FX markets continue to send of complex and puzzling signals. Risk appetite seem to be recovering supported by EURCHF testing 1.2000 level. Yet demand for EM remains weak.
Brent nearing $75 threshold on the back of supply concerns, declining US inventories and OPECs announcement that the supply glut that has been weighing on prices is now gone. Participates are using higher oil prices to pick winner and loser form the EM FX space.
The correlation between FX and interest rate spreads has weakened, yet now with US 10s nearing 3.00% market are pointing to the sudden attractiveness of US assets. However, Trump tax cuts will clearly widen US fiscal and current account deficits introduction fundamentals headwinds.
If our comments feel confusing, that's because they are. Markets have been too quick to embrace current drivers and completely reversing well-established themes. This fashionable 'right now thinking' makes us sceptical. For example, the Indian Rupee. Despite solid structural fundamentals and cyclical upturn risk in oil price has triggered absolute fear of capital flight due to energy related current account deficit.
In addition, the US Treasury report placing India on the watch list of currencies to be closely monitored, oddly freaked everyone out. However in reality India is far from being labelled a currency manipulator due to its persistent current account deficit. While higher oil prices have already trigger the RBI vigilance on inflation spillover and potential of earlier then expected interest rate hikes. True, jumping early on the bandwagon would have been profitable, but right now we need to focus on the longer term. With global yields low, volatility low, and growth solid, this is what we will trade on. However if you must trade now, higher oil should support NOK, CAD, ZAR, BRL and AUD.
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