The famous section title from the New Yorker Magazine suits my purposes for a brief review of current markets. The headlines are full of accusations by Dominic Cummings, ex-senior advisor to Prime Minister Boris Johnson, against the UK government’s handling of the pandemic: Incompetence, opaque explanations of the measures taken to tackle the crisis, etc. On the other side of the Atlantic, market watchers are addicted to statements from the Federal Reserve about rising inflation, to get a sense of an increase in rates in 2022. A number of Federal Reserve officials in recent days have suggested that the Fed is at that point where it needs to start talking about talking about tapering (whatever that means). That still gives the impression that an official announcement about a tapering of the Fed’s USD120bn per month bond purchases is still some way off. But if the market is so anxious about tapering, it will do so now, or very soon, not when the policy is finally announced. It is difficult to predict how USD will react to inflation data as the market had been uncertain, depending on market sentiment, whether the USD-negative effect of high inflation was more important as the Fed is assumed to react with an insufficient reply to the rise in inflation, or the USD positive effect which results from higher Fed interest rate expectations.

A fork in the road

Emerging markets have been on a tear lately, and the BBDXY chart is now at a key level – the low of February 2018 which itself is the lowest BBDXY got since 2014. At this fork in the road, should we take profit or stay long? Old Yogi Berra jokes aside, we opt to stay positive. First of all, sentiment and positioning are not “all in” (yet). In January our EMFX sentiment indicator hit “sell” due to universal exuberance. Now, our indicator is still in the neutral range. Indeed, we don’t sense unfettered bullishness on EMFX when talking to investors. Investors face still too many question marks about U.S. rates, China growth, geopolitics (Russia, etc.) and local politics (mostly in LatAm). The recovery in EMs (excl. China) lag substantially behind the U.S. In a rare occurrence, EMs (with or without China) will be growing less than the U.S. this year after having contracted more than the U.S. last year. Overall, EMs will need until 2022 to get back to the pre-Covid output levels, and some countries will take even longer. So far, so bad. However, we might be in the “darkest hour before dawn”. The gap between the U.S. and EMs in the new orders component of the manufacturing PMIs is the most negative (for EMs) ever. History shows a reasonably reliable element of mean-reversion in this gap though which suggests that ultimately global growth tends to re-synchronize.

– David Hauner, strategist, BofAML, May 28

Making new lows

The Turkish lira exchange rate has been making news lows over the past days: against the U.S. dollar, it broke through the crucial 8.50 level which had served as a cap since last November; in basket terms (50% USD, 50% EUR) it broke through its low of last November already by mid-May this year – yesterday, it broke through these recent lows as well. Why is this significant? The low of last November was made at the height of the problems which led to ex-CBRT governor Murat Uysal being dismissed and Naci Agbal being appointed. Agbal was expected to implement strict, conventional inflation-targeting – this idea led to a sizeable lira recovery. Since then, the subsequent dismissal of Agbal and the more recent replacement of another deputy governor, Oguzhan Ozbas, by low interest rate advocate Semih Tumen completed the full circle in the market’s perceptions about what kind of monetary policy will follow. This is what the lira’s behavior is now telling us. More significantly, the lira’s moves need to be watched closely because the exchange rate rarely trades purely on economic fundamentals – instead, it has followed a relentless depreciation trend, constituted of large, sudden slides punctuated by deceivingly calm periods. In the background, economic fundamentals remain more or less the same.

– Tatha Ghose, strategist, Commerzbank, May 28