Global Investing

Venezuelan yields make it hard to stay away

The 60-70 basis-point post-election surge in Venezuela’s benchmark foreign currency bond yields  is already starting to reverse.

Despite disappointment among many in the overseas investment world over a comfortable re-election in Venezuela of populist left-wing President Hugo Chavez  on Sunday there are quite a few who are already wading in to buy back the government’s dollar bonds.  Not surprising,  as Venezuelan sovereign bonds yield some 10 percentage points on average over U.S. Treasuries and 700 basis points more than the EMBIG sovereign emerging bond index.  It’s pretty hard to keep away from that sort of yield, especially when your pockets are full of cash, the U.S. Federal Reserve is pumping more in every month and Venezuela is full of expensive oil .

The feeling among investors clearly is that while a victory for opposition candidate Henrique Capriles would have been preferable, Chavez is not not a disaster either  given that his policies are helping maintain a steady supply of thse high-yield bonds. And with oil prices over $110 a barrel, it is highly unlikely he will shirk on repaying debt.

Analysts at JPMorgan are among those who have moved Venezuelan bonds back to overweight in their model portfolio. They argue first of all that Chavez’s convincing win has removed the risk of post-election violence (a major fear in a country awash with guns) and second, they note the continued demand for high-spread assets:

The post-election market pull-back offers better levels to re-enter positions against a backdrop of ample global liquiditywhere Venezuela continues to look like an outlier if we compare its double-digit yields to the very low risk (in our view) of default in the foreseeable future.

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.

Iran currency plunge an omen for change?

In recent days Iranians all over the country have been rushing to dealers to change their rials into hard currency. The result has been a spectacular plunge in the rial which has lost a third of its value against the dollar in the past week. Traders in Teheran estimate in fact that it has lost two-thirds of its value since June 2011 as U.S and European economic sanctions bite hard into the country’s oil exports. The government blames the rout on speculators.

According to Charles Robertson at Renaissance Capital,  the rial’s tumble to record lows  and inflation running around 25 percent may be an indicator that Iran is moving towards regime change.  Robertson reminds us of his report from back in March where he pointed out that autocratic countries with a falling per capita income are more likely to move towards democracy. (Click here for what we wrote on this topic at the time)

He says today:

The renewed collapse of the currency recently suggests sanctions are working towards that end.

This week in EM, expect more doves

With the U.S. Fed having cranked up its printing presses, there seems little to stop emerging central banks from extending their own rate cut campaigns this week.

The most interesting meeting promises to be in the Czech Republic. We saw some extraordinary verbal intervention last week from Governor Miroslav Singer, implying not only a rate cut but also recourse to “unconventional” monetary loosening tools. Of the 21 analysts polled by Reuters, 18 are expecting a rate cut on Thursday to a record low 0.25 percent.  Indeed, in a world of currency wars, a rate cut could be just what the recession-mired Czech economy needs. But Singer’s deputy, Moimir Hampl,  has muddled the waters by refuting the need for any unusual policies or even rate cuts.  Expect a heated debate (forward markets are siding with Singer and pricing a rate cut).

Hungary is a closer call, with 16 out of 21 analysts in a Reuters poll predicting an on-hold decision. The central bank board (MPC) is split too. Analysts at investment bank SEB point out that last month’s somewhat surprising rate cut was down to the four central bank board members appointed by the government. These four outvoted Governor Andras Simor and his two deputies who had favoured holding rates steady, given rising inflation. (Inflation is running at 6 percent, double the target).  That could happen again, given the government just last week reiterated the need for “lower interest rates and ample credit.  So SEB analysts write:

Fed re-ignites currency war (or currency skirmish)

The currency war is back.

Since last week when the Fed started its third round of money-printing (QE3), policymakers in emerging markets have been busily talking down their own currencies or acting to curb their rise. These efforts may gather pace now that Japan has also increased its asset-buying programme, with expectations that the extra liquidity unleashed by developed central banks will eventually find its way into the developing world.

The alarm over rising currencies was reflected in an unusual verbal intervention this week by the Czech central bank, with governor Miroslav Singer hinting at  more policy loosening ahead, possibly with the help of unconventional policy tools. Prague is not generally known for currency interventions — analysts at Societe Generale point out its last direct interventions were conducted as far back as 2001-2002.  Even verbal intervention is quite rate — it last resorted to this on a concerted basis in 2009, SoGen notes. Singer’s words had a strong impact — the Czech crown fell almost 1 percent against the euro.

The stakes are high — the Czech economy is a small, open one, heavily reliant on exports which make up 75 percent of its GDP. But Singer is certainly not alone in his efforts to tamp down his currency. Turkey’s 100 basis point cut to its overnight lending rate on Tuesday (and hints of more to come) was essentially a currency-weakening move. And Poland has hinted at entering its own bond market in case of “market turmoil”

Carry currencies to tempt central banks

Central bankers as carry traders? Why not.

As we wrote here yesterday, FX reserves at global central banks may be starting to rise again. That’s a consequence of a pick up in portfolio investment flows in recent weeks and is likely to continue after the U.S. Fed’s announcement of its QE3 money-printing programme.

According to analysts at ING, the Fed’s decision to restart its printing presses will first of all increase liquidity (some of which will find its way into central bank coffers). Second, it also tends to depress volatility and lower volatility encourages the carry trade. Over the next 12 months these  two themes will combine as global reserve managers twin their efforts to keep their money safe and still try to make a return, ING predicts, dubbing it a positive carry story.

The first problem is that yields are abysmal on traditional reserve currencies. That means any reserve managers keen to boost returns will try to diversify from the  dollar, euro, sterling and yen that constitute 90 percent of global reserves. Back in the spring of 2009 when the Fed scaled up QE1, its move depressed the dollar and drove reserve managers towards the euro, which was the most liquid alternative at the time. ING writes:

Emerging market FX reserves again on rise

One of the big stories of the past decade, that of staggering reserve accummulation by emerging market central banks, appeared to have ground to a halt as global trade and economic growth slumped. But according to Bank of America/Merrill Lynch, reserves are  starting to grow again for the first time since mid-2011.

The bank calculates that reserve accumulation by the top-50 emerging central banks should top $108 billion in September after strong inflows of around $13 billion in each of the first  two weeks. Look at the graphic below.

 

So what is the source of these inflows? As BoA/ML points out global trade balances are at their cyclical lows and that is reflected in the dwindling current account surpluses in the developing world. But as risk sentiment has improved in the past six weeks,  there has been a pick up in fixed income and equity investment flows to emerging markets, compared to the developed world.

No BRIC without China

Jim O’ Neill, creator of the BRIC investment concept, has been exasperated by repeated calls in the past to exclude one or another country from the quartet, based on either economic growth rates, equity performance or market structure. In the early years, Brazil’s eligibility for BRIC was often questioned due to its anaemic growth; then it was the turn of oil-dependent Russia. Over the past couple of years many turned their sights on India due to its reform stupor. They have suggested removing it and including Indonesia in its place.

All these detractors should focus on China.

China’s validity in BRIC has never been questioned. Aside from the fact that BRI does not really have a ring, that’s not surprising. China’s growth rates plus undoubted political and economic clout on the international stage put  it head and shoulders above the other three. And after all, it is Chinese demand which drives a large part of the Russian and Brazilian economies.

But its equity markets have not performed for years.

This year, Russian and Indian stocks are up around 20 percent in dollar terms while China has gained 9 percent and Brazil 3 percent. In local currency terms however China is among the worst performing emerging markets, down 5 percent. Brazil has risen 9 percent.

No policy easing this week in Turkey and Chile

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.

Emerging corporate debt tips the scales

Time was when investing in emerging markets meant buying dollar bonds issued by developing countries’ governments.

How old fashioned. These days it’s more about emerging corporate bonds, if the emerging market gurus at JP Morgan are to be believed. According to them, the stock of debt from emerging market companies now exceeds that of dollar bonds issued by emerging governments for the first time ever.

JP Morgan, which runs the most widely used emerging debt indices, says its main EM corporate bond benchmark, the CEMBI Broad, now lists $469 billion in corporate bonds.  That compares to $463 billion benchmarked to its main sovereign dollar bond index, the EMBI Global. In fact, the entire corporate debt market (if one also considers debt that is not eligible for the CEMBI) is now worth $974 billion, very close to the magic $1 trillion mark. Back in 2006, the figure was at$340 billion.  JPM says: