It may be a bit early to declare a full-fledged global currency crisis, but things moved decisively in that direction this week

Despite close calls Saturday night and again on Thursday night, we at least made it through the week avoiding “the start of WW3.” I’m afraid the same cannot be said for the beginning of WW2D (World-Wide De-Risking/Deleveraging).

Key speculative leverage epicenters were under notable pressure this week – global bond markets, EM currencies and bonds, and big tech.

Some Headlines: “Resurgent Dollar, Higher Yields Send EM Currencies to 2024 Lows”; “US Nods to ‘Serious’ Japan, S.Korea Concerns Over Slumping Currencies”; “Korea Discusses Currency Concerns with Japan, Ramps Up Jawboning”; “Indonesia’s Plunging Rupiah Twists the Policy Plot”; “Indonesia Ramps Up Steps to Shield Economy From Strong Dollar”; “Philippine Peso’s Drop Past 57 Puts Pressure on Central Bank”; “Japan’s Yen Hits a Fresh Three-Decade Low of 154”; “China Pledges to Steady Yuan as Asian Currencies Come Under Pressure.”

Under the Friday Bloomberg (Marcus Wong) headline, “‘Super Peso’ Slides as Middle East Risk Threatens Carry Trade”: “The Mexican peso slumped the most in four years, as increasing conflict in the Middle East sapped demand for the currency that has been one of the favorite targets for carry trades. The peso tumbled more than 6% against the dollar as news began to filter through Friday of an Israel retaliatory strike on Iran, in what some in the market described as a ‘flash crash.’ The currency had climbed to the strongest in almost nine years last month, driven by relatively high local interest rates and low currency volatility.”

We can assume that global “carry trades” (borrow in cheap currencies to lever in higher-yielding instruments) have mushroomed over recent years to the Trillions, with speculative leverage seductively bolstering liquidity and asset prices virtually everywhere. Such massive speculative leverage has become untenable.

So-called “flash crashes” are anathema to leverage. And with the Mexican peso a major (and favored) EM currency, Thursday night’s market dislocation confirmed the backdrop has turned precarious for “carry trade” leveraged speculation.

April 19 – Bloomberg (Catherine Bosley and Matthew Burgess): “Central banks from Jakarta to Seoul intensified the defense of their currencies, as Asia’s struggle against a resurgent dollar faced a fresh challenge from reports of armed conflict in the Middle East. Bank Indonesia increased its interventions on Friday to support the rupiah and urged government-backed firms to avoid making huge dollar purchases. The State Bank of Vietnam’s deputy governor said it was ready to intervene in the foreign exchange market… With the won shy of a 17-month low against the greenback, South Korea pledged to respond immediately to excessive currency market volatility. Asian currencies have slid precipitously against the dollar as investors lose hope of imminent reduction to US borrowing costs.”

For the week, the Mexican peso declined 2.6%, the Indonesia rupiah 2.5%, the Philippine peso 1.9%, the Brazilian real 1.6%, the South African rand 1.3%, and the Colombian peso 1.3%.

It may be a bit early to declare a full-fledged global currency crisis, but things moved decisively in that direction this week. The situation becomes more serious when the Bank of Japan (BOJ) is forced to intervene, potentially unleashing disorderly currency trading and “flash crash” contagion across the “carry trade” universe. Major currency crisis dynamics will be at full force when Beijing loses control of its renminbi currency peg. It’s a challenge to envisage a more precarious environment to be locked into a dollar-peg currency regime.

April 16 – Bloomberg (Tania Chen and Iris Ouyang): “China’s second attempt in a month to loosen its grip on the yuan is opening up the door for the currency to test a psychological milestone that hasn’t been seen since November. The yuan will weaken to test 7.30 per dollar by the end of this quarter, according to 10 analysts polled… after Beijing moved to guide the managed currency weaker Tuesday…. While that is less than 1% from the yuan’s current level, the path leading to it will be paved with official pushback against sharp declines, they said.”

Losses are mounting throughout Asian currency markets. The Japanese yen has declined 8.8% y-t-d, the Thai baht 7.4%, the South Korean won 6.8%, the Taiwanese dollar 5.6%, the Indonesian rupiah 5.3%, the Malaysian ringgit 4.0%, and the Philippine peso 3.9%.

China’s vulnerable currency is today tethered to a surging dollar, while its struggling export sector confronts competitors benefiting from devalued currencies. Beijing would surely prefer to relax the peg and weaken the renminbi. Understandably, maintaining stability remains a top priority. So, officials are left to yearn for a gradual and smooth currency devaluation. Meanwhile, any indication that Beijing has decided to loosen the peg triggers trepidation for a disorderly devaluation.

Why would one wait to withdraw funds from China, with devaluation only a matter of time? With rising risks of disorderly devaluation and capital controls? Meanwhile, the currency derivatives time bomb ticks. Ongoing big bank renminbi support only exacerbates already heightened banking system risks, while market players are given additional time to accumulate currency hedges.

April 16 – Bloomberg: “A selloff in Chinese small-cap stocks extended Tuesday as tighter market oversight pledged by the cabinet sparked fears over the delisting of those with weak financial health. The CSI 2000 Index fell 7.2%, taking the decline this week to 11%. The CSI 300 Index, which tracks mostly blue-chip firms, outperformed. The benchmark slipped 1.1% after rallying more than 2% on Monday. Traders are reacting to a late Friday statement by the State Council, which vowed to strengthen stock listing criteria and urged companies to improve corporate governance and beef up dividend payouts.”

China’s small cap CSI partially recovered, reducing the week’s losses to 5.5%. The index is down 18.7% y-t-d. Recall that China’s small cap indices crashed to multi-year lows during the February hedge fund (“quant”) crackdown. This week’s disorderly trading points to intensifying speculator de-risking/deleveraging pressures.

It’s worth noting that Tuesday’s China small cap meltdown corresponded with equity market downdrafts throughout Asia. Japan’s Nikkei 225 slumped 1.9% in Tuesday trading, on its way to a 6.2% pounding for the week. South Korea’s Kospi fell 2.3% Tuesday (down 3.4% for the week), Taiwan’s TAIEX 2.7%, (down 5.8%), Thailand SET Index 4.5% (down 4.3%), Philippine’s PSEi Index 2.4% (down 3.2%), and Hong Kong’s Hang Seng Index 2.1% (down 3.0%).

Hedge funds and levered speculation have proliferated throughout Asia in recent years. Especially after this week’s drubbing, we can assume the levered players are reeling. And with the global leveraged speculating community a key transmission mechanism between markets and geographies, unfolding trouble at the “periphery” needs to be closely monitored.

Fragile EM bond markets remained under pressure this week. In dollar-denominated EM bonds, Indonesia yields rose 13 bps to 5.28% (one-month rise 39bps), Philippines eight bps to 5.39% (35bps), Panama 23 bps to 5.41% (50bps), Colombia six bps to 7.69% (52bps), and Brazil three bps to 6.73% (25bps). Over the past month, local currency bond yields were up 116 bps in Turkey, 66 bps in Colombia, 61 bps in Brazil, 58 bps in Mexico, 52 bps in Hungary, 50 bps in Peru, and 50 bps in the Philippines.

I would typically expect stress at the “periphery” to take some time to be transmitted to the “core.” Moreover, the “core” might even enjoy temporary liquidity benefits from “periphery” risk aversion. Not today. That the “core” today faces acute endogenous de-risking/deleveraging risk is an alarming aspect of the current environment….