Central Banks Bully Forex Back In Line

It seems that the emerging markets are not sick enough for the rest of the world to be concerned about just yet. This appears to be the consensus view amongst analysts just as investors consider testing the waters again. Only time will tell if any potential unhinging is limited only to a few unbalanced economies like that of Turkey and Argentina. The developed world is supposedly somewhat immune now that growth is evident, backed by a pliable domestic Central Bank policy. The investor should be deeply worried if slowdowns and sell-offs deepen in bigger economies – like in China – that manage to “infect the financial markets of industrial nations and deprive them of demand for exports and commodities.”

What has transpired so far in 2014 is being considered as a warning shot across the global investors bow. So long as the emerging markets do not put the US economy particularly at risk, the world is supposedly healthy enough to overcome almost everything. The interrelationship between the developed and developing economies has dramatically shrunk over the past two decades. In the US, the investors beacon, emerging markets drive 15% of the sales of companies in the S & P 500 Index, with China accounting for a third of that percentage. According to the IMF the growth gap between the two is the smallest in a “bakers dozen years. It’s no wonder that when a developing economy catches the sniffles the global investor becomes concerned very quickly.

It’s the pliable Central bank that has kept the market in tow, from the Fed to the CBRT (Turkey). They are required to be more proactive than in history’s past. It’s not even odd anymore that a governor is adorned like a “rock star” – in particular, Governor Carney at the BoE, and outgoing Fed Chair Ben Bernanke. Vacating his Fed position, you can be sure that Helicopter Ben will have many accolades heaped upon him as if he was the sole savior of the developed world during the last recession- Just ask Greenspan.

The actions of a Central Bank are required to be fast and immediate. India for instance surprised the market with an overnight rate hike to cope with a Fed taper. The RBI raised the Repurchase Rate by 25bps to 8.00%. Their actions have gone some ways to help emerging market currencies encounter modest strengthening. Turkey’s CBRT will hold an extraordinary MPC meeting later today – this action has stopped the lira bleed, allowing USD/TRY to decline to 2.28 from 2.40 yesterday. Obviously some significant tightening has been priced in already, making it a tad more difficult to surprise the market on the hawkish side. The market expects CBRT policy makers to revise the year-end inflation higher from the previous 5%.

Transparency and forward guidance has become a common tool amongst developed central bankers. Certainly an instrument that is required to be handled correctly. Governor Carney at the BoE has had a tough time with his unemployment percentages and the markets perception of the timing of a tightening bias. So far, UK policy makers have under estimated the strength of their own economy, particularly employment, so much so that Carney and company will have to redefine the interest rate boundary lines for the market. Earlier this morning the UK’s Q4 flash GDP came in bang on target at 0.7% on the quarter, and 2.8% on the year. The market was expecting a tad more, and this slight slowdown could strengthen Carney’s resolve to keep the stimulus taps open to encourage further growth. The UK’s economy is considered a darling amongst the many across the Atlantic. Growth is expected to accelerate again this year, with the IMF predicting 2.4%. Sterling’s initial reaction was to drop half a cent on disappointment to £1.6549, and the EUR/GBP to spike 20 ticks to 0.8248 before the pound was able to regain its composure.

Central Banks have held the forex market in check for many months and even the fear of potential contagion has them working the markets hard, fast and in tandem with other interested parties. The response time from policy makers is far quicker and more aggressive than in times past, just ask the ECB – they found that out the hard way. Notwithstanding what’s going on in the developing world, the markets attention will be mainly focused on the Fed’s two-day meet ending tomorrow, and what tapering the Fed is willing to do. Central banks moves will be considered a fine balancing act between a loose and tight monetary policy. A road never travelled can be full of surprises, especially when ones directional priority is very different from everyone else’s.

Forex heatmap

Other links:
Will The Fed Tug Harder On The Safety Blanket?

This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.

Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
Dean Popplewell