Emerging markets to remain squeezed into the Fed

  • EM markets continue to spiral lower
  • Key risk this week comes from Wednesday’s Fed meeting
  • Euro and yen the main beneficiaries as carry trades unwind
  • GBP lower after Carney speech on Friday. Inflation report in Feb the focus

Volatility in emerging markets is continuing to weaken riskier assets across the board, with the typical haven trades benefiting as investors rush for the door. Whether this is down to last week’s poor Chinese manufacturing PMI number, the relaxation of currency controls in Argentina, sabre-rattling by the Japanese Prime Minister or the political protests in Egypt, Ukraine and Thailand, the weakness has become contagious.

Euro and yen are in the spotlight today, flying higher as investors get rid of emerging market trades. Emerging market currencies such as the Turkish lira, South African rand and Argentinian peso have been crushed in recent sessions, as money heads for the door. Money is like energy in that it must be transferred from one state to another; destruction is impossible. In this case, the money is moving into the euro and yen as they were popular funding currencies for these riskier bets in the past. Much like most emerging market ‘crises’, there is a likelihood that this will get worse before it gets better.

Given the rather idiosyncratic nature of the reasons behind the ‘move, there is little to suggest that it will come to an end soon. Political pressures are one thing but ongoing fears around Chinese weakness and the negative effects of all-too-fast reduction in stimulus by the Federal Reserve are more dangerous.

The Fed’s meeting on Wednesday evening is by far the most important event of the week. It is the last meeting under the stewardship of Ben Bernanke, with Janet Yellen taking over from Feb 1st. Following the Fed’s decision to reduce its monthly stimulus by $10trn in December the conversation has shifted from “when will asset purchase reduction begin?” to “when will asset purchases end full-stop?”. We expect that this month’s meeting will see the Fed decide to reduce stimulus by another $10trn with half from mortgage backed securities and half from treasuries. This involves looking through the horrendous payrolls announcement at the beginning of the month and the ongoing weakness in inflation. There is no press conference with this meeting but the additional statement should echo December’s closely in that the Fed has seen encouraging signs within the US economy but that risks remain and rates will remain at “ultra-accomodative” for a long time.

GBP was put on the back foot by the Bank of England Governor on Friday. Mark Carney had spoken on Thursday night detailing that the Bank’s forward guidance plan to signal rate movements in the UK will need changing. Friday delivered little new news from the Governor but we will now see a review of ‘how to evolve forward guidance’ at February’s inflation report. The Governor also attempted to talk down the pound by reiterating that sterling appreciation will hamper export growth. Mervyn King was guilty of always weakening sterling when he opened his mouth; so far Carney’s utterances have had mixed results.

GBP’s focus this week will be tomorrow’s GDP report at 09.30. This will be the preliminary look at Q4 and hopes will be that the strength seen in manufacturing, service and construction surveys can be replicated in ONS output numbers. The market is somewhat below where we thought it would be, with the consensus being a 0.7% increase, so we will go slightly above with 0.8%.

JPY has retreated from its bull run a tad this morning following some worse than expected trade deficit numbers. An increase in the cost of oil imports following the fall in the yen and the increase in reliance on fossil fuels since the Fukushima nuclear disaster caused imports to rise by 24.7% in the past year. USD selling will likely be seen if USDJPY gets closer to the 100 level. For now, we are looking for USDJPY to recover over the week.

European focus today will be on the German IFO report from German businesses. Last week’s ZEW number missed expectations heavily but the correlation is poor at best. For what it’s worth, the figure will be overshadowed in the short term by Draghi’s comments overnight that the ECB could buy bank loans in a bid to stimulate the economy and drive fears of deflation away.

Indicative Rates



GBPEUR 1.2061 1.2084
GBPUSD 1.6515 1.6536
EURUSD 1.3676 1.3696
GBPJPY 169.36 169.49
GBPAUD 1.8941 1.8965
GBPNZD 2.0056 2.0083
GBPCAD 1.8282 1.8306
NZDUSD 0.8227 0.8244
GBPZAR 18.46 18.51
USDZAR 11.179 11.205
GBPPLN 5.0749 5.0977
EURJPY 140.07 140.26

Disclaimer: The above comments are only our views and should not be construed as advice. You should act using your own information and judgment. Although information has been obtained from and is based upon multiple sources the author believes to be reliable, we do not guarantee its accuracy and it may be incomplete or condensed. All opinions and estimates constitute the author’s own judgment as of the date of the briefing and are subject to change without notice. Any rates given are ‘interbank’ i.e. for amounts of £5million or more thus are not indicative of the rate offered by World First for smaller amounts. E&OE. Definitions of jargon/market terms can be found in our Glossary of Foreign Exchange Terms.

Sectors: Foreign Exchange
Topics: Finance
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