Market sending mixed signals on risk appetite

John Hardy

Head of FX Strategy

The market tried to put together a relief rally yesterday with mixed success. USDTRY was back toward 6.50 driven by some intervention from Turkish authorities, and Turkish government bond prices bounced respectably, but the move is far from convincing and President Erdogan’s continued lambasting of the situation as a coordinated attack on Turkey makes it clear that no solution will be found through an appeal to an institution like the International Monetary Fund. 

Erdogan may even prefer to default on foreign obligations and some sort of capital controls rather than permitting the massive rate hikes required to restore confidence in the lira. We point again to Russell Napier’s pointed analysis of the situation and risks that need to be measured in behaviour rather than in dollars and cents, yet history is littered with numerous examples of those who could pay but have chosen not to pay, and a historian who points out these facts commits apostasy in the eyes of the keepers of the spreadsheets.

Historically many have chosen not to pay because the socio-economic pain of paying has been considered too great. For a country with large foreign currency debt, in particular, a mass sale of local assets to foreigners or a crushing recession delivering a major current account surplus are the only ways to repay excessive levels of such debt. These two options are rarely compatible with re-election for politicians and are seen by the populace as sacrificing local livelihoods for the benefit of foreign financial predators.

Yesterday’s tragic bridge disaster in Genoa prompted an anti-European Union response from Deputy Prime Minister Salvini, who seized on the story as a sign that larger fiscal outlays are needed to bolster Italian infrastructure. Italy government members are appealing to the European C to prevent speculators from “attacking” its debt markets. But this is the essence of the entire flaw in the EU’s foundation – Italy is merely not considered a trustworthy borrower – and its higher yields are simply called “a bond market”. And effectively, Italy’s funding issues are not any different than those of Turkey. As long as the Italian central bank can’t print money, Italy is effectively funding itself with a foreign currency.

Elsewhere, we only note that USDCNY continues to press higher to new highs and perilously close to the 7.00 level that will begin to test global risk sentiment from a new direction (the fear that China will feel forced to devalue its currency on USD liquidity squeeze.) Plenty of signs of stress in China as authorities move to inject funds into banks to boost lending.

The calendar today is not interesting save perhaps for UK CPI and whether this continues to cool, though even there the focus is on EU existential and Brexit developments.

Chart: USDJPY

The USDJPY bounce has taken the pair back out of the downside pivot zone that was set in motion well below 111.00, at least partly rejecting the bearish developments of late. We won’t know until/unless the markets suffer another ugly bout of risk deleveraging, but could this be a sign that the “global offshore USD liquidity squeeze” narrative is more important during bouts of risk off than the “yen strength on capital flows linked to Japanese savings repatriation pressures” that has normally dominated over the last 12-15 years during bouts of risk-off. We simply file under “interesting” for now... we would still expect both currencies to strengthen versus most other major and minor currencies if another risk-off move is unleashed.

Enlarge
Source: Saxo Bank

The G-10 rundown

USD – the greenback remains strong and it's hard to see what development would see the currency weaker at the moment, besides a full return of key EM pairs to their old ranges and return of low volatility. The next key event risk for the USD is any policy signal from next week’s Fed Jackson Hole conference.

EUR – the euro remains weak, with new lows posted in EURUSD and we keep our eye on the 1.1200 area as a potential target and even lower if Italian yield spreads to the core widen to new extremes. 

JPY – as we note above, we wonder if the USD will prove the chief focus of any risk deleveraging on the global USD liquidity angle, but still expect broad JPY levels to correlate with risk-off (JPY strength) risk on (JPY weakness). Apparently, Japanese savers were quite enamoured with Turkish debt

GBP – sterling keeping the upper hand versus the struggling euro, but GBPUSD poking to new lows and lower levels still could come into view there on any CPI miss from the UK today. Rate policy from Bank of England is not likely a sustainable driver for the action in the near term.

CHF – EURCHF is perhaps more driven by elevated EU peripheral spreads than the ups and downs in the TRY at the moment (though there is a link if Turkey defaults via EU bank exposures). USDCHF actually has been sidelined below parity despite the USD strength.

AUD – AUD out of favour across the board, likely on concerns linked with China. AUDCAD slammed to new two-year lows over the last couple of sessions. Tonight’s employment data from Australia are the next event risk. 

CAD – CAD quite the outperformer as the BoC rate outlook has more than kept pace with the Fed’s lately. Still, surprised CAD hasn’t taken more of a hit on this latest oil sell-off and more USDCAD upside risk if today’s US inventories trigger further weakness there.

NZD – the 1.1000 level in AUDNZD barely hanging in there – tonight’s Australia employment data likely providing further input there. Otherwise, expect NZD to trade passively to the swings in risk on/risk off.

SEK and NOK – both trading indifferently. Widespread arson incidents in Sweden adding to potential for a strong turnout for anti-immigration Sweden Democrats party at the September 9 election. NOK under pressure from weak oil prices and lack of anticipation for developments at tomorrow’s Norges Bank meeting.

Upcoming Economic Calendar Highlights (all times GMT)

   • 0830 – UK Jul. CPI / RPI / PPI
   • 1230 – US Jul. Retail Sales
   • 1230 – US Jul. Empire Manufacturing Survey
   • 1315 – US Jul. Industrial Production / Capacity Utilization
   • 1430 – US Weekly DoE Crude Oil / Product Inventories
   • 0130 – Australia Jul. Employment Data

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