Talking Points:
- The dramatic moves of key emerging market currencies and assets cooled Tuesday, and a cautious steadying of risk trends followed
- Despite the balance in speculative bearing, the Dollar would not unwind its run nor would the Euro put in for a recovery
- Scheduled event risk for the Pound and Aussie Dollar may generate volatility, but what about the Franc, Loonie and Gold moves?
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A Pause in the Emerging Market's Razing
Fear of contagion has gripped the financial markets from the end of the past week through the open of this one. While there were plenty of fundamental outlets for concern - and they remain to this day - the focus was turned to the most recent spark: emerging market's volatility. This pressure prompted by sanctions employed by the United States leveraged extreme response from those currencies and countries directly in the line of fire, but it was a sentiment that clearly spread to the general grouping of 'emerging markets'. That said, this past session, the pressure clearly let up. The Turkish Lira and Russian Ruble both put in for a significant rebound versus the US Dollar. And while, the correction is far from fully compensating for the losses over the preceding tumble, it has broken the cycle of sentiment that was starting to creep into the broader 'risk' markets. The EEM Emerging Market ETF stabilized - though it didn't forge a meaningful rebound of its own - while regional EM funds offered up similarly stabilizing efforts. In junk bonds, Treasury yields and carry trade; there was a similar restricted recovery effort. Even the 'core' speculative measures in equity indices found balance. While the Nikkei 225 and ASX 200 jumps Tuesday were hearty, the DAX and S&P 500 technical gains still lack technical conviction.
There are More Systemic Risks to Supplant Sanction if the Market is Looking
There is little doubt that the feedback loop in speculative exposure through emerging markets is a systemic risk and that the use of sanctions by the United States is a dangerous escalation in protectionism beyond tariffs in the trade war. However, this recent and intense risk is not the only threat to the global financial system's stability. With that said, putting out this particular fire does not free us from the broader concerns that still plague a market that has been indulgent with exposure and negligent of value for so long. Trade wars in particular remain a threat to economic strength with limited fundamental adjustment to account for uncertainty this path leads towards. Further, the outlook for a more moderate pace of growth, a normalizing of monetary policy and recognition of the use in leverage are all unresolved value skews that leave investors unduly exposed to a future of volatility. Headline-dominating catalyst can concentrate focus and help secure a decisive change in speculative positioning throughout the financial market, but the weight of excessive exposure itself can prove its own motivation. Focus not on the fuse, but rather the explosive.
A Restraint for the Dollar and Euro
What was remarkable this past session in the FX market was not that there was some reprieve for the throttled emerging markets or correction for risk assets. Those are inevitable as the threat cannot continuously escalate. Rather, what was more surprising was the resiliency from the Dollar and Euro to the course correction. The Greenback was charged recently by the impact the sanctions had on emerging market currencies. The market depth of these exchange rates relative to the majors may be small, but the scale of the moves certainly compensated for the imbalance. Nonetheless, the pull back for pairs like USDTRY, USDZAR, USDRUB and others didn't lead the primary reserve to a market-wide retreat. In fact, the EURUSD would find itself under steady pressure following its critical break late last week to clear the 'neckline' of its longer-term head-and-shoulders pattern around 1.1500. This is further a remarkable performance as the Euro was heavily, negatively impacted by the pressure exerted on Turkey and Iran. European banks hold large exposure to Turkish asset (leading to concern from the ECB) and its collective government is expending considerable political capital trying to salvage the nuclear deal with Iran. To find even some temporary relief would seemingly put the Euro in a position of a modest rebound, but an equally-weighted view of the currency showed that would not come to pass. If EM issues are resolved or paused, there is still Italian pressure and monetary policy to deal with. Be mindful of the Euro.
Moves with Loaded Events and Moves Without
While the deeper themes should command our attention when they under power, there is no reason to ignore ore concentrated event risk when the likes of 'risk trends' is in equilibrium. On the upcoming docket, there are a few fundamental highlights that can capture the attention for certain currencies. While the US TIC capital flows figures will be worth keeping tabs on amid threats from China, Russia and Turkey to sell its holdings of the country's assets, this is a figure for June; and there are far more complicated matters to untangle in order to set a course for this currency. For the British Pound, this past session offered up a disappointing run of employment data and the upcoming inflation dump can feed into a more commanding fundamental interest in the BoE rate decision. Yet, a gradual pace of rate hikes from the central banks will earn little movement when Brexit is still open. This past session, the Foreign Minister warned a 'no deal' outcome is increasingly likely. That will raise the stakes and interest in the UK-EU technical discussions Thursday and Friday. The Australian Dollar in contrast is far more active with its recent tumble, and only now volatility-inducing data is on the docket. Thursday morning's jobs figures and inflation expectations can generate traction if not trend. For the Canadian Dollar and Swiss Franc, strong moves carry less prominent event risk; but their progress could point to a shift towards systemic interests out to these currencies further from the gravity of the systemic themes. We discuss all of this and more in today's Trading Video.
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