On Thursday, this column suggested that a bunch of stock markets selling off in tandem did not satisfy the definition of contagion. Central banks dumping U.S. assets, weak auctions of government debt in seemingly less related countries, and big sell offs in less affected currencies? That’s getting closer to the mark.
Foreign central banks cut their holdings of U.S. debt stored at the Federal Reserve by the most in seven months in the past week, in a bid to defend weak currencies. “It makes sense,” said Scott Carmack, fixed income portfolio manager at Leader Capital, which has $1 billion under management. “It will probably continue as emerging markets try to prop up their currencies.”
So, overall foreign holdings of securities like Treasuries, mortgage-backed securities and agency debt at the Fed fell by $20.77 billion to $3.325 trillion in the week ended Wednesday, the biggest drop since June. The overall draw-down has come to about $55 billion since the Fed first said it would cut back its monthly bond buying. Debt and equity funds, meantime, continue to shift away from the emerging markets, with EPFR reporting a pullback of about $10 billion from such funds; debt funds have shed $4.6 billion so far in 2014, about one-third of 2013′s total drawdown of $14.3 billion (and that’s for a full year).
While in some ways, the most attractive solution for some of these countries to try to stem capital flight is through higher interest rates (making their debt more attractive to investors who need a bigger return over inflation, which is too hot in places like Brazil and Turkey), higher rates aren’t going to entirely solve the problem. And so you get the spectacle of Hungary cutting its 1-year Treasury bill auction and yields rising by about two-thirds of a percentage point just to garner enough interest for what they did manage to sell.
Hungary’s less in danger than some other countries. It’s got a big current account surplus rather than a deficit, but that hasn’t stopped investors from pulling back there either, driving the forint to a two-year low against the dollar.
The ongoing weakness in currencies – which many analysts say has not yet run its course – is going to pinch economic growth in tandem with higher rates. This can sometimes launch a vicious cycle that has consumers in those countries saving money rather than spending it – again, because of inflation. Combine that with a slowing in capital flows, and a weak export environment thanks to the China slowdown, and it gets a lot uglier, as Reuters’ Sujata Rao pointed out in an overnight story.
She quotes Steve O’Hanlon, a fund manager at ACPI Investments, who summarizes it well by saying: “Markets are pricing a pretty dire situation in emerging markets (but) is EM cheaper given potential future output? I wouldn’t say so but it’s getting there. When currencies stop selling off, if (governments) produce real reforms, I will be investing in those markets. If you don’t see any reforms, the rate hikes will just destroy growth, discourage investors and make the situation far worse.”
On the U.S. side of things, the stock market might see a bit of relief, however briefly. The outperformance by bonds against stocks this month might spur some reallocation trades, helping the market on its last day of the month. So it’s got that going for it, which is nice. Of course, futures are getting hit hard this morning, so maybe this is false hope.
SUPER BOWL SHUFFLE
From a more grounded (well, ridiculous) perspective, it’s the Super Bowl this weekend in the U.S.
Strategists have long made sport of the vaunted “Super Bowl Indicator,” which, for a long time, stipulated that when teams in the National Football Conference (the 49ers, Giants, Cowboys, to name a few) were victorious, the stock market was in line for a good year, but when teams in the American Football Conference (Dolphins, Raiders) won the big game, the equity market was set for a bad year.
That was modified a few years ago to include old NFL teams that had migrated to the AFC – the Steelers and the Baltimore Colts (this column does not recognize teams that move in the middle of the night.) So that puts us in a unique position this year.
First off, the AFC team is the Broncos, so a win by them should put the market on track for weakness for the rest of 2014. This is, of course, undermined by the fact that when the Broncos do win (and they won in early 1998 and early 1999), the market does pretty darned well. Furthermore, their opponent, the Seattle Seahawks, spent most of their existence in the NFC before moving to the AFC a few years back. If the Steelers and Colts can be grandfathered into the good side of the ledger, it stands to reason that the Seahawks ought to be included on the bad side of the ledger, no?