ECB bazooka triggers currency war?
A malaise has fallen over financial markets. The lack of meaningful news has left prices to drift. Tactically, we watching media for any news on US-China trade, ECB, Brexit, general data to support a Fed direction, for insights to short term price action. In Asian trading, the lack of negative news (Bolton’s exodus can be seen as a positive for globalist) has helped the Nikkei and Hang Seng bounce sharply. Looking forward, the ECB’s rate cut, tiering and asset purchases felt like a well-played record. The spillover into prices should remain limited (although supportive). In reality, EU economic outlook is weak but not terrible, so for the ECB to come out with both guns blazing is a bit overkill, unless there is an alternative objective. For the FX markets, ECB action will be more insightful. The incremental benefit of lowing interest rates (deposit is already negative and yield curve across EU is ultra-low) are will be marginal, but the “dog whistle” to currency traders is more profound. The “race to the bottom”, the debasing of currency to achieve a competitive advantage has become the favorite FX trade. With solid annual GDP growth rates of 2.3% and 6.2%, RBNZ and RBI could have held-off cutting rate until data indicated clearer deterioration. However, the proactive decision, in our view, was targeting their currencies (especially consider the rapid devaluation of CNY). With slower US growth and weaker outlook combined with falling yields, demand for USD is expected to dry up. To stay competitive countries must aggressively cut interest rates now. In our heads, we hear the echos of Brazil’s finance minister, Guido Mantega in 2010 declaring an “international currency war” has broken out. The ECB action will trigger the next wave of devaluations.
Turkey to cut 275bp
In Turkey, we expect the CBRT to over-deliver with a policy rate cut of 257bp on Thursday. After the initial 425bp cut in July, inflation dynamics have improved while the currency relative stability and global low-interest rates have provided a backdrop for the CBRT to chop rates. It also does not hurt that President Erdogan has basically order the central banks to aggressively cut rates. With inflation stuck around 14% the size of cuts should taper off. Also, the resurgence of pressure on the lira could force policy markets to take a caution strategy. 2Q GDP data was encouraging indicating a faster than expected recovery in private consumption and in growth, which will likely embolden politicians. Cutting rates should support investment, which remains weak. And remains a negative signal for the long term outlook. Finally, we don’t expect significant changes in language around the interest rate announcement. We expect the MPC to highlight “monetary tightness will be determined by considering the indicators of the underlying inflation trend”. In the short run, any cut above 250 should cause short-term weakness in the lira.
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