues that even after the intervention before the close on May 2, market equilibrium has been disrupted:

• Hedging behavior of insurance companies and exporters: Despite the intervention by the Central Bank of the Republic of China (Taiwan) last Friday, market equilibrium has been disrupted. UBS predicts that insurance companies and exporters may increase their hedging ratios when the NTD corrects, and merely restoring foreign exchange hedging/deposits to trend levels could lead to a sell-off of up to USD 100 billion (equivalent to 14% of Taiwan's GDP).
• Risks for NTD short positions: The report believes that global investors' short positions on the NTD, especially those with arbitrage trading needs, face further liquidation risks.

Regional Spillover Effects: But Do Not Blindly Extrapolate

The report points out that the appreciation of the NTD may produce regional spillover effects. Specifically manifested as:

• Regional currency linkage: Due to Taiwanese life insurance companies using regional currencies as hedging tools, this may lead to a 3 standard deviation fluctuation in the Korean Won (KRW) and the Singapore Dollar (SGD) exchange rate reaching new highs.
• Other Asian currencies: If trade tensions between China and the US ease, this hedging trend among exporters may also spread to other countries, such as Malaysia (MY) and Thailand (TH)
• Central Bank Intervention: The report also emphasizes that for those countries listed on the "monitoring list" (South Korea, Thailand, Malaysia), the foreign exchange smoothing function of regional authorities is also a newly emerging unknown factor.

The report also points out that Taiwan's net international investment position (NIIP) is very large (165% of GDP, while the average level for other Asian emerging economies is about 0%), making the New Taiwan Dollar more sensitive to exchange rate fluctuations. In addition, the positive outlook for trade is rapidly being digested by the market, as reflected in the G3 currencies against the Asian currency basket, which almost completely reversed previous trends in April.

Is the Rise Too Fast? Is There Still Room?

Nevertheless, UBS believes that the rise of the New Taiwan Dollar is indeed too fast, but also points out:

• Valuation Model: According to the financial fundamental valuation model, the New Taiwan Dollar has shifted from moderately undervalued to 2.7 standard deviations above fair value.
• Market Expectations: Foreign exchange options and forward markets indicate that market expectations for the appreciation of the New Taiwan Dollar are the fastest in five years.
• Historical Experience: Reviewing the largest single-day increases in the history of the New Taiwan Dollar, the report finds that the increase on the first day did not continue to expand in the following month.

Considering these factors, UBS expects the appreciation of the New Taiwan Dollar to continue. While normalization of volatility and arbitrage trading may occur, the report suggests not to take contrary trading strategies too early. UBS expects that when the New Taiwan Dollar Trade Weighted Index (TWI) rises another 3% (close to the upper limit of the tolerance range set by Taiwan's "Central Bank"), the market may see stronger smoothing interventions