News: Syria Pushes TRY over the Edge, MXN Roller Coaster Continues

I did not think Syria would have much of an effect on the markets, but as one story on the wires put it, the market has "a good old fashion case of the geopolitical jitters."  Risk is being sold today, and the usual suspects are coming out on top.  JPY and CHF are both modestly up today, with USD/JPY falling off towards the 97 base.  USD/CHF was also dinged for a good 40 pips.  

EM space was mixed; USD/MXN pushed as high as 13.38 before falling sharply back toward 13.25.  This pair has been especially volatile of late.  Today marks the second time in a week that the Peso has fallen sharply only to regain its footing and then some.  Recent numbers in the Mexican trade account also present a puzzle.  Surging imports for in July in both consumer and capital goods contradicts the story that the Mexican economy is slowing, since weak sentiment ought to hurt both investment and consumer demand.  Exports to the US were also up, for both petroleum and non-petroleum products.  The fact that a currency under mild to moderate pressure from general EM turmoil also did not crimp Mexican demand for both capital and consumer broads from abroad further underscores the resilience of both consumer and business confidence.  Indeed, the former is approaching its one year high.  Business confidence is still subdue but is rising.  The X-factor is the Fed and the Bank of Mexico.  When and if tapering comes, and if the Bank of Mexico is willing cut further will dominate headlines in short term.  However, longterm, Mexico still appears to be poised to benefit from the US recovery.  

Turkey's Lira continued its free fall, with USD/TRY surging past the big 2.00 figure to reach highs of 2.04, before retreating to 2.03  These record lows for the Lira vis-a-vis the dollar expose underlying vulnerability of the lira and the overall performance of the Turkish economy.  Turkey remains highly dependent on exports to both the Middle East and Europe.  With the former in political upheaval and the latter still years away from full employment, Turkish growth prospects and diminishing and that is being reflected by the fall in the lira.  To make matters worse, a falling lira and rising energy prices brought on by Mid-East turmoil threaten to erase hard won gains in plugging Turkey's substantial current account deficit.  Finally, markets responded poorly to statements by the governor of the Turkish Central bank, indicating that the monetary authorities will use reserve sales in the FX market, rather than interest rate hikes, as its main tool to shore up the lira.  Perhaps markets are overdoing it as usual, but I must agree that in the medium to longterm, Turkey's outlook has weakened.          

Commentary: EM Blows Out, No Surprises from Fed Minutes

Today's Fed minutes held no surprises, but that didn't stop the market from selling EM currencies, and CAD and AUD in anticipation of a scale back of asset purchases next month.  After the minutes were release, the dollar extended gains against the above currencies.  The greenback also strengthened against EUR and CHF, but it was a subdued, with both pairs moving only about 30 pips in favor of the USD.  USD/JPY ground higher all day, moving up roughly 70 pips from 97.11 towards 98.  However, the real action happened in EM space.  USD/INR and USD/TRY hit all time highs today, and both the RBI and the Central Bank of the Republic of Turkey intervened in the FX market today.  The RBI sold USD 1.3 billion to satiate local demand for the greenback.  Turkey continues to tighten rates, and today announced that it will sell USD 100 million everyday until further notice.  Peru's central bank, which has in the past has intervened to calm FX markets in times of high volatility sold a record USD 600 million to prop up the Nuevo Sol.  Peru's economy, one of the most dynamic in South America has grown robustly over the previous few quarters though has slowed with the rest of the world economy in 2013.  Last year capital inflows pushed the Sol higher but uncertainty over US monetary policy has spooked investors causing a near 10 percent slide YTD.  Likewise, MXN and ZAR were both hit hard, sliding near nearly 3000 pips each against the dollar.  Neither the Bank of Mexico nor the South African Reserve Bank intervened in the FX market today.  

Today's developments has me reassessing my strategy somewhat.  While I still like Mexico's prospects in the year ahead, markets are obviously terrified of the abrupt end of QE.  Furthermore, MXN seems to be much more sensitive to taper fears than CHF, my funding currency.  The result is that hand wringing from the Fed causes CHF to weaken, but MXN to weaken more.  I have thus taken the step of become a net long USD by buying more USD/CHF than I sold of USD/MXN.  The result is that I can continue to be hedged against taper fears will still earning attractive carry of my MXN long position.  

Of final note is the dilemma facing Turkey, which is still coping with large current account deficit despite recent progress on this front.  Turkey, which must import nearly all of its energy for surface vehicles, will wind up with a higher gas bill if the Lira continues its downward slide.  However, unlike other imports such as consumer products, higher prices is unlikely to hurt demand for petrol.  Finally, Turkish consumer is likely to simply absorb the price spikes, especially since the economy has picked up steam in the last quarter. Turkey's already very high current account deficit is likely to increase with a stabilization of FX markets.  Rising inflation which is surging back up toward nine percent from 6.5 percent earlier this year also explains the very hawkish tone of the CBRT, which has now explicitly committed to stabilizing the lira and constraining credit growth.  Alas, while I feel Turkey's pain, it is unlikely that the European nation can do much without a coordinated effort from other world central banks.  Unless a crisis occurs and Turkey can convince the Fed to buy lira, TRY remains at the mercy of the markets.   

News: USD Continues to Struggle Along, but Fundamentals Still Look Good

The USD continues to struggle, down against both the Euro and the Japanese Yen.  EUR/USD is looking to break above 1.34, a point which over the last year has been an area of strong technical resistance.  It will be interesting to see if pair can find fresh sellers here or will grind higher.  On the Yen front, technical speculators are short USD/JPY with a target of 93.  These are interesting short term trades but appear to be quite risky.  The actions of the Federal Reserve other next few months will set the medium term trend for both these pairs.  If the US economy continues to pick up steam and the Fed does decide to taper this year, both these trades could be caught on the the wrong side of some powerful macroeconomic fundamentals.  Specifically, growth differentials between the advanced economies will likely remain in favor of the US.  Accordingly, the Fed is likely to tighten before both the BOJ and the ECB.  Should US joblessness fall below seven percent, a reduction in monthly asset purchases by the Fed seems likely. 

It is curious that EUR and CHF remain at such elevated levels, given that the Eurozone is still mired in recession and continues to face significant headwinds.  With unemployment near a record high of 12 percent, record low interest rates, and a fiscal crisis for several major national governments, it would appear as though Europe has run out of counter-cyclical treatments to apply.  John Taylor of FX concepts cites the Eurozone's modest current account surplus as grounds for being long the EUR.  But surely capital flows will overwhelm international payments registered in the current account.  And with rates set to rise Stateside, USD denominated assets are becoming more attractive.  Furthermore, the Swiss Franc continues to be 56 percent over valued in PPP terms.  The Swiss economy, though one of the healthiest in Europe also appears to be slowing, with the jobless rate moving up for the first time in five years.  Weak external demand for Swiss exports, and a sky high CHF with the associated deflation, finally seem to be taking their toll.  I expect the SNB to keep overnight rates at zero ad infinitum, and will stand prepared to purchase Euros in unlimited quantities to maintain its 1.20 floor on EUR/CHF . 

The biggest news in emerging markets continues to be Mexico.  While analysts continue to be largely bullish, Mexican economic performance has moderated this year, along with the US, its major trading partner.  A report today for the Bank of Mexico summarized trends in inflation and growth.  The national statistics agency reported annualized inflation at 3.47 percent for the second quarter, or 47 basis points above the central bank's target.  The Bank also lowered its 2013 growth forecast to between two and three percent, done from the 3-4 range it had estimated at the beginning of the year.  The bank cited weaker export demand and fiscal consolidation by the central government as the main headwinds to growth.  On the whole, given the inflation outlook, rates seem to be on hold for the medium term.  On FX specifically, the fact that foreigners have not fled Mexican fixed income is a promising sign.  Structural reforms by the new government continue to move along.  The widely anticipated energy reform proposal form the new administration is expected to be friendly to foreign direct investment.  In PPP terms, MXN is still close to 25 percent undervalued.  While USD/MXN is probably in for some Fed driven volatility, I target 12.30 by year end.  However, given the fact that I am both a USD and MXN bull, I prefer funding my long MXN carry trade with CHF or EUR.