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Money Monitor: Emerging Market Currency Plunge

By long as emerging markets remain under pressure, the path of least resistance has likely changed.

We must take note of yesterday's plunge in a trio of key emerging market currencies, all of which came under big selling pressure and all of which have now broken down on a long-term technical basis.

First, note the mini-collapse on Wednesday in the Turkish Lira, evidenced in the daily chart on display below, as the Lira's breakdown pattern intensifies significantly.

Wednesday's downside acceleration takes place on the heels of Tuesday's Turkish Central Bank meeting in which the monetary authorities failed to deliver the anticipated hike in official short-term interest rates, against a macro-backdrop dominated by rising yr-yr CPI data.

Hmmmm … gee, at issue again: central bank credibility.

More importantly on a long-term secular basis, as exhibited in the weekly chart seen below, today's convincing violation of 1.600 is an ominous technical signal, putting the (newer) Lira's "all-time" low in jeopardy.

Of course we are not focusing on the political situation in Turkey, which could in fact provide the catalyst for a major breakdown, amid the power struggle between 'secular' factions, and 'religious' (Islamic) factions. And, when we toss the EU-linked situation as relates to Cyprus, there are plenty of reasons to adopt a more severe risk assessment than has been the case, as reflected by the market's pricing.

Putting the political angle to rest, and spotlighting the macro-inflation-CB-market risk is more easily accomplished when we note the similarities in the action in the Icelandic Krona, and the Turkish Lira.

Of interest from the macro-inflation-risk perspective then is the data released on Wednesday by Iceland, revealing a huge +0.9% single-month jump in the StatsOffice Wage Inflation Index during May.

Moreover, the monthly rise drove year-on-year wage inflation to a new high of + 8.7% in May, up from + 8.0% in April.

Relative to a CPI target of 2.5% yr-yr, this is NOT good news for the Central Bank, nor the currency, as the Krona's trend towards depreciation continues to solidify, and accelerate.

Evidence last week's Krona-bearish-cross (USD bull-cross) in the long-term moving averages, and the trend towards year-on-year depreciation in the ISK reflected by the ROC.

Suddenly it seems that looking very similar in terms of executing a longer-term trend reversal is the South African Rand, seen from the secular trend perspective in the weekly chart below. The ZAR has broken down.

Moreover, observe how quickly the ZAR has depreciated from a second failed test of, and thus double-bottom at, 6.00 rand per buck straight thru the 7.0 level yesterday to today's steep decline, as evidenced in the daily chart on display below.

In retrospect that is one 'tight' technical pattern and ZAR breakdown.

We have already 'covered' the Colombia Peso at length and thus again we observe the latest depreciation in this South of the Border Gang member, as evidenced in the daily chart below. Indeed, the Peso continues to get whacked, is clearly accelerating to the downside, and has now lost three hundred 'big-figures' in the YTD.

Compared to the stable price action and gradual appreciation in the Colombian Peso experienced since 2004, the YTD dump represents not only a major breakdown technically, but also a clear departure from 'stability' and 'low-vol,' as might be associated with an environment of risk de-pricing.

In other words, we can use these emerging market currencies, along with the push in the Morgan Emerging Market Bond Index (+) out to a YTD high of +232 basis points, a far cry from the record tight risk spread of less than +150 basis points posted in late 2005 to strongly suggest that: The macro-market trend has now reversed, towards risk being re-priced as opposed to the environment of DE-PRICING risk that has been so dominant in the era of monetary reflation.

With that in mind we are closely monitoring the all-important emerging market behemoth and barometer, Brazil. Note the long-term weekly overlay on display below plotting the Colombian Peso and the Brazilian Real, implying an increasing risk to the BRL, a la the tight historical correlation.

A breakdown in the Brazilian Real would be a macro-signal on many fronts … from its heavily weighted position as an emerging market debtor, to its hard-core commodity-export link. Indeed, we produced the chart below several times over the last few weeks, and now we 'find' similar overlays appearing in other highly respected research reports, meaning it has meaning. Thus we again reveal the TIGHT correlation between the MSCI Emerging Market Index (EEM) and the Commodity Research Bureau Index (CRB), as exhibited in the overlay below.

For sure, a breakdown in the Brazilian Real, the MSCI Emerging Market Index and the CRB commodity index would be 'three-strikes-and-you-are-out' against a continued monetary-paper-debt-wealth-asset reflation trend.

However, we left something out of the overlay chart above and we include it in the amended overlay study seen below, as we add the path of the inverted US Dollar Index (inverted to reflect 'depreciation' in line with reflation in commodities and emerging markets).

Simply, from our examination of the triple-overlay chart seen at the bottom of the previous page, we might suggest that dollar depreciation via monetary debasement was a leading cause of the 2003-2005 reflation in both emerging markets and commodities, offering full-blown monetary support to the Chinese demand dynamic, and the Japanese liquidity dynamic.

Now, it is possible that all three of these things may dissipate at the same time.

For sure, the dollar-depreciation stimulus is done, for now, as it would take a broad based plunge in the greenback to drive the USDX to new lows, an event that the charts in today's Monitor strongly suggest will not happen.

Thus, with the Chinese Central Bank looking to squelch credit growth, the onus to 'support' reflation is left squarely on the shoulders of the Bank of Japan, who is now also worried about credibility.

So, we look to dissect the Bank of Japan's thought process in our next Money Monitor, with the solidifying belief that a trend change towards risk re-pricing is well underway, putting all monetarily reflated assets at intensified risk of striking out.

And while the US stock market is 'oversold' and might be due for a short-covering/bargain-hunting bounce, as long as emerging markets remain under pressure, the path of least resistance has likely changed, to the downside, on a trend basis.
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