Despite what on the surface would appear to be a very supportive backdrop for emerging market currencies, EM currency performance has either been relatively indifferent or in the worst cases, absolutely terrible over the last three weeks. Some of the recent support for EM conditions and the more liquid EMs globally has come from very strong risk appetite as the market holds high hopes for the US-China trade negotiations and as the US Federal Reserve’s recent policy easing and resumption have been very welcomed, especially as a few of the more recent US data points have led to a narrative that the US may skirt recession or is stabilizing now from all of the stimulus.
The US Fed’s efforts do improve USD liquidity in general, all other things being equal. At the margin, another factor has likely been China allowing the USDCNY rate to cross back below 7.00 as China applies whatever goodwill pressure it can to get the US to drop tariffs in the ongoing trade negotiations.
Just before posting this, however, we are reminded of how fragile the trade deal narrative remains as a negative story breaking on a possible misunderstanding between the two sides has the USD moving higher and risk appetite suddenly swooning. One thing for sure, the general uncertainty has muted volatility as we await the outcome, though we are already likely priced for more than any trade deal can actually deliver. Likewise, the market is of course very poorly positioned for a fresh breakdown in talks akin to what unfolded earlier this year, when Trump jacked tariffs sharply higher.
Chart: Saxo Bank Global Risk Indicator
Before easing back lower a bit over the last couple of weeks, our global risk indicator recently saw some of the most positive readings in its history (remember, the readings for the indicator are never absolute, but rather merely based on standard deviations relative to a moving average, all with a 150 day look-back period.) Most interesting for EM traders, the EM credit spreads have been a major contributor to strong indications of risk appetite, and have absolutely collapsed at an incredible pace to within about 25 basis points of the lowest levels since the global financial crisis. Given that collapse, the short term performance of EM is not particularly impressive, with EM perhaps held back by the stubbornly strong US dollar and the recent back-up in US interest rates. If EM hasn’t put in a particularly noteworthy performance given a nearly historically supportive backdrop, it is hard to see what can support from here, save for some profound breakthrough in trade tensions or a broad upswing in the economic outlook.