How the tail is wagging the dog in forex trading

Ongoing tumult in the currency markets appears to have rubbed the markets the wrong way. FILE PHOTO | SHUTTERSTOCK

Ongoing tumult in the currency markets appears to have rubbed the markets the wrong way.

Ever since the debate around the country’s currency adequacy of its FX reserves emerged, markets have been caught up in the maelstrom of this negative feedback loop that appears to be building.

Is the tail wagging the dog? Probably yes. When markets take their cues from a small corner of the economy, then the tail is wagging the dog.

Ideally, economic data should theoretically drive markets, but it seems the opposite has been true and it is a troubling cycle.

On that account, as the dominant theme driving the markets, more bad news for the Shilling is begetting more bad news for the markets.

Shilling has lost by 3.3 percent against the Dollar year-to-date. Same time, the NSE 20 Share Index has slid 2.5 percent lower with foreign investors yanking out about Sh3.5 billion.

Not to be outdone, Eurobond yields (except the 10-year) have traded between 50–100 basis points higher since the year began.

But this is not just the market’s concern. When S&P Global recently revised down its outlook on the country from stable to negative, it cited pressure in the interbank FX markets as a problematic trend.

Read: How to spread and mitigate your risks in forex trading

Likewise, Fitch cited similar reasons for its December downgrade.

Last month’s Purchasing Managers Index (PMI) lower reading at 46.6 also pointed at Shilling’s weakness against the US Dollar as a factor causing operational difficulties.

In its December review, the IMF expressed similar concerns highlighting the rising currency risks, especially within the banking system.

With about half of the government’s stock of debt in foreign currency – a hefty bill of $2 billion Eurobond maturing in June next year awaits, it’s easy to see why currency risk is the main talking point.

Altogether, these headlines are feeding into negative investor perceptions and low valuations.

Is it possible to draw investors away from the grind of following the effects of the currency markets? It’s an open question. Annual earnings expected this month may not change much.

Equity markets are yielding about 7.4 percent which is sort of hard to see why anyone would own stocks when they could own the Treasury at a higher yield – currently averaging at 9-14 percent.

Recently syndicated Sh77 billion foreign currency loan, which is expected later this month, may temporarily halt the depreciation but may not be enough to turn the currency debate.

Remember FX reserves have dwindled by 22 percent in the last twelve months going into March 2023.

Look, in a perfect world, investors think for themselves and do not obsess over what everyone else is doing. But this is an imperfect world. Everything and everyone is worth paying attention to. There are no ancillary markets.

So when a country is heavily drawing on its FX reserves to meet its external debt repayments, you bet the foreign investor, the local institutional investor, the do-nothing investor, the pessimist, even the wanna-be investor, is watching. But of course, all this market-watching rarely has good effects.

Read: Forex trading made easy, convenient, and secure

It can easily lead to contagion, where selling in one market triggers selling in the next. Now, whether you believe this presents opportunities or not, the fact is, sometimes, the tail wags the dog.

Mwanyasi is MD, Canaan Capital.