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Weak signals, TRY old demons resurface
Weak Signals on a Summer Monday
European markets have walked into Asian equity markets in the red. Fridays strong, US labor reports has put speculation of a 50bp Fed cut in July on hold. The market had fully priced in a 25bp cut this month but talk of additional easing has slowed. With nearly 100bp cut pricing in for 2019, a resilient US economy will put this forecast in jeopardy. Bond yields rebounded marginally on the back of the unexpected strong US job market data. While the US job growth has slowed, it remains robust to consider ten years of economic expansion. US 10-year treasury yields climbed 8bp to 2.03% giving the USD a boost against g10 currencies. This week Trade uncertainties have reappeared as a primary driver. Trade talks between China and the US are expected to begin as soon as this week. News flow indicates that Huawei will be the key theme in the next few rounds of trade discussion.
Last week’s goodwill generated by the G20 statement, condemning protectionism and promise that central banks would support economic expansion, has faded (since nothing had fundamentally changed). What is left is the negative effect of trade worries. Incoming data from Germany, indicates the engine of economic growth for Europe, continues to falter. Germany’s auto sectors specifically have been damaged by a lack of demand from China. At this point, even ECB stimulus will be inadequate to support Germany’s elevated economic forecasts. Even the expectation of easing monetary policy has not materially de-escalation in trade tensions. Which is weighing on confidence and investment. Sentiment around European equities has improved in anticipation of looser monetary policy. However, a deeper repricing will have to be accompanied by economic recovery, which prospected has weakened. Summer trading and lack of real news flow suggest that rogue volatility is likely rather than pure directional trading.
TRY old demons resurface
Market participants will likely take some time to consider the global impact of Saturday’s headline relating to the dismissal of Turkish Central Bank Governor Murat Cetinkaya, in office since April 2016. The constructive discussions at the G20 summit between Turkish President Tayyip Erdogan and US President Donald Trump had given Turkish lira a relief for the past few weeks. Yet the trend is likely to reverse as the timing for a change in Turkish Central Bank (TCMB) forward guidance is worst amid a significant loss of TRY carry advantage and a stronger dollar as expectations of Fed rate cuts is on the sideline following upbeat labor data.
Investors are therefore questioning again the independence of the TCMB, which cost TRY a major depreciation against major currencies (USD/TRY: +40%) last year and put pressures on the Turkish banking sector. This scenario could well recur as a quick U-turn of monetary policy towards rate cuts at its next monetary policy committee on 25 July 2019 will likely corroborate the statement and put upward pressures on Turkey’s inflation. Furthermore, the June assessment made by Moody’s on Turkey’s sovereign credit, whose credit rating has been cut deeper into junk territory (from Ba3 to B1), and a group of 18 banks among which two state-owned banks Ziraat Bank and Vakifbank have been notified as having deteriorating credit profiles, confirms the vulnerability of Turkish financial sector to extreme monetary policy measures. A sustained rally in USD/TRY is therefore expected looking forward.
USD/TRY is currently trading at 5.7260, bouncing from 5.5967 (04/07/2019 low) 2-months low and heading along 5.80 short-term.