Emerging market currencies sell-off as US interest rate hikes loom
10/Nov/2014 • Currency Updates•
Last week financial markets moved in line with recent trends. The US Dollar rallied once again, buoyed by strong macroeconomic numbers out of the US. Last week, however, the Euro and Sterling held their own relatively better, edging down only moderately against the greenback. The brunt of the sell-off was borne again by emerging market currencies, led by the Real, the Ruble, the Rand and the Turkish Lira, all of whom ended the week down anywhere from 2% to nearly 10% (in the case of the Ruble). The portfolio flows that went to emerging markets over the past few years in search of yields have only began reversing. The period of dead calm and record low volatility we saw in the summer is over for good, and a bumpy road lies ahead as the Federal Reserve gets ready to hike interest rates.
The PMI indices of business sentiment pulled back in October, in line with the general softening of macroeconomic data from the UK. The drop in the services index was significant, from 58.7 to 56.2. In absolute terms, any reading above 55 has been usually consistent with above trend growth, but the loss of momentum is worrisome; the PMIs tend to trend the same way for months, and it is unlikely that the October drop will be reversed soon. These surveys lead us to believe that we will not see a repeat of the previous quarter’s GDP growth above 3% in the fourth quarter, as the Eurozone slowdown filters through the UK economy. All eyes are now on the Bank of England Inflation Report next week, which will put exact figures on the BoE’s view of the extent and duration of the recent economic slowdown. This publication is more critical than ever as markets try to gauge the exact timetable of interest rate hikes during 2015.
The recent stabilisation of key leading indicators and macroeconomic numbers (albeit at a low level) has diminished the possibility of an outright contraction when the Eurozone publishes its third-quarter GDP growth figures next week. The PMIs final numbers confirmed a slight rebound. German industrial production also rebounded somewhat in September from its sharp August fall. However, the numbers will show at best anaemic growth, clearly below 1% annualised. If this is what passes for good news in the Eurozone, it is no surprise Draghi has successfully neutralised Bundesbank opposition and apparently obtained a surprising level of unanimity around an explicit numerical goal for balance sheet expansion: 3 trillion Euros.
Yet another solid employment report out of the US in October leaves the Federal Reserve on track for a first interest rate hike sometime late in the second quarter of 2015. The US economy generated 214,000 jobs for the month, unemployment dropped again to 5.8%, and wages ticked modestly higher in both real and nominal terms. High frequency indicators, such as weekly claims for unemployment benefits, are also consistent with a fairly quick pick up of labour force slack. The only blemish in a strong week of data was the trade deficit report, which confirmed that exports are slowing down noticeably. However, in the relatively closed US economy, this will be no worse than a moderate headwind. Stage is set for growth around 3% for the next three quarters and higher overnight rate beginning in the second quarter of 2015.