Market Turmoil Continues, Risk Shunned

  • Investors still have not found solid footing this year
  • Sterling continues to trade heavily ahead of the Bank of England decision
  • Adding to investors’ anxiety was the terrorist strike in Jakarta
  • It’s central bank day in EM; Korea lays the groundwork for a cut in 2016 and Indonesia cut rates 25 bp; Poland kept rates steady; Chile, and Peru to meet later

Price action: The dollar is mixed against the majors as market turmoil persists. The euro and the Swiss franc are outperforming, while the dollar bloc and sterling are underperforming. The euro is trading higher and back above $1.09, while sterling is trading near the cycle low of $1.4350 from earlier this week, ahead of the BOE decision. Dollar/yen is trading near 117.65. EM currencies are mostly weaker. RUB and the CEE currencies are outperforming while KRW, IDR, and INR are underperforming. Bank Indonesia cut rates as expected, while the terrorist attacks in Jakarta rattled local markets. Bank of Korea kept rates steady, but lowered its growth and inflation forecasts. This suggests rate cuts remain likely this year. MSCI Asia Pacific was down 1.8%, with the Nikkei falling 2.7%. MSCI EM is down 1.4%, though the Shanghai Composite was up 2% and the Shenzen Composite up 3.8%. Euro Stoxx 600 is down 2.9% near midday, while US futures are pointing to a lower open. The 10-year UST yield is down 3 bp at 2.06%, while European bond markets are mostly firmer. Commodity prices are mostly higher, with oil up around 1%.

Investors still have not found solid footing this year. Equity markets have continued to sink, even though China’s equities advanced. Bond markets are mostly firmer, with the US 10-year yield seemingly being drawn back toward 2.0%. Oil prices are little changed, after Brent slipped to marginal new lows. There is much talk about the Iranian sanctions being lifted as early as Monday.

The US dollar itself is mixed. The yuan weakened about 0.25%. The renewed pressure so new widening of the onshore and offshore yuan. The euro is the strongest of the majors, rising to almost $1.0940 in the European morning. It is poised to move higher. The ostensible reason was the report suggesting that many ECB officials do not support more policy action now.

Yet this is hardly news. The ECB moved in December. It may not have been as much as many had expected, but it still delivered a rate cut and extended the asset buying program. It would not be the ECB’s way to change policy again without taking time to understand the impact of its past action.

Instead, we suggest sales of European equities and the unwinding of short euro hedges, coupled with the triggering of stops may offer a better explanation. The euro flirted with the lower end of the range yesterday near $1.08 and when this held, late shorts were caught in weak hands. On the upside, the $1.0970-1.1010 area will likely offer formidable resistance.

The dollar is steady to slightly higher against the Japanese yen. This is notable because the usual drivers, like the slippage in US rates, weakness in equities, and the general risk-off mode would typically bolster the yen. The greenback held JPY117.30 in Asia and pushed to JPY118.20 by early European activity.

Sterling continues to trade heavily, though it has thus far remained above the multi-year lows set on Tuesday near $1.4350. The Bank of England meets. The focus is on whether McCafferty abandons his lone dissent. The minutes, which are released at the same time, are expected to be dovish. There is headline risk, but we suspect that the pendulum of expectations has already swung to push a rate hike out until the end of the year at the earliest. We suspect that market has discounted a great deal of bad news for sterling and a bounce is near.

With uncertainty about policy intentions in China, concerns about commodity prices, and the general risk off attitude, perhaps it is not so surprising that Australian dollar has shrugged off a favorable employment report. The Aussie is off 0.4% today. The low so far (as the intraday technicals warn of continued downside risks) has been $0.6910. It is the lowest level since the multi-year low was set in early September just below $0.6900.

For the record, the 1k job loss was a result of a slightly larger fall in part-time jobs (-18.5k) than increase in full-time positions (+17.6k). The November series was revised to show that Australia grew a revised 47.3k full-time jobs (from 41.6k). The 0.2 percentage point decline in the participation rate to 65.1% only managed to keep the unemployment rate steady at 5.8%. This will play into economists’ suspicions that Australian jobs data have some methodological quirks.

Adding to investors’ anxiety was the terrorist strike in Jakarta. Reports indicate at least three explosions in a shopping district (Sarinah). The Islamic State was immediately identified as the likely culprits. Separately, the central bank met and cut its reference rate, as many expected, to 7.25% from 7.5%. The rate on overnight deposits was also cut 25 bp (to 5.25%). It is the first rate cut since early last year. CPI rose only 3.4% y/y in December, and is back in the 3-5% target range for the second straight month. As such, we see further easing this year. The rupiah is off nearly 0.6%.

It is interesting to note that although the Bank of Korea left rates on hold, the Korean won has fallen more than the rupiah and is off about 0.8%, making it the weakest Asian currency today. However, it cut its 2016 growth forecast from 3.2% to 3.0% and cut its 2016 inflation forecast from 1.7% to 1.4%. The bank added that uncertainties regarding growth remain high. With inflation seen falling short of the new 2% target, we think a rate cut this year is still likely. The Bank of Korea has been on hold since the last 25 bp cut to 1.5% in June 2015.

The Hong Kong dollar weakened sharply, with the US dollar trading at its highest level since late 2011. Yet HKD remains in the strong half of the 7.75-7.85 trading band and below the midpoint of 7.80. We do not think it is a speculative attack, as some in the press are suggesting. Rather, we think it reflects another leg in capital outflows from the mainland. Previously, outflows had found their way into the Hong Kong financial system, as investors parked their money there with the hopes of redeploying back in China when the opportunity arose. Now, we suspect some investors are moving that money out of Hong Kong in light of rising China risks.

National Bank of Poland kept rates steady at 1.5%, as expected. CPI came in at -0.5% y/y in December, as deflation persists. Virtually the entire MPC will be replaced this month and next, and the next group is expected to be more dovish. As such, the easing cycle will likely resume later in 2016.

Chile’s central bank meets and is expected to keep rates steady at 3.5%. CPI rose 4.4% y/y in December, back above the 2-4% target range after a brief move within it. As such, we think the tightening cycle will continue, albeit modestly. The bank just hiked 25 bp in December, and another one this month seems unlikely given the soft economy. A hike is likely later in Q1, however.

Peru’s central bank meets and is expected to hike rates 25 bp to 4.0%. However, the market is split. Of the 15 analysts polled by Bloomberg, 6 see no change and 9 see a 25 bp hike. CPI rose 4.4% y/y in December, further above the 1-3% target range and the high for this cycle. As such, we think the tightening cycle will continue, albeit modestly. The bank just hiked 25 bp in December, and we think another one this month seems unlikely given the soft economy. A hike is likely later in Q1, however.