Earlier today, Standard Chartered delivered a set of truly terrible results.
Impairments skyrocketed by 87% and the total pre-tax red ink for the year added up to $1.5 billion. 2015 marked the first annual net loss for the bank in more than 25 years.
The problem: EM and commodities which are of course inextricably bound up with one another. The slump in crude prices precipitated by Saudi Arabia’s epic quest to bankrupt the US shale space and the downturn in mining facilitated by China’s acute overcapacity problem have played havoc with emerging markets and their currencies. The pain is compounded by prolonged USD strength and the (however unrealistic) threat of more Fed hikes which, were they to occur, would trigger further EM outflows.
According to an interesting new note out today from Goldman, persistent OPEC headline hockey and the attendant volatility in crude may be set to cause more trouble for EM FX than has traditionally been the case.
“The oil price has recently become more important for EM FX,” Goldman writes, adding that “the tighter link between oil and EM FX began during the 2014 oil price shock.”
What’s notable here is that, as you can see from the regression diagrammed below, it’s not just exporters that have become more sensitive to oil prices - it’s importers as well.
That, Goldman says, is evidence that the FX market is attempting to divine something about demand and thus about the health of the global economy from fluctuations in crude. “Recent fluctuations in the oil price appear to be driven by supply shifts specific to the oil market, not shifts in demand that can be used to make meaningful inferences about the health of the global economy [and] while fluctuations in the oil price, whatever their cause, are likely to affect oil currencies such as the RUB, MXN and COP, it is less clear why supply-driven fluctuations in the oil price would drive other EM currencies, including those of oil importers like INR,” Goldman writes. Here are two possible explanations:
- One possibility is that market participants are attempting to extract a demand signal in the lower oil price, affecting global risk more broadly, as evidenced by the rising correlation between oil and a variety of global risk assets.
- Another, potentially more rational, explanation is that, after the 2014 oil price shock, the market has become especially sensitive to shifts in the oil price, interpreting every daily fluctuation in the price of oil not as benign trading noise but instead as, potentially, the beginning of the 'next' dramatic shift
Underscoring the above are the following two charts which plot oil price volatility and the relative importance of that volatility for EM FX. As you can see, the correlation has increased markedly.
In short, it would appear that the oil price shock of 2014 has changed the dynamic when it comes to how EM currencies respond to trading and volatility in oil markets.
Oil has become the barometer for global demand and as such, EM FX trades blindly off of price fluctuations regardless of whether the main drivers of day-to-day price action are supply-related.
Of course the market has a way of getting things right and we've been saying for quite some time now that while supply concerns (the Saudis, US shale, etc.) certainly play an outsized role in the downturn, the situation wouldn't be as acute if global demand were robust.
So perhaps EM FX is reading the market exactly as it should and that, as Goldman notes above, isn't good news for risk assets.