- People’s Bank of China liquidity injection improves sentiment on financial markets
- EM currencies remain under pressure, but domestic developments take centre stage
- Germany’s ZEW economic sentiment indicator almost unchanged at high level
People’s Bank of China liquidity injection
The People’s Bank of China (PBoC) pumped a large amount of liquidity into the money markets on Tuesday to alleviate increasing stress as demand for cash rose ahead of the Lunar New Year Holiday. In the past year, China’s monetary authority has on several occasions unexpectedly tightened liquidity, resulting in a funding squeeze. This was seen as a signal of its intentions to reduce the risks of strong credit growth, particularly in the shadow banking sector. China faces a difficult balancing act of reducing these risks, while sustaining robust GDP growth. In any case the central bank has enough tools to provide liquidity to markets if needed. The PBoC’s liquidity injection was welcomed by financial markets and investor sentiment improved, also helped by positive corporate earnings and the IMF upgrading its US and global forecasts.
Turkey caught between a rock and a hard place
Meanwhile, the Turkish central bank (CBRT) decided to hold official policy rates, pointing to previous measures it has taken, which have helped to push up interbank rates. The CBRT remains caught between political pressure to keep policy rates unchanged and market pressures to hike rates to stem the fall of the lira. Even though the outcome was in line with the market consensus, the calls for a rate increase were getting loader. With the CBRT remaining on hold for now, we expect further lira weakness going forward. We believe that Turkey – given its large external deficits financed by short-term capital inflows, in combination with political issues – will remain vulnerable to market turmoil, while future rate hikes could still prove necessary if pressures on the currency and capital flows continue.
Last year’s fragile five in EM FX diverge in 2014
In 2013, emerging market currencies came under heavy pressure, with the Indonesian rupiah (IDR), South African rand (ZAR), Turkish lira (TRY), Brazilian real (BRL) and Indian rupee (INR) being sold off the most. These five currencies were classified as the fragile five, because of their sensitivity to lower investment flows, based on a current account deficit, fiscal deficit, political uncertainty and weak growth prospects. Since the start of this year, emerging market currencies have remained under pressure but the order differs. The Turkish lira still tops the list of weakest performing currencies and South African rand is still among the five weakest performers. However, the Indonesian rupiah leads the ranks as top performer so far, modestly outperforming the USD, followed by the Chinese yuan (CNY) Brazilian real (BRL) and Indian rupee (INR). The reasons for the change in fortunes are more positive fundamentals in case on the INR, more confidence in the central bank (INR and BRL) and profit taking after a large sell-off, while fundamentals have barely improved (IDR). For the remainder of the year we expect emerging market currencies to underperform the USD, but domestic developments to make the difference in terms of the extent of underperformance. We believe that only the Chinese yuan and the Mexican peso will be able to outperform the USD in 2014.
Germany’s ZEW almost unchanged at high level
Germany’s ZEW expectations indicator edged lower, to 61.7 in January, from 62.0 in December. Given the normal level of monthly changes in the series, this decline is minimal, while it follows upon five successive monthly rises of 26 points in total. Participants to the ZEW survey became more optimistic about the economies of the eurozone and the US during the next six months, while there prognoses for Japan and the UK deteriorated. The expectations indicator tracks changes in GDP growth relatively well, and at its current level (which is well above the long-term average value of around 25) it signals a pick-up in growth in the coming quarters to levels of around 0.5-0.6% qoq (well above the eurozone total), which is in line with our base scenario for Germany.