Via Citi FX Technicals,
Up the escalator, down the elevator shaft
The volatility in Local Markets which began in 2013 may just be beginning as much of the excess liquidity that went in search for yield may reverse course. During the next few months to few years, we would not be surprised to see even greater stress as the “Greenspan/Bernanke/Yellen put” begins to fade and volatility returns to markets.
LatAm is coming under pressure with Brazil, Mexico, Chile and Colombia all setting up for further losses. In CEEMEA, stress has been more selective with Turkey, South Africa, Russia and Hungary being the countries in focus for now.
While Asian Local Markets remain relatively calm compared to LatAm and CEEMEA, the ADXY Index is testing a major support level at 115. A monthly close below there would be concerning and suggest Asian currencies could come under significant pressure.
We can’t help but feel that the current pressure being felt in Local Market currencies and equity indices may only be starting. As we pointed out yesterday (and re-printed here), the backdrop over the last decade is very similar to that seen from 1989-1998 when:
1989-1991: US housing and Savings and Loan crisis: Fed eases aggressively as economy enters deep recession
1992-1994: Existing financial architecture in Europe (ERM) blows apart
1995-1998: European convergence trade in both FX and Bond spreads keeps European currencies relatively stable vis a vis the USD with a good rally in 1998. By 1996 BUBA has lowered the discount rate to 2.5% while US rates remain well below the pre-crisis highs of 9.75% in 1989.
The carry trade and capital flow into emerging markets (Asia in particular) is center stage:
March 1997: In a seemingly “innocuous” move the Fed “tinkers” by raising rates 25 basis points.
April 1997: Japan raises its consumption tax as USDJPY has rallied from a post Kobe Earthquake low of 79.7 to 127.50. USDJPY collapses to 111 by June
June 1997-Jan 1998: Severe reaction in Asian currencies as “hot money flees”
August-October 1998: Russia defaults, Long term capital folds and the Fed eases aggressively as the Equity market drops 22% (S&P)
History may not repeat…..but it sure RHYMES
In the years since the Financial Crisis, major Central Banks have been engaged in incredible easing programs that included the injection of massive amounts of liquidity into the financial system. That liquidity had to go somewhere, and in a search for yield, much of it went indiscriminately into Local Markets.
The announcement by the Fed in May 2013 that it would be looking to reduce its bond buying program was the first indication by a major Central Bank that the period of free money/excess liquidity was going to start winding down. The immediate reaction was panic and volatility across all “risk” assets, with Local Market currencies and equities being especially vulnerable. Soon after, though, markets began to adjust to the reality that this was the beginning of the end of the “Bernanke/Yellen put” (at least for now) and since then we have seen Local Markets come under pressure.
So far, the exodus of money from Local Markets has been “tame” compared to previous EM crises and it has also been selective since countries with weaker economies and foreign reserves have been the ones taking the largest hits. However, our bias is that this is just the beginning. We have only begun to see “volatile” price action and the charts in the following pages show just how far some of these Local Market currencies and equities can go. In focus for now is LatAm and select CEEMEA countries as they have come under the most pressure.
However, the bigger danger over the next few months/years is that the markets begin to ‘throw out the baby with the bathwater” and Local Market investors begin to exit through the same small door.
Though Asia Local Markets have been rather calm in comparison to other regions, we still think caution should be maintained
The ADXY Index is testing very good support at 115, the 55 month moving average, and a close below there on a monthly basis would be bearish. If seen, it would also be the first close below the 55 month moving average since 2008.
There is good support closely below there around 113.58-113.68, the 2012 and 2013 lows which also serve as the 76.4% retracement pivots of the 2011-2012 decline
A break below there would further suggest even larger losses are likely, potentially towards the 200 month moving average which is currently at 106.75 (there is support before there at 108.77, the 2010 low,that would be worth keeping an eye on).
It is important to note that 49% of the Index is made up by CNY and HKD. As we are not currently of the bias that these currencies would see significant (if any) depreciation even if the EM sell-off were to become more aggressive in Asia (as a reminder, during the major ADXY collapse in 2008, USDCNY and USDHKD remained essentially unchanged)
As a result, if we were to see a continued bearish development in the ADXY, it would suggest the other currencies in the Index (INR, IDR, KRW, MYR, PHP, SGD, TWD and THB) would see greater weakness then the overall weakness. We will be watching for any developments closely...