Yeah, so on Tuesday, in “One Bank Sees ‘Ominous Signs For The World’s Most Important Financial Institutions’” I highlighted the latest from Nedbank’s Neel Heyenke and Mehul Daya who, as regular readers know, have been busy pounding the table on the dollar liquidity story.
Obviously, the dollar’s ascent to 11-month highs and the Fed’s demonstrable hawkishness in the face of what, for the time being anyway, is generally buoyant U.S. economic data (emblematic of what happens when you engineer a sugar high with late-cycle fiscal stimulus) has weighed heavily on emerging markets.
EM FX is looking to snap a six-session losing streak on Wednesday and as you’re probably aware, the iShares J.P. Morgan USD Emerging Markets Bond ETF looks like it’s in all manner of trouble:
“Investors don’t really seem to have any convincing case for improving fundamentals, so EM is likely to remain at the mercy of USD and core rates for the time being,” BofAML muses.
“EM currencies have resumed the sell off that started in early February [and] it could get a lot worse if real money de-risks their bond portfolios,” SocGen’s Jason Daw wrote on Wednesday, weighing in, before adding that “EM currencies will depreciate with periodic episodes of stress during the late-cycle Fed tightening phase [but] it will get really bad if the Fed is hiking when growth is slowing.”
Right. And those comments from Daw brings us neatly back to the above-mentioned Neel Heyenke and Mehul Daya who, in separate note from the one cited in the first linked post above, underscore the notion that Fed tightening against a backdrop where trade tensions could undercut global growth is exceptionally dangerous. To wit, from Nedbank:
The bias for major DM central banks, in particular the Fed, remains firmly towards further monetary tightening. At the same time a growing trade dispute between the US and China are dampening expectations for the global growth outlook. To put US/China trade in perspective, the total trade between the US and China was $650bn in 2017, of which the US imports from China constituted $505bn. The US threatens to impose tariffs on almost $300bn of these imports.
After updating their forecasts for ZAR, they highlight several key charts and one thing that Heyenke and Daya are particularly adept at is using their chart headers to effectively and concisely communicate their point.
Obviously, rising FX vol is bad for the carry trade. About a month ago, amid the lira turmoil, I showed you the following chart in “Requiem For A Meme: 3 Charts“:
As Bloomberg wrote at the time, the “potential carry trade in Turkey’s currency, based on interest-rate differential adjusted for volatility and dollar-funding costs, [has] plummeted to the lowest since January 2017.”
Well here’s Nedbank underscoring this point with a chart that plots EM FX vol. against political uncertainty:
But the really important point here is communicated in the following two charts, which show that the bottom can fall out quickly for EM FX and that a contraction of USD liquidity is bad news:
Let me just leave you with the following excerpt from Nedbank’s note (this one is dated Tuesday):
At this point our base case is for global $-Liquidity growth metrics (y/y) not to turn negative, but merely to slow down which is currently materializing. However, what if the external environment for EM’s worsen and our global $-Liquidity indicators contract (instead of just slowing down)?