Poland, the lonely inflation targeter
Is the National Bank of Poland (NBP) the last inflation-targeting central bank still standing?
The bank shocked many today with a quarter point rate rise, naming stubbornly high inflation as the reason, and signalling that more tightening is on its way. The NBP has sounded hawkish in recent weeks but few had actually expected it to carry through its threat to raise rates. Economic indicators of late have been far from cheerful – just hours after the rate rise, data showed Polish car production slumped 30 percent in April from year-ago levels. PMI numbers last week pointed to further deterioration ahead for manufacturing. And sitting as it does on the euro zone’s doorstep, Poland will be far more vulnerable than Brazil or Russia to any new setback in Greece. Its action therefore deserves praise, says Benoit Anne, head of emerging markets strategy at Societe Generale.
(Poland’s central bank) is one of the last orthodox inflation-targeting central banks in the global emerging market central bank universe. They are taking action because they are seeing inflation creeping up and have decided to be proactive.
The rate rise is especially notable given many central banks in developing countries appear effectively to have surrendered their inflation-fighting mandate. Nowhere is the push for lower interest rates more pronounced than in Brazil where the government last week announced plans to scrap fixed-rate savings deposits in a move that is seen paving the way for more agressive rate cuts. Clearly there is tolerance here for higher inflation, which will still end 2012 well above target.
But many analysts such as Manik Narain at UBS consider Poland’s decision a high-risk one given the growth issues. Narain sees it possibly motivated by the need to signal Poland will not welcome further currency weakness (the zloty like most emerging currencies has shed much of its early-2012 gain) Therefore a prolonged monetary tightening cycle is unlikely, he says. Indeed many reckon the NBP may find itself, like the European Central Bank last year, reversing an ill-considered rate rise. Analysts at Capital Economics write:
If we are right in expecting growth and inflation to slow by more than most expect over the second half of this year then this may well be the NBP’s “ECB moment”. Recall that having hiked rates twice in the first half of 2011, the ECB was forced to start loosening policy once again by November as the economy weakened. In Poland’s case, we think there is a good chance that today’s rate hike will be reversed by the end of the year.
March bulls give way to April bears in emerging markets
The dust has settled on a scintillating first quarter for emerging markets but the cross-asset rally of the first three months has already run out of steam. A survey by Societe Generale of 69 EM investors shows that over half are bearish — at least for the near-term.
This marks quite a turn-around from the March survey, when 80 percent of investors declared themselves bullish on emerging markets. What’s more, investors are currently running very little risk and 47 percent of hedge fund respondents (these make up half the survey) feel they are over-invested in EM. (The following graphic shows the findings — click on it to enlarge)
Almost a quarter of the hedge fund and real money investors are neutral tactically on the market, compared to just 4.5 percent last month. Serious optimism has dried up, SocGen commented:
Looking at the distribution of answers, it is quite clear that the mega-bullish investor on EM has disappeared at this point.
The return of worries about the euro zone debt crisis, U.S. growth and a slowdown in China have all contributed to a higher degree of pessimism on financial markets. It’s not all gloom though. Looking at emerging markets over the next 3 months, sentiment does pick up, with 64 percent of investors bullish. So this falling out of love with EM could be a temporary blip.
Only 13 percent of investors were more bearish on a 3-month time horizon than over the next two weeks. That included 83 percent of real money investors that believed in an improvement in the GEM outlook from two weeks to three months.
Asian bonds may suffer most if QE on ice
Bonds issued in emerging market currencies have been red-hot favourites with investors this year, garnering returns of 8.3 percent so far in 2012. But for some the happy days are drawing to a close — U.S. Treasury yields are nudging higher as the U.S. recovery gains a foothold and the Fed holds back from more money printing for now at least. That could spell trouble for emerging markets across the board (here’s something I wrote on this subject recently) but, according to JP Morgan, it is Asian bond markets that may bear the brunt.
Their graphic details weekly flows to local bond funds as measured by EPFR Global (in million US$). As on cue, these flows have tended to spike whenever central banks have pumped in cash. (Click the graphic to enlarge.)
Over the past several years, inflows have driven local curves to very flat levels, but current levels of flatness are not sustainable if/when inflows begin to slow, let alone reverse.As there is a clear correlation between the Fed’s “QE periods” and large inflows into Asian markets, we think the next few months will be difficult for Asian bonds markets (JPM writes)
JP Morgan says risks are greatest for Malaysia, Indonesia and Thailand because that’s where foreign ownership ratios are largest – in Indonesia for instance foreigners hold a third of local debt. Deficits in these three countries are also rising meaning debt issuance is rising faster than elsewhere, the bank warned. It advises clients to be underweight Asian local debt (countered by overweights in Latin America and emerging Europe)
Asian currencies face risks too –from China. The yuan is up 30 percent since mid-2005 but ended March with its first quarterly loss since 2009 and many reckon China, fearful of an exports slowdown will not permit any more big rises for now. Asian governments will have to fall into step if they want their own exports to compete. And that, JPM says, is robbing the region’s currencies of a major support anchor.
Yield-hungry tilt to equity from credit
For income-focused investors, the choice between stocks and corporate bonds has been a no-brainer in recent years. In a volatile world, corporate debt tends to be less sensitive to market gyrations and also has offered better yields – last year non-financial European corporate bonds provided a yield pickup of 73 basis points above stocks, Morgan Stanley calculates.
But, long a fan of credit over equity, MS reckons the picture may now be changing and points out that European equities are offering better yields than credit for the first time in over a decade. (The graphic below compares dividend yields on non-financial euro STOXX index with the IBOXX European non-financial corporate bond index. The former narrowly wins.)
The extra yield available on equities, coupled with perceptions of a more stable macro backdrop, may encourage income-oriented investors back into stocks.
The bank has put together a 10-stock basket with an average 2012 yield of 5.1 pct (vs MSCI Europe’s 3.9 pct). That is around 250 bps higher than corresponding bonds. Check out Britain’s Vodafone – its shares offer a whopping 8.3 percent yield. That’s 600 bps above its 5-year implied credit yield.
That sounds tempting. But there are caveats. The best yield pickup is available in sectors where investors remain underweight — utilities and telecoms. And a positive yield gap is not always a bullish signal for stocks, Morgan Stanley warns. Japanese dividend yields have been above bond yields since 2008.
End of LTRO = end of equity rally 2012?
This year’s global equity rally is unlikely to survive the end of the ECB’s liquidity injections, warns HSBC.
World stocks have jumped 10 percent since the start of 2012, emerging markets are up 15 percent and the index of top European stocks has gained 8 percent. These gains, HSBC says, are almost entirely down to the European Central Bank’s end-December refinancing operation, or LTRO, that injected $500 billion to ease banks’ liquidity worries. The tentative improvement in the U.S. and global growth picture along with beaten-down stock valuations added only limited ammunition to the rally, the bank says.
The findings of HSBC’s analysis? First, past episodes of quantitative easing — Japan in 2001-2004 and the United States, Britain and the euro zone after 2008 – provided a significant fillip to equity markets. U.S. stocks rose an average 6 percent, UK stocks by 8 percent and euro zone markets by 15 percent in the three months following the post-Lehman QE rounds, though in Japan the gains have been short-lived. Second, unexpected changes in monetary policy produced a larger impact on stock prices than the continuation of a previous policy.
And when QE stopped, the effect on stocks was immediately negative. HSBC found:
The periods when the Fed halted QE and allowed its balance sheet to shrink (in August 2009, June to October 2010 and July to October 2011) were all periods of weakness for the stock market.
The ECB is gearing up for another LTRO round in two weeks time. But it will not come as a surprise to markets and there are no plans for more.
HSBC concludes:
Emerging market local bond rally has more legs
Just a month and half into 2012, emerging local currency bonds have already returned 9 percent, one of best performing asset classes. But the rally has further to go, says J.P. Morgan which runs the most widely used emerging debt indices. The bank is now predicting its benchmark local currency debt index, the GBI-EM, to end the year with returns of 16 percent, upping its original expectation for 11.9 percent.
There are several reasons for this bullishnesss. JPM’s latest client survey reveals investors’ positioning is still neutral, meaning there is potential for more gains. Cash inflows to EM local debt have been dwarfed this year by investments into dollar bonds, considered a safer, albeit lower-yielding asset than locally issued bonds. So when (and if) euro zone uncertainties abate, some of this cash is likely to make the switch.
Many emerging countries are still cutting interest rates, which will push down yields on short-dated bonds. Other countries may tolerate some more currency appreciation to dampen inflation, benefiting the currency side of the EM local bond trade. Above all, with all developed central banks intent on quantitative easing (Japan announced a surprise $130 billion worth of extra QE this week), the yield premium offered by emerging markets — the carry — is irresistible. On average the GBI-EM index offers a 4.5 percent yield pick up on U.S. Treasuries, JPM notes:
From an EM perspective there is little reason to fight the rising tide of monetary policy support in the near term. Comparisons to the 2009 global carry trade are unavoidable given the scope of G-4 central bank balance sheet expansion.
So far, around 70 percent of the gains posted by the GBI-EM index have been down to currency appreciation (see here). That could change going forward as some central banks may act to slow FX appreciation. That’s already been happening in Brazil. Gains from the duration trade — derived from interest rate cuts — are also more or less done, analysts reckon, because emerging central banks are more likely from here to keep interest rates on hold than to cut. J.P. Morgan adds:
While we look for approximately 7 percent in additional returns in the GBI-EM for the remainder of the year, the majority of this is due to carry (5 percent) while spiot FX returns should be muted at 1.9 percent and duration returns flat.
Interest rates in emerging markets – - harder to cut
Emerging market central banks and economic data are sending a message — interest rates will stay on hold for now. There are exceptions of course.
Indonesia cut rates on Thursday but the move was unexpected and possibly the last for some time. Brazil has also signalled that rate cuts will continue. But South Korea and Poland held rates steady this week and made hawkish noises. Peru and Chile will probably do the same.
The culprit that’s spoiling the party is of course inflation. Expectations that slowing growth will wipe out remaining price pressures have largely failed to materialise, leaving policymakers in a bind. Tensions over Iran could drive oil prices higher. Growth seems to be looking up in the United States.
On top of that, all the major central banks in the developed world are intent on flooding the world economy with cash and some of it will inevitably make its way to emerging nations. So while economies could do with a good dose of policy easing, most central banks cannot afford to let their guard down on inflation.
Take China where January inflation came in well above expectations on Thurday, with food prices up 10.5 percent on the year. Expect no cuts to the policy rate this year, warn analysts at RBC. Over in Seoul, Bank of Korea governor Kim Choong-soo said policymakers needed to be “on alert” for inflation risks and described inflation expectations as “considerably high.” The verdict from Barclays:
Taken together these comments reflect a tilt in concern towards inflation.
Most central banks in emerging Europe never had much room to cut rates anyway, exposed as they are to the euro zone malaise. But as my colleague Emily Kaiser wrote a week back, policy easing bets in Asia are also being trimmed.
Is end-game approaching for Turkey’s policy experiment?
In less than two months, Turkey will mark the first anniversary of the start of an unusual monetary policy experiment, and it may well do so by calling it off. The experiment hinged on cutting interest rates while raising banks’ reserve ratio requirements, and as recently as August, the central bank was hoping it would be able to slow a local credit boom a bit but still protect exports by keeping the currency cheap. Instead, an investor exodus from emerging markets has put the lira to the sword, fuelling at one point a 20 percent collapse in its value against the dollar. That has forced the central bank to roll back some of the reserve ratio hikes and last week it jacked up overnight lending rates in an attempt to boost the currency. It has also sold vast quantities of dollars and is promising to unveil more measures on Wednesday.
But what the market really wants to see is an increase in Turkey’s main interest rate. ”Not sure that ‘measures’ short of rate hikes will help,” RBS analyst Tim Ash writes.
Given Turkey’s massive current account deficit of almost 10 percent of GDP, an interest rate of 5.75 percent will provide little protection to the lira if emerging markets come under serious pressure again. Even if the lira stabilises at current levels, an inflation spike to double-digits looks inevitable. Meanwhile the central bank’s hard currency reserves are vanishing at an alarming rate — just last week it spent $2.7 billion. That’s a lot given Turkish reserves are just $86 billion, or four months of imports. Current central bank policy is ”an open door to reserve depletion,” Societe Generale strategist Guillaume Salomon says, noting that despite the massive dollar sales, the lira is not far off record lows hit earlier this month.
Undoubtedly, the central bank’s misfortunes have a lot to do with global sentiment. But the overall verdict on its policies is negative – analysts point out that annual credit growth still close to 40 percent, the current account gap is narrowing far too slowly and inflation is spiralling. Some even predict a recession next year. Ash of RBS argues that a modest half point rate increase now is the way to go and could save Turkey from much bigger rate rises in coming months.
Many saw last week’s increase to overnight lending rates as a step back towards policymaking orthodoxy. “The end-game could be higher policy rates going forward,” SocGen’s Salomon says, though he expects the central bank to try a while longer before it throws in the towel on its experiment.
Act now or forever hold your (b)-piece, Obama
It appears the penny has finally dropped in Washington.
Bank bailout watchdog Elizabeth Warren, chair of the Congressional Oversight Panel, has unveiled a report that outlines the perilous state of the U.S. commercial mortgage sector, which left unaided could spark “economic damage that could touch the lives of nearly every American”.
The Havard Law School Professor and her panel colleagues are talking the kind of apocalyptic language that may just shock the White House and its star policy advisers into facing problems banks have now rather simply obsess about those they may or may not encounter in the future.
The global banking system may well need some kind of Volcker-esque guidelines to curb the next generation of excessive risk-takers but critics say Obama is putting the cart before the horse in his efforts to haul the economy back on track.
Certainly, the U.S. government has toiled long and hard to stabilise the U.S. housing market, like propping up Fannie and Freddie and their dysfunctional offspring, but the subprime mess has distracted attentions from the toxic commercial market, where the clean-up task is no less important.
Warren reckons there is about $1.4 trillion worth of outstanding commercial real estate loans in the U.S that will need to be refinanced before 2014, and about half of them are already “underwater,” an industry term that refers to loans larger than the property’s current value.
But some believe bank brains are wasting too much time figuring out how the so-called “Volcker rule” might affect their operations and future profitability, instead of getting their arms around the real estate loans that could snap their institutions in two long before the anti-risk measures even take hold.
has it ever occured to people that the Obama administration is not there to fix anything ? just asking
Bosch Boss Bashes Bloated Bank Bonuses
Everyone complains about fat banker bonuses, but Bosch Chief Executive Franz Fehrenbach is taking the debate to a new level. The head of the world’s biggest car parts maker is going to review ties with its financiers and may break off business with those that pay excessive bonuses, he told reporters. “We find it irresponsible if some big banks more or less go back to business as usual before the crisis despite what we have gone through,” he said. He cited HSBC and JP Morgan as positive examples of good corporate behaviour. Of course it’s easier to be picky when you are unlisted and generate huge cash flow.
