USD rolling over on shift in sentiment to EM

The US dollar is turning broadly lower, likely due more to the shift in sentiment in emerging markets and risk appetite rather than due to the weaker-than-expected US CPI data and any spin from the European Central Bank meeting.

The US August CPI data came in much lower than expected, with the core month-on-month reading at  +0.1% versus 0.2% expected and the year-on-year figure at 2.2% versus 2.4% expected and 2.4% prior. Plenty of other evidence points to ongoing inflationary pressure in the US and the US Treasury market reaction was swiftly reversed later in the day, so we can safely say that this looks like a blip.

Nonetheless, the US dollar remained lower, suggesting other factors are afoot. One of those was Turkey’s massive 625 basis point increase in the one-week repo rate, which was about double the consensus expectations and engineered a significant rally in the Turkish lira yesterday, with other EM currencies rising in sympathy with the move. 

That shift in sentiment is critical here and could have legs if the move sticks – EM have been under pressure for a long time. A less important factor was the ECB meeting, which more or less confirmed the autopilot timetable of further tapering purchases into year end. On the “hawkish” side, the ECB’s fresh inflation forecasts were unchanged from the previous round of forecasts, though growth forecasts were moderately lower. The rate outlook was entirely unchanged, so the rally in EURUSD was more about getting past the event risk rather than deriving any narrative from it.

Interesting to note that the renminbi has pushed to new lows versus the euro, even as USDCNY remains rangebound. This has an interesting signaling value that China will allow the exchange rate to move around more as that 8.00 level has not been crossed except for briefly intraday in July.

Russia’s central bank meets later today and chief Nabiullina is in the hot seat as the government pressures to ease rates after she indicated a bias to hike. Given the decent RUB rally of last few session, she may choose to not hike but still issue a two way statement.

Chart: EURUSD

EURUSD has pulled higher here, and looks ready to take on the key resistance zone into 1.1750-1.1800 at minimum if it vaults the minor 1.1733 local high hurdle. A weak US dollar is the more likely driver of the action as we may have just seen a momentum shift in USD sentiment. As well, a move higher . Targets higher, assuming 1.1800 is properly cleared, could be the 200-day moving average ahead of 1.2000 or the big round level itself. To see more than that to the upside, we would like need a more profound shift higher in the EU economic outlook or downward shift in the US outlook.