Wednesday, January 29, 2014

Turkey - Are Trading Correlations to Global Risk Valid?

It's probably worth following up on the last post as there are a few linkages in the markets that we feel now need questioning.

TRY and ZAR and of course current account deficit EM in general, are easy meat to attack , even more so as they have a good story to back the trade. "QE USD outflow leads to falling currency as the inflows that have been needed to counter the current account deficits these countries have been building now have no inflows to counter them". Fair enough.

We then see rate hike responses in said countries. In a way you could think it ironic that these countries moaning directly about US inspired tightening global liquidity causing their problems only to have to respond by hiking their own rates to the moon.

There are a couple of purposes in raising rates. One is to make it more expensive to speculate against the currency but as per our last post we are not sure this works and used the analogy of the UK in 1992 with the GBP crisis. The other function is to actually fix some of the long term problems and as far as Turkey goes this is a sensible move.

The problem in 1992 was that the UK was in a straightjacket where they were 'forced' to import German monetary policy, which was totally inappropriate for the UK, whereas in Turkey, monetary policy is becoming more aligned i.e. real interest rates are going positive, and credit growth will be curbed. It's the right medicine. Whereas in 1992 it was the wrong policy for the UK.

But back to that sentiment function. We also mentioned this morning that a market loves to hang its hat on one price to act as the barometer of fear. Sentiment has so far indeed followed the price of USDTRY almost to the second. Below is USDTRY against inverted S+P futures.

But there comes a point when assumed connections have to be challenged as there is only so far a pack of lemmings can run before one of the pack asks themselves why they are all following each other and whose got the cliff map. So TMM would like to ask a couple of simple questions -

How much does it really matter to the global economy if the likes of Turkey and South Africa are FX torched back to becoming cheap holiday destinations? Can we really justify huge panicky swings in the US top 500 corporates because Erdogan and his mates are going to have to suffer a bit of austerity after years of dinning on cheap USDs?

And do the DM markets grind to a deflationary halt because deficit EM are suffering (and note its Deficit EM countries here we are talking about, the surplus ones are numerous and surpluss'ed enough to make a 1998 style crisis nigh impossible)?

We doubt it. So that leads us to ask if this shake down is DM is actually being caused by EM, or is it just being triggered by it?

DM has had its own reasons for needing a corrective pullback with a number of contributory factors. Such as people being overexposed to equities in general after 2013 and real money (corp pensions mostly) rebalancing from equities to FI en mass as 30yr neared 4% and their funding levels neared 100%. Interestingly there is also a self reinforcing function as the quickest hedge to EM positions is to sell the more liquid DM markets as a hedge on an assumed correlation. This hedging in itself reinforces the assumed correlation in EM and DM through price action, even if the underlying real link is small. This raises the interesting scenario that returning confidence in EM will be indicated by a rise in DM prices as hedges are lifted rather than a lift in EM prices.

TMM think this is a triggering rather than a cause.

Having seen the price action today we are beginning to think there was a spike blow off in in some of the extreme sentiment after EM stories had "gone Tabloid" today and we are now seeing assumed correlation without causality reinforcing itself until someone notices that in the big picture Turkey and South Africa don't matter.

So, despite casting ourselves in a spivvy light. We are back in the long DM side of the trade.


Anonymous said...

The market does seem to attach the general "fear-o-meter" randomly to what ever headline happens to be in Marketwatch or Bloomberg at a given time. But how quickly can it detach again? Some heavyweight data imminent for the rest of the week with US GDP and Chinese PMI. Probably these will take over to dictate whatever direction and the Lira will fade into the shadows, where it belongs.

Probably equities really were bound for a correction anyway, and current account weak EM's just gave a good cover story for that. The Fed (surprise surprise, even Yellen voted for taper, against consensus expectations?) certainly gave another cold shower for Turkey moving the needle in the risk meeter a bit higher for the short term.

Very interesting activity for the bond bulls today despite the taper event. But hey, rates going down again where we (and the FED) need them to be, that's all that matters. Maybe that will also bring the floor closer to equities.

Anonymous said...

Call me naive but I like nibbling on China here versus Monday lows. Seemed relatively robust today among the EMs.

Falco said...

I tend to agree. My worry is related to the fact that this seems very much consensus. EM are much more important now than they were in the `90 (Thai, Russian crisis etc) they account for around 50% of global gdp stock (vs around half of that in the `90s) and around 76% of of global growth. Problem could be coming from a domino effect triggered by outflow from emerging markets (hey, lemmins are there too!), which I believe could last a bit longer. Aren`t you worried about this? (plus the potential effect of a street pretty much still short bund for example, that can weight on risky assets because of spread trades etc). I would really be interested in understanding your opinion on this.

PS: thanks for taking the time to put your thoughts on "paper", always a good read!

Anonymous said...

C says
I care about the EM story only in so far as it applies to earnings.
If US policy causes tightening elsewhere then this is not very encouraging because a feature of top line revenue is how much it has depended on consumer growth outside of DM. The trend for that growth has been under pressure as it is and appears to be more on view in current guidance. It almost seems irrelevant to say that a strengthening dollar also weakens the balance sheets exchange on those pressured foreign sales.
I've never really liked being short of a fast selloff at the turn of the month because of reinvestment progs ,but I think the potential to short bounces from these is now on the up.

Leftback said...

Mr Shorty looks a bit uncomfortable today as vol sellers look as though they will run rampant once more. The only thing that apparently matters is USDJPY, and longs are back in control today. Even dodgy EM equities are bid, in spite of a firm USD.

Polemic said...

And Lb, then what happens to the short DM hedges against EM .. ?

Leftback said...

EEM is slightly ahead of SPY today, but a lot of short DM chaps would definitely be caught leaning the wrong way today, Pol, unless they took some evasive action. Bollinger bands were stretched to the limit yesterday, and VIX made a right shoulder. Those are usually good buy signals, short term.

Slapped on some SPY calls during yesterday's grind around SPX 1770-1775ish. Now we wait to see if this is a short painful squeeze or a long slow grinding squeeze, before the next phase begins. From here, SPX 1792 already looks like toast and then we are looking at the SPX 1813 area first. After that, still bearish but we will see what happens.

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