A few thoughts ahead of the weekend and early next week, with my next update not until next Thursday.
USD not adding to the melt-up narrative. Broader measures of the US dollar rally largely topped out a week ago, and the momentum dropped before then, meaning that the “USD liquidity is driving everything” argument is getting more than a bit threadbare. Before, I have mentioned the US Treasury’s stockpiling of over $1.7 trillion, a move that on balance reduces liquidity. That and the fact that the Fed balance sheet has not grown for months now are two factors eroding the USD liquidity narrative, with all arguments in that direction pointing to expectations for more rather than the current state of affairs. Unless the Treasury is set to flood the market with new stimulus and/or the Fed is set to up its pace of purchases, it is tough to argue for fundamental support for an imminent extension of this USD move lower.
Some TRY transmission into EM nerves and an interesting weekend ahead for RUB – the USDTRY move pulled higher still today after about a 3% rally yesterday, though was tamed a bit as of this writing. We have highlighted that European bank exposure to Turkey is non-trivial and could even hurt the euro at the margin after its aggressive runup versus the USD. Turkey seems to be turning the corner on policy to address the drivers of TRY weakness, but this is early days. Select other EM’s have suffered a rough ride recently, among these ZAR and RUB, both of which have traded near recent extreme lows versus the Euro, with the weak USD hiding to a degree just how weak they have been. Foreigners are dropping South African debt from their portfolios, with July data showing a drop to 30.1% ownership of sovereign debt by foreigners, versus over 37% in January. Moving over to the Russian ruble (RUB): this weekend sees an historic Belarus election, where any popular perceptions that the results have been rigged could see the record protests emboldened further to stay on the streets. Any Russian involvement in the situation (Belarus’ embattled leader Lukashenko traditionally very aligned with Moscow, but has pushed back against Putin’s recent overtures on closer union) could bring echoes of Ukraine’s “colour revolution” and the spectre of fresh sanctions from the US and Europe.
The negative rates story is driving everything – this was one of our main themes in today’s Saxo Market Call podcast, where we point out that market pricing of forward US inflation points to market pricing in aggressively negative real rates (inflation above so). This doesn’t have to be a US-specific story, of course, meaning that as long as other countries are moving in the same direction as the US on budget imbalances and stimulus and perceived inflationary risks, this doesn’t have to be a USD story – but it is a hard assets story (see many commodities prices, especially iron ore and gold and silver of late – if not yet the very important energy component!) and a solid, profitable company story (US tech and internet giants). On that note, AUD seems particularly attuned to this story and therefore also vulnerable if there is a significant consolidation in commodities in particular and in the narrative in general.
US economic data – who cares? It is tough to argue that the market will pull much from data surprises in either direction. If the economy is running hotter than expected, it enhances the negative real rates story noted above as the Fed, for example, has declared it would like to see things run hot and for employment to normalize before considering a rate hike. Weak data, on the other hand, means the market will anticipate that ever greater quantities of fiscal stimulus will be forthcoming until morale improves… The key risk to the narrative would be either a) fiscal stimulus surprisingly fails to match up to the scale of the problem and the growth outlook deteriorates badly, or b) either growth or the fiscal stimulus or both sees longer yields rising more determinedly, with the Fed tardy to send out the alarm on imminent yield-curve-control. Finally there is c) the case in which inflation arrives even as the economy stays weak – a nightmare stagflation scenario that is positive for almost nothing save gold.
USDCAD has become the latest USD pair to tease that it is becoming uncomfortable with the latest wave of USD weakness, as it consolidates back into and even above the 1.3300-50 zone that was so pivotal on the way down. Locally, a more full-bore reversal back to 1.3450 is needed to suggest a reversal of more conviction, but we’re watching this pair into the close of the week, especially as oil trades in technical limbo as it finds itself back below the range highs that were briefly taken out this week.