Dollar dominates
By Peter Rosenstreich
USD continues to dominate FX markets. Whether trade tensions, sanctions, Brexit concerns, European politics, exposure to oil prices or interest rates etc, USD is the safe haven. Even on the US-China trade battle, markets are biased towards a positive US outcome. Domestically the US continues satisfy: Friday’s jobs report was solid with unemployment at 3.9% and wage growth 2.7%. 10-year treasury yields jumped towards 3%, providing a meaningful spread within the G10 (although sharp retracements were seen today). Elsewhere US data has reported as expected. July manufacturing employment indicated no negative effect from protectionism. While the Federal Reserve continues its message of gradual rate increases, there is a growing case for a more aggressive hiking cycle, especially considering that sizable upward adjustment in personal income should support higher consumption. Jamie Dimon, JPMorgan Chase’s CEO, over the weekend suggested that US 10-year bond yields could reach 5%. We remain optimistic on the short-term USD outlook as other G10 currencies struggle with idiosyncratic issues. Our most negative view is on the cable as Brexit outlook remains extremely clouded. It’s hard to image after last week’s Bank of England comments that the Bank would tighten aggressively with Brexit risk mounting.
Bye Bye TRY
By Peter Rosenstreich
The Turkish lira remains the primary FX casualty in this risk-off environment. Not blind, unbridled EM selling, but select liquidation of currencies with clear faults. Turkey, with a heavy USD dominated debt load, has failed to play by international investors’ rules and is now facing the devastating consequences. The Turkish lira dropped to its weakest level as the White House indicated the US would impose sanctions on two ministers of the Turkish government who were involved with the false detention of Pastor Andrew Brunson.
The Turkish stock market is the world’s worst performer in local currency, bond yields have hit a record high and the lira has dropped around 25% against the greenback this year. Last weeks sanctions aggravated a situation where President Erdogan has suggested the removal of the central bank’s independence. Without policy control the Central Bank of Turkey has been unable to address surging inflation. This failure of correct governance has triggered investors’ sustained rush to the exits.
The deadly combination, of a puppet central bank and out of control inflation, sent USDTRY above 5 for the first time ever. Perhaps the lira’s only saving-grace was the July inflation came in slightly lower than expected at 15.85% verse 16.30% (yet still above June’s read). Erdogan’s meddling in CBT policy prevents the bank from taking critical action to slow accelerating prices. Erdogan has sacrificed price stability by stopping the central banks from raising rates in order to stimulate economic growth. Incredibly, Turkish interest rates at 17.75% have been too low to halt the mass exodus (real rate a paltry 1.9%). Is the lira collapse over? Doubtful. The CBT would have to raise rates right now (not at September meeting) 3-5%. Interest rates at 20% would all but kill the Turkish economy: Erdogan is unlikely to let that happen.
China introduces reserve requirement as yuan tumbles
By Vincent-Frédéric Mivelaz
The Peoples Bank of China, in an attempt to stabilize the currency, introduced a 20% reserve requirement ratio on CNY in the forward market. Similar measures were taken in Q3 2015 when the yuan was under pressure, but the relief was short-lived, as selling pressures rekindled a few weeks later. Despite continued trade tensions, the USD/CNY depreciation will stabilize at some point. The PBoC will maintain the currency below the psychological level at 7. Currently trading is at 6.8455. We expect the pair to weaken slightly in the short-term to 6.8220.
Trade tensions are intensifying, as China retaliates, announcing additional tariffs on USD 60 billion of US imports ranging from 5–20% following threats from the US to implement a 25% tariff on USD 200 billion Chinese imports. Asian markets are paying the costs, with Shenzhen and Shanghai Composites closing at -2.08% and -1.29% respectively, Shanghai CSI 300 is off 1.27% and South Korean Kosdaq decreasing by 0.94%.