All week long the mighty dollar has been buoyed by U.S. Treasury yields as higher rates suggest a stronger greenback. Outflows from emerging market bonds and equities funds accelerated on expectations that the U.S. Federal Reserve will start withdrawing its stimulus measures. Thus, foreign exchange (forex) investors are shunning risk in emerging markets and that’s leading them to fold their bets on a larger scale. In the overnight session, the moderation in the U.S. 10-year Treasury yields to the +2.89%/2.91% range is seen as a support for risk assets across Asia.
The forex market does not have the time to sit on its laurels. If anything, it needs to suck in a second wind and get ready for six consecutive weeks of event risks. Traders are faced with the impacts of a federal election Down Under and in Germany, a decision by the Japanese government on a consumption tax, nonfarm payrolls, and the Federal Open Market Committee’s (FOMC) tapering decision.
Vulnerable India Rattled by Outflows
Meanwhile in Asia, emerging forex markets stabilized, with the U.S. dollar, Thai baht, and Malaysian ringgit trading off their highs. One of the bigger movers of the week, the USD-Indian rupee (INR), managed to open lower but the Indonesian rupiah continues to trade on the weaker side, ahead of Indonesia’s policy package announcement. The rest of the G-10 currencies could be described as mostly treading water, with the 17-member single currency confined to its tight, pre-FOMC July minutes trading range.
The governments and central bankers of emerging market nations are trying in vain to stop the flight of foreign capital out of their economies and into the embrace of the U.S. dollar. One of the instigating currencies has been the INR. Overnight, the Indian government held a press conference to reassure investors that the rupee was “undervalued.” India’s Minister of Finance, P. Chidambaram, emphasized his government has no intention of introducing any type of capital control, including controls on repatriations — the rupee is undervalued and has overshot appropriate levels. The Reserve Bank of India’s recently published annual report highlights the importance of preserving macro financial stability as the prospect of reduced U.S. Fed stimulus contributes to a slide in the rupee. Emerging economies are concerned by the twin threat of higher consumer inflation and their ever-increasing “current account deficits” that are exceeding sustainable levels. This all adds up to sluggish growth and hot money looking for an exit.
Global rating agency Fitch said in a statement yesterday that “policy management will be the key factor in determining whether economic and financial stability is maintained in India and Indonesia following the intensified pressure on currencies and asset prices.” These pressures have exceeded those of other emerging Asian economies, but Fitch Ratings does not view these developments as a trigger for action at this point. The ratings already incorporate both “recognition of vulnerabilities and some tolerance for volatility in market conditions.”
Expect Much Volatility
Capital markets are to remain volatile and uncertain in advance of decisions by the Fed. The majority of market analysts firmly believe that the Fed will begin tapering as early as next month. What about the global investor? Have they already priced in that expectation? Data this morning confirms that the U.K. economy grew more than previously thought in the second quarter (+0.7%). Elsewhere, the final release of German second-quarter gross domestic product figures confirmed earlier estimates, while in China manufacturing activity this week suggested stabilization. However, despite the plethora of better news, the various asset classes stay on tenterhooks, as investors remain concerned over when the Fed will actually begin to rein in its $85-billion-a-month bond-buying program. The threat of less accommodation continues to put a premium on liquidity of emerging market asset classes. It seems that both hot money and the global investor are done with emerging markets. The shifting of assets and rebalancing of portfolios will not be completed until after the Fed’s tapering actually begins. Until then, heightened volatility remains the order of the day!
Forex heatmap
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