Risk appetite diminishes in an era of sanctions, trade tariffs

Emerging market currencies plummet

KUWAIT: It was a light week in terms of economic data for G7 countries’, while political disputes on trade and policies continued to hover over markets. The main winners in the financial markets were the Japanese yen, USD, and dollar denominated bonds. Risk aversion was the main theme as emerging market currencies plummeted. The US administrations’ stance on trade and external policies were the main factors for safety demand, while China’s tone suggests backing down is not an option. The ECB has warned that the escalating tariff war presented serious downside risks to the global economy in the short and medium term.

The Bank said “if all the threatened measures were to be implemented, the average US tariff rate would rise to levels not seen in the last 50 years.”

Looking at the Turkish lira, the TRY is experiencing severe losses since May. The TRY has lost nearly 43 percent of its value to the USD YTD. The Turkish lira made a new low of 6.8010 on Friday due to concerns over Europe’s banking exposure to the lira outshined assurances by the Turkish government to support the economy. In details, Spanish banks have outstanding $83.3bn by Turkish borrowers, French banks are owed $38.4bn and Italian lenders $17bn. Thus, Turkish entities will have high cost burdens to repay borrowed liquidity. The lira’s sharp deprecation began after President Erdogan’s unorthodox views on interest rates reached the market and claimed that “interest rate is the mother and father of all evil.” The downward trend of the currency gained further momentum as the US sanctioned certain Turkish officials and Turkey responded in a similar fashion. Negotiations between the two countries failed to make progress.

As for the Russian ruble, the currency fell to the lowest level in more than 2 years following US plans to enforce harsh trade restrictions in reaction to the poisoning of former military intelligence agent Sergei Skripal in the UK. The USD/RUB pair opened on Monday at 63.33 and ended Friday’s session at 67.67. The sanctions come in two segments. The first aims on US exports of sensitive nationalsecurity correlated goods. The second tranche will become active in around 3 months, if Russia fails to offer trustworthy guarantees that it will not use chemical weapons and permit on-site assessments by the UN or other international observer groups the US stated.

In Regards to other sanctions, the first phase of sanctions on Iran was implemented last week prohibiting Iran from using the Dollar as a median of exchange. The sanctions also restrict Iran from trading in vehicles, metals and minerals (gold, steel, coal and aluminum). The country will also be banned from buying US and European aircraft. The second phase of the sanctions will be imposed in November, targeting Iranian oil production. The Iranian rial has sunk more than 50 percent against the US dollar this year.

US consumer inflation

The US economy continues to deliver robust economic reading, while other peers fail to follow in the same direction. The core consumer inflation rose to the highest level in 10 years, paving the road for the FED to gradually hike interest rates. The underlying CPI rose 0.1 percent to 2.4 percent in July and the headline CPI also moved in the same attitude towards 2.9 percent.

On the producer front, prices halted for the first time this year as the monthly PPI reading remained unchanged. In annual terms, the data was 3.3 percent higher than a year ago, down slightly from the 3.4 percent seen in June. Headline inflation was subdued by a drop in energy and foods prices. On the other hand, stripping out volatile items like food and energy, the core producer inflation rose 0.3 percent in July. In the 12 months through July, the core data increased 2.8 percent after rising 2.7 percent in June. The inspiring data comes at a time when the economy is near full employment and experiencing robust growth. Future readings on inflation may rise as the Trump administration’s tariffs on imports start to influence price pressures. Moreover, manufacturers appear to be absorbing some of the higher expenses for now, with more threatening tariffs in the pipeline, it may be a matter of time before final demand inflation begins to rise.

The US dollar index soared last week to level not seen in 13 months. The index broke the 95 and 96 levels, rising to a high of 96.452, the highest since July 2017. The Dollar has been appreciating continuously since April as the US economy is doing well fundamentally and the Fed is moving towards a more predictable path of interest rates. However, the sharp rise in last week’s session occurred as the USD absorbed some safe-haven flows. The greenback has been enhanced by growing global trade tensions and strained geopolitical relationships. The US has lately stated it would impose new sanctions on Russia, while involved in a diplomatic dispute with Turkey. In the last five trading sessions the DXY has gained nearly 1.1 percent against a basket of currencies and is up by 4 percent YTD.

Single currency tumbles

The reversal of the economic dynamic this year that provided support for the euro in 2017 may continue to pressure the single currency and risks remain skewed to the downside over the short-term. It was the surprising strength of the European economy that assisted the euro once the political risks surrounding the French election subsided. However, the positive fundamentals from the euro economy have turned less positive indeed. The sell-off in the euro has clearly strengthened, in particular with EUR/USD finally breaking through the 1.15 support level. Technically, EUR/USD’s break of 1.1507 key support indicates the end of the consolidation pattern that started back in May. The continuous deprecation from February’s high of 1.2555 has resumed.

In regards to last week, it was light in terms of economic indicators for the euro. Hence, most of the euro’s dip was attributed to a stronger US dollar. Another factor causing the euro’s slide was the exposure of European banks to the Turkish lira. Turkish entities have a large exposure of USD and euro denominated debts, therefore it will be more expensive for Turkish organizations to pay those debts. The EURUSD began its weekly session at 1.1561 and sank to a 13 months low of 1.1383. The euro fell by 1.3 percent in the last five trading days versus the USD.

UK GDP improves

The British economy picked up momentum in the second quarter, preceding a sharp winter slowdown earlier in the year. The second quarter GDP rose 0.4 percent as markets have predicated, bring the annual Q2 rate to 1.3 percent. The 1.3 percent figure is barely above a six-year low touched in the first three months of the year. In terms of the main GDP components driving the UK economic growth higher were services and construction that increased 0.5 percent and 0.9 percent Q/Q respectively. Furthermore, household spending and business investment also contributed positively rising 0.5 percent and 0.3 percent. On the negative side, industrial production fell by 0.8 percent Q/Q and the trade deficit broadened by £4.7 billion to £8.6 billion

Since the vote to leave the EU, Britain has fallen from the fastest growing economy in the G7 to the slowest. The economic thrust looks restrained in comparison to some global peers and uncertainty continues to loom over the UK on the Brexit front. Investors are thinking twice before investing in Britain as the outcome on a Brexit deal becomes more unclear by the day. The EU, an important trading partner for the UK has also witnessed sluggish growth and business investments continue to be delayed by Brexit uncertainty. Looking at the Sterling pound, the GBP/USD dived quite significantly last week to the lowest level since June 2017. The pair depreciated to a low of 1.2736 on Friday, losing 264 basis points since the start of the week. The Sterling’s struggle began after BOE Governor cautioned that a nodeal Brexit is becoming highly likely and UK Trade Minister added that there is 60 percent chance that a deal won’t be met before the deadline of March 2019. The pound has also been affected fundamentally when markets realized that interest rate hikes were likely to be as limited as one a year.

Japan economy rebounds

Japan’s economy rebounded in the second quarter of the year after experiencing the first contraction in 8 quarters. The preliminary GDP expanded 1.9 percent in Q2 on an annualized basis, from the revised contraction of 0.9 percent in Q1. The main drivers of growth were private consumption and business spending. Private consumption, which accounts for about 60 percent of the economy, mounted at an annualized rate of 2.8 percent. The recovery in customer spending is a wanted development for the BoJ, however it’s unlikely to change its stance on interest rates. Export growth of 0.8 percent was easily overtaken by a 3.9 percent rise in imports, suggesting a weaker trade environment.

The absence of significant wage momentum in the economy has continued to put a cap on price growth which remains well below the BoJ’s 2.0 percent target. Furthermore, the central bank dropped its inflation forecast for 2018 and added forward guidance to its statement to highlight the prolongation of its overall attitude toward extremely easy monetary policy. The US and Japan failed to reach any agreement on trade last week as Japan prefers a multilateral trade negotiations, while the US is aiming for a bilateral one. Trade friction between the US and China is creating a lot of uncertainty. If the uncertainty persists and intensifies it may begin to hurt Japan’s export and manufacturing sector. The safe haven yen performed relatively well against the US dollar last week, despite strong USD movements vs. the euro and the pound. The yen was supported by escalating trade tensions, global political disputes and a rebound in Japan’s GDP. The USDJPY began the week at 111.24 and closed the week at 110.92. The USD lost 0.30 percent of its value to the yen last week.

Mixed data out of China

Consumer price growth in China inflated to a 4 months high in July, while producer inflation deflated for the first time since March. The CPI rose 0.3 percent on a monthly basis, triggering the annual rate to rise from 1.9 percent to 2.1 percent. The support for the headline CPI came from an annual rise of 2.4 percent in non-food items, which were elevated by higher fuel prices. However, core inflation persisted steadily at 1.9 percent for the third straight month, indicating benign domestically generated inflationary pressures. On the producer front, the PPI shrank marginally from 4.7 percent to 4.6 percent.

All in all the effect of import tariffs on inflation appears minor for now. Although, trade war shows no signs of abating as both parties are ready to strike back. China publicized further retaliatory tariffs taxed at 25 percent on $16 billion worth of US imports. Tariffs are projected to elevate the cost of production in some industries and possibly weigh on corporate earnings. Import prices may rise as the Renminbi has already depreciated by 8 percent since January and raw material input costs are increasing in the energy sector due to higher oil prices. With headline inflation running below the 3 percent target set by the central bank, this should give the People’s Bank sufficient room to further loosen monetary policy if needed.

Imports to China soar

China’s trade exports moved higher last month despite trade tensions intensifying and the implementation of US tariffs on $34 billion for Chinese imports came into effect on July 6. In details, the dollar denominated value of exports rose 1 percent in July to 12.2 percent, at the same time imports rose at a faster rate from 14.1 percent to 27.3 percent. Hence, China’s trade surplus narrowed to $28 billion from June’s $41 billion. Most importantly China’s closely watched surplus with the US fell slightly to $28.09 billion from $28.97 billion in June. One major factor supporting Chinese exports has been the weakness of the Renminbi, which has depreciated by 8 percent since the start of the year. The weaker currency seems to have taken the sting out of tariffs and the impact of tariff on $34 billion is minimal compared to last year’s $505 billion US imports from China. However, China’s trade balance may become less favorable as trade tension between the two largest economies continues to heat up, with no side backing down. The Chinese economy has already reshaped tremendously toward internal growth drivers and policies to support the sustained growth in these parts of the economy will hold the key to economic stability.

RBA maintains rate

The Australian central bank maintained its official cash rate unchanged at 1.50 percent, marking the longest streak without a change. The RBA acknowledged that China is experiencing a slower growth momentum and may affect Australia negatively as China is Australia’s biggest trading partner. Moreover, the Bank claimed that diminishing household expenditure persisted as a source of uncertainty for the economy and a factor for maintaining the interest rate at a record low. On the inflation front, price growth is now projected to decline towards 1.75 percent, outside the RBA’s preferred 2 to 3 percent target.

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USD/KD opened at 0.30340 yesterday morning.