'Global markets are now in a critical danger zone'

The US 10-year yield rushed higher yesterday as US retail sales data failed to provide any support for US Treasuries, which were already struggling ahead of the data release. The US 30-year yield is the last hold-out, as it has yet to close at new high for the cycle (around 3.25%), a resistance area with significance for that benchmark all the way back to 2014. 

But the damage was done yesterday as the 10-year is the most immediate focus and risk appetite did not take kindly to the development, with major equity indices in a fresh, ugly correction that came at a pivotal moment not long after resistance had just been cleared, for example, in the US S&P 500 index. In exchange rates, the USD generally rushed higher, especially versus the struggling euro, as EURUSD probed the lows and USDJPY pulled above 110.00 for the first. 

But the real damage continues versus emerging market currencies, which never appreciate the price of “global money” (the USD reserve currency) rising and long-term interest rates on that money also rising quickly.

This latest move in US longer interest rates has global markets entering a critical danger zone that could set off a negative spiral of deleveraging. The factors we will watch from here include not only the longer US rates and the now 3.00% support level in the US 10-year benchmark, but also the 200-day moving average in the S&P 500.

Among emerging market currencies, we focus especially on the Turkish lira, the most liquid of the EM currencies with notable risk of a “run on the country” if foreign capital takes flight. We are in a “quiet period” ahead of the June 24 election and President Erdogan has promised more political involvement in traditional central bank policy, including the threat to cut rates – the opposite move is normally made to shore up a currency in trouble. It is a long wait until the election and the post-election policy uncertainty, which will see Erdogan with vastly expanded executive powers. The market could justifiably fear that he will choose drastic intervention measures once he is sworn in as president – with the worst version of these fears something along the lines of the harsh capital controls implemented by Malaysia’s Mahathir in the late 1990s?

Japan’s Q1 GDP estimate overnight showed a miserable performance for the Japanese economy, as nominal growth limped in at -0.4% quarter-on-quarter and the annualised growth was a terrible -0.6%, the worst performance since 2015. While recent inflation data has picked up, this kind of growth performance is going to keep the Bank of Japan far away from a policy adjustment for now. The one saving grace for the yen is that a possible decline in risk appetite could support the yen in some of the crosses (versus the struggling euro, for example).

Chart: EURJPY
The EURUSD decline is well advertised and much of the talk is about the strong USD driving this, but we also have a weak euro on our hands if we have a look at most of the euro crosses, including EURJPY. This pair has found resistance at an interesting resistance area (the Ichimoku daily cloud) and the euro may underperform from here on underappreciated political concerns.