Another Freaky Friday

BBH CurrencyView

  • EUR/USD headed back below 1.347 as European stocks extend early morning losses; DAX down 2.7%
  • G20 communiqué indicates that EZ actions to increase EFSF flexibility is likely; details remain light
  • Singapore’s inflation continued to surge in August; Poland retail sales beat market expectations

The nascent London equities rally has lost some momentum as the markets remain wary of EU political risk and the chances of international policy co-ordination appear thin, even if the desire for international co-ordination and market intervention tactics have grown rapidly this week as visible from the G20 and BRIC statements and Asian CB interventions to support domestic currencies overnight. EU comments on the need for more bank capitalization have put fresh salt in the markets wound and French bank shares have plummeted 2-2.5% since then. The Dax and CAC40 are leading declines, down -2.4% and 2.2% respectively. Core government bonds are little changed to better bid near record highs. Crude oil collapses through $80bbl, gold and copper down 1.7% and 5.8% on a fresh wave of flight to cash. US futures point to a another negative open, with the S&P down 1.0%.

Today with little data to focus on, markets will look for guidance from policy makers to support the global economy and restore financial health to the Europe’s ailing banking system as the IMF and World Bank host their annual meeting. This is followed by the G20’s emergency meeting last night, which on the whole achieved very little in terms of substance but ended with policy makers endorsing a plan to help the world find a path to growth. According to the press reports by the time the next meeting comes around the euro zone will have implemented actions to increase the EFSF’s flexibility and potentially its size. What’s more, the G20 communiqué statement suggested that governments will take all necessary actions to preserve the stability of banking systems and financial markets as required. Color us skeptical. For one, they provided no time line for action and in the meantime the EFSF will need to be ratified by all members of the EZ before policy makers can make any changes to the current structure of the facility. To date, there have only been a few European governments that have ratified the implementation of the EFSF, including Belgium, Estonia, France, among others, with Germany and Finland slated to vote next week. Portugal, meanwhile, has not even set a date for the vote, suggesting that it is unlikely to vote until sometime in October. To us, that indicates that European policy makers are again unlikely to take decisive action to vote on the implementation and potential enhancement of the EFSF, which implies further downside potential for risk appetite, the EUR/USD and growth sensitive currencies despite the potential for momentum models to be flagged by “oversold” signals. In fact, the EUR/USD continues to track the 2-year German-US rate spread quite well (now at only 15bps) and with the OIS market implying nearly a 100% chance for an ECB rate cut in October it seems likely that a downside break of 1.338 opens up a longer-term move to 1.30.

In the EM space price action continues to be dominated by external developments in developed markets and we suspect that this is unlikely to change anytime soon with the correlation of most EM currencies remaining at cyclical highs to developed market equity indices. Contagion effects aside, markets continue to need to focus on the fundamentals of most EM countries since many of the different regions have idiosyncratic macro stories that are likely in part to contribute to the outlook for many of these currencies. In Singapore, for instance, inflation continues to surge, with August CPI accelerating to 5.7%y/y from 5.4% y/y. The drivers continue to remain higher transport and housing costs, while fuels costs have come down a tad. Nevertheless, the expected increase in public transport fees next month should keep transport costs elevated. This unexpected rise in inflation will likely complicate the MAS’s next move. Despite the acceleration in inflation, we suspect against the current market backdrop that the MAS is unlikely to shift policy. And while it is too early to move to an easing bias given the recent rise in inflation, we suspect the MAS look to begin easing in April if the global outlook continues to worsen. Poland’s retail sales increased by 11.3% y/y, exceeding market expectations by a wide margin. Impressive domestic demand growth signals no room for monetary easing but it also shows strong fiscal performance. While a large domestic market should shield Poland from the global turmoil, PLN is once again one of the worst EM performers due to its exposure to the euro zone financial stress. We saw this back in 2008-2009, and this trend is likely to continue despite decent fundamentals. Upcoming October 9 general elections are not seen having much impact, as ruling Civic Platform is leading in the polls and expected to win a second term.

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