KRUGER INSIGHTS WEDNESDAY, FEBRUARY 19, 2014

By: Joel Kruger

Dont Look Here, Look Over There - Major currencies continue to consolidate this week and there haven't been any glaring moves. However, upon closer glance, there is definitely something brewing and one needs to look no further than the emerging markets. I think this is something that could easily cross back over into the forefront and make waves that rock the developed markets. The Russian Ruble has led the declines in this block of currencies, and the intense weakness here has resulted in fresh record losses for the RUB against the US Dollar and Euro. But all of the emerging markets are under pressure and I am a bit surprised that there hasn't been more talk of this and the potential implications. The escalation of stress on this front is a serious issue and once again highlights the fact that the global economy is still reacting to the shock from the crisis of 2008. Weakness in the emerging markets is a sign of rotation back into lower yielding and safer, developed investment, as these economies start to move towards recovery and paths of tighter monetary policy. It really comes down to narrowing yield differentials right now, and this will be a story that continues to dominate the flow of the market for much of 2014. The expectation of ultra low rates moving higher will attract investors that have been taking advantage of higher yield in more unstable currencies, and will ultimately impose additional layers of stress in the emerging markets. Unfortunately, the emerging market economies will be left holding the bag, unable to cope with this aggressive mass rotation, having to juggle deteriorating local economic prospects, depreciating currency and rising inflation. Quite the ugly mix. A lot of the coordination in the developed economies that we had seen at the start of the crisis will not translate in an EM crisis, with this part of the world incapable of coordinated intervention to stabilize an accelerated deterioration.

The Next Big Wave - So as I look at the markets mid-Wednesday, I see vulnerability in risk correlated assets, and anticipate a spillover into major markets that should weigh on equities and most currencies and benefit the likes of markets more identified with safety, like the US Dollar, Swiss Franc and Yen. We have seen a little bit of this through the Yen already today, but not enough that would turn heads just yet. USD/JPY has been locked in some consolidation in recent trade, but should be at risk for another drop below 100.75 and towards 100.00 over the coming sessions. Again, also pay attention to EUR/CHF and movement in this cross rate below 1.2200. The key level here is 1.2165, and a break below would probably intensify broader risk liquidation themes. I don't see much more upside for EUR/USD at the moment, and still think this market remains well offered on a medium-term basis into the 1.3800 longer-term falling trend-line off of the record 2008 highs. I also see GBP/USD well capped ahead of 1.7000 as this market is stalling yet again by multi-month range resistance that has been defined since 2009. Strategically, I have gone ahead and established a fresh S&P 500 short at 1838.1, as I believe this market has yet to react to this latest rumble in markets that it somehow feels it is immune to. Technically, the Dow has already started to reverse after putting in a bearish close on Tuesday, and this offers some added comfort. I also remain short risk via the currency markets, with my Kiwi exposure. I have been in and out of NZD/USD with overall success in 2014, but still am looking for this market to play catch-up (catch-down) with its cousins. Aussie and Cad have both weakened quite significantly over the past 12 months (Aussie first and more recently Cad), and I expect no different from what should prove to be a lagging Kiwi. I'd like to see a break and close back below NZD/USD 0.8280 to get things going and open the door for what should be an appropriate acceleration of declines.