FX Update: EM under pressure as USD rises broadly

Yesterday the market tried to piece together a recovery in sentiment after many saw the Trump administration’s account of President Trump’s phone call with the Ukrainian leader as less damning than initially thought, though that certainly depends on whose opinion you read in the hopelessly biased media reporting landscape. Trump also tried to make promising noises on the prospects for a US-China trade deal just a day after bashing China before the world at a UN speech.

Working against the recover in risk sentiment late yesterday, the US dollar rallied broadly, likely driven by ongoing liquidity issues. The Fed announced that it is increasing the size of repo operations in response to demand, doubling the size of today and tomorrow’s 14-day repos to $60 billion and increasing the overnight repo to $100 billion. There may be a lull in liquidity demand once we get past the quarter end date, but expect these operations to only expand from here as the large US financial institutions look to do all they can to shrink their balance sheets (for example, by not participating in repos) ahead of year end to reduce balance-sheet-size penalties they must pay as G-SIFI’s – global systemically important financial institutions. Today also sees an auction of 7-year treasuries after yesterday’s 5-year auction went reasonably smoothly. The last 7-year auction in late August was perhaps the weakest single Treasury auction for the cycle.

EM assets markets and currencies (very often the same thing) are finally waking up a bit to the stronger US dollar and put in a bad session yesterday. An interesting test for broader EM sentiment today as Mexico’s Central Bank meets and is expected to cut rates 25 basis points to 7.75%. These cuts can only continue as long as EM has the luxury of supportive conditions – which were about as good as they will ever get before the last few days.

Today we have a rather light economic calendar as we have a look at how markets deal with the pivot to quarter end and the run into likely accelerating USD liquidity issues into year end, US earnings season starting mid-October and the next chapter of Brexit and US-China trade talks. A pickup in volatility in October seems almost inescapable.

Chart: EURUSD
EURUSD saw a new low daily close for the cycle near 1.0950 and looks ready to test toward the 1.0800 level next if the seemingly unstoppable force of the rising USD liquidity issues are not countered forcefully enough by the Federal Reserve.