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Focus Remains on Emerging Market Risk

By OFX

The US Dollar index continued its momentum as a sell-off in commodity-based currencies in emerging markets fueled the DXY run up to higher highs overnight of 96.96. The major slide in Metals saw movements back into safe-haven assets in a general risk-off tone. US Dollar initial moves higher were supported by a strong reading in United States retail sales for July with the suggestion that the economy is more robust than expected. A rise of 0.5% was the best performance in Q2 in four years as the growth story continues and is supportive of future interest rises this year by the Federal Reserve.

The main story this week has been focused on emerging markets, the main contributor to the collapse in risk sentiment. The Turkish Lira again dominated headlines with their surprising appreciation against a rampant USD. The Lira strengthened by about 5% after Qatar committed to a $15b direct investment package for Turkey. Regulators in Turkey also highlighted further limits on FX swaps which helped ease concerns for the Lira. Despite the positive step forward, the rhetoric stepped up a notch with President Erdogan announcing tariffs on a variety of US goods. Despite the appreciation in the Lira, emerging markets continued their broad sell-off, pointing to other underlying issues with the sector.

On the agenda, today of importance is the Philly Fed Manufacturing Index which missed expectations of 22 and posted an 11.9. Building Permits in the United States were also released this morning, printing better than previous and consensus. We expect markets to continue to see heightened volatility on current emerging market risk with the Volatility Index spiking to its highest level since June.

The Canadian Dollar fell through trade on Wednesday pushing back to the 1.3171 to touch intraday high of 1.3180. Despite a broader consolidation across G10 currencies following a pledge from Turkey’s central bank to underpin the Lira the CAD gave up gains hard won earlier in the week and extended the downward depreciation that started in the immediate risk-based sell-off.

The Canadian dollar moved lower as investors looked to square positions on narrowing expectations to BoC will raise rates again in 2018. Despite steady gains across employment data last week, the run on effect to wage growth and inflation remains subdued as household earnings narrowed and inflation expectations held steady ahead of Friday’s CPI print. Signs of lackluster price pressures suggest the BoC will maintain its current monetary policy stance when it next meets in September leaving little doubt the US will extend a yield advantage.

The Euro opens higher this morning after reaching its lowest levels since July 2017. Touching lows of 1.1301 in the London session before rebounding 50 pips early in US trade, EUR/USD then stabilized around the 1.355 handle. The bounce is mainly attributable to a mild correction in the greenback and a further rebound in the Turkish Lira. The rise in the TRY did little to stem the broad-based losses in European and US equity markets with commodity prices and emerging market currencies also being sold off.

The remainder of the week presents a light calendar for the Euro, with no macroeconomic datasets due out of the eurozone, traders will continue to take their cues from offshore releases and risk sentiment out of emerging markets. Risk sentiment front of mind, EUR/CHF and EUR/JPY will continue to serve as an indicator of EUR direction more broadly. Given the overnight price action, EUR/USD topside resistance can now be seen at 1.1428 with 1.1331 level seen as support.

UK CPI rose slightly to 2.5% y/y latest figures showed yesterday. The market was not taken by surprise as a higher reading was expected, the sterling barely moved on the back of the release. The report cited rising prices for computer games and transport fares as adding the main upward pressure to the basket of goods CPI is calculated on. At the same time, PPI released showing, products and raw materials purchased by manufacturers rose 0.5% m/m higher than the 0.1% expected. This pipeline pressure could add some support to inflation in the medium term if it is passed on to consumers.

Overnight all metrics of the UK Retail Sales numbers all posted better than previous and forecasts. GBP/USD continues to trade left and right of the 1.27 handle, The GBP/CAD mover higher and trade back over the 1.6725.

The Australian dollar edged marginally higher through trade on Wednesday pushing back through key supports at 0.7230. With broader direction driven by fluctuations in risk sentiment following the Turkish lira’s collapse, the AUD came under increased pressure following a lackluster quarterly wage growth print. Wages grew at a moderate pace through the 2nd quarter but failed to excite investors or prompt any amendment to expectations for RBA monetary policy change, further exacerbating the burgeoning yield gap between the RBA and FOMC. The mediocre print forced the AUD toward intraday lows at 0.7203, opening the door for a consolidated break below 0.72.

While the immediate panic following the Lira collapse on Monday has subsided somewhat the AUD outlook through the short term remains bearish. Ongoing trade hostilities threaten global growth, iron ore prices face mounting pressures and the gap between the US, and Australian interest rates appear likely to only widen through the coming 6-12 months. Having gapped lower, we now seem to have entered a new trading band with little upside momentum on hand to drive the AUD back toward 0.74/0.75.

The New Zealand Dollar continues to consolidate in the general risk-off environment over the past 24 hours. Initially, the Kiwi dipped to a fresh low of 0.6548 but otherwise held its ground as emerging markets broadly softened, and market conditions favored the strengthening Greenback. Opening this morning at 0.6593, the NZD looks to be stuck in a number of geopolitical cross-currents.

Overall, the New Zealand Dollar was caught in the cross-winds as broad weakness in emerging markets, falling commodity prices, US Monetary Policy, Chinese growth and trade wars all begin to take its toll. As a currency that benefits from risk-taking, this environment does not help the Kiwi’s fortunes. The New Zealand Dollar now looks to hold its ground with attention firmly affixed to off-shore events.