EM Rundown: What China's Trading Band Move Means for EM FX

Two big news stories dominated trading this weekend: Crimea’s referendum to secede from Ukraine and China’s decision to widen its currency’s trading band.

Market Shrugs Off “East vs. West” Escalation over Crimea

To tackle Crimea first, the region’s vote was an absolute landslide in favor of secession, with over 95% of voters in favor of leaving Ukraine to become part of Russia. Russia still must decide whether to accept the region into the Russian Federation, but Western powers have already slapped sanctions, including asset freezes and visa restrictions, on 21 Russian and Ukrainian officials.

While these actions represent a potentially dangerous escalation of geopolitical tensions between Russian and Western Europe, the market reaction shows that these actions were already priced in; in fact, US equities and most risk currencies (including the ruble itself) are actually trading higher on the day.

China Loosens Its Yuan Belt One Notch

The other major development this weekend was China’s decision to widen the yuan’s trading band against the U.S. Dollar from 1% to 2%. As my colleague Chris Tedder noted in his analysis of the move, “[t]his theoretically means that market forces will play a greater role in determining the value of the currency” (see "Beijing Widens the Yuan’s Trading Band" for more on the mechanics of this change and its effect on China’s economy).

As for the markets, the effect of this change has been minimal on G10 currencies, with currencies like the Australian and New Zealand dollars trading higher in line with general risk sentiment. On the other hand, some regional emerging market currencies have been negatively impacted, including the Singapore dollar.

USD/SGD: Symmetrical Triangle Breakout Imminent

A number of little-known emerging market currencies have thrust themselves into the spotlight over the last few weeks, but the Singapore dollar has managed to stay off most traders’ radar screens thus far this year. Because of its strong fundamentals (current account surplus and low, but stable inflation) the SGD has held up well this year; in fact, the USD/SGD pair is essentially unchanged around the 1.2650 level since New Year’s Day. However, the PBOC’s decision may finally lead to more volatility in the USD/SGD, especially considering that nearly 25% of Singapore’s exports go to China and Hong Kong.

Looking to the chart, the unit has been consolidating within a symmetrical triangle pattern since late January. This classic price action pattern is also called a “coil,” bringing to mind the apt comparison to a coiled spring. As a series of lower highs and higher lows forms, energy builds up within the spring (market). When one of the barrier lines is eventually broken, the market tends explode in that direction.

While it can be difficult to predict the direction of the breakout in advance, it is worth noting that the RSI indicator has already broken below its corresponding triangle line, potentially foreshadowing a bearish break in the USD/SGD rate itself. If we do see a bearish break, the pair could quickly drop to test the YTD lows and 50% Fibonacci retracement support at 1.2580, with further support around 1.2525, the 61.8% Fibonacci retracement. Meanwhile, if the pair reverses to break out above the top of the triangle, rates could quickly continue up to test the March highs near 1.2725 or the 1.2800 round handle.