Turkey hikes, ECB and BoE don’t. Trump dampens trade hopes

Despite comments from Turkish President Erdogan railing against prospects for a rate hike, Turkey’s central bank, CBRT hiked the repo rate to 24%, a much bigger than expected 625bp increase.  This may not be sufficient to turn things round sustainably but will at least prevent a return of the extreme volatility seen over past weeks.  The decision saw USDTRY drop by about 6% before reversing some of the move.  Undoubtedly the decision will provide support to EM assets globally including in Asia today.

Elsewhere the European Central Bank (ECB) delivered few punches by leaving policy unchanged and reaffirming that its quantitative easing will reduce to EUR 15bn per month (from EUR 30bn) from October while anticipating an end after December 2018.   The ECB also downgraded its growth outlook but kept the risks broadly balanced.  The outcome will likely to help put a floor under the EUR.  Unsurprisingly the Bank of England (BoE) left its policy on hold voting unanimously to do so, leaving little inspiration to GBP.

President Trump poured cold water on US-China trade talks by denying a Wall Street Journal article that he faces rising political pressure to agree a deal with China.  Trump tweeted, “They are under pressure to make a deal with us. If we meet, we meet?” . Meanwhile US CPI missed expectations at 0.2% m/m, 2.7% y/y in August, an outcome consistent with gradual rate hikes ahead.   The data will also help to undermine the USD in the short term.

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China Trade talks, ECB, BoE and CBRT

Today marks the most interesting day of the data calendar this week.  Central banks in the Eurozone (ECB), UK (BoE) and Turkey (CBRT) all announce policy decisions while US CPI (Aug) is released.  The ECB and BoE meetings should be non events.  The ECB is likely to confirm its €15 billion per month taper over Q4 18.  The BoE monetary policy committee is likely have a unanimous vote for a hold.

The big move ought to come from Turkey.  They will need to tighten to convince markets that the central bank it is free from political pressure and that it is ready to react to intensifying inflation pressures.  A hike in the region of 300 basis points will be needed to convince markets.   This would also provide some relief to other emerging markets.

The big news today is the offer of high level trade talks from US Treasury Secretary Mnuchin to meet with Liu He (China’s top economic official), ahead of the imposition of $200bn tariffs (that were supposedly going to be implemented at end Aug).  This shows that the US administration is finally showing signs of cracking under pressure from businesses ahead of mid-term elections but I would take this with a heavy pinch of salt.

Mnuchin appears to be increasingly isolated in terms of trade policy within the US administration. Other members of the administration including Navarro, Lighthizer, and Bolton all hold a hard line against China.  Last time Mnuchin was involved in such talks with China in May they were derailed by the hawks in the administration.  So the talks could mark a turning point, but more likely they are a false dawn.  That said it will provide some relief for markets today.

Catching a falling knife

After a very long absence and much to the neglect to Econometer.org I am pleased to write a new post and apologise to those that subscribed to my blog, for the very long delay since my last post.   There is so much to say about the market turmoil at present, it is almost hard not to write something.

For those of you with eyes only on the continued strength in US stocks, which have hit record high after record high in recent weeks, it may be shocking news to your ears that the rest of the world, especially the emerging markets (EM) world, is in decidedly worse shape.

Compounding the impact of Federal Reserve rate hikes and strengthening US dollar, EM assets took another blow as President Trump’s long threatened tariffs on China began to be implemented.  Investors in countries with major external vulnerabilities in the form of large USD debts and current account deficits took fright and panic ensued.

Argentina and Turkey have been at the forefront of pressure due the factors above and also to policy inaction though Argentina has at least bit the bullet. Even in Asia, it is no coincidence that markets in current account deficit countries in the region, namely India, Indonesia, underperformed especially FX.  Even China’s currency, the renminbi, went through a rapid period of weakness, before showing some relative stability over recent weeks though I suspect the weakness was largely engineered.

What next? The plethora of factors impacting market sentiment will not just go away.  The Fed is set to keep on hiking, with several more rate increases likely over the next year or so.  Meanwhile the ECB is on track to ending its quantitative easing program by year end; the ECB meeting this Thursday will likely spell out more detail on its plans.  The other major central bank that has not yet revealed plans to step back from its easing policy is the Bank of Japan, but even the BoJ has been reducing its bond buying over past months.

The trade war is also set to escalate further.  Following the $50bn of tariffs already imposed on China $200 billion more could go into effect “very soon” according to Mr Trump. Worryingly he also added that tariffs on a further $267bn of Chinese goods could are “ready to go on short notice”, effectively encompassing all of China’s imports to the US.  China has so far responded in kind. Meanwhile though a deal has been agreed between the US and Mexico, a deal encompassing Canada in the form a new NAFTA remains elusive.

Idiosyncratic issues in Argentina and Turkey remain a threat to other emerging markets, not because of economic or banking sector risks, but due increased contagion as investors shaken from losses in a particular country, pull capital out of other EM assets.  The weakness in many emerging market currencies, local currency bonds and equities, has however, exposed value.  Whether investors want to catch a falling knife, only to lose their fingers is another question. which I will explore in my next post.

Eurozone data releases this week

There are several first tier Eurozone data releases on tap this week including March flash purchasing managers indices (PMIs), preliminary HICP inflation and the March IFO business confidence survey.

We look for a slight increase in the “flash” composite PMI, with the data restrained by concerns about China and the Ukraine. Inflation in March could move lower, while the German IFO survey is expected to flat. The data will not be particularly spectacular but ought not to detract from the fact that growth momentum in the Eurozone is picking up.

Lower inflation may provide more support to lower policy rates from the European Central Bank but some of the pressure on the ECB to ease policy rates may have eased given the decline in the EUR last week.

After last week’s sharp drop EUR/USD is likely to consolidate around 1.3800 over coming days.

Talking the Euro down

It looks like the European Central Bank is finally waking up to the fact that belligerence over further monetary policy easing is resulting in a firming in the currency.

The fact that EUR/USD came dangerously close to breaching the psychologically important level of 1.40 must have triggered some panic within the governing council. To counter this ECB President Draghi noted that the currency’s level is becoming “increasingly relevant in our assessment of price stability”.

The problem is that words alone will not do the trick. Draghi believes that enhanced forward guidance will help to loosen monetary conditions by lowering real interest rates and this will weaken the EUR as real rates fall relative to other countries.

The market will expect action and not only words. If the Draghi really wants to weaken the EUR some form of monetary measures will need to be announced otherwise there may be little to stop EUR/USD testing 1.40 and beyond.

In the near term Draghi may have helped cap EUR/USD although technical support around 1.3825 (28 Feb previous high) will limit any downside.

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US dollar under renewed pressure

After hitting a multi month low at the end of last week the USD (index) failed to extend gains this week dropping overnight to 79.592 overnight in the wake of some slippage in US Treasury yields (10 year treasury yields fell to around 2.73%).

Conversely EUR/USD once again breached the 1.39 level despite attempts by European Central Bank officials to convince the markets that the message from last week’s policy meeting was in fact dovish. Markets have yet to be convinced (as do I), however, given that the ECB has yet to put its words into action in terms of further policy easing.

The key to a more sustainable EUR decline / USD recovery is to shake off the bad weather impact on the US economy. This is likely to take place soon although not quickly enough to be revealed in today’s release of US February US retail sales data, which will reveal that core sales remained pressured, leaving the USD without much support.

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Safe havens in demand

Risk aversion increased further overnight, as reflected in the VIX “fear gauge and my Risk Aversion Barometer, both of which moved higher. Risk assets in general slipped, with US equities closing lower, while safe havens including JPY and gold were in demand.

Ukraine tensions have intensified, with diplomatic efforts yielding no success and Russia stating that it would recognise the results of the referendum in Crimea. Wheat prices are feeling the direct impact of these tensions, with prices rising to a 13 week high while in contrast copper prices continue to be hit by China growth worries.

The outlook today is not a positive one, with a negative follow through expected in the trading session. There is little on the data front of note, aside from Eurozone industrial production which is unlikely to be a market mover.

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