US and China events make EM FX attractive
For the first time traders sit down to financial markets no longer pricing in policy tightening in 2016. Following Friday’s disappointing read which suggested that external weakness is spilling into domestic conditions it appears that Yellen’s cautiously dovish stance was in fact correct and that consequently, we should see a cyclical period of soft US economic data. The monetary policy divergence trade is officially dead…for now. IMM data indicates that bearish USD positions have hit their highest levels since February 2013, while the US yield curve shifted lower (US 10-year yields slid to 1.70%). This week, Fed’s Dudley, Rosegren, Mester, William and George are all scheduled to speak, potentially providing further insight into the Fed’s thinking. However, with the markets completely dovish, only hawkish comments are likely to move USD.
With Fed-related fears fading into the background worries over EM fundamentals, should also subside. However, rushing into high-beta EM currency trades would be premature without a stable and economically active China. Judging from today’s Chinese data we may have to wait a little longer for strong evidence. China’s end-April FX reserves increased $6.4bn to $3,219bn, the second consecutive month of increase, after a $10.3bn rise in March. A significant portion of the increase was due to valuation effect yet the number clearly indicated that fears of destabilising capital outflows have decreased. Within the trade data which indicated a sharp deterioration of exports to the US and Japan, exports to ASEAN rose 6.3%. This is good news for our expectations for select Asian EM FX to outperform.
Slow recovery in the Chinese economy, highlighted by an improvement in housing prices (giving domestic capital a domestic asset to invest in) combined with authorities restrictions of illicit channels has slowed outflows. We believe that the recovery in China will continue as fiscal and monetary efforts enacted since 2014 (to offset rebalancing efforts) should support revised higher growth forecasts (largely driven by credit expansion). Despite the CNY overvaluation it is unlikely to significantly depreciate (rather orderly two way movement), as even a small, but steady decline will have China bears screaming “collapse”, triggering excessive capital flight. However, with USD appreciation, sideline pressures on the yuan will be limited.
Swiss inflation improves
The Swiss consumer price index (CPI) surprised higher at 0.3% m/m against 0.1% expected, while y/y improved to -0.4% from -0.9%. Supported by the weaker CHF, inflation is finally exhibiting a positive trend (despite continued inflationary territory on y/y basis), which will give the SNB something to smile about. Barring a risk-off scenario potentially driven by events in Europe, we believe that the CHF will continue to depreciate against the USD and EUR.