EM FX Macro: H2 Outlook - US Goldilocks and the China bears

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28th July 2023Subscribe nowAfter a strong H1 for Emerging market FX, I write this outlook seeing some of the strongest levels of the year. This is a mainly a US-driven phenomenon, as we’ve seen progress on the inflation front without the kind of weakness in growth that would raise recession risks – full goldilocks. Easing core inflation raises hopes that the Fed may not need to throttle growth to achieve its inflation mandate. Meanwhile, China bears have grounds for pessimism but are watching the policy response to the Q2 softening, expecting some level of short-term relief. Is this as good as it’s going to get? I have a feeling it might be. Disinflation momentum will naturally wane, particularly in year-on-year terms as base effects from the energy spike fade. Base effects aren’t ever a surprise, but perhaps irrationally, they do colour sentiment. With a focus on services inflation, volatile items can easily throw a spanner in the works of Goldilocks even if the thesis is correct. In China, policy actions may disappoint, and sentiment could easily swing towards an excessive focus on structural issues. I remain constructive on EM FX in all the ways discussed ad nauseam this year, but I’m defensive and tactical in my trading for now with the aim of having ammunition to trade any accidents that the backdrop and high valuations leave us vulnerable to.In this note, I touch on the following issues.Outlook for the broad USDChina weaknessEvolving EM policy expectationsTheme performance and driversTWI trends and driversUpdated market monitorsBefore I go any further, I will briefly …