Brief Respite but Little Relief

  • Corrective pressures grip the capital markets today, helped by the easing of the selling pressure on Turkey
  • Favorable European economic data was insufficient for the euro to hold on to even modest upticks
  • Nor was the UK data enough to deter selling into sterling’s gains
  • Disappointing Chinese data could not send the yuan lower, though Chinese equities are a different story
  • Turkey may not be a systemic shock to the EU, but it is still a new headwind
  • Argentina’s central bank hiked rates 500 bp to 45% yesterday; Poland, Czech Republic, and Hungary reported Q2 GDP

The dollar is mixed against the majors as corrective forces grip the markets on Turnaround Tuesday.  Loonie and Kiwi are outperforming, while Aussie and yen are underperforming.  EM currencies are broadly firmer.  TRY and ZAR are outperforming, while PHP and MYR are underperforming.  MSCI Asia Pacific was up 0.5%, with the Nikkei rising 2.3%.  MSCI EM is flat so far today, with the Shanghai Composite falling 0.2%.  Euro Stoxx 600 is up 0.2% near midday, while US futures are pointing to a higher open.  The 10-year US yield is up 2 bp at 2.90%.  Commodity prices are mixed, with Brent oil up 0.8%, copper down 0.6%, and gold up 0.1%.

Corrective pressures grip the capital markets today, helped by the easing of the selling pressure on Turkey.  However, it’s more a respite than a relief as no new policy initiatives are behind the lira’s upticks.  The implication is that it is unlikely to last.  In fact, the dollar’s low in early Europe at just above TRY6.41 after trading a little above TRY7.23 yesterday may be about the most that can reasonably be expected.  And not all countries are participating.  India’s rupee and Indonesia’s rupiah fell to record lows, spurring reports of central bank intervention and only then did they recover.

Favorable European economic data was insufficient for the euro to hold on to even modest upticks.  The euro had retested yesterday’s highs near $1.1430 after stronger than expected growth from Germany (Q2 GDP 0.5%).  Q1 was revised up (0.4% from 0.3%) but the data failed to help the euro sustain its gains.  German GDP helped spur an upward revision to the EMU GDP to 0.4% from 0.3%.  Separately, the August ZEW survey, both the assessment of current conditions and expectations also improved more than expected.  The euro found bids near $1.1380, and corrective forces remain intact.

Nor was the UK data enough to deter selling into sterling’s gains that had carried it through yesterday’s high (~$1.2790) and a little past $1.2825.  Sterling fell to nearly $1.2765, ahead of support seen near $1.2740.  Employment growth slowed in the UK to 42k (3m/3m) from 137k.  This is the slowest period since last October.  Separately, regular earnings grew 2.7%, as expected, though the May reading was revised to 2.8% from 2.7%.  The unemployment rate fell to 4.0% from 4.2%.

On the other hand, disappointing Chinese data could not send the yuan lower, though Chinese equities are a different story.  The MSCI Asia Pacific Index rose nearly 0.5%, but, Chinese stocks slipped lower.  The yuan both onshore and offshore is a little firmer.  China’s data (retail sales, industrial production, and fixed asset investment) were all softer than expected.  This followed the slower lending and money supply figures.  The anticipation and implementation of the trade tensions may have contributed, but a broader slowdown was already underway.  Just as importantly, Chinese officials have already signaled a policy shift toward greater economic support.

The relaxation of market angst has weighed on the yen.  The dollar already had begun recovering yesterday after trading below JPY110.20.  It finished the US near JPY110.70, which, as it turns out, is the long-run average (since the end of 1989).  It approached JPY111.20 today, where offers were encountered at the end of last week.  The Nikkei rallied 2.3%, and the Topix tacked on 1.6%.  Telecom led the rally, and while all the sectors participated, materials and financials lagged.

European equities are retracing yesterday’s losses.  The Dow Jones Stoxx 600 is up about 0.4%, led by consumer staples and health care, while energy, materials and real estate are not participating.  Financial are flat, but Italy’s bank index is off for a fifth consecutive session (~-0.3%).  Spanish banks are slightly firmer.

The corrective mood is also evident in the bond markets.  Core bond yields, including 10-year JGBs, are 1-2 bp higher, while peripheral bond yields are lower.  The US 10-year benchmark is almost two basis points higher, just below 2.90%.

There is important insight Turkey can glean from Argentina.  Yesterday, Argentina surprised investors with a 500 bp increase in the key seven-day note yield to 45% and pledged to keep it there until at least October.  It announced it would sell $500 mln to relieve pressure on the peso.  The $50 bln IMF package is barely two-months old.

And yet, the Argentine peso finished the day on its lows, off 2.4% to extend its slide into a sixth consecutive session.  It has lost 9.5% over this run, as Argentina is still facing broad-based pressure on EM as well as a home-grown graft scandal.  Turkey’s key policy rate is at 17.75%.  Its inflation was a little more than half of Argentina’s near 30% pace but will quicken as the lira’s depreciation works its way through the economy.

There is an important reminder for traders and short-term investors.  For all practical purposes, there is no yield high enough to offset the risk of a 9.5% currency depreciation over a two-week period.  Medium- and long-term investors know that the exchange rate is an important part (and risk) of total returns.  The variability of currencies can generate two-thirds of the returns of global bond funds and a third of the return of a global equity fund.

Turkey may not be a systemic shock to the EU, but it is still a new headwind.  There are four direct channels:  trade, bank loans, portfolio investment, and on the ground assets.  Turkey is the EU’s fifth largest export market, especially for capital goods like machinery and transportation equipment.  European companies had a stock of direct investment in Turkey of around $80 bln.  Global banks, mostly European banks, have around $250 bln of gross exposures, without counting hedges and other offsets.  Foreign investors own an estimated 60% of Turkey’s government bonds (~30% of GDP) and about 20% of the equity market.

The North American session will be dominated by the corrective/consolidative forces that have emerged.  The economic calendar is light, and US import/export prices are small beer.  The NY Fed released the Q2 Household Debt and Credit Report, which always makes for sober reading, but it is not a market mover.  We suspect that there is room for additional upside correction in the euro toward $1.1460 and sterling toward $1.2850.   The dollar may have scope toward JPY111.40 and maybe CAD1.3045.  The Australian dollar is inside yesterday’s range but could rise toward $0.7290.

Poland Q2 GDP grew 5.1% y/y vs. 5.0% expected and 5.2% in Q1.  This is a disappointing reading given the low base effect from 2017.  This would support the stance of the central bank doves, though we think rising inflation warrants tightening.  Next policy meeting is September 5, no change expected then.

Czech Republic Q2 GDP grew 2.3% y/y vs. 2.7% expected and 4.2% in Q1.  This was the slowest rate since Q4 2016.  Yet the central bank appears ready to continue hiking rates.  September 26 may be too soon after back-to-back hikes, but another 25 bp hike November 1 or December 20 seems likely.

Hungary Q2 GDP grew 4.6% y/y vs. 4.1% expected and 4.4% in Q1.  This was a disappointing reading given the low base effect from 2017.  This would support the stance of the central bank doves, though like Poland, we think rising inflation warrants tightening here.  Next policy meeting is August 21, no change expected then.