The stabilization of the Yuan has encouraged a positive start to the week for the markets despite the price of WTI continuing to record new milestone lows. Although the Yuan volatility has calmed down, the tone from the Chief Economist at the People’s Bank of China (PBoC) over the weekend was a warning that two-way volatility in the currency can be expected to continue. China’s GDP is vulnerable and looking exposed to falling below the government’s target at 7% and the comments from the Chief Economist at the PBoC suggest that the central bank is willing to do whatever it takes to protect the 7% government target for growth this year.  

The combination of increased China risks and continual pressure in commodity markets showing no signs of coming to an end means there is no floor in selling for emerging market weakness. Both the Malaysian Ringgit and Indian Rupee have hit new milestone lows today, with the Ringgit falling in line with a sell-off in Malaysian stocks and the Rupee reaching its lowest against the USD since September 2013. The Ringgit has been aggressively punished on a repeated basis due to a variety of different weights to investor sentiment with this including the US interest rate outlook, resumed selling in commodities and increased risks in China. While the reported government scandal has weighed on the currency and further weakened investor confidence, it is the emergence of increased China risks that are behind the aggressive weakness over the previous week.   

The question over whether the Bank Negara should step in to defend the Malaysian currency or whether a peg should be installed will now be actively asked mainly because the decline in the Ringgit over the previous three weeks has been extremely intense. The USDMRY has exploded from an already highly-valued 3.80 towards 4.1370 and due to the increased possibility that WTI is looking vulnerable to falling below $41, matters could get even worse. The most supportive factor for the Ringgit and other emerging market currencies right now would be a rebound in the price of WTI and the outlook would be for further losses in these currencies if WTI extends below $41. This would also mean that central banks are powerless to watching their currencies continue to decline if the selling in commodities continues, mainly because this would naturally further weaken the currencies of these markets.                                                                              

EURUSD

Since approaching a monthly high at 1.1231 and appearing over-extended, the EURUSD has dropped nearly 200 pips over the past three days to extend back down towards 1.1061. The EU GDP data last Friday was largely unconvincing and provided a reminder to the markets that the EU economy continues to stare directly at the issue of stagnant economic growth. The EU economy requires both structural reforms and an even weaker currency to reinvigorate economic momentum. Following the sub-par GDP figures, I am even more convinced that the ECB will threaten the prospect of extending its QE stimulus with the aim of talking down the Euro.

GBPUSD                        

After the GBPUSD extended to the top of its monthly trading range at 1.568, the sellers have appeared once again and driven the Cable back down towards 1.5639. Due to the consistently strong UK economic outlook, buying interest in the Pound is strong, but I would expect a more cautious investor sentiment over the next few sessions as the markets await UK inflation data. The resumed selling in the commodity markets means that the UK economy is going to encounter an extended period of weak inflation, meaning that the Bank of England’s (BoE) strict inflation outlook will return once again and haunt investor sentiment.

Although BOE policymaker Kristin Forbes made headlines over the weekend by expressing that the central bank waiting too long to raise interest rates would undermine the UK’s recovery, the bottom line is that the weak inflation pressures is exactly why the central bank have not been able to begin raising interest rates. It is going to take a long time for the gains in wage growth and disposable income to begin filtering its way through the UK economy and move inflation back towards the BoE’s target at 2%. I am actually expecting the resumed selling in the commodity markets to lead to less comments from BoE Governor Carney on future rate rises, because an attractive Pound would also weigh down on inflation expectations.

Japanese Yen

The Yen (JPY) has weakened across its major trading partners at the beginning of the week, following confirmation that the Japanese economy contracted during the previous quarter. A contraction was expected, but what would have further alarmed the markets is that the economy is suffering from both declining consumer spending and a larger than expected drop in exports. The dramatic decline in the JPY over the previous 12 months has threatened purchasing power from Japanese consumers in the hope of improved export competitiveness, but economic weakness outside of Japan exposes further vulnerabilities to exports and there is an increased risk of another recession in Japan.

Gold

Gold is attempting to consolidate just below $1120 after the yellow metal benefited from last week’s China uncertainty and expectations that this might delay the Federal Reserve from potentially raising US interest rates as early as next month. Now that Gold has managed to climb back above that critical psychological $1100 level, the outlook for further gains is more positive but this would also depend on how investors react to this Wednesday’s highly-anticipated FOMC Minutes. If the FOMC release suggests that voting members are still sitting on the fence and refusing to put a timeframe on when to begin raising interest rates then this could provide some inspiration to Gold buyers.

What the markets really want from the FOMC Minutes release is clarity on when the Federal Reserve are looking to begin raising US interest rates. I personally believe that this should be in September because the US economic data is consistently robust with this raising confidence that the United States economic recovery is sustainable. If the FOMC release does indicate that an interest rate increase in September is a possibility, Gold would be at threat to losses and we could encounter a reversal of the sudden $30 gains over the past week.  

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