Article17 October 2018Reading time about 4 minutes

EM: Fixing the roof while the sun shines

Emerging market FX shows signs of recovery, with Turkey issuing its first Eurobond since April. As the dollar consolidates, the euro should be doing better. What's going on? 

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USD 24h call: Quiet data calendar allows for some consolidation

A relatively quiet week for US data and protectionist rhetoric has seen risk assets recover and the dollar edge a little softer. Better sentiment has allowed Turkey to issue its first Eurobond since April ($2 billion 2023 priced at 7.5% versus an initial guidance at 7.75%) and Argentina’s peso to show some stability as investors reassess the IMF programme. But the external factors that contributed to the summer sell-off in emerging markets remain. Namely, there’s no sign of the Fed slowing down its methodical rate hikes - we look for US wages to break above 3% year-on-year in early November - and world trade volumes and Chinese growth look set to slow (China 3Q18 GDP released Friday). For that reason, we think the recovery in EM currencies and the decline in implied yields presents a good opportunity for corporates to hedge EM FX exposure over the next twelve months. For example, the recovery in the South African rand (ZAR) and the fall in ZAR implied yields means that the currency can be hedged one year out at 14.90 today versus levels near 16.20 in early September. For today, better news for US tech stocks (FAANG index up 8% from last week’s lows) suggests the risk environment remains cautiously favourable. The US dollar index (DXY) to consolidate around 95.

EUR: Should be doing better

We are surprised that the euro is not doing better given that emerging market FX is showing signs of recovery and the dollar is consolidating. This may be related to Italy or it may have to do with EUR:USD rate spreads moving to staggering new wides – e.g. 328 basis points on the two-year swap spreads. These massive US dollar hedging costs are making it very expensive for corporates to maintain large forward sales of dollar to hedge expected dollar receivables. Expect EUR/USD to continue to trade a 1.1520-1.1620 range for the time being – but a failure of EUR/USD to recover this week is a worrying sign for us.

GBP: Another EU summit, less risk of disappointment

At least the participants of today’s EU summit are playing down the chances of a Brexit deal at tonight’s dinner – unlike the debacle in Salzburg. We think GBP could make a little more headway over coming months, perhaps more against EUR than USD – but 0.8700 will be a tough nut for EUR/GBP to crack. A lower core CPI figure today is less important to the Bank of England than strong wages yesterday.

ZAR: 14.00/25 is a big support area for USD/ZAR

Given its commodity exposure and large weightings in emerging market equity and debt benchmarks, the South African rand is seen as a bellwether for EM risk in general. 14.00/14.25 is a major support area for USD/ZAR and its performance here will help tell us whether this EM FX recovery has much further to run – possibly not.