Weary EUR Supported By Weak Long Dollar Yen Position

by: Dean Popplewell

Capital markets cannot be too disappointed – the early summer lull, one of the quietest in recent memory, is now becoming a forgotten couple of weeks as we wait for further developments on Syria. How is the rest of the world to react to the “bully-boy” tactics? No one knows just what is to occur; however, renewed saber rattling in the Middle East is having a pronounced effect on capital markets. The possibility of military action against Syria has been sending global investors into the perceived and historical safety of U.S. government bonds, the dollar (for the weak longs that is a different situation), the yen, and a flight out of emerging market currencies so far this week.

Geopolitical issues are making it near impossible for fundamental data or events to have a “true” impact. Rising tension in the Middle East continues to dominate sentiment as investors shy away from assets perceived as risky. The concerns over a possible U.S. military strike against Syria are intensifying. The issue is not about any U.S. led coalition action against Syria for using chemical weapons on its own people. It’s far more sensitive than that. The real reason is what an attack might lead to -- how will Syria respond? How will its allies, like Iran, respond? The key worry for market observers is that despite Syria not being a major oil producer, the country is situated near major sea routes and shipping lines. The possibility of an attack could draw oil rich Saudi Arabia and Iran into a conflict – this would lead to a huge disruption of global oil supplies.

The specific region concerns have also caused crude prices to firm even further. This in turn is providing support for commodity sensitive currencies like the CAD and NOK, while at the same time plying further pressure on "net" energy importing counties like Turkey (TRY). Comments from the Central Bank of the Republic of Turkey (CBRT) have so far fallen short of preventing the TRY from posting new record lows this week. The central bank governor has disappointed many market watchers who had assumed that Governor Basci would step up government rhetoric to stem the currency’s slide and maybe even possibly raise lending rates – This would be a break from their policy of selling USDs and raising interest rates. Nothing has been done so far. Governor Basci said the central bank will “not step back on interest rates” and that he sees the currency slide as only being temporary (2.0490). So far TRY has fallen -15% outright year-to-date.

The fear of the Fed beginning tapering as early as next month coupled with the sharp increase in U.S. Treasury yields has contributed considerably to the twin towers of market "volatility" and "volume". The reduction in both the emerging "bond" and "equity" positions have led to a massif outflow of capital from the emerging markets. The region's debt trading volumes rose +12% on the year to +$1.587T in Q2, 2013 according to the EMTA (emerging market trading association).

Gold prices have officially returned to bull market territory this morning $1,427, rallying just under +2% this week so far. The U.S. Comex gold futures have advanced for three-consecutive weeks, rebounding +20.4% since the commodity’s trough in late June. Year-to-date, prices have declined -15.3%. The fear of an allied strike against Syria within days has prices of most “safer havens” assets, including gold and U.S. Treasuries, remaining better bid.

It’s worth noting that even the emerging market central banks continue to add gold to their reserves. For instance in Russia, the country has added +6.3 tons to its gold reserves, which now exceed 1,000 tons and constitute +7.4% of the total reserves compared to the +70% being held in the U.S. In India, the plunge of the INR to new record lows outright (66.00), at least -20% since May, has inflated their gold prices – the surge in prices is expected to hamper the upcoming festival where gold jewelry are always in demand. India is the world’s largest consumers of the yellow metal, mostly for wear.

Are global investors about to witness, “the perfect capital markets storm”? For many in the U.S., the ideal-case scenario would be to witness the potential makings of one that does not take true flight. What is it exactly? We are “witnessing the rising geopolitical risks with elevated valuations and the potential unwinding of the stimulus (U.S.) that has pushed these markets higher, and this is all combining into a perfect storm.” The emerging market asset rout is ongoing due to fear and uncertainty. Both geopolitical and event risk are expected to intensify over the next six-consecutive weeks. With U.S. tapering possibilities, Aussie and German elections, the decision on the Japanese consumption tax and the NFP, capital markets will be kept busy and are expected to be very volatile.

Euro data this morning shows that M3 money supply in the eurozone continues to grow at a meager rate, with the July reading showing a +2.2% print, but private loans have fallen -1.9% in July (y/y). The “communication” mechanism remains broken with little fresh stimulus from the ECB, who seem “more interested in stopping rates from moving higher rather than for rates to move lower.” With all the attention on “forward guidance” (market is expected to hear more FG chatter from the BoE’s Governor Carney later this morning) the crux of the eurozone concerns is the “lack of stimulus in the region either monetary or fiscal.” The 17-member single currency trades are unaffected as the market heads stateside. Any weakness would suggest that the currency pair remains a fade on strength. Some speculators still believe that there is a possibility of a stop chase above 1.3400 – for now the market continues to trade away due to the real money supply presence. They are likely defending a big barrier, and more reasons why the market feels like selling rallies.

Forex heatmap