FX: 3 Reasons for the Recovery in Risk

Emerging market central banks are getting desperate and their latest attempts to drive up the value of their currencies helped risk appetite recover across the financial markets. Last week, the crisis of confidence in EM FX spilled over to the majors and today the Turkish and Argentinian governments sprung into action to stem the losses in their currencies. There are a number of reasons why major currencies are affected by the rollercoaster ride in emerging markets. As shown by the 2.5% slide in the Nikkei overnight and the 1% rise in Nikkei futures this morning, investor confidence affects demand for all assets and makes central banks in other parts of the world uneasy. The Federal Reserve has a monetary policy meeting this week and the sell-off in emerging market assets will make their decision to continue reducing asset purchases difficult. However based on the rebound in U.S. yields, investors expect the latest announcements from Argentina and Turkey's emergency monetary policy meeting tomorrow to keep the Fed on track to taper.

Here are the 3 reasons for the recovery in risk appetite this morning.

1. Emerging Market Central Banks are Getting Desperate
2. China Credit Trust Avoids Default
3. Stronger IFO from Germany

After devaluing their currency last week, Argentina took further measures on Friday to prevent outflows. The government eased capital controls by allowing Argentines to buy dollars as long as they earn a minimum of 7,200 pesos per month but restricting their purchases to $2,000 per month. They also lowered the tax on dollar purchases from 35% to 20%. Thee announcement was made a few days ago but today is the first day that it comes into effect. Unfortunately the impact on the currency has been nominal because many investors fear these steps will backfire because it makes imports more expensive and raises the risk of inflation in a country that is already dealing with significant price pressures. Prices of refrigerators have already gone up as much as 30% since the devaluation. Turkey said this morning they will hold an emergency meeting tomorrow and a big announcement is expected to follow.

Aside from the desperate actions of emerging market central banks whose currencies and reserves are falling, risk appetite also recovered after China Credit Trust announced that they secured funding that would avoid the near term risk of default. Stronger business confidence in Germany also eased concerns about the outlook for the Eurozone but the initial gains in the euro have since evaporated.

According to noted Fed watcher Jon Hilsenrath, the sell-off in emerging market won't stop the Ben Bernanke will from tapering because the impact on U.S. assets have been small. He argues that stocks are falling from high levels and interest rates are under control. However if the Fed decides to provide more support to the U.S. and the global economy by keeping asset purchases unchanged this month, we could see a relief rally in emerging and developed currencies.

U.S. new home sales are schedule for release later this morning and the impact on the dollar is expected to be small.