Global Investing

Sparring with Central Banks

Just one look at the whoosh higher in global markets in January and you’d be forgiven smug faith in the hoary old market adage of “Don’t fight the Fed” — or to update the phrase less pithily for the modern, globalised marketplace: “Don’t fight the world’s central banks”. (or “Don’t Battle the Banks”, maybe?)

In tandem with this month’s Federal Reserve forecast of near-zero U.S. official interest rates for the next two years, the European Central Bank provided its banking sector nearly half a trillion euros of cheap 3-year loans in late December (and may do almost as much again on Feb 29). Add to that ongoing bouts of money printing by the Bank of England, Swiss National Bank, Bank of Japan and more than 40 expected acts of monetary easing by central banks around the world in the first half of this year and that’s a lot of additional central bank support behind the market rebound.  So is betting against this firepower a mug’s game? Well, some investors caution against the chance that the Banks are firing duds.

According to giant bond fund manager Pimco, the post-credit crisis process of household, corporate and sovereign deleveraging is so intense and loaded with risk that central banks may just be keeping up with events and even then are doing so at very different speeds. What’s more the solution to the problem is not a monetary one anyway and all they can do is ease the pain.

Low interest rates and liquidity schemes can’t solve what ails the developed world. Societies must accept that in order to alter their current perilous course they must undergo great change, moving away from entitlements to which they have become accustomed. The alternative is weak economic growth, a loss of competitiveness and negative external balances — a loss of face and place in the global hierarchy.

As if to reinforce the underlying point that the developed world faces a protracted reform period that tests political, economic and social priorities, credit rating firm Standard & Poors’ — not the most popular company in corridors of power over the past year — warned on Tuesday  that it may downgrade the debt of “a number of highly-rated” Group of 20 countries from 2015 if their governments fail to enact reforms to curb rising healthcare spending and other costs related to ageing populations.

from Mike Dolan:

Sparring with central banks

Just one look at the whoosh higher in global markets in January and you'd be forgiven smug faith in the hoary old market adage of "Don't fight the Fed" -- or to update the phrase less pithily for the modern, globalised marketplace: "Don't fight the world's central banks". (or "Don't Battle the Banks", maybe?)

In tandem with this month's Federal Reserve forecast of near-zero U.S. official interest rates for the next two years, the European Central Bank provided its banking sector nearly half a trillion euros of cheap 3-year loans in late December (and may do almost as much again on Feb 29). Add to that ongoing bouts of money printing by the Bank of England, Swiss National Bank, Bank of Japan and more than 40 expected acts of monetary easing by central banks around the world in the first half of this year and that's a lot of additional central bank support behind the market rebound.  So is betting against this firepower a mug's game? Well, some investors caution against the chance that the Banks are firing duds.

According to giant bond fund manager Pimco, the post-credit crisis process of household, corporate and sovereign deleveraging is so intense and loaded with risk that central banks may just be keeping up with events and even then are doing so at very different speeds. What's more the solution to the problem is not a monetary one anyway and all they can do is ease the pain.

Good reasons for rupee’s fall but also for recovery

It’s been a pretty miserable 2011 for India and Tuesday’s collapse of the rupee to record lows beyond 52 per dollar will probably make things worse. Foreigners, facing a fast-falling currency, have pulled out $500 million from the stock market in just the last five trading sessions.   That means net inflows this year are less than $300 million, raising concerns that India will have trouble financing its current account gap.  The weaker currency also bodes ill for the country’s stubbornly high inflation.

Why is the rupee suffering so much? First of all, it is a casualty of the general exodus from emerging markets. As a deficit economy, India is bound to suffer more than say Brazil, Korea or Malaysia.  And 18 months of interest rate rises have taken a toll on growth.

UBS analysts  proffer another explanation. They point out a steady deterioration in India’s net reserve coverage since the 2008 crisis. The reserve buffer — foreign-exchange reserves plus the annual current account balance, minus short-term external debt — stands at 9 percent of GDP, down from 14 percent in 2008.  Within emerging markets, only Egypt, Venezuela and Belarus saw bigger declines in net reserve coverage than India.

Venezuela — high risk, higher yield

Venezuela's Chavez with Lukashenko of Belarus

Which bond would you rather buy — one issued by a country with an unpredictable leader but huge oil reserves, or one with  a dictatorial president as well as empty coffers? The answer should be a no brainer. Not so. The countries are Venezuela and Belarus, and a basic comparison of their debt profiles shows how strangely risk can be priced in emerging markets.

Venezuela’s 2022 dollar bond yields 15.5 percent while the 2022 issue from state oil firm PDVSA trades at 17 percent yield. Venezuelan debt pays a 1200 basis point premium to U.S. Treasuries, according to the EMBI Global bond index.

Now check out Belarus. Dire public finances, a huge recent currency devaluation, and seeking an $8 billion bailout from the IMF, yet able to pay 11 percent on its 2018 issue. Its yield premium to Treasuries is 900 bps or three percentage points less than Venezuela.

Emerging bonds this year. The riskier the better.

Politics have turned nastier than usual this year in emerging markets. Nonetheless, if you were a buyer of emerging bonds, you would have been ill-advised to play safe. That’s because the best performing emerging credit so far this year is Ivory Coast, which at the end of January effectively defaulted on its $2.3 billion dollar bond. Yes really, according to JP Morgan, which runs the most widely-used emerging debt indexes.

That’s because the bond has risen about 15 points since the start of the year on hopes Alassane Ouattara — seen as the rightful winner of last year’s election — would wrest back the presidency from Laurent Gbagbo who had refused to quit ofIVORYCOAST/fice. Ouattara, now installed in the presidential palace, is expected to honour the bond. So if you’d bought this bond at the end of December you would have earned a notional return of 25 percent, according to JP Morgan. The index overall has returned just 1.6 percent.

In second place? Ecuador. It too defaulted in 2008 — on $3.2 billion in bonds — but has benefited recently from oil prices at well over $100 a barrel. That should help its economy grow 5 percent this year.  Another oil power, Venezuela, is in third place. Its bonds may be trading at a 10 percent yield premium to U.S.  Treasuries, reflecting its riskiness, but Venezuelan bonds returned close to 10 percent so far this year, JP Morgan told clients. Many fund managers have piled in, noting  that despite the unpredictability of its President Hugo Chavez, he is raking in oil export revenues and  has never shied away from repaying debt.

Jean-Claude Trichet, EM c.bankers’ new friend

What a friend emerging central bankers have in Jean-Claude Trichet. Last month the ECB boss stopped euro bears in their tracks by unexpectedly signalling concern over inflation in the euro zone. Since then the euro has pushed steadily higher  — against the dollar of course, but also against emerging currencies. The bet now is that interest rates – and the yield on euro investments — will start rising some time this year, possibly as early as this summer.

That’s ptrichetrovided some relief to central banks in the developing world who have struggled for months to stem the relentless rise in their currencies.

Being short euro versus emerging currencies was a popular investment theme at the start of 2011, partly because of EM strength but also because of the euro zone debt crisis. “What that also means is that people who were short euro against emerging currencies had to get out of those positions really fast,” says Manik Narain, a strategist at investment bank UBS. Check out the Turkish lira — that’s fallen around 5 percent against the euro since Trichet’s Jan 13 comments and is at the highest in over a year. South Africa’s rand is down 6 percent too. Moves in other crosses have been less dramatic but the euro’s star is definitely in the ascendant. The short EM trade versus the euro  has more room to run, Narain reckons.

Solar activities and market cycles

Can nature’s cycles enrich our finance and market theories?

Market predictions based on the alignment of the sun, moon and the earth and other cycles could help investors stay disciplined and profit in economic storms, says Daniel Shaffer, CEO of Shaffer Asset Management.

SPACE/SUN

Shaffer writes that sunspot activities show that the sun has an approximate 11-year cycle and as of March 31, 2009, sunspot activity has reached a 100-year low (this, interestingly, coincides with a cycle low in equity markets, reached sometime mid-March in 2009).

But a low in solar activity seems to be followed by a high. Scientists are predicting a solar maximum of activity in sunspots in 2012 that could e the strongest in modern times, according to Shaffer.

from Jeremy Gaunt:

And the investor survey says…

Reuters asset allocation polls for August are out. They show very little change from July, which suggests investors are still cautious and uncertain about what is happening.

One big difference, month-on-month, was a large jump into investment grade corporate debt.  Andrew Milligan of Standard Life Investments reckons this  may in part  have been because  sovereign debt rallied so much over summer that returns from government bonds are now too meagre.

Here is the big picture:

Poll

Scrambling for debt

Developing countries must be eyeing with alarm the vast amounts of bonds that the euro zone and the United States are planning to sell this year and for years to come. Having borrowed large sums, starting a couple of years back to fund the bailout of  U.S. and European banks, developed economies must now raise the cash to repay the holders of those old bonds  – in market parlance, they need to roll over the debt.

The prospect of rolling such vast sums continuously in the current fragile market must be unnerving to say the least. But what about other countries who too have creditors to pay off — emerging markets in particular?  How will their deals fare if  U.S. and European bonds, seen usually as safer assets,  flood the market and drive up yields?

Not too badly, it would seem. The first reason is a simple matter of numbers. The United States needs to roll over one-fifth of all  its outstanding bills in 2010, — a whopping $1.6 trillion. The euro zone must find 1.3 trillion euros in the coming year — more than the recent Greek aid deal that took them so much time and hand-wringing to finalise.   Emerging markets’ needs are tiny in comparison.  ING Bank reckons they need as little as $75 billion to service their hard currency debt in 2010 and half of this has already been raised.  Should not be a problem, then.

from MacroScope:

The nuclear option for financial crises

They finally realised how serious it was. With stock markets tumbling, bond yields on vulnerable debt blowing out and the euro in danger of failing its first big stress test,  the European Union and International Monetary Fund came out with a huge rescue plan.

At 750 billion euros (500 billion from the EU; 250 billion from the IMF), the rescue package is the equivalent of taking a huge mallet to a loose tent peg.  Add to that an agreement among central banks to help out and the actual purchase of euro zone bonds by Europe's central banks and you turn the mallet into a pile driver.

That tent is not going anywhere for now.

Does this remind anyone of anything? How about a lot of small attempts to stop the subprime/Lehman crisis failing, only to be followed by the  likes of the $700 billion Troubled Asset Relief Program in the United States?