FX markets sprung to life last week, with concerns about Turkey and the collapsing Lira fuelling currency flows into the Dollar and the Japanese Yen and Swiss Franc “safe-havens”. However, global equities were down only slightly, suggesting that markets do not yet view this as a more widespread downturn in global risk appetite.
The Euro weakened sharply against these three currencies as markets focused on Eurozone banks’ exposure to Turkish borrowers and EUR/USD today traded below 1.14 for the first time in just over a year. Sterling did not fare better, with GBP/USD down 2% since 3rd August at just above 1.27, and neither did other European currencies or the Australian and Kiwi Dollars.
Contagion from the Lira’s 25% collapse versus the Dollar in the past ten days to high-yielding currencies, including the Russian Rouble and South African Rand, has perhaps unsurprisingly been even more acute. Asian currencies have fared better, posting only modest losses versus the Dollar in the past 7-10 days, as has the Canadian Dollar thanks to robust Canadian employment data.
US Dollar
The Dollar, along with the Swiss Franc and the Yen, was the main beneficiary of weakness in other developed and emerging market currencies sparked by the collapse in the Turkish Lira and other high-yielding currencies. The Lira had been rapidly weakening for many months, due in part to large economic imbalances (including a current account deficit) and capital outflows from Turkey spurred by high inflation and concerns about President Erdogan’s autocratic rule. But the pace of Lira depreciation accelerated last week after the US administration doubled tariffs on imports of Turkish steel and aluminium, with the Turkish government seemingly unable to arrest the slide in its currency.
Aside from this risk-event, the strength of US economic growth and rising CPI-inflation have put a floor under market pricing of Federal Reserve rate hikes and in turn the Dollar, which in trade-weighted-terms is now at its strongest level in 17 months.
Euro
EUR/USD tumbled on Thursday and Friday and is currently trading around 1.138, with the main catalyst being market concerns about the potential impact on Eurozone banks which have exposure to a collapsing Turkish Lira, including via commercial loans and long-Lira positions. Eurozone banks are on the whole well capitalised and should be able to deal with an increase in non-performing Turkish loans but weaker banking systems, including Italy, will be under pressure at a time when Eurozone growth is modest at best.
In trade-weighted-terms, the Euro managed to appreciate 3% – the largest weekly increase among major currencies – to a multi-year high but this was principally due to the fact that the collapsing Turkish Lira and significantly weaker Russian Rouble and South African Rand account for about 7.5% of the Euro basket. Had the lira been unchanged last week, the Euro TWI would have been down about 0.4%.
Sterling
Sterling, like the Euro, weakened sharply versus the Dollar last week as global risk aversion in currency markets took hold. Markets took little solace from the NIESR’s latest forecast that UK GDP growth will accelerate to 0.5% qoq in Q3 from 0.4% qoq in Q2, with concerns still prevalent that the British government may fail to secure a post-Brexit deal with the EU. Moreover, VISA data revealed that real consumer spending fell 0.9% yoy in July, pointing to still modest underlying household demand growth. The BoE hiked rates 25bp on 2nd August but its dovish outlook for the rest of the year has held back expectations that the BoE could and will hike rates again this year.
In trade-weighted terms, Sterling managed to appreciate 1% to a one-month high but, as was the case for the Euro, this was principally due to the fact that the collapsing Turkish Lira accounts for about 2% of the Sterling basket. Had the lira been unchanged last week, the Sterling TWI would have been down about 0.6%.
Australian Dollar
The AUD/USD cross fell 1.8% last week to below 0.73, despite signs that the Chinese Renminbi may be stabilising at current levels. With the RBA seemingly in no rush to even consider a rate hike and the more risk-sensitive currencies under pressure, the Australian Dollar is now trading at its lowest points versus the Dollar since January 2017.
New Zealand Dollar
It was a similar story for the Kiwi Dollar, with the added weight of a dovish Reserve Bank of New Zealand. The RBNZ downgraded its macro forecasts at its policy meeting on 8th August and at this stage a rate cut is seemingly almost as likely as a rate hike.
Swiss Franc
The Swiss Franc was flat against the Dollar last week, resulting in a 2.6% gain in the trade-weighted-index to its highest level in over a year. Even if the Turkish Lira had been unchanged last week the Swiss Franc would have been up about 1.4%, with the Swiss Franc having seemingly regained its status as a safe-haven during periods of global market turmoil.
