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.

Markets remain skittish as caution prevails

There has been a slight easing in tensions overnight as reflected in the small decline in my risk barometer and the VIX ‘fear gauge’. However, markets remain skittish and the mood is somewhat cautious as the focus remains on emerging market travails.

Additionally a sharp fall in Apple shares in after hours trading may also dampen equity markets today. Although specific country specific factors may have provoked the current bout of pressure contagion has spread quickly, reminiscent of the onset of previous crises.

The current bout of pressure may yet be contained but there is still some way to go before market stress is alleviated. Consequently correlations between asset classes have strengthened, in particular for currencies. Indeed most emerging market currencies have depreciated especially those of the “fragile 5”.

Overnight US yields rose while US and European equities continued to sell off and gold prices dipped following recent gains. The USD index held gained slightly following the rise in US yields.

Aside from emerging markets attention will focus on the US, with President Obama’s State of the Union address, December durable goods orders and January consumer confidence on tap most attention will quickly shift to tomorrow’s Fed FOMC policy decision. UK Q4 GDP will also garner some attention.

USD edges higher, AUD supported, KRW in focus

US equities and risk assets in general edged higher overnight as US politicians edged towards a budget deal. The nomination of Janet Yellen as next Fed Chairman was met with a positive reaction from risk assets as it was perceived that she would be more likely to maintain the easy policy of her predecessor, with markets in any case delaying expectations of tapering into next year.

The Fed FOMC minutes released overnight gave little clarity on the timing of Fed tapering however, but it did highlight the split within the FOMC between those wanting to begin tapering in September and those preferring to wait. More consolidation is likely today as markets await political developments in the US.

Contrary to our expectations the USD has actually edged higher over recent days shaking off some the pressure associated with the budget impasse in the US. News that President Obama will meet around 20 senior Republicans from the House following a similar meeting with Democrats highlights progress of sorts, with hints of compromise in the air.

A slight uptick in US bond yields has managed to provide the USD with a semblance of support and further consolidation is likely in the short term as market fears over a US default gradually recede. Indeed, it appears that the USD is in a bottoming out process at present, with short term pain likely to give way to medium term gain.

GBP has lost ground over recent days undermined yesterday by disappointing August manufacturing/industrial production data and a worse than expected trade deficit. The data is unlikely to affect the outcome of today’s Bank of England MPC meeting however, with an unchanged outcome both on policy rates and asset purchases on the cards.

Despite yesterday’s data disappointments UK data has been improving and point to a reasonably good growth outcome in Q3 and a reduced likelihood of further asset purchases by the BoE. Nonetheless, GBP’s gains look overdone, with scope for short covering having diminished. Further pressure is expected against both EUR and GBP in the short term.

Australian jobs data revealed an increase of 9.1k in employment evenly split between full time and part time jobs and a surprise drop in the unemployment rate to 5.6%. The headline increase in employment was below consensus. Moreover, there was a marginal drop in the participation rate which helped to push the unemployment rate lower. On balance, the data will leave the AUD unperturbed, with the AUD/USD likely to remain supported over the short term. AUD/USD looks primed to test resistance around the 0.9530.

Asian currencies are on the back foot in the face of a slightly firmer USD. KRW will be in focus, with the Bank of Korea delivering an unchanged policy outcome but revising lower its growth and inflation forecasts. Against this background KRW appreciation looks overdone and appears to face strong resistance on any breach down to USD/KRW 1070. Nonetheless, downside risks will be limited. Encouragingly Korea has been a major beneficiary of the prospects of a delayed Fed tapering, with the country recording a strong return of equity portfolio flows over recent weeks

Little respite for the dollar

Given that the government shutdown has reduced the number of market moving US data releases on tap, tensions surrounding the US budget and likely debt ceiling impasse continue to weigh on sentiment. Signs that senior Republicans are becoming less focussed on defunding Obamacare hint at potential for a compromise. However, a deal looks a long way off and nervousness is set to grow ahead of the October 17 debt ceiling deadline.

Reflecting this, risk measures rose overnight, with the VIX “fear gauge” spiking higher and equity markets lower. Safe haven currencies including CHF and JPY remain well supported against this background although gold prices have been range bound. Giving some relief from politics markets will be able to focus on the onset of the US Q3 earnings season this week.

The USD is susceptible to further slippage as traction towards a US budget deal remains out of reach. The USD index has now dropped by over 5% in the last three months, undermined more recently by a potential delay in Fed tapering and lower US Treasury yields. Uncertainty about the economic impact of the budget delay and prospective failure to raise the debt ceiling over coming weeks suggests that any upside traction for the USD will be extremely limited.

What is clear is that the longer the delay in reaching a deal the bigger hit on the economy and in turn the bigger the pressure on the USD. A delay in the release of trade data originally scheduled for release today will mean that market angst over the political impasse will be the bigger driver of the USD today. The USD index is set to edge further below the 80.00 level over coming days.

JPY is a clear beneficiary of the malaise in the US over recent days and looks set to strengthen further in the short term especially as risk aversion continues to increase and US yields remain constrained. The day’s ahead will be particularly important for the JPY from a domestic policy perspective too. Japan’s parliament meets from October 15 to December 16, marking a crucial period to pass legislation on Prime Minister Abe’s “growth strategy”.

Given past disappointment with Abe’s “third arrow” markets will look for strong evidence that reforms will move Japan to a higher and non deflationary growth trajectory. This is by no means guaranteed. Further disappointment would imply a firmer JPY. Having tested its 200 day moving average around 96.72 near term technical support for USD/JPY is seen around 95.92.

US budget impasse deepens

There has been no sign of agreement between the US administration/Democrats and Republicans over resolving the budget impasse that has caused a partial government shutdown as well as havoc with the timing of government data releases. If anything both sides have become more entrenched in their positions, implying that any agreement on raising the debt ceiling required by October 17 also looks out of reach.

Market reaction so far has been relatively muted in the expectation of an agreement but such hopes may prove optimistic. Following the delay in the US employment report which was originally scheduled for release last Friday markets will also be scrambling for clues as to the impact on the timing of any Fed tapering.

US data releases will not help the market mood or the USD, with consumer confidence set to soften, which will play for further delay in tapering. US September retail sales and August trade data are likely to be delayed although the Federal Reserve FOMC minutes of the last meeting will hopefully provide some clues to the timing of tapering.

Markets are set to become increasingly nervous over coming days suggesting an increase in risk aversion. Consequently pressure on risk assets is likely unless some sign of rapprochement is seen. So far US Treasury yields are holding above 2.6% while the USD index has stabilised around the 80.00 level.

Surprisingly gold has failed to benefit from the lack of budget agreement in the US. The VIX ‘fear gauge’ dropped slightly but none of this will last if Congress does not get its act together. A deal soon would minimise the economic impact but a protracted impasse would be much more negative for growth. Either way the beginning of Fed tapering looks to have been pushed into next year.

USD pressure is set to extend further against most major currencies, with safe havens, in particular JPY and CHF set to be well supported in the days ahead. The drop in US Treasury yields will help yield sensitive currencies especially the likes of the INR but higher risk aversion will counter any positive impact on high beta currencies.

The EUR meanwhile, looks well placed to take advantage of further USD weakness, especially given the prospects of firmer data releases this week including a series of industrial production data.

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