Dollar Continues to Look For 'Its' Direction

by: Dean Popplewell

A week is a long time in politics; a week is also a long time in the forex market where investors, if lucky enough, get to ride a wave of volatility, some to profitability and some not. Global stock markets were particularly anxious last week as they waited for the minutes from the latest FOMC meeting held at the end of the previous month. Investors' uncertainty over the Fed’s intentions has been weighing on capital markets and managed to back up U.S. Treasury yields over the past few weeks. All that the market has been looking for from “helicopter” Ben and company is for a clarification of timing from the Fed. The question obviously was when would the Federal Reserve begin curtailing its $85b-a-month bond purchase program?

The answer was even simpler than the question. According to the minutes, there is no timetable to reduce QE3. The Fed committee continues to say that its decisions are U.S.-data dependent. With recent data mixed and some key data points revised lower, like last Friday's disappointing new housing sales report in the U.S. (+394k or -13% m/m), precision of timing to "taper' remains difficult for policy members.

The U.S. is not the only region with problems. The emerging markets are having their own difficulties, as investors shift capital back to less risky markets like the U.S., and to a certain extent back into Europe. Convincing investors to dilute more of their holdings in the region were the minutes from the FOMC meeting, which left unchanged market expectations that Bernanke would begin to taper the Fed’s asset buying program as early as next month. That sentiment sent the U.S. 10-year Treasury note yield (2.82%) to a two-year high in intraday trading last week while the “mighty” dollar has remained overall in demand.

Outflows from emerging markets bonds and equities have been accelerating on fears that the Fed will begin withdrawing stimulus sooner rather than later. Has the time come for the global investors to “fold their bets on the region on a larger scale”? In the overnight session, Asian bourses have managed to trade higher as investors have tempered their expectations that the Fed is going to be so quick to withdraw its stimulus. So far this week, fundamentally there are only a few trading cues for capital markets to take their lead from – everyone seems to be just watching U.S. economic data for signs on whether the Fed will alter its monetary policy.

So far investors are believed to have pulled just under +$2b out of emerging market “equity” funds in the last week alone. That is more than double the amount that left the emerging market sector in the previous week. In the bond category, it’s a similar story. For the 13th consecutive week, investors continue to pull monies from the bond funds to the tune of $1.3b, just under double the $834m that was liquidated the week before. The forex investor is very much shunning risks in the region and is happy to look at the USD in a more favorable light, which is supported by a U.S. yield curve that is backing up.

The fear that the Fed will begin tapering next month is making some investors worried that the “tide of money that has been flowing into the emerging markets over the past few years will diminish.” The fear that “helicopter” Ben and his fellow cohorts will begin tapering as early as next month should continue to ply outbound pressure on capital from the bond and equity funds in the emerging market. However, the outflow of funds is not on the same scale as what occurred in the region during late May and June. Investors pulled $37b from the region in June alone!

The emerging markets rely heavily on cheap dollars to fund various countries large current account deficits and any increase in U.S. Treasury yields makes it more expensive to raise affordable capital. Both the INR and TRY currencies have managed to hit new record lows outright and their stock markets and bond prices have also declined. The IDR, MYR and THB have also printed, “multi-year lows,” while bourses across the Asia region have fallen to a six-week low. The various central banks have been trying to reassure the markets that they would act if needed just like the Bank of Turkey’s hasty dollar auction last week. It seems that no emerging currency has been able to escape the clutches of the nervous investor – KRW fell to two-week low, MXN lost -2% last Wednesday, while the Russian ruble (RUB) sank to almost a four-year low against a euro-dollar basket – the Bank of Russia dollar sales number +$3.7b so far this month alone.

What is interesting is that the weaker expectations for a change in Fed policy are helping support the price of gold. Overnight, the “yellow metal” managed to push above the key $1,400 psychological level to its highest print in almost three-months, putting the commodity within striking distance of “bull-market territory.” It’s really the combination of weaker U.S. data and geopolitical tensions that has helped to boost commodity prices. Gold has managed to rally +19% since late June and technically is only +1% shy for a market to declare the commodity officially in bull-market territory.

This last week of August brings forth key economic data from Europe including unemployment, retail sales and consumer and business sentiment. Global investors will get to see how PM Abe is faring as Japan releases a slew of economic data for July including industrial production, retail and household spending and the all-important consumer price index. Economic growth data from India and the Philippines, as well as trade data from Thailand, are expected to be in focus this week as investors assess the outlook for Asia’s battered emerging markets.

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