The wake-up call last week was that Turkey matters. It’s hard to ignore a 21% weekly drop in FX and say it is a one-off, isolated event. The arguments about idiosyncratic pain trades in emerging markets FX, begins to fall about as the TRY falls 41% on the year today followed with Argentina ARS off 36% on the year, cascading into Russian RUB off 15% year-to-date followed closely by Brazil BRL off 14.25% and ZAR off 12% - all this puts foreign investments into a panic and makes for a tipping point as asset losses pile up and force sales elsewhere.

The root problem for investors is that hedging the FX risks for the above lists cuts into the returns enough to make it less simple – rate spreads and option implied volatility eats away any of the easy gains from growth and value investments. So many jump in and take the risks unhedged in FX and then are forced into stopping out at some line in the sand.

We reached this line again last week for many currencies. This means buying the worst levels after the crisis becomes the game and yet the natural cycle is to face fear of a larger meltdown. Unfortunately, defining an end to a crisis isn’t so simple – Turkey TRY blew past 5 and 6 levels and seems set for 7 and higher unless the Erdogan government can regain credibility for its central bank and for its policies.

Begging citizens to sell gold and buy fiat paper won’t work. Backing the TRY with gold or some other currency (other than the USD given US sanctions and issues) may attract but this risks credibility as well. Money doesn’t stay in nations that don’t play by international rules.

Ripples of Turkey last week became significant waves.The knock-on effect from Turkey to Europe is in EU banks with RUB pain adding to the fear trade. The effect on the rest of the other emerging markets is obvious: USD gains were universal over the year - with the MXN an exception in part because it’s the liquid hedge that didn’t work so well – its up 4% year-to-date as the AMLO election and NAFTA deal hopes rise.

The tipping point risks next week won’t solely be about Turkey but China. The ability for China to ignore the rest of the EM world and to push for stability and battle against the economic pain of US tariffs will be watched in the economic data from retail sales to industrial production to fixed investments. It will be analyzed against their frontier exposures to the Belt-and-Road nations – from Pakistan to Africa.  

The CNY is off just 5% on the year – keeping pace with KRW – and the urge for China to keep the CNY stable and hope for investment back into bonds and stocks balances against the pain of exports. The fear is that the pain there is larger and that the Trump administration isn’t going to back down adding to the risks everywhere that nothing is safe abroad – whether you live in Japan or Switzerland or the US.

This begs the return to current account deficits and the cost of money mattering less than the return of it. Whether we have reached that tipping point for a larger market panic remains the central question for the week ahead. The added difficulty will be in the lack of attention and experience given the summer holidays and the urge to blame all moves as speculative and caused by illiquidity. The modest tick up in volatility outside of EM will be a barometer.

The other G10 issue rests with the EUR and CAD. Last week was aggravated by the Italian political focus as the budget plans clash with the EU rules. For Canada, the Saudi weaponization of its investments in the great North became a new risk for CAD where fundamentals point to a 1.28 test and the flow of capital reopens 1.32 instead. So far, the fear in developed markets is modest – the chart of G10 volatility from the DB CVIX makes this clear and the spike up last week doesn’t look like enough to make last week an ending of trouble but more of a tipping point for more.

Question for the Week Ahead: Is this the time to buy EM? Does fear beat greed in the week ahead? 

Is this catching a falling knife or should you buy when there is blood on the streets?

The question for the week ahead is whether the EM value proposition (it can’t get much worse) attracts enough money to reverse the ongoing position washouts. There are many that suggest you buy when bullets fly and sell when you see the doves of peace. 

The bulls for EM will argue that the present Turkey story and the fear of China tariffs leading to a larger global slowdown are overblown compared to the yield and carry opportunities. This isn’t so simple when markets are shrouded in positions that are illiquid and volatility rises. Risk events have long tails when they prove contagious. The pain of last week maybe simple to explain as just a washout of the trades put on in July after the June pain trade. The fact that markets continue to test new lows for TRY and ARS opens focus on BRL and RUB and ZAR in similar ways. 

The contagion of EM leading to DM pain shows up first in banks, then in credit. Banks last week looked vulnerable to a capital margin call writ large should TRY trade over 7. This was unthinkable in July and almost reality in August. The biggest story over the summer has been the watch for whether the trade tariffs/sanctions matter to more the focus on just the day-to-day markets and hurt the global economy. The global trade bounce appears to have stalled and turned and that maybe the real story for why buying EM now is still dangerous.

Market Recap:

Last week was supposed to be easy – summer vacations and less worries about US/China trade leading to a buying of equities. Monday, Beijing said that it would levy 25% tariffs on an additional $16 billion worth of U.S. imports starting August 23—the same day that the U.S. plans to start collecting 25% extra in tariffs on $16 billion of Chinese goods. The escalating tariff cycle comes as the People’s Bank of China (PBOC) has stepped up efforts to stabilize the yuan. This fell apart with Russian and Turkish sanctions from the US and accelerated as knock on effects to banks become a key focus.

The gains in the USD were across the board and the safe-havens of developed market bonds returned despite big supply from the US and Europe. As for key economic data, US July CPI +0.2% m/m as expected, with energy prices -0.5% on gasoline -0.6% and food prices +0.1%. The y/y rate for headline CPI stayed at +2.9% in July, while the y/y rate for core CPI increased to +2.4% from +2.3%, largest since September 2008 (+2.5%).

Canada saw iis July jobs jump 54.1k above the 19k gain expected – leading to the unemployment rate to drop 5.8% vs. 5.9% expected. The average hourly wage disappointed at 3% y/y from 3.7% y/y leaving CAD gains limited thanks to broader USD moves and to some doubts that BOC would care. Other positives – US job opening rose 8.8% y/y to 6.662mn, US weekly claims fell to 213,000. 

Abroad, focus was on China trade with exports and imports both higher than expected though the surplus narrowed. The UK GDP beat expectations but most of the data was lost to geopolitical issues. The RBA and RBNZ meetings didn’t lead to any changes in policy but rates reacted sharply as both are dovish.

Equities: 

The MSCI all-country World Index fell 0.76% on the week. The MSCI EM index fell 1.031% on the week. The US saw a bounceback in technology while Asia stabilized as China/US fears were less obvious and EU doubts over Italy and Turkey dominated hitting Germany and financial shares. Of the big bourses, China and India and the UK all gained. Within the S&P 500 Index, technology and Internet-related shares fared best, while the typically defensive consumer staples and real estate segments lagged. Generally, growth beat value. Tesla was a key focus for the US market with good earnings overwhelmed by Elon Musk tweets about taking the firm private and securing funding, leading to doubts about such and official inquiries. 

• The US S&P500 fell 0.25% to 2,833.28 on the week. Selling Thursday and Friday dominated a rather quiet week with focus on USD gains and EM pain. The DJIA fell 0.59% to 25,313.14 on the week. The NASDAQ rose 0.35% to 7,839.11 on the week. The VIX rose 6% or 1.5pp to 13.16% up from 10.57% lows early Thursday and from11.64% last Friday.
• The Stoxx Europe 600 fell 0.85% to 385.86 on the week. Turkey and EU/Italian budget fears dominated.  Italy was hit the hardest with MIB off 2.30% to 21,090.78 on the week. German DAX off 1.52% to 12,424.35. French CAC40 off 1.17% to 5,414.68 on the week. The UK FTSE rose 0.1% to 7,667.01 with GBP weakness helping.
• The MSCI Asia Pacific rose 0.12% to 365.45 on the week with Friday losses almost erasing gains from Tuesday to Thursday.Japan fell the most, the Topix off 1.29% to 1,720.16 on the week, the Nikkei off 1.01% to 22,298.08 with JPY gain, BOJ policy focus. The Hong Kong Hang Seng rose 2.49% to 28,366.62 on the week and the China Shanghai Composite rose 2.0% to 2,795.31 on the week. Korea Kospi fell 0.21% to 2,282.79 on the week while the Australian ASX 200 rose 0.70% to 6,278.39. India Nifty50 continued to rally up 0.60% to 11,429.50.

Fixed Income:

Despite heavy new supply and in line inflation reports, the US saw its 10-year bond yields rally to the best levels in a month.The idea of US rates breaking 3% faded as risk-off moods took hold Thursday and Friday. The heavy supply from corporates added to the story. The overall trend of buying bonds and selling equities dominated the last part of the week globally. Focus in Europe was on the Italy and Turkish situations hitting banks and the periphery markets. In UK, Brexit fears remained high and BOE mistake fears countered.In Asia, BOJ policy did as expected – keeping market stable – while PBOC left skipped open market operations all week. In EM, the pain trades of Turkey and Russia bled over to LATAM and then most everywhere.  

• US bonds bull flatten despite new supply. 2Y off 2.5bps to 2.606%, 3Y off 6bps to 2.679%, 5Y off 7.5bps to 2.745%, 10Y off 7.5bps to 2.875%, 30Y off 6bps to 3.03%.
• Canadian 10-year bond yields fell 5.5bps to 2.295% on the week – despite good jobs, C$ hit from Saudi selling notable driver.
• Japan JGB yields fell 2bps to 0.09% on the week – with good auction and focus on BOJ policy unchanged.
• Australian 10-year bond yields fell 13bps to 2.585% on the week – with the RBA on hold, SOMP 2.25% CPI by 2020 coupled with dovish RBNZ driving.
• UK Gilt yields fell 9bps to 1.24% on the week – half of that came Friday – with focus on EU and banks overwhelming data and BOE comments. CPI next key.
• German Bund yields fell 9.5bps to 0.315% on the week – move came with Turkey and with Italy as drivers. The 2s10s spread has narrowed to 95.5bps.
• French OAT yields fell 12.5bps to 0.665% on the week – outperforming Bunds with focus on banks driving.
• Italy BTP yields rose 4bps to 2.98% on the week – with 3.10% back in play. 2-year BTP trades at 1.11%, while the 2s10s spread has narrowed 5.5bps just on Friday.
• Spain Bono yields fell 2bps to 1.40% on the week. Yields at the longer end of the Spanish curve gave up gains Friday - the 30-year at 2.515%.
• Portugal 10-year bond yields fell 2bps to 1.76% on the week – trading off Italy.
• Greek 10-year bond yields rose 5.5bps to 4.155% on the week – hit like Italy with fear that the best of times has passed for growth and rates.

Foreign Exchange:

The US dollar index rose 1.15% to 96.27 on the week. The break of 95.65 opens 96.45 and 97 targets – driving on EM and EUR weakness.The EM FX world was USD bid – LATAM: MXN off 1.84% to 18.91, BRL off 4.07% to 3.864 and notable ARS off 6.58% to 29.22; ASIA: CNY off 0.29% to 6.846, KRW off 0.1% to 1129, INR off 0.32% to 68.835; EMEA: RUB off 6.48% to 67.734 – sanctions hit, ZAR off 5.46% to 14.093, TRY off 21% to 6.432 on the week. In Crypto Currencies, another tough week: BTC $6316 off 11.8% with futures down 13.8% on the week, ETH $321 off 26.7% on the week.

• EUR: 1.1415 off 1.35% on the week with the 1.15 break opening 1.12 targets again as focus turns to Turkey and Russia pain trades bleeding over and 1.1680 now seems far away like ECB.
• JPY:110.85 off 0.4% on the week with EUR/JPY off 1.75% to 126.50 – equities and EM driving with 110.70 and 110.50 pain levels holding but 109 and lower should China fears return.
• GBP: 1.2760 of 1.87% on the week with EURGBP off 0.4% to .8935 with Brexit politics lost against better data and EUR weakness but 1.2750 break opens 1.2550 next with 1.29 resistance.
• CHF:.9950 up 0.1% on the week with EUR/CHF up 1.25% to 1.1360 – all about Italy and Turkey with bank focus. Break of 1.1450 cross opens 1.12 while USD 1.00 still pivotal.
• AUD: .7305 off 1.38% on the week with the RBA SOMP and on hold view key against data next week and crosses with .7250 and .71 next. NZD: .6590 off 2.28% on the week with RBNZ pushing out hike forecast to 2020 good for half the move – break of .6650 opens .6520 next.
• CAD: 1.3140 up 1.13% on the week with focus on NAFTA hopes, better data (jobs mixed with wages flat) and BOC hike expectations supporting vs. Saudi selling spree, US rates, politics.

Commodities:

The S&P/GSCI fell 0.76% to 2686.23 on the week. NatGas and Oats in the lead last week with Soybeans and Rice the laggards.Commodities were not the key focus other than knock on effects to trade tariffs and sanctions.

• Oil: $67.63 off 1.26% on the week. Brent $72.81 off 0.55% on the week. Notable rally in NatGas up 3.19% to $2.944 as US heatwave hits. Focus is on US supply vs. OPEC production still but backdrop of EM pain and sanctions moving USD matters more. Techincals mixed with WTI stuck watching $65.50-$69.50 while Brent lives in a $72.50 tent.
• Gold $1210.60 off 0.35% on the week. Despite EM meltdown and sanction worries the safe-haven isn’t working with $1204.60 still key base and $1220 bounces sold. Silver off 0.68% to $15.31 with $15.25 key. Platinum off 0.4% to $910.61 and Palladium off 0.24% to $910.61.
• Corn: $371.75 off 3.25% on the week – USD up, sanctions, but weather still factor. Wheat off 1.7% to $569.50 – give back after last week’s weather squeeze – while Soybeans off 4.54% to $861.75 with China tariffs hurting.
• Copper: $2.7830 flat on the week. Comex Copper off 0.76% to $274.25. Tracking equities and watching China data next.Iron Ore sharply higher with environmental restrictions increasing demand for high quality and with trade data last week helping – Sep futures $69.73 up 4.4% on the week.

Calendar for the Week Ahead:

This is the biggest week for Summer vacations but one that perversely has plenty of economic data – with focus next week on China M2, IP, retail sales, asset investments and unemployment.The US gets retail sales, Philly Fed, housing starts, industrial production, productivity and Michigan – all important for the tariff/USD knock on effects. Europe focus is on GDP, German ZEW while UK gets retail sales, jobs, and PPI/CPI. Norges Bank and Indonesia central bank meetings are assumed non-events but how they react to markets matters. Australia will be watching the semi-annual RBA Lowe testimony for the same along with jobs.Light week for earnings and for auctions makes it more prone to political headlines and positioning. Turkey remains front and center given the pain trade it has caused in EM and EU with banks and contagion fears. OPEC monthly and US relationships with Iran, Russia, China, Nafta talks and Japan talks on trade all in focus.

Monday, August 13: China M2/new loans

• 1000 pm China July M2 8.0%p 8.2%e / New Loans CNY1.84trn p CNY1.2trn e/ TSF 1.18trn p 1.2trn e
• 0400 am Italy July final HICP (m/m) 0.2%p -1.4%e (y/y) 1.4%p 1.9%e /CPI 1.3%p 1.4%e
• 0545 am Italy sells 3Y-7Y-30Y BTP

Tuesday, August 14: China retail sales, IP, Eurozone 2Q GDP and IP, German ZEW, UK jobs

• 0930 pm Australian July NAB business confidence 6p 6e / conditions 15p 15e
• 1000 pm China July retail sales (y/y) 9%p 9%e
• 1000 pm China July industrial production (y/y) 6.0%p 6.3%e
• 1000 pm China July fixed asset investment (ytd) 6%p 6%e
• 1230 am Japan Jun final industrial production (m/m) -0.2%p -2.1%e (y/y) 4.2%p-1.2%e
• 0200 am German 2Q preliminary GDP (q/q) 0.3%p 0.4%e (y/y) 2.3%p 2.1%e
• 0200 am German July final HICP (m/m) 0.1%p 0.4%e (y/y) 2.1%p 2.1%e
• 0230 am India July WPI (y/y) 5.77%p 5.2%e
• 0245 am French July final HICP (m/m) 0%p -0.1%e (y/y) 2.3%p 2.6%e
• 0300 am Spanish July final HICP (m/m) 0.2%p -1.2%e (y/y) 2.3%p 2.3%e
• 0430 am UK July claimant count 7.8k p -8k e / 3M to June ILO unemployment 4.2%p 4.2%e / 3M to June Avg. Earnings 2.5%p 2.5%e / ex bonus 2.7%p 2.7%e
• 0500 am German August ZEW economic sentiment -24.7p-20e / current 72.4p 72.3e/EU Sentiment -18.7p -15.6e
• 0500 am Eurozone 2Q preliminary GDP (q/q) 0.4%p 0.3%e (y/y) 2.5%p 2.1%e
• 0500 am Eurozone June industrial production (m/m) 1.3%p -0.4%e (y/y) 2.4%p 2.5%e
• 0600 am US July NFIB business optimism 107.2p 106.7e
• 0830 am US July import prices (m/m) -0.4%p 0%e (y/y) 4.3%p 4.6%e / exports 5.3%p 4.2%e
• 0430 pm US weekly API oil inventory -6mb p +0.1mb e

Wednesday, August 15: Assumption Day holidays, Australia wages, UK CPI/PPI, US retail sales, IP, productivity

• 0830 pm Australia Aug Westpac consumer confidence 106.1p 103e
• 0930 pm Australia 2Q wage price index (q/q) 0.5%p 0.6%e (y/y) 2.1%p 2.1%e
• 0930 pm China July house price index 5%p 5%e
• 0500 am Indonesia central bank rate decision no change from 6% expected
• 0430 am UK July PPI output (m/m) 0.1%p 0.1%e (y/y) 3.1%p 3.2%e /core 2.1%p 2.3%e / input 10.2% 10.8%e
• 0430 am UK July CPI (m/m) 0%p -0.2%e (y/y) 2.4%p 2.5%e /core 1.9%p 2.0%e / retail 3.4%p 3.4%e
• 0540 am German E1bn Bund 30Y sale
• 0830 am US Aug NY Empire Manufacturing 22.6p 20e
• 0830 am US July retail sales (m/m) 0.5%p 0.2%e / ex autos 0.4%p 0.3%e / core 0%p 0.4%e
• 0830 am US 2Q productivity 0.4%p 2.5%e / ULC 2.9%p 2.9%e
• 0915 am US July industrial production (m/m) 0.6%p 0.3%e / cap utils 78%p 78.1%e
• 1000 am US Jun business inventories 0.4%p 0.1%e
• 1000 am US Aug NAHB housing market 68p 67e
• 1030 am US weekly EIA crude oil inventory -1.35mb p +1.21mb e / gas 2.9mb p -0.8mb e
• 0400 pm US June TIC flows $69.9bn p -$80bn e / long term $45.6bn p $59bn e

Thursday, August 16: Japan trade, Australia jobs, Norges Bank rate decision, UK retail sales, US housing starts, Philly Fed

• 0750 pm Japan July trade balance Y721.4bn p -Y50bn e / imports 2.5%p 14.4%e / exports 6.7%p 7% e
• 0830 pm Australia July Westpac LEI 0%p 0.1%e
• 0930 pm Australia July jobs 50.9k p 15k e / unemployment 5.4%p 5.4%e / participation 65.7%p 65.6%
• 0300 am Norges bank rate decision – no change from 0.5% expected.
• 0430 am UK July retail sales (m/m) -0.5%p 02%e (y/y) 2.9%p 2.9%e / ex-fuel 3%p 2.8%e
• 0440 am Spain sells 3Y-5Y-10Y bonds
• 0500 am France sells 3Y-5Y BTAN
• 0500 am Eurozone June trade surplus E16.9bn p E18.2bn e
• 0830 am US July housing starts -12.3%p +5%e /1.173m p 1.25m e
• 0830 am US weekly jobless claims 213,000 p 217,000 e
• 0830 am US Aug Phil Fed Manufacturing 25.7p 22e
• 0830 am Canada Jun manufacturing shipments +1.4%p +1%e
• 0830 am Canada July ADP employment -10.5k p +45k e

Friday, August 17: RBA Lowe speech, Canada CPI, US Michigan Consumer Sentiment

• 0700 pm Japan Aug Reuters Tankan 25p
• 0700 pm Korea July unemployment rate 3.7%p 3.8%e
• 0730 pm RBA Lowe speech
• 0200 am German July wholesale prices (m/m) 0.5%p (y/y) 3.4%p
• 0300 am RBA Ellis speech
• 0500 am Eurozone July final HICP (m/m) 0.1%p -0.3%e (y/y) 2.0%p 2.1%e / core 0.9%p 1.1%e
• 0830 am Canada July CPI (m/m) 0.1%p 0.1%e (y/y) 2.5%p 2.5%e / core 1.3%p 1.3%e
• 1000 am US Aug preliminary Univ. Michigan Cons. Sentiment 97.9p 97e
• 1000 am US July Conference Board leading indicator 0.5%p 0.4%e

Conclusions:

Last week left more questions than answers for investors.

There are some new themes popping up for markets – ones that make the power of buying the EM dip less convincing.