Myriad Flaws

The Turkish are starting to act
As dollars they try to attract
Restrictions imposed
Effectively closed
The method short-sellers had backed

But problems in Turkey remain
And although we’ve seen lira gain
The myriad flaws
In Turkey still cause
A major league capital drain

Much to my chagrin, I am forced to continue the discussion on the Turkish lira as it remains the driving force in FX conversations. Despite the fact that Turkey is a bit player on the world stage economically, the fear engendered by its recent policy actions and subsequent market gyrations continues to have spillover effects elsewhere around the world. The latest example is that the Indonesian central bank surprised most analysts last night and raised their policy rate by 25bps to 5.50% specifically to help fight further IDR weakness. The rupiah finds itself weaker by 1.2% this week, despite the rate hike, and nearly 5% since late June, which has included two rate hikes. Clearly, the market has evaluated the macroeconomic situation in Indonesia and sees too many similarities to Turkey, notably the significant amount of USD debt outstanding there. As long as the Fed continues to tighten policy, and there is no hint that they will be slowing down anytime soon, every emerging market with significant USD debt outstanding (besides Turkey and Indonesia, Malaysia, South Africa and Argentina come to mind) will continue to see their currency under pressure.

The question of whether the Turkey situation is a harbinger of others remains the hottest topic in FX markets. Last night, the Bank of Turkey took a page from China’s activity book and attacked the forward FX market by reducing the limit on banks’ swap transactions to 25% of shareholder equity, down from the previous level of 50%. This had the effect of driving up short-term lira rates substantially, with the overnight rate touching 34.5%. It should be no surprise that the lira has continued yesterday’s rebound, rising a further 3% this morning, but that is well off the highs for the session, when it traded back below 6.00 briefly. The point is that despite not raising the base rate, the central bank there does have some tools to help address the situation, at least in the short term. However, there is very limited confidence that President Erdogan will allow the central bank the leeway deemed necessary to address the lira’s problems in the long run. This story is nowhere near over, although several days into it, the story is starting to get a little tired.

Turning away from Turkey, the dollar is having quite a good session. Versus its G10 counterparts, we have seen consistent strength to the tune of 0.2%-0.3%. Data has not been the driver as the only notable release has been UK inflation, where the headline came out at 2.5%, 0.1% higher than last month, but right on analysts forecasts. There has been a modest amount of Brexit conversation, but none of it has been positive, and at this point, every day without positive news is likely to weigh further on the pound. Meanwhile the euro is making a run at 1.1300, a level not traded since late June 2017, and unless we see some policy adjustments, it is hard to believe that the data is going to turn things in the near future.

Regarding the rest of the emerging markets, there has been some substantial weakness in ZAR (-3.3%), MXN (-1.2%), KRW (-1.3%) and RUB (-1.4%), none of which have released any economic data of note. This feels much more like contagion as traders seek proxies to short while the Turkish authorities use up their ammunition. But of more interest to me is CNY, which has fallen 0.4% this morning to 6.9250 or so. Many analysts have been confident that the PBOC would not allow the renminbi to weaken past the 6.90 level, as they are concerned over potential capital outflows. However, I have maintained that the renminbi has much further to fall. I believe the PBOC will continue to see the renminbi as the most effective release valve for the pressures that continue to build in the economy there. Remember, too, that the government imposed much stricter capital controls earlier this year and so they are feeling more and more confident that they will not have a repeat of the 2015-6 situation. In fact, the most recent data showed that FX reserves in China actually rose last month, surprising every analyst. The upshot is that there is further room for CNY to decline, and a move past 7.00 is merely a matter of time. In fact, it would not surprise me if it occurred before the end of August.

Turning to today’s data releases, we actually receive a great deal of new information as follows: Empire State Manufacturing (exp 20); Retail Sales (0.1%, 0.3% ex autos); Nonfarm Productivity (2.3%); Unit Labor Costs (0.3%); IP (0.3%); Capacity Utilization (78.2%); and finally Business Inventories (0.1%). While Retail Sales will garner the most attention, I will be watching ULC carefully as wage growth remains the watchword at the Fed. If that number surprises on the high side, that will serve to reinforce the idea that Chairman Powell is going to ignore the screams of the emerging markets for quite a while yet. In the end, nothing has changed with regard to the broad macroeconomic picture and the dollar ought to continue to see support across the board. Don’t say I didn’t warn you.

Good luck