Emerging market currencies fall sharply as investors flee from risky assets
24/Αυγ/2015 • Currency Updates•
The recent Yuan devaluation and the generally weak tone of economic data from China continued to ripple through markets last week. Risky assets, including stocks, non-sovereign bonds, and emerging market currencies sold off hard throughout the week, and most of them closed the week near lows.
Somewhat puzzlingly, the currency chosen as safe haven was the Euro, more than the US Dollar. While the latter rallied against all major emerging market currencies, it actually sold off quite sharply against the common currency, ending the week down nearly 3% against the Euro.
We think that this unusual divergence is a product of August currency trading, and would expect the downward trend in the Euro to reassert itself as we get closer to the September FOMC meeting.
Last week we received a strong upward surprise in inflation readings out of the UK.
The headline inflation number rose lightly, to 0.1% from flat on the year in July. More importantly, however, was the sharp acceleration of the core number, from 0.8% to 1.2%. The jump in core inflation was driven by the more volatile components, and we may see a partial unwind in the August report. However, it is clear that inflation in the UK is headed back towards the MPC’s target over the medium term, and we expect this to result in additional dissenters in the MPC interest rate votes over the next few months, culminating in a February 2016 hike.
None of this mattered much to markets last week, occupied as they were with the general sell off in risky assets. Sterling traded almost in lockstep with the Dollar, rising against emerging markets by giving up a surprising amount of ground against the common currency.
Data out of the Eurozone continues to be mildly disappointing.
GDP growth in the second quarter is now estimated at no better than 1.3% annualised, a significant downgrade from the 2% that most economists (ourselves included) had been expecting only a few weeks ago. We did not get much clarity on future prospects from the key PMI business sentiment indices, which were essentially unchanged in August. These remain at levels that in the past have been consistent with roughly 2% growth. However, lately the PMIs have proven too optimistic, as actual growth numbers have come in significantly below the levels predicted by the former.
None of that mattered much in markets last week, which were driven by liquidation of positions rather than economic fundamentals.
Investors focused mainly on the publication of the minutes from the Fed July meeting and the inflation numbers out last week.
Each release pointed in a different direction. On the one hand, inflation numbers came out lower than expected, as both the headline and core numbers rose just 0.1% in the month. On the other, the minutes suggested that the Federal Reserve is edging ever closer to its first hike in interest rates, although divisions remain as to its timing.
The FOMC continues to be positive on growth prospects, but the inflation outlook is now somewhat lower on the back of falling commodity prices and a stronger Dollar. We continue to expect a September interest rate hike but expect it to be a very close call.