Australian dollar hangs on as world crumbles

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DXY was soft last night but EUR and CNY crumbled anyway:

AUD fell to new two year lows but ended roughly where it started versus DMs:

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It was strong against EMs:

Gold is once again illustrating that it is useless in a market crisis:

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Oil is fading:

As are base metals:

And big miners:

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EM stocks are at the cliff edge:

The leading indicator, EM junk, is over it. US high yield does not care:

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Treasuries actually sold:

Bunds were bid:

As Italy catches fire again:

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Stocks were down but very calm given the context:

It’s the great divergence. The US is booming and the resulting strong dollar is crushing emerging markets one by one. Goldman sums up the US:

Company commentary and business surveys increasingly highlight bottlenecks and price pressures, as well as a growing shortage of workers in the trucking, healthcare, and construction industries. Yet despite tight labor markets and rising input costs, core PCE inflation has yet to exceed 2 percent on a sustained basis. To paraphrase Robert Solow, price pressures seem to be everywhere except the inflation statistics.

…Barring a sizeable rebound in capital formation or labor-force participation, capacity constraints are likely to become increasingly binding as the expansion continues. While the Fed may view further declines in the unemployment rate with some ambivalence, the implications of broadening labor shortages and product-market bottlenecks are more clear-cut, representing a textbook form of overheating that the Committee has historically taken great pains to avoid.

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Meanwhile, EMFX gets taken to woodshed:

The excellent Viktor Shvets of Macquarie sums it all up:

Are politics & economics on a suicide course?

Key points

  • An illiberal global order is being compounded by CBs draining liquidity.
  • The flashpoint is now Turkey but the prospect of contagion is real.
  • While Asia ex is less exposed, trade disruption, less liquidity, rising US$ and falling Rmb are a deadly combination. It could go beyond Turkey & South Africa.

Tocqueville strikes again – stress leads to illiberal answers

This week’s Economist had a timely article on Alex de Tocqueville whose classics ‘Democracy in America’ and ‘The Old regime and the French Revolution’ were the reference books for liberals like John Stuart Mill and autocrats like Xi Jinping. They guided democrats how to avoid destruction of liberal order while being equally useful to autocrats on how to avoid revolutions.

What has it to do with emerging markets? EM equities do best when volatilities are low, environment is predictable, capital flows freely and trade expands. However, as we have been highlighting, this outcome is becoming increasingly less likely. As de Tocqueville warned, while liberal order requires democracy, democracy does not necessarily lead to free and liberal order. When pressures rise, democracies frequently turn to xenophobic and protectionist policies. In such times, people do not want freedom, they want help. In our view this explains recent trend towards more illiberal causes and politicians, whether in the US, Turkey, Poland, Hungary, Italy, Mexico, Phil or India. It is not relevant whether a country lurches to the left (Mexico) or right (Turkey), the outcomes are less freedom, greater state control and international disruption.

Turkey is a canary in the coal mine; watch global liquidity & China

While history does not repeat itself, it does rhyme, and while de Tocqueville could not envisage CBs role in economic and political life, he did warn about dangers of state centralization. This brings us to Turkey. For the last decade, Turkey’s political and economic climate has become less liberal and more centralized. A hopeful spring of early 2000s, when Turkey seemed to have a realistic chance to escape never ending cycles of extreme lurches between free markets and statism and between inflationary/currency crises and periods of technocratic management, is all in the past. While in 2010, there was still a question whether Turkey would continue along liberal path, by now it has become clear that the answer is no. Also, worryingly, this time, illiberal Turkey is meeting an illiberal US and an increasingly autocratic and illiberal world.

Economic mismanagement (twin deficits are ~9% of GDP while inflation is ~15%), and ‘strong man’ stand-off between US and Turkey, has driven TRY to an unheard of levels of 7:1, raising a realistic prospect of capital controls, defaults and greater interference in CB policies, capital flows and businesses. As in the case of Greece, the danger of Turkey is not its own debts (even Eurozone banks’ impact is likely to be manageable) but contagion. As usually, the weakest (e.g. SA) are the first in the line of fire. The good news for Asia ex is that even most exposed (Indo, Mal, Phil & India) are far better positioned.

The concern is that lurches towards protectionism and trade wars are now compounded by Fed policies to drain liquidity and raise cost of capital, almost irrespective of consequences for a wider world. Even ECB and BoJ are being reluctantly dragged along. At the same time, China is caught in the middle of its de-leveraging, and it clearly uses Rmb to help economy and reduce trade drag. Less liquidity, rising US$ & declining Rmb are deadly for EM equities. Turkey might just provide a trigger. Watch China and how it manages liquidity.

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It is managing it using panic:

Which is OK short term but longer term only kills the CNY, enraging Donald Trump, triggering more tariffs and US inflation, more rate hikes and a higher USD, driving further EM capital outflow.

China is still caught mid-deleveraging and is going to slow through H2 as well.

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Steel and bulks are flying on the easing, now almost solo, but how can they hold up as China slows further then shuts down half of its production over Winter?

The scenarios are multiple:

  • US slows into next year and the Fed pauses ending the crisis;
  • US launches infrastructure stimulus, doesn’t slow and wages keep rising with Fed and DXY and EMs crater;
  • China slows in H2 then booms into next year first hurting then helping EMs
  • China slows and can’t get traction on stimulus owing capital outflow and melts down with EMs;

And all of that overlaid with the US economic war on China so that some of those decisions may, in fact, be geopolitical not economic.

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We could be staring the end of the cycle square in the face or another round of debt-fueled economic boom in 2020.

Either way, the AUD has further to fall yet.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.