Fed waits, the dollar gains

The Federal Reserve didn’t change monetary policy parameters on December’s meeting and it couldn’t be any different really. The Fed is slightly more optimistic about the US economy and it has good reasons for it. Even though November’s retail sales data (+0,2% m/m) was weaker than expected, generally the US economy has responded surprisingly well to the global slowdown thus far. As we argued yesterday the Fed is very unlikely to initiate the QE3 in a foreseeable future, taking the burden off the dollar and leaving room for a downside potential on the pairs like EURUSD, GBPUSD and AUDUSD to materialize.

The EURUSD broke 1,3145 yesterday moving close to 1,30 – the levels not seen since January. The next support is at 1,2870 and it is not unimaginable to see the pair there as there is hardly a good reason for investors to buy the euro at the moment. A price of gold declined considerably as well, reaching a support zone of 1605-1620 USD per ounce. Should the whole H&S realize, the price would decline to 1535 USD in the mid-term.

Europe hits emerging markets

Last week we pointed out a “divergence” between the forex and equity markets. It is striking to see even stronger divergence between equities and emerging markets currencies. Obviously one could argue that the PLN (Polish zloty) or HUF (Hungarian forint) follow the euro and this is partly correct. However, the MXN (Mexican peso) should be relatively resilient to pressures in Europe and track the US equity market. Meanwhile, emerging currencies outside of the Central Europe keep losing value too (including MXN). 

That phenomenon has few implications. Firstly, emerging market currencies become severely undervalued… which doesn’t mean that cannot become dirt cheap before they revert to their fundamental value (and probably above as the economic cycle will go on).

Secondly, this is a warning signal for equities which may not offer a sufficient discount at the moment. Weakness of emerging currencies means that medium and long term investors are unwilling to take risks on less liquid markets and that may also mean that there will be no fuel for sustainable rally on equities.

Thirdly, it only confirms that the euro-bears have good reasons to push the market lower. For as long as the rating uncertainty hangs above the euro zone, it is hard to imagine a major reversal as investors might (rightly) fear that a rating cut to France or Germany may trigger a sell-off and even a banking crisis and send any risk-related assets way lower than currently.

Przemysław Kwiecień PhD, Chief Economist

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