Strong dollar fears set week’s tone for markets

(The Daily Star)- Here are the big talking points for markets as a new week beckons.

Q: Are we set for another strong dollar scare?

A: Three consecutive weekly losses have pulled the euro down to its lowest level since March, below $1.09. That leaves the dollar index just shy of 100, a level last scaled back in December. Also losing steam is the renminbi, bumping along at a six-year low. Few doubt that the US Federal Reserve will tighten in December. So central bank divergence, the dominant trend at the start of the year, appears to be back to close out 2016. Hence, we are seeing the US S&P 500 spinning its wheels with only the financials sector positive in October and an emerging market rally showing signs of fading.

The big risk for now is whether the Fed will deviate from having signalled that a very modest tightening path looms in 2017. Any sense of inflation picking up – a prospect that inflation break-evens are reflecting – would suggest a faster pace of tightening is required and add further fuel to the stronger dollar trade.

Q: Are emerging markets heading for another correction?

Nothing hurts an EM rally like the whisper of a stronger dollar. While it has been the surprise investment of the year, the market remains cautious about stepping too far into EM trades. South Africa’s rand, Brazil’s real and Russia’s rouble were among the best currency performers last week, as they have been all year. In a low-rates environment, why not carry on?

Two reasons. Flow data suggest long positions in several EM currencies are excessive. Meanwhile, the dollar is showing signs of strengthening, albeit sporadically. The market is becoming more comfortable in the belief that Donald Trump’s campaign has run its course and that a Clinton victory next month clears the runway for a December rate rise.

Bank of America Merrill Lynch says there is good reason to feel bullish about the rouble and real, but advises prudence and recommends hedging short-term event risks.

Citigroup is worried that “policy confusion” in the US, Europe and Japan will take the momentum out of EM, as might slowing global trade and rising inflation in developed markets.

The key to EM’s success has been the G3 central banks, says Citi’s Luis Costa, “and these agents are now showing a much more erratic approach in their monetary policy”.

An important week for the US corporate earnings season

It’s showtime for big tech and plenty rides on the sector beating estimates and raising hopes that the broad market’s longest profit recession since the Great Recession is coming to a close. Sector heavyweights, Apple, on Tuesday, followed by Google parent Alphabet, Amazon and Twitter on Thursday, are set to report their results.

The technology sector led the S&P 500 during the previous quarter with a 12.4 per cent rally, but has slipped during October. Disappointing guidance from the likes of Intel and eBay suggests a rocky course ahead.

Wall Street analysts now forecast a 0.63 per cent year-on-year rise in S&P 500 earnings per share, marking an improvement from the roughly 1 per cent decline projected before the reporting period began last week.

Q: How sickly is the pound?

A: For a brief moment last week, the pound traded above $1.23, only to slip below $1.22 late last week. The 50-day moving average loiters far away, at $1.2909. Societe Generale argues: “Brexit matters more than the current account balance for sterling.” That could well maintain downward pressure on the pound until Article 50 is triggered – next March – and the market has some clarity about the terms and costs of the UK’s divorce from the EU.

Q: Can oil remain stuck in a narrow range?

A: Brent crude and WTI remain above $50 a barrel, buoyed by expectations of a substantive production cut emerging when Opec gathers in Vienna at the end of November. At a big oil industry gathering in London last week, movers and shakers were of the view that oil was preparing to settle into a $50-$60 a barrel range.

The swing factor is US shale drillers. Leaner after the long decline in crude prices, the revival in oil prices above $50 a barrel could well tempt greater production from the US and renew downward pressure on crude well before Opec gathers in Vienna.

Q: Further weakness for the euro?

A: For all the speculation over the European Central Bank tapering its pace of bond buying, there was no mention of any taper from Mario Draghi after last week’s ECB meeting. Until we see eurozone inflation firmly on course to hit 2 per cent, ECB stimulus will not fade. That’s helped sustain pressure on the euro and is seen bolstering risk taking, with analysts at Credit Agricole noting: “Markets have, for now, shrugged off their fears about ECB and Bank of Japan taper, and reloaded on euro and yen-funded carry trades.”

Still, selling the euro may become tougher as the currency heads lower within its longstanding range of $1.05 to $1.15. Analysts at Societe Generale note that the eurozone’s robust current account surplus looms as a tailwind for the currency, and the bank warns: “Keep in mind that the fundamental equilibrium fair value is above $1.20.”