“All of the data that we have had up until now has been, I think, encouraging… But there are a few significant-and I would say have now grown larger-headwinds that have developed”
John Williams, San Francisco Federal Reserve Bank President
After an impressive nonfarm payroll print on Friday, September 4, 2015 the dollar opens the holiday shortened week on its heels 10 days ahead of ominous September 17 FOMC rate announcement meeting. Markets are understandably split going into this critical policy meeting, which could see rates lifted for the first time since 2006 and off the zero bound floor for the first time since 2009. The split in the market comes from the confusion as to whether or not the strengthening dollar over the last 14 months has done a majority of the job for the Federal Reserve or if we could begin seeing the first of many hikes from the first of many central banks, in the midst of a fragile global economy.
Over the extended weekend, we saw next the data out of China with in line export growth while import growth surprised to the downside, which follows last week’s disappointing PMI print from South Korea. In other words, the trade surplus increased on weakening imports. Additionally, euro zone Q2 GDP came in above consensus estimates of 1.2% at 1.5%
A New Set of Key Factors in EMFX
While the US dollar has been a key component of the slide in emerging markets, other factors need to be understood as well. One of these places to start is the recently coined term “low-flation,” which can be tracked back to commodities. Much has been said about the decline in oil and rightfully so that other base metals like copper have also tracked the decline of emerging market currencies.
Watch the USD & You’re Watching EMFX
At the risk of oversimplifying what is happening in emerging markets, the strength of the US dollar is the observed focal point for understanding what is next for many currencies under the emerging-market umbrella. In the last month, emerging-market baskets have lost 5% versus the US dollar, historically a wide move on an annual basis and a little over 3% on a trade weighted basis
Emerging Markets:Emerging markets are regional economic forces that are divided by Asian, Central & Eastern Europe, Middle East, Africa, and Latin America FX.
“Downside risks to the outlook have increased, particularly for emerging market economies. Against this backdrop, policy priorities have taken on even more urgency since we last met in April. A concerted policy effort is needed to address these challenges, including continued accommodative monetary policy in advanced economies; growth-friendly fiscal policies; and structural reforms to boost potential output and productivity.”
Christine Lagarde,IMF Managing Director
Overview: September 17 will likely say a lot for emerging markets and the larger global economy. Capital Economics says EM capital outflows at highest levelsince global financial crisis; close to $250B in net terms flowed out of EMs in 3 months to Aug., an increase mostly dueto flows from China. We’ve recently heard, as shown above, key people involved in international macroeconomics and monetary policy discouraging the Federal Reserve from hiking rates due to pressures on less advanced economies like Myanmar, Philippines, Brazil, Greece and other countries that IMF has leant to through the recent credit boom.The IMF has warned the Fed again and again against raising interest rates prematurely. By prematurely, they mean before US trading partners are prepared for rate increase. Given the heavy declines in local currencies, the argument is that emerging markets are ill prepared for such a move.However, they also note the global implications would likely set back presently fragile US economic recovery.
Pacific Asian FX:
The USD strength extended after a rather bland payroll numbers ended up exciting USD bulls and those looking for the Fed to hike, aside from the IMF, are confident that now is the time to come off the zero-bound floor. Looking to the data in the Asia-Pacific region, we’re seeing the week open with improved risk sentiment on the back of suspected China fiscal policy being strengthened, which could boost the local and peripheral regional economies. The next key focus in Chinese markets will be the bond markets, as the Yuan market and bourse have seen extraordinary volatility. An encouraging view would come from the understanding that Chinese consumers are far less levered than their international counterparts, whereas Chinese household wealth is held more in real estate and bank deposits with stocks only accounting for roughly 2% of household assets. In other words, defaults on a large scale shouldn’t be too big of an issue and if confidence is restored, the larger economy could bounce back but that’s a big ‘If.’
Central Eastern Europe Middle East & Africa:
Earlier this week , emerging market currencies whose prosperity is seen tide to global demand, which lately has been highly linked to China, caught a significant but short-lived bid. This came on the back of news out of China that the government would look to continue with large scale projects in order to prevent a worsening downturn in the global economy. The projects that China has planned require many natural resources like Copper, Silver, and Iron Ore intensive and also provide a boost to global risk sentiment, and when risk sentiment rises typically emerging market currencies do as well. However, as the week played out, central banks remain uncertain of the economic future despite the trillions of dollars in quantitative easing and equity markets seem unable to hold a bid. All of these macro factors continue to paint an unlikely picture for EM FX appreciation, like the South African Rand.
Even though the South African Rand has lost around 12% vs. the USD this quarter, some institutions are making noise that the panic is providing great opportunity to buy these currencies at “panic-like” selloff levels. However, while cheap, the fear of the currency getting cheaper is valid. Africa’s biggest bank by market value, FirstRand Ltd. recently noted that they expect bad debts on their books to start taking up due to unsecured lending on the personal side and depressed sectors like mining metals and other commodities on the corporate side. This development caused their CEO to note, “We are continually cutting back on our risk appetite.”
Latin America FX:
Brazil’s credit rating is dropped to junk. On September 10, ratings agency standard and poor’s cut Brazil’s sovereign credit rating one notch from BBB+ to BB-. This puts Brazil out of investment-grade status also known as non-investment-grade, or “junk” status. Adding insult to potential economic injury, S&P left the rating on, “watch negative,” indicating potential downgrades could be in the future due to the nations physical deteriorating outlook. To date, the Brazilian Real is the worst-performing EMFX falling over 42% versus the dollar, which has been mirrored by the IBOVESPA drop of nearly 35%.
Technical Watch: The first day of the week sees the South African Rand and Australian dollar up nearly 2% and 1.5% respectively against the US dollar. The extremes in the direction of the trend posted last week can act as a short-term bias to see whether the dollar can weather the next fundamental disruption of global markets ahead of the Federal Reserve meeting on September 17.
Written by Tyler Yell, CMT of DailyFX; you can join his distribution list with this link, and you can talk markets with him on Twitter @ ForexYell
