Global Investing

The big easing continues. A major surprise today from the Bank of Thailand, which cut interest rates by 25 basis points to 2.75 percent.  After repeated indications  from Governor Prasarn Trairatvorakul that policy would stay unchanged for now, few had expected the bank to deliver its first rate cut since January.  But given the decision was not unanimous, it appears that Prasarn was overruled.  As in South Korea last week,  the need to boost domestic demand dictated the BoT’s decision. The Thai central bank  noted:

The majority of MPC members deemed that monetary policy easing was warranted to shore up domestic demand in the period ahead and ward off the potential negative impact from the global economy which remained weak and fragile.

Thailand expects GDP to grow 5.7 percent this year and Prasarn has cited robust credit demand as the reason to keep rates on hold. But there have been ominous signs of late — exports and factory output have now fallen for three months straight, which probably dictated today’s rate cut.  Remember that exports, mainly of industrial goods, account for 60 percent of Thai GDP and the outlook is perilous — the BOT has already halved its export growth forecast for 2012 to 7 percent and has said it will cut this estimate further.

Second, as in most places, pressure is growing from governments on central banks.  Radhika Rao, an economist with Forecast in Singapore says:

Official circles have been mounting pressure on the bank to keep its eyes trained on growth rather than price stability.

More and more emerging central banks have been embarking on the policy easing path in recent weeks. But Chile and Turkey which hold rate-setting meetings this Thursday are not expected to emulate them. Both are expected to hold interest rates steady for now.

In Chile, the interest rate futures market is pricing in that the central bank will keep interest rates steady at 5 percent for the seventh month in a row. Most local analysts surveyed by Reuters share that view. Chile’s economy, like most of its emerging peers is slowing, hit by a potential slowdown in its copper exports to Asia but it is still expected at a solid 4.6 percent in the third quarter. Inflation is running at 2.5 percent, close to the lower end of the central bank’s  percent target band.

Turkey is a bit more tricky. Here too, most analysts surveyed by Reuters expect no change to any of the central bank rates though some expect it to allow banks to hold more of their reserves in gold or hard currency. The Turkish policy rate has in fact become largely irrelevant as the central bank now tightens or loosens policy at will via daily liquidity auctions for banks. And for all its novelty, the policy appears to have worked — Turkey’s monstrous current account deficit has contracted sharply and data  this week showed the June deficit was the smallest since last August. Inflation too is well off its double-digit highs.

This week has the potential to bring an interesting twist to emerging markets monetary policy. Peru, South Korea and Indonesia are likely to leave interest rates unchanged on Thursday but there is a chance of a rate rise in Russia. A rise would stand out at a time when  central banks across the world are easing monetary policy as fast as possible.

First the others. Rate rises in Indonesia and Peru can be ruled out. Peru grew at a solid  5.4 percent pace in the previous quarter and inflation is within target. Indonesian data too shows buoyant growth, with the economy expanding 6.4 percent from a year earlier. And the central bank is likely to be mindful of the rupiah’s weakness this year — it has been one of the worst performing emerging currencies of 2012.

Korea is a tougher call. The Bank of Korea stunned markets with a rate cut last month, its first in three years. Since then, data has shown that the economy is slowing even further after first quarter growth eased to 2008-2009 lows. Exports are falling at the fastest pace in three years. But most analysts expect it to wait it out in August and then cut rates in September. Markets on the other hand are bracing for a rate cut as yields on 3-year Korean bonds have fallen well under the central bank’s main 7-day policy rate.

As we wait for ECB Mario Draghi to come good on his promise to do all in his power to save the euro,  the case for governments intervening in financial markets is once again to the fore. Draghi’s verbal intervention last week basically opened up a number of fronts. First, he clearly identified the extreme government bond spreads within the euro zone, where Germany and almost half a dozen euro countries can borrow for next to nothing while Spain and Italy pay 4-7%,  as making a mockery of a single monetary policy and that they screwed up the ECB’s monetary policy transmission mechanism.  And second, to the extent that the euro risks collapse if these spreads persist or widen further, Draghi then stated  it’s the ECB’s job to do all it can to close those spreads. No euro = no ECB. It’s existential, in other words. The ECB can hardly be pursuing “price stability” within the euro zone by allowing the single currency to blow up.

Whatever Draghi does about this, however, it’s clear the central bank has set itself up for a long battle to effectively target narrower peripheral euro bond spreads — even if it stops short of an absolute cap.  Is that justified if market brokers do not close these gaps of their own accord?  Or should governments and central banks just blithely accept market pricing as a given even if they doubt their accuracy?  Many will argue that if countries are sticking to promised budgetary programmes, then there is reason to support that by capping borrowing rates. Budget cuts alone will not bring down debts if borrowing rates remain this high because both depress the other key variable of economic growth.

But, as  Belgian economist Paul de Grauwe argued earlier this year,  how can we be sure that the “market” is pricing government debt for Spain and Italy now at around 7% any more accurately than it was when it was happily lending to Greece, Ireland and Portugal for 10 years at ludicrous rates about 3% back in 2005 before the crisis? Most now accept that those sorts of lending rates were nonsensical. Are 7%+ yields just as random? Should governments and the public that accepts the pre-credit crisis lending as grossly excessive now be just as sceptical in a symmetrical world? And should the authorities be as justified in acting to limit those high rates now as much as they should clearly have done something to prevent the unjustifiably low rates that blew the credit bubble everywhere — not just in the euro zone? De Grauwe wrote:

Investors are wondering how much longer the rally in South Africa’s local bond markets will last.

The market has received inflows of over $7.5 billion year-to-date, having benefited hugely from Citi’s April announcement that it would include South Africa in its elite World Government Bond Index (WGBI).  But like many other emerging markets, South Africa has also gained from international investors’ hunger for higher-yielding bonds. And the central bank’s surprise rate cut last week was the icing on the cake, sending 5-year yields plunging another 30 basis points.

There are some headwinds however. First positioning. Around a third of government bonds are already estimated to be in foreigners’ hands. Second, markets may be pricing in too much policy easing (Forward rate agreements are assigning a 77  percent probability of another 50 bps rate cut within the next six months).  That’s especially so given local wheat and maize prices have been hitting record highs in recent weeks.

Another central bank has caved in and cut interest rates — South Africa lowered its key rate to a record low of 5 percent at Thursday’s meeting. In doing so, the central bank noted growth was slowing further. ”Negative spillover effects (from the global economy)  likely to intensify,” it said.

Very few analysts had predicted this outcome, reckoning the central bank (or SARB as it’s known) would hold fire until its next meeting due to concerns over the currency and inflation.  But in fact, forward markets had guessed a cut was coming, especially after June inflation was lower than expected. And after all, even the conservative Bank of Korea cut rates last week to buck up domestic growth and compensate for slumping exports.  There have also been some policy easing in Taiwan and Philippines in the past week while earlier on Thursday, Turkey’s central bank unleashed more liquidity into the banking system. Kevin Lings, chief economist at Stanlib in Johannesburg says:

(South Africa’s rate cut) would suggest that the Reserve Bank feels they are a little bit behind the curve when they look at interest rate movements in other countries and hence the decision.

Interest rate meetings are coming up this week in Turkey,  South Africa and Mexico.  Most analysts expect no change to interest rates in any of the three countries.  But chances are, the worsening global growth picture will force policymakers to soften their tone from previous months; indeed forwards markets are actually pricing an 18-20 basis-point interest rate cut in South Africa.

Doves in South Africa will have been encouraged by today’s lower-than-expected inflation print, coming soon after data showing a growth deceleration in the second quarter of the year. Investors have flooded the bond markets, betting on rate cuts in coming months. In Turkey and Mexico, no policy change is priced but a few reckon the former, reliant on a policy of day-to-day tinkering with liquidity, may narrow the interest rate corridor in a nod to slowing growth.

For now, all three banks could be constrained from cutting rates by fear of currency volatility and the potential knock-on effect on inflation. Of South Africa, analysts at TD Securities write:

Emerging market investors may have got used to policy surprises from Turkey’s central bank but they don’t expect them from South Korea. Such are the times, however, that the normally staid Bank of Korea shocked investors this morning with an interest rate cut,  the first in three years.  Most analysts had expected it to stay on hold. But with the global economic outlook showing no sign of lightening, the BoK probably felt the need to try and stimulate sluggish domestic demand. (To read coverage of today’s rate cut see here).

So how much impact is the cut going to have?  I wrote yesterday about Brazil, where eight successive rate cuts have borne little fruit in terms of stimulating economic recovery. Korea’s outcome could be similar but the reasons are different. The rate cut should help Korea’s indebted household sector. But for an economy heavily reliant on exports,  lower interest rates are no panacea,  more a reassurance that, as other central banks from China to the ECB to Brazil  ease policy, the BoK is not sitting on its hands.

Nomura economist Young-Sun Kwon says:

We do not think that rate cuts will be enough to reverse the downturn in the Korean economy which is largely dependent on exports.

Brazil’s central bank meets today and almost certainly will announce another half point cut in interest rates, the eighth consecutive reduction since last August. But so far there is little sign that its rate-cutting spree – the longest and most aggressive  in the developing world – is having much success in resuscitating the economy.

HSBC’s closely watched emerging markets index (EMI), released this week, shows Brazil as one of the weak links in the EM growth picture,  with sharp declines in manufacturing and export orders in the second quarter.

The government is expected to soon revise down its 4.5 percent growth projection for 2012; the central bank has already done so.  Industrial output is down, and automobile production has slumped 9 percent in the first half of 2012. Nor  it seems are record low interest rates encouraging the middle classes to take on more debt — the number of Brazilians seeking new credit fell 7.4 percent in the first half of this year, the biggest fall on record, according to credit research firm Seresa Experian.

Investors with exposure to Argentina will have been dismayed in recent weeks by the surging cost of insuring that investment — Argentine 5-year credit default swaps have risen more than 300 basis points since mid-May to the highest levels since 2009. That means one must stump up close to $1.5 million to insure $10 million worth of Argentine debt against default for a five year period, data from Markit shows.

The rise coincides with growing fears that President Cristina Fernandez Kirchner is getting ready to crack down on people’s dollar holdings. Fears of forcible de-dollarisation have sent Argentine savers scurrying to the banks to withdraw their hard currency and stash it under mattresses. That has widened the gap between the official and the “black market” exchange rate. (see the graphic below from Capital Economics)

While government officials have denied there is such a move afoot, Fernandez has not helped matters by exhorting people to “think in pesos”.  That will be hard for Argentines, most of whom have vivid memories of hyperinflation, default and devaluation. Unsurprisingly, most prefer to save in dollars.