Outlook for EM FX – poring over Powell’s Jackson Hole rhetoric
We remain as defensive as ever in the forward outlook for EM currencies, though values in some currencies are beginning to look attractive. A 70%-plus decline in Turkish equities, for example, certainly looks interesting for long-term holders, even if it appears far too premature to speculate on any sustained recovery in the lira. The strong US dollar is the chief risk indicator of the moment with USD liquidity squeeze is at the heart of EMs' structural vulnerabilities as the Fed tightens policy on a funding currency that has been far too popular over the last decade.
As ever, we keep our eye on the CNY for the risk of the floor giving way, and this is something that has a kind of a “binary” feel about it – i.e. would China allow the USDCNY rate to merely crawl higher in the face of further USD strength, or just let it rip? China has vowed it won’t pursue a CNY devaluation as a policy, but it could easily argue that USDCNY above 7.00 is merely driven from market forces if there is a strong USD backdrop.
But the most readily identifiable event risk that could either introduce a bit of a relief rally in EM or engineer a significant new meltdown on the scale of the 2013 taper tantrum is the speech by Fed chair Jay Powell at next Friday’s Fsyposium in Jackson Hole, Wyoming. This yearly event has been the launching pad for major moves in global markets, particularly the 2010 Jackson Hole speech from Ben Bernanke, which signaled the coming of the Fed’s QE2 policy. If Powell shrugs off Fed responsibility for USD liquidity conditions globally after this recent episode, it may remind the market of what it fears most: that the so-called 'Fed put' has a much higher lower strike price than was the case under Greenspan/Bernanke/Yellen and that the put will only be exercised with domestic US considerations in mind.
We would suggest that the risk of this stance is rather high and remind our readers that Powell speaks in a very frank manner that the market may not have fully adjusted to after the 30-plus (!) years of dovish wishy-washiness under his predecessors. EM currency performance: Recent and longer term, carry-adjusted Chart: weekly spot and one-month carry-adjusted EM FX returns versus USD
: The Turkish lira volatility on obvious display here as the currency posts the strongest one-week performance together with the worst one-month performance. Elsewhere, the picture is mostly negative for the one-month timeframe as all of EM has been spooked by a fresh bout of risk-off, USD strength, and the sharp CNY weakening. The “next domino” if we are to see a wider spread contagion, is widely expected to be South Africa due to its external indebtedness and current account deficit, and no coincidence that the ZAR has posted the weakest one-week and one-month performance after TRY.