Panic is present but not in currency market (Daily analysis 11.10.2018)

Rapid drops in the global share market with no significant impact on the perception of emerging market currencies risk. Is it the end of problems in Turkey? The zloty reacts calmly to the global situation due to the weaker dollar.

The most important macro data (CET - Central European Time). Surveys of macro data are based on information from Bloomberg unless noted otherwise.

• 1:30 a.m.: Record of the talks at the ECB September meeting.
• 2:30 a.m.: CPI inflation from the USA (estimated at 0.2 % m/m and 2.4 % y/y; excluding fuels and food 0.2 % m/m and 2.3% y/y).

Fear but not among currencies

Last day was very difficult for investors on the share market. The fall of the S&P 500 futures contract since yesterday's midday amounted to less than 5%. This is a lot, taking into account the instrument simulating the behaviour of the main global trading market. Strong declines are and were also observed in Asia and Europe.

The reason for the falls is difficult to point out precisely, but we must probably agree that the quotations on some markets are relatively high and at the same time the Federal Reserve is tightening monetary policy. The yields on Treasury bonds have recently reached their multi-year highs on almost the entire yield curve. On the one hand, this usually competes with the share market, and on the other hand, it causes higher financing costs for companies, so that the profile of future profits may be less attractive than is currently expected. In addition, there are issues related to the trade war, lower economic forecasts presented by the IMF and generally weak sentiment in emerging markets. Why aren' t we dealing with a simultaneous strong appreciation of the yen, the dollar or the franc and a weakening of emerging market currencies during the last few hours of falling share markets?

The answer is not so obvious at all, but it can be explained by the fact that the strong fall on the stock exchange caused a slight decrease in yields and a slight reduction in the expectations of future interest rate increases in the USA. This has exerted pressure on the dollar and allowed the EM currencies to overcome the problems. Moreover, the information for the markets that the US economy is not as strong as it seemed and will converge to the condition of the rest of the world may be another reason. Therefore, incentives (stock market, bond market) for foreign capital will be relatively smaller than previously expected. Now, however, another question arises. Will this optimistic outlook on emerging market currencies be maintained?

It seems that it is not the case. A strong increase in risk aversion (e.g. continued decline, panic in the world, etc.) is unlikely to make EM currencies secure. It is the franc, the dollar or the yen that should benefit from the return of capital to their home countries, even if the USA would also take into account the deeper economic slowdown. For the time being, the last reaction seems to be a short-lived disorder, which is unlikely to continue.

It is worth referring to President Trump's statement that the Fed has gone crazy by tightening monetary policy and this is the main reason for the drops on the stock exchanges. The market does not see this as an attack on the independence of the Federal Reserve, but as part of the campaign before the elections to the Congress on November 6th. The Fed's independence should not be questioned and the FOMC will probably ignore politically motivated statements that are not even believed in by the author.

Turkish surplus

The Turkish central bank's reports on the current account surplus were a certain oddity in emerging markets. In August it amounted to over 2.5 billion USD, which was the highest result in at least 20 years. Does this mean that the weakened lira suddenly increased the competitiveness of the Turkish economy?

Unfortunately not. Detailed data in the payment balance shows that it was the collapse of imports (over 20% compared to August 2017) that caused a strong improvement in the trade balance. Little was missing and imports would be the lowest in almost 8 years. Exports have also fallen, but much less, i.e. around 8%. The data indicates that the economy is slowing down very seriously. On the other hand, the improvement in the service balance, where the surplus is growing (thanks to higher revenues from tourism), can be clearly perceived positively. In general, the data is less positive than indicated by the headline information, and in addition, summer months for Turkey usually have a better current account balance than the rest of the year.

Stable zloty

The Polish currency remains stable. This time the zloty is not so special. Most of the EM currencies do not lose their value, and some of them appreciate. Even the recently troubled Turkish lira or Indian rupee are strengthening to the dollar. This rather surprising reaction is mainly a result of the weakening of the dollar (details in the previous paragraphs). It seems, however, that the persistence of panic on the stock exchanges at some point will also force a strong weakening of the EM currencies.

Signals from the US share market are still important for the zloty. The continuation of the sale, although it has not caused any pressure on the zloty, is likely to have a negative impact on it. This negative impact may be weakened by the pressure on the dollar. However, a hypothetical collapse in the US share market will harm rather than help the zloty in the long run, especially as the economic downturn in the USA may quickly translate into further GDP growth prospects deteriorating in other regions of the world.