Global Investing

Emerging Policy: Rate cuts proliferate

Emerging market central banks have clearly taken to heart the recent IMF warning that there is “an alarmingly high risk”  of a deeper global growth slump.

Two central banks have cut interest rates in the past 24 hours: Brazil  extended its year-long policy easing campaign with a quarter point cut to bring interest rates to a record low 7.25 percent and the Bank of Korea (BoK) also delivered a 25 basis point cut to 2.75 percent.  All eyes now are on Singapore which is expected to ease monetary policy on Friday while Turkey could do so next week and a Polish rate cut is looking a foregone conclusion for November.

South Africa, Hungary, Colombia, China and Turkey have eased policy in recent months while India has cut bank reserve ratios to spur lending.

The BoK’s explanation for its move shows how alarmed policymakers are becoming by the gloom  all around them. Its decision did not surprise markets but its (extremely dovish) post-meeting rhetoric did.  The bank said both exports and domestic demand were “lacklustre”.  (A change from July when it admitted exports were flagging but said domestic demand was resilient) But consumption has clearly failed to pick up after July’s surprise rate cut — retail sales disappointed even during September’s festival season.  BoK clearly expects things to get worse: it noted that ” a cut now is better than later to help the economy”.

Analysts argue that more EM central banks could and should cut interest rates.  After all, developed rates are rock bottom and falling (Australia cut rates last week and Japan is expected to ease policy again at the end of October). ING’s chief EEMEA economist Simon Quijano-Evans urges central banks in emerging Europe, especially Poland, to follow the example of Brazil and Korea. He notes:

Weekly Radar: Q3 earnings; China GDP; EU summit; US debate

Markets have turned glum again as October gets underway and the northern winter looms, weighed down by a relentless grind of negative commentary even if there’s been little really new information to digest. The net loss on MSCI’s world stock market index over the past seven days is a fairly restrained 1.5%, though we are now back down to early September levels. Debt markets have been better behaved. The likes of Spain’s 10-year yields are virtually unchanged over the past week amid all the rolling huff and puff from euroland. The official argument that Spain doesn’t need a bailout at these yield levels is backed up by analysis that shows even at the peak of the latest crisis in July average Spanish sovereign borrowing costs were still lower than pre-crisis days of 2006.  But with ratings downgrades still in the mix, it looks like a bit of a cat-and-mouse game for some time yet. Ten-year US Treasury yields, meantime, have nudged back higher again after the strong September US employment report and are hardly a sign of suddenly cratering world growth. What’s more, oil’s back up above $115 per barrel, with the broader CRB commodities index actually up over the past week. This contains no good news for the world, but if there are genuinely new worries about aggregate world demand, then not everyone in the commodity world has been let in on the ‘secret’ yet.

So why are we all shivering in our boots again? Perennial euro fears aside for a sec, the latest narratives go four ways at the moment. 1) The IMF’s World Economic Outlook (WEO) downgraded world growth and its Financial Stability report issued stern warnings on the extent of European bank deleveraging 2) a pretty lousy earnings season is just kicking off stateside, 3)  U.S. presidential election polls are neck and neck again and unnerving some people fearful of a clean sweep by Republicans and possible threats to the Federal Reserve’s independence and its hyper-active monetary policy 4) it’s a new quarter after a punchy Q3 and there’s not much new juice left to add to fairly hefty year-to-date gains. Maybe it’s a bit of all of the above.

But like so much of the year, whether the up moments or the downers, there’s pretty good reason to be wary of prevailing narratives.

Drought for some, green grass for others

The British National Farmers Union has just announced that this year’s  wheat yields will be the lowest since the 1980s.  Already,  corn and soybean prices are at record highs as the worst drought in more than 50 years in the United States has added to supply worries caused by drought in Russia.

Fears are running high of a global food crisis like the one that led to rioting in poor countries in 2008.

As with everything, the grass is greener in some places than in others.  In this case, the grain exporters may actually benefit from the droughts. Kazakhstan, for example, one of the world’s top 10 grain exporters, saw the value of its wheat exports soar by almost 500 percent between January and July this year compared with the same period in 2011.

Winners, losers and the decline of fear

Lipper has released its monthly look at fund flow trends in Europe, and as ever, it throws up some intriguing results.

August saw bond funds again dominate inflows, pulling in a net 20.8 billion euros and just a tad down on July’s record. Stocks funds continued to suffer, as British equity products led the laggards with close to 2 billion euros withdrawn by clients over the month. North American equity funds and their German counterparts also saw big outflows.

Looking regionally, the Italian fund sector continues to show some surprising strength. Net funds sales there topped the table for the second month running. You can see Lipper’s heat map of sales and AuM below:

Euro emigration – safety valve or worker drain?

Four years of relentless austerity in many of the euro zone’s most debt-hobbled countries have forced many of their youngest and sometimes brightest workers to grab the plane, train or boat and emigrate in search of work. For countries with a long history of emigration, such as Ireland, this is depressingly familar — coming just 20 years after the country’s last debt crisis and national belt-tightening in the 1980s crescendoed, with the exit of some 40,ooo a year in 1989/90 from a population of just 3-1/2 million people.

The intervening boom years surrounding the creation and infancy of the Europe’s single currency and expansion of the European Union eastwards saw huge net migration inflows back into the then-thriving euro zone periphery  — Ireland, Greece, Portugal, Spain and Italy — and created a virtuous circle of rising workforces, higher demand for housing/goods and rising exchequer tax receipts.

But all that has gone into reverse again since the credit, property and banking crash of 2008.

Fears of collateral drought questioned

Have fears of global shortage of high-grade collateral been exaggerated?

As the world braces for several more years of painful deleveraging from the pre-2007 credit excesses, one big fear has been that a shrinking pool of top-rated or AAA assets — due varioulsy to sovereign credit rating downgrades, deteriorating mortgage quality, Basel III banking regulations, central bank reserve accumulation and central clearing of OTC derivatives — has exaggerated the ongoing credit crunch. Along with interbank mistrust, the resulting shortage of high-quality collateral available to be pledged and re-pledged between banks and asset managers,  it has been argued, meant the overall amount of credit being generating in the system has been shrinking,  pushing up the cost and lowering the availability of borrowing in the real economy. Quantitative easing and bond buying by the world’s major central banks, some economists warned, was only exaggerating that shortage by removing the highest quality collateral from the banking system.

But economists at JPMorgan cast doubt on this. The bank claims that the universe of AAA/AA bonds is actually growing by around $1trillion per year.  While central bank reserve managers absorb the lion’s share of this in banking hard currency reserves,  JPM reckon they still take less than half of the total created and, even then, some of that top-rated debt does re-enter the system as some central bank reserve managers engage in securities lending.

Citing a recent speech by ECB Executive Board member Benoit Coere dismissing ideas of a collateral shortage in the euro zone, JPM said ECB action in primary covered bond markets and in accepting lower-rated and foreign currency collateral had helped. It added that the average amount of eligible collateral available for Eurosystem liquidity operations was 14.3 trillion euros in the second quarter of 2012 — with 2.5 trillion euros of that put forward as collateral by euro zone banks to be used in the ECB’s repo operations of 1.3 trillion.  Critically, the majority of that 2.5 trillion posted at the ECB was either illiquid collateral such as bank loans or collateral associated with peripheral issuers and thus unlikely eligible for use in private repo markets anyway, they added. This process of absorbing low quality collateral in order to free up higher-quality assets for private use has been an approach of both the ECB and Bank of England.

Election test for Venezuela bond fans

Investors who have been buying up Venezuelan bonds in hopes of an opposition victory in this weekend’s presidential election will be heartened by the results of a poll from Consultores 21 which shows Henrique Capriles having the edge on incumbent Hugo Chavez.  The survey shows the pro-market Capriles with 51.8 percent support among likely voters, an increase of 5.6 percentage points since a mid-September poll.

Venezuelan bonds have rallied hard ever since it became evident a few months back that Chavez, a socialist seeking a new six-year term, would face the toughest election battle of his 14-year rule. Year-to-date returns on Venezuelan debt are over 20 percent, or double the gains on the underlying bond index, JP Morgan’s EMBI Global. And the rally has taken yields on Venezuela’s most-traded 2027 dollar bond to around 10.5 percent, a drop of 250 basis points since the start of the year.

But Barclays analysts are advising clients to load up further by picking up long-tenor 2031 sovereign bonds or 2035 bonds issued by state oil firm PDVSA:

Wages wag the tail of the DAX

This week, Germany celebrated its Tag der deutschen Einheit (Day of German Unity) marking twenty-two years since the wall was torn down between East and West.

Back in the present, Frankfurt’s main share index, the DAX, has outperformed all of its European peers this year and in dollar terms has outshone almost every other global equity index. Re-unification has been painful, fostering social tensions and still huge disparities between east and west, but some analysts argue that it is precisely those disparities, not least in wages, which have underpinned the primacy of German stocks today.

There are other crucial factors of course. Germany’s high-value and high cost exports such as BMW cars are in high demand in countries such as China and India, all the more because of the weak euro.  And despite the outperformance, the market seems to price German stocks as bargains — they currently trade around 10 times forward earnings compared to over 12 times for the world index. According to fund managers at Baring Asset Management:

Funds will find a chill Wind in the Willows: Lipper

“Asset managers are emerging from their comfortable burrow to face a battery of lights.”

Sheila Nicoll, Director of Conduct Policy at Britain’s Financial Services Authority (FSA), had perhaps been reading Kenneth Grahame before her recent speech, and her words are likely to have sent a chilly wind through the willows of the UK funds industry.

The warning “poop poop” being sounded by the regulator has been getting louder and louder. Indeed the FSA may even be traveling faster than Labour Party leader Ed Miliband, who has recently suggested that he would impose a 1 percent cap on pension charges.

Is the rouble overhyped?

For many months now the Russian rouble has been everyone’s favourite currency. Thanks to all the interest it rose 4 percent against the dollar during the July-September quarter. How long can the love affair last?

It is easy to see why the rouble is in favour. The central bank last month raised interest rates to tame inflation and might do so again on Friday. The  implied yield on 12-month rouble/dollar forwards  is at 6 percent — among the highest in emerging markets.  It has also been boosted by cash flowing into Russian local bond market, which is due to be liberalised in coming months. Above all, there is the oil price which usually gets a strong boost from Fed QE.  So despite worries about world growth, Brent crude prices are above $110 a barrel. Analysts at Barclays are among those who like the rouble, predicting it to hit 30.5 per dollar by end-2012, up from current levels of 31.12.

All that sounds pretty bullish. But there are reasons why the rouble’s days of strength may be numbered. First the QE effect is unlikely to last. As we argued here, QE’s impact will be less strong than after the previous two rounds. Analysts at ING Bank point out that in 3-6 months after the launch of QE2 oil prices gained 40 percent, pushing the rouble up nearly 10%. This time oil won’t repeat the trend this time, and neither will the rouble, they say: