Prospects for Fed tapering, political and economic concerns in the Eurozone, and major currency intervention from emerging market central banks are the top stories heading into September.
Early US dollar (USD) gains were erased this morning after the release of weaker-than-expected US durable goods orders. The last unofficial week of summer is generally expected to be a quiet one, and the market's outsized reaction to the durable goods report may be a sign that this is true. However, with a heightened focus on Fed tapering, a busy Eurozone economic calendar, and overactive emerging market central banks, traders should always be prepared for big swings in the forex market.
See also: The Curtain Call for the “Summer Stall”
The only economic data released from North America today was durable goods, and unfortunately, orders fell 7.3% in the month of July, a sign that US manufacturing activity could be weakening. Economists had been looking for a 4% drop, but aircraft orders dragged the overall index lower, causing the dollar to sell off slightly on the report. Excluding transportation, durable goods fell 0.6% as demand for computers and electronics weakened.
Meanwhile, the euro (EUR) is shrugging off the 2% slide in Italian stocks and concerns that Greece could need another round of aid.
Elsewhere, Silvio Berlusconi is no longer leading the Italian government, but he continues to cause havoc for the markets. Members of his center-right Freedom Party threatened to bring down the government by calling early elections if Berlusconi is pushed out of parliament after being convicted of tax fraud. The vote on evicting him from the government is scheduled for October. If new elections are held, there may be no majority government, and that could mean a complete standstill for fiscal reforms in Italy. Aside from stocks, Italian bonds also moved sharply lower, driving ten-year yields up by seven basis points (bps).
As for Greece, German Finance Minister Wolfgang Schaeuble said on Sunday that debate regarding a new debt cut prompted him to say that the country will need further aid. German Chancellor Angela Merkel agrees that a debt cut would be dangerous and could potentially unsettle the market. Greece, on the other hand, continues to deny that debt levels are a concern, while European Central Bank (ECB) Board Member Jorg Asmussen called on Greece to press ahead with reforms despite the pain.
Major Intervention from Emerging Market Central Banks
Emerging market currencies were a big focus last week, with Brazil launching a $60 billion currency intervention plan, Indonesia rolling out a package of reforms to stabilize its currency and fix the current account deficit, and India verbally intervening in the rupee.
Central banks in emerging market nations have been overly active because the currencies have been weakening rapidly of late. A lack of confidence by investors and a rising US dollar have put significant pressure on currencies around the world, particularly in countries where the current account deficit is extremely high.
Unfortunately, the problems don't end, and the Turkish lira (TRY) dropped to a record low this morning. The central bank attempted to calm the markets by conducting a $350 million forex auction.
Emerging market central banks are fighting an uphill battle, and the results of their efforts have been limited because intervention rarely works. For example, the Indian rupee (INR) completely erased Friday losses, while the Indonesian rupiah (IDR) holds near its lows. As a result, central banks still need to do more, which is why Brazil is widely expected to follow the intervention announcement with a 50-bp rate hike this week.
By Kathy Lien of BK Asset Management
