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US debt ceiling returns into focus

Dear beggars, brace yourselves for the return of the ugly US DEBT CEILING! Yes, it’s true. Following the momentary suspension of the debt limit in October 2013, the debt ceiling is back in focus as we quickly approach the end of the suspension on 7 February 2014. Although most analysts expect the debt ceiling to be raised before the US Treasury manages to exhaust the limit, which Treasury Secretary Jack Lew says would be at the end of February, investors should consider that this issue is likely to weigh on the US dollar this month. For traders, this may well be an opportunity to enter speculative USD shorts with tight stops and an investment horizon of up to a month, given that February may see increased volatility in USD exchange rates.

For example, we just posted USDTRY short as a high-risk trade idea in light of this issue and the fact that the problems surrounding Turkey have began to cool down following the Turkish central bank’s interest rate increase. If you want to stay clear of EM exposure, there is always EURUSD long, but this should only be a short-term trade as we still expect the euro to depreciate versus the dollar in 2014.

Money continues to flow out of EM

With January drawing to a close, one can only conclude that it was dominated by risk-off trading activity. In the last trading week of the month, investors continued to sell equities and moved money into assets they perceived to be safer, such as US or German government bonds, and commodities, such as gold. Hardest hit were emerging market stocks, which the FT reported saw a money drain of more than $12bn in January 2014. However, today all stock markets suffered, with both the S&P 500 and the EuroStoxx 50 down almost one percent.

Hot money flows not only sent EM stocks dwindling down but especially caused heavy losses in the respective countries’ currencies. Since many emerging market economies already suffer from current account deficits or political complications and rely heavily on imports, the depreciation of their local currencies seen in 2014 so far represents a serious risk for their further economic growth and recovery.

In Turkey, the main risk remains the country’s prime minister, Recep Tayyip Erdogan, who at first opposed a rate hike deemed necessary by most economists and who desperately fights for being able to keep his political power, apparently believing that the country is being undermined by foreign conspirators. As became evident over the past few months, Turkey suffers from a high level of corruption. Just this week the government removed another 800 police officials and many prosecutors from their positions. The Turkish lira is all the more vulnerable because the country’s foreign reserves are draining off. If the recent increase of the deposit rate does not keep hedge funds from betting against the TRY, the central bank will only have very limited resources available to support the currency. Earlier this week, Mr Erdogan told journalists that he had additional fire power ready to support the TRY, but he did not give any details or supporting facts, which will hardly convince professional investors that the government will be prepared to fend off TRY shorts.

Inflation also poses a challenge for South Africa, whose currency has already fallen some 6% against the US dollar. The country’s unemployment rate is a whopping 25% and there continue to be crippling mining strikes. South Africa is slightly better off in terms of foreign reserves than Turkey, though. It also recently raised interest rates to stop the decline of the ZAR. From a technical point of view, we believe that USDZAR short may be a nice short-term trade idea. As of now, the ZAR trades below 11.14 and just today managed to stay well away from its low around 11.38. With ZAR short positions already at very high levels, technical oscillators such as the RSI indicating that the currency is temporarily oversold and EM central banks finally waking up, we see a chance that the ZAR will recover against the USD over the next few weeks but recommend setting SL limits not too far away.

TRY slump continues in light of strong US data

Thursday saw the Turkish lira (TRY) decline further despite the Turkish central bank’s surprise move from Tuesday night to more than double the weekly repo rate to 10 percent (although effectively this was more like a 7 to 10% hike considering that the CB had previously not lent money at the official rate of 4.5%). The decision was all the more bold given Recep Tayyip Erdogan’s clear opposition to higher interest rates.

At first, the TRY quickly rebounded from its all-time low against the USD of more than TL2.39 to roughly TL2.16. However, that has only been a temporary breather with hedge funds well aware of Turkey’s economic and political challenges as well as the central bank running out of foreign currency reserves. On Thursday, the situation turned worse again following both strong economic data releases from the US and disappointing news from Turkey where it has been reported that the government again removed more than 800 police officials and 90 prosecutors from their positions. The political struggle is far from over, causing further USDTRY volatility.

Other EM currencies faced similar challenges. For instance, the decision in South Africa to carefully raise rates on Wednesday, although a surprise, was not as bold as the rate increase in Turkey and was very short-lived, too. The Rand is among the biggest EM currency losers and currently trades at ZAR 11.21 per USD. Emerging market woes were additionally fuelled by the Federal Reserve’s clear stance to continue to reduce its monthly asset purchases. In Ben Bernanke’s last speech as Fed chairman, he did not mention the emerging markets with one word, hinting at the US just not caring about the problems of the weaker countries.

Silvio Berlusconi sparks new concerns in Europe

Today is former Italian prime minister Silvio Berlusconi’s 77th birthday. In the run-up to this special day, Mr Berlusconi almost single-handedly cast his country into a government crisis by demanding that his party’s ministers resign from parliament. The five People of Freedom (PdL) ministers loyally complied with the Cavaliere’s wish last night, in effect breaking up the grand coalition with the centre-left Democratic Party of current prime minister Enrico Letta and thereby causing new trouble for the still ailing euro zone. The unexpected move raises the probability of new elections, although Mr Letta will certainly try to find other coalition partners to avoid going back to the polls.

The latest dramatic event in Italy comes at a truly disadvantageous time: Confidence in Europe’s economy had just improved and there were signs that the EU may finally have left the recession. The news from Italy, one of Europe’s problem childs, could put pressure on the euro, considering that Italy faces many problems and that important reforms cannot be worked on as long as the government is not capable of acting. The spread between the yields of German and Italian government bonds is likely to increase again, and the EUR will have a hard time against the USD on Monday despite the United States’ own problems concerning the nation’s debt ceiling and the looming government shut down.

US dollar declines due to debt ceiling debacle

Expectedly, the US dollar softened on the final trading day of the week following an announcement by Treasury Secretary Jack Lew that the US government may run out of funds at some point in October if congress fails to close a deal on lifting the debt ceiling. A part of the American congress will be shut down on October 1, which is the latest date when a deal should be made in order to avoid excess volatility in the financial markets.

However, even if the US congress fails to lift the debt ceiling by then, crucial parts of it will continue work (it is only a partly shutdown), technically giving the country roughly two more weeks to find a solution. Investors should thus not buy into the fear-mongering in the financial press, even though caution is advised. Looking at the still relatively calm markets, especially compared to 2011 and the end of 2012, market participants seem to expect the US government to eventually come to an agreement before the deadline.

In addition to the budget talks, the increased uncertainty in the US stems from an ambiguous forward guidance policy of the Federal Reserve with respect to its tapering plans as well as an unfortunate search for a successor of Fed chairman Ben Bernanke.

The USD currently trades at $1.6134 against the GBP. The 0.6% gain of the British pound is not just due to the uncertainty in the United States but also because of an interview with Bank of England governor Mark Carney stating that there was little support for further quantitative easing (QE) in the UK. Cable is still about 1% below its rate from January 2013, but it has gained 6% over the past six months alone without any imminent signs of losing momentum.

The European common currency also appreciated relative to the dollar on a daily basis with EUR/USD currently trading at $1.3523. Looking at the performance over the last five trading days, this leaves the euro almost unchanged for the week. In the first half of the trading week, reports from Italy that members of the People of Freedom party were going to resign collectively if Silvio Berlusconi would be removed from the Senate caused the euro to decline. The losses have since been reversed against the dollar given the problems in the US. However, the situation in Italy still poses a serious problem, because the threat by Berlusconi’s party members could well turn into a government crisis in the Southern European country. This is a risk for the European currency that may not be ignored, no matter how boring the troubles surrounding the “clown” Berlusconi may have become over the years.




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