This is one of the more fascinating developments to start off this short trading week. We came into the session already very bullish of US Dollars, particularly against the Euro. But now we’re seeing this money flow into US Dollars affecting Emerging Markets. Today’s chart of the day shows what is currently happening to the EM currency space.
This is a daily ratio chart where Emerging Market Currencies ($CEW) represent the numerator and US Dollars are the denominator ($UUP). We can see the nice rally from the beginning of the year that kick started the recent strength we’ve seen in emerging market stocks. But now we’re running into former resistance as momentum rolls over and uptrend lines are breaking:
Needless to say, these are not bullish characteristics. Far from it. But just because we run into former resistance, doesn’t mean that we need to sell-off. Even though we are. A bearish momentum divergence doesn’t necessarily need to lead to selling. But it is. And now we’re breaking uptrend lines in both price and momentum. Not exactly a great recipe for the bulls.
So what does this mean? Well Emerging Market currencies have very high positive correlations with their equities markets. This is a big reason why you tend to see EM stocks sell off when US Dollars rally. We’ve seen this before. So it fits right into my bullish US Dollar thesis. It all makes sense, especially with precious metals also selling off this week. Remember that a lot of the emerging markets, Latin America in particular, are very much tied to mining. So it makes sense.
The WisdomTree Emerging Markets Currency Fund is well diversified, so we’re looking at them as a group. As I’ve mentioned here before, there are and will be exceptions. In the case of $CEW, 46% of the fund is in Asia, about 27% is in Europe, Middle East and Africa, and the other 27% or so is in Latin America. Here’s the full breakdown:
I would keep a very close eye on this ratio. For this bearish thesis to be invalidated, I would need to see the ratio take out last month’s highs. Although this would be an extremely bullish development, I see this as the very low probability outcome. More selling from here is likely.
If you see further deterioration here and follow through after this break, it could/should be devastating for emerging markets currencies and therefore their equities as well.
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Tags: $CEW $EEM $EPI $PIN $EWZ $ECH $EPU $RSX $FXI $UUP $DX_F $GLD $GDX $EURUSD $FXE