Turkey, Emerging Market Central Banks, Eurozone Divergence

Attention today is on developments in Turkey. Despite consensus expectations of a 100bp (1%) hike in rates, Turkey’s central bank delivered a bigger than expected 200bp increase last week, with a hawkish statement.  This appears not have been welcomed by Turkish President Erdogan who promptly removed central bank (CBRT) Governor Aqbal on Saturday.  Despite some reassurance from Aqbal’s replacement that policy would deliver price stability the result has been substantial pressure on Turkey’s currency the lira (TRY) at the start of trading in Asia today, with the lira down as much as 15% initially, erasing more than four months of gains.  Turkish authorities are likely to intervene to limit the damage, but the damage has been done.  There has also been some, albeit more limited fall out on other emerging market currencies.

The end of the week saw a bit of a reversal in recent trends, with tech stocks gaining most, at the expense of bank stocks, which were weighed down by the news that the US Federal Reserve would not extend the Supplementary Leverage Ratio (SLR) exemption but rather to look at a more permanent solution. This could lower banks demand for Treasuries while constraining dealer balance sheets. Both S&P 500 and Nasdaq recorded declines over the week amid a further rise in US Treasury yields.  Quadruple witching saw an increase in volumes and oil prices recorded a sharp close to 8% decline over the week while Chinese stocks continued to suffer. 

Aside from Turkey there was some interesting central bank action last week in the emerging markets.  The BCB in Brazil hiked by 75bps, more expected, and indicated the high likelihood of another 75bps at the May meeting.  The CBR in Russia also joined in on the hawkish emerging markets (EM) action surprising markets by hiking rates by 25bps, with a likely acceleration in tightening likely over coming meetings.  EM central bank decisions this week include China (today), Philippines (Thu), Thailand (Wed), Hungary (Tue), South Africa (Thu), Mexico (Fri) and Colombia (Fri).   Separately, the SNB in Switzerland also decides on policy (Thu). China’s loan prime rates were left unchanged as expected and no changes are likely from any of the other central banks this week. 

Other data and events this week include the US PCE report (Fri), President Biden’s press conference (Thu) which could offer clues to the “Rescue” package that could amount to $3-4trn. A host of Fed speakers are also on tap, including Fed Chair Powell, as well as Eurozone flash purchasing managers indices (PMIs) (Wed), and UK retail sales (Fri).  The data will reveal stark differences in the recovery picture in the UK and Eurozone while the difference between the US and Europe looks even more stark.  Europe is struggling with a third wave of Covid case, vaccination delays and tighter restrictions, leading to a reduction in growth forecasts, while US growth forecasts are being revised higher in the wake of the $1.9tn stimulus package. This will likely result in some underperformance of Eurozone markets relative to the US.  

Oil Surges, Central Banks Galore

Oil prices jumped following drone attacks on Saudi Arabian oil facilities over the weekend.  Oil rose by around 20% to just shy of $72, before halving its gain later.  Even after failing to hold onto initial gains the rise in oil prices still marks one if its biggest one day gains.  Concerns about reduced oil supply have risen as a result of the attacks as they could reduce Saudi oil production for a prolonged period, with around 5% of global oil supply impacted.  Additionally the attacks could raise geopolitical tensions in the region.

As markets digest the impact of the drone attacks, there will also be several central bank decisions globally to focus on this week.  The main event is the Fed FOMC meeting mid-week, where a 25bp cut is largely priced in by the market.  Given that a rate cut is well flagged markets will pay close attention to the Fed’s summary of economic projections, in particular the Fed’s dot plot.  It seems unlikely that Fed Chair Powell is going to sound too dovish, with little to suggest that the Fed is on path for a more aggressive easing path.

Another major central bank meeting this week is the Bank of Japan (BoJ) on Thursday.  While a policy move by the BoJ at is unlikely this week BoJ policy makers have sounded more open to easing.  A consumption tax hike planned for next month together with a strong JPY have increased the pressure for the BoJ to act. Separately easier policy from other major central banks amid slowing global growth are unlikely be ignored.  However, policy is already ultra- easy and the BoJ remains cognisant of the adverse secondary impact of policy on Japanese Banks.

The Bank of England deliberates on policy this week too but it seems highly unlikely that they would adjust policy given all the uncertainties on how Brexit developments will pan out.  Until there is some clarity, the BoE is likely to remain firmly on hold, with the base rate remaining at 0.75%.  GBP has rallied over recent weeks as markets have stepped back from expectations of a hard Brexit, but this does not mean that a deal is any closer than it has been over the past months.  Elsewhere the SNB in Switzerland and Norges Bank in Norway are also expected to keep policy rates on hold this week.

Several emerging markets central banks will also deliberate on policy this week including in Brazil, South Africa, Indonesia and Taiwan.  The consensus (Bloomberg) expects a 50bp rate cut in Brazil, no change in South Africa and Taiwan and a 25bp rate cut in Indonesia.  Overall many emerging markets continue to ease policy amid slowing growth, lower US policy rates and declining inflation pressures.

 

Central banks in focus this week

Several central bank decisions are on tap this week including Japan (BoJ), Switzerland (SNB), Norway (Norges Bank), Brazil (BCB) and Thailand (BoT).  Among these only the Norges Bank looks likely to hike rates.

US data is largely second tier this week, with August housing data due for release.  After a run of weak readings a bounce back in starts and existing home sales is expected.   RBA minutes in Australia and NZ Q2 macro data are also in focus.

Political events will garner most attention, with the delayed announcement on China tariffs ($200bn) possible as early as today after being delayed due to the consideration of revisions raised via public comment.  Another twist in the saga is that China is considering declining the US offer of trade talks given the recent Trump threat of fresh tariffs (WSJ).

Other political events include Japan’s LDP election and US trade negotiations (assuming China participates) at the end of the week.   A few Brexit events this week include the General Affairs Council and Informal EU Summit.

 

CHF under pressure

In sharp contrast to AUD but for the same rationale (improving risk appetite and low volatility) the CHF has succumbed to pressure. Comments this week by Swiss National Bank officials highlighting their resolve to enforce the CHF cap, their belief that the currency is still overvalued, and are prepared to take further steps, highlight that the Swiss authorities wish for a much deeper correction lower in the currency. This is unsurprising as the CHF real effective exchange rate has been on a strengthening path over recent months, much to the likely chagrin of the SNB.

The fact that Swiss CPI inflation dropped back into negative territory on a YoY basis in February reinforces the need to further weaken the currency. Steps such as negative deposit rates and/or FX intervention cannot be ruled out. In the meantime, USD/CHF looks set to test resistance around 0.8930 (26 Feb high).

EUR/CHF still clinging to 1.2000

The job of the Swiss National Bank has become increasingly tougher over recent weeks. Speculation of a Greek exit or ‘Grexit’ and continued flight of capital from Greece as well as other peripheral countries mean that there is more prospect of upside for the CHF than downside versus EUR. The EUR/CHF 1.2000 floor has not deterred investors from parking such capital in CHF, much to the chagrin of the SNB, which has even warned about implementing capital restrictions.

Elevated risk aversion means that inflows of capital to Switzerland from the Eurozone periphery will persist. As a result, EUR/CHF looks set to trade around the 1.2000 floor for some time to come, with the risk that the SNB increasingly has to buy EUR to protect the floor. My forecasts reflect the view that any CHF weakness versus EUR will be extremely gradual in the months ahead as I expect any improvement in risk appetite to be similarly slow.

On the economic front the arguments for CHF weakness have actually lessened. Consumer confidence increased to its highest in a year in April. More importantly from the point of view of the SNB, Switzerland has registered positive CPI readings on a monthly basis for the past three months. Unfortunately, CPI is still negative on an annual basis, meaning that deflationary concerns continue to persist. On balance, the SNB’s fears over deflation will eventually lessen, suggesting in turn that worries about CHF strength will also be pared back.

Although the CHF has remained strong against the EUR it has weakened against the USD, but this is attributable to EUR weakness (due to the EUR/CHF floor) rather than inherent CHF weakness.
It will not be a one-way bet lower against the USD for both the EUR and CHF. The speculative market is highly short both currencies and they could rally in the event of any good news from Greece or the Eurozone. The CHF may also find itself weakening against the EUR if the news is sufficiently good to help stem outflows of capital from Greece and other parts of the Eurozone, but I believe this is unlikely. For the next few weeks at least, ahead of Greek elections, EUR/CHF is set to continue to cling to the 1.2000 floor, with the market set to test the SNB’s resolve.

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