It was a remarkably active session overnight as seemingly one by one, riskier asset classes and curious investors followed the Turkish lira down the rabbit hole in classic risk-off fashion. Markets are getting increasingly consumed by geopolitical risks again. Fasten up as this will surely get bumpier with tariffs, NAFTA and North Korea dominating headlines still.
The tumultuous trifecta of higher US yields, stronger US dollar and high oil prices continues to wreak havoc on EM risk as business and governments alike are suffering from stronger dollar and higher US interest rates which negatively impacts external debt borrowing costs, while higher oil prices are exposing significant energy dependency risks. The underperformance of emerging market currencies and heightened global geopolitical risks should continue to wear on investors' risk appetite. In Turkey, which has been absorbing the biggest body blow of late, the corporate sector is saddled with a record $ 337 billion in foreign currency debt which has been increasingly challenging to fund due to political and currency turmoil.
And of course, it’s difficult to ignore the waning optimism on China Trade relations, even more so with President Donald Trump’s hawkish national security advisor, John Bolton, in the mix. Investors could continue to fade the misplaced optimism of markets on trade and global growth. But of course, as we’ve seen before, the Trump tends to walk back some of his more boisterous rhetoric time and time again. So back on the Twitter hamster wheel, we go.
The FOMC minutes were very much in line, and forex traders barely blinked. The Fed is finding few signs of accelerating inflation and wage growth while hinting they would be comfortable letting inflation run higher to avoid making a policy error.
But the main story for FX was Turkey’s 300 bp hike. With the lira apparently on a collision course with the USDTRY 5 handle, the market was preparing for some form of Band-Aid intervention after the central bank called an emergency meeting. But the 300 bp was much more than expected and while the lira has recovered handily, is the tightening enough to break the inflation and FX death spiral?
Oil markets
Sentiment has been pressured after OPEC threatened to turn on the taps to counter the global supply concerns in Venezuela and Iran, which have been overhanging the market for months. But adding to the negative sentiment was the EIA reporting a weighty build in crude oil inventories of 5.8 million barrels for the week ending May 18. Leaving traders scratching their heads and trying to figure out where this saturation is coming from. But despite the bearish indicators, prices are holding up well, likely supported by chatter that Sinopec (NYSE:SHI), Asia’s most massive refiner, will increase US crude oil imports to record highs.
However, recent flow is suggesting short-term traders are looking to sell the $ 80 chart-toppers, anticipating a possible compliance shift within the OPEC-Non OPEC supply agreement.
Gold Markets
It does appear the market optimism on trade and global growth was misguided. The resulting risk-off moves overnight have provided a boost to gold prices. But with the US dollar firmly in the driver’s seat and Turkeys central bank providing a lifeline to local currency markets, gold fell shy of breaking the critical 1300 mark.
Nonetheless, geopolitical risk is starting to permeate once again offering a boost to gold sentiment.
The FOMC minutes were viewed dovish despite a June hike in the cards. But what is right for gold bulls is the Fed remains closer to the three-rate hike scenario than four as inflation remains elusive. The slightly more dovish interpretation is providing near-term support for gold.
But the Fed, in general, remains very data dependent with both inflation and wages at the top of their shopping list.
Equity markets
The US equity market rebounded convincingly after the FOMC minutes, suggesting the Fed will stay the course of interest rate policy by not singling a shift to the 4-rate hike camp for 2018. And the US central bank is willing to let inflation run higher to avoid a policy error.
From where I sit, there was no definitive conclusion but rather the sameness suggests Fed policy will remain extremely dependent on both inflation and wage growth. But that interest rates are going up is not that hard of a call—the question remains whether we get 3 or 4 for 2018.
Given the geopolitical overhang from trade and tariffs, this equity bounce could be little more than a short-term reprieve however.
Asia FX Markets
Risk sentiment has turned lower on geopolitical concerns an on the backdrop of a stronger USD. Asia will continue to trade from a defensive posture.
MYR: The ringgit remains mired in political risk as the market tries to understand details about the new government’s plan to deal with the fiscal deficit after repealing GST. And of course, the credit agencies continue to look over Malaysia's shoulder. Yesterday's weaker CPI release will keep the BNM on hold but the market's 'no fuss no muss' reaction suggests this could be the inflationary low water mark as higher oil prices will filter through in the months ahead.
Currencies
USD: The currency market continues to confuse as the meltdown in EM currencies saw riskier G-10 profiles remain relatively calm. The FOMC minutes expressed no concern about the rising USD. The dollar's fate will continue to be intrinsically linked to data and central bank policy divergence.
EUR: The euro area PMI data continues to look very shaky. This indicates a negative trend across all EU sectors which suggests an extension of the dovish ECB narrative.
JPY: EM risk and geopolitical concerns will continue to thwart the yen's upside momentum near-term