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Piotr Matys, EM FX Strategist at Rabobank, suggests that the MSCI EM FX Index has reached a critical juncture following the sell-off in emerging currencies, driven by escalating concerns about growing trade tension between the US and China and the prospect of further widening of interest rate differentials between the Fed and other major central banks.

Key Quotes

“The MSCI EM FX Index broke lower in the second half of April. The sharp fall has extended towards a crucial support area formed by the long-term upside trendline and Fibonacci retracement levels.”

“It is a make or break for the bulls and the bears. The bulls may argue that current levels provide an opportunity to re-establish long positions in EM currencies, based on the assumption that the upside trend from the 2016 low remains intact.”

“The bears, however, will be looking for a break lower towards the October low at 1615.47 to confirm that the pullback which started in the second half of April is just the beginning of a much bigger correction of the 2016-2018 rally.”

“At this stage the odds are skewed in favour of the bears.”

“While constructive comments from the White House and Beijing may defuse tension in the shortterm, it would probably only postpone the MSCI EM FX Index penetrating the key support area given that the risk of trade conflict is likely to prevail.”

“Based on this notion it is reasonable to assume that trade tension may continue to rise and risk aversion may escalate further triggering another wave of outflows from EM assets which would lead to the MSCI EM FX Index falling towards 1570 level next.”