Global Investing

Emerging markets facing current account pain

Emerging markets may yet pay dearly for the sins of their richer cousins. While recent financial crises have been rooted in the United States and euro zone, analysts at Credit Agricole are questioning whether a full-fledged emerging markets crisis could be on the horizon, the first since the series of crashes from Argentina to Turkey over a decade ago. The concern stems from the worsening balance of payments picture across the developing world and the need to plug big  funding shortfalls.

The above chart from Credit Agricole shows that as recently as 2006, the 34 big emerging economies ran a cumulative current account surplus of 5.2 percent of GDP. By end-2011 that had dwindled to 1.7 percent of GDP. More worrying yet is the position of “deficit” economies. The current account gap here has widened to 4 percent of GDP, more than double 2006 levels and the biggest since the 1980s. The difficulties are unlikely to disappear this year, Credit Agricole says,  predicting India, Turkey, Morocco, Tunisia, Vietnam, Poland and Romania to run current account deficits of over 4 percent this year.

Some fiscally profligate countries such as India may have mainly themselves to blame for their plight. But in general, emerging nations after the Lehman crisis were forced to embark on massive spending to buck up domestic consumption and offset the collapse of Western export markets. For this reason, many were unable to raise interest rates or did so too late. As the woes of the Turkish lira and Indian rupee showed last year, the yawning funding gap leaves many countries horribly exposed to the vagaries of global risk appetite.

There are some supportive factors however. The Fed’s signal this week that  U.S. interest rates are unlikely to rise before 2014 shows  that central banks in Europe and the United States will continue to gush money for now. So there should be enough cash available to plug the gaps in emerging nations’ balance sheets. Second, as growth eases, so will the deficits.  For these reasons, Credit Agricole says the market will be forgiving of large current account deficits this year. But it warned:

What will happen once (developed market) rates are raised is another story, and emerging markets would better have fixed their main imbalances when the global monetary normalisation begins.

from Jeremy Gaunt:

Twisted Sister and the Federal Reserve

The Federal Reserve's "Operation Twist" has set the literary- and musical-allusion juices flowing.  It is all about the Fed selling or not rolling over short-term debt and buying long-term bonds instead in order to keep borrowing costs low.

But that is frightfully dull for economists, analysts and reporters trying to get attention for their work. So, so far we have heard:

-- "Let's Twist Again", a reference to the 1960's Chubby Checker record about the dance craze . Problem is that the second line is "Like we did last summer", and the Fed did nothing of the sort, launching plain old quantative easing instead.

from Jeremy Gaunt:

The unsyncopated rhythm of central banks

The European Central Bank is off and running with its tightening cycle -- raising by 25 basis points last week and talking in tongues enough to persuade markets that another hike is coming by July.  At the same time, the Fed -- despite some hawkish comments recently about QE -- isn't seen actually tightening for some time. Next year, actually.

Bank of America-Merrill Lynch is now wondering whether there is something wrong with this. " Surely one of these central banks is heading to a painful policy mistake? " it says.

Key to the question is the fact that U.S. and euro zone economics are not as far apart normally as one might think. Take growth, where there is a 0.6 positive correlation between the two across business cycles. Or inflation. The correlation there is even greater at a positive 0.75 over a whole economic cycle.

Clever Fed

Proof  that a little surprise can be quite big.

Ahead of the Federal Reserve’s decision on more quantitative easing there were three possible outcomes that  could have threatened what is becoming a strong global equity rally. In short:

– Meeting expectations could have been seen as boring, leading to a sell off

– Not meeting expectations could have been seen as widely disappointing, leading to a sell off

Bad economic data, please

Interesting twist at the moment – how are financial markets going to view not-so-bad or good data out of the United States in the run-up to the next Federal Reserve meeting.

Investors have been pricing in a chunky operation by the Fed to feed the markets with cheap cash – look at the gold, silver, the Australian dollar and the Canadian dollar. Bad data from the United States will keep investors confident of such Fed action and support the flows into high yielding assets.

But any data showing the pace of recovery in the world’s largest economy is not in such a bad shape. Investors will adjust their expectations and positions, causing a sell-off in equities, speculative-grade credit and high-yielding currencies.

Emerging bonds say thank you, Ben

Last week the U.S. Federal Reserve may have lit a small fire under the emerging bonds market. Already boasting double-digit returns this year, bonds from the developing world are the hot ticket this year, contrasting with the lacklustre performance on stocks or commodities.

The Fed’s move is likely to increase this divergence in returns.

Essentially the Fed has decided it will reinvest proceeds from its maturing mortgage investments back into Treasury bonds, thus keeping market liquidity levels high and signalling to the world its belief that the U.S. economy is still weak enough to need financial stimulus.  Its action also leaves  investors staring at the prospect of near-zero interest rates in the United States and the industrialised world for another year or so.

Such monetary stimulus is usually a godsend for stocks — something investors such as Phil Poole of HSBC Asset Management liken to a “comfort blanket” for investors. In 2009 for instance emerging stocks  jumped 80 percent as global central banks unleashed torrents of liquidity onto world markets.  But Chart1this year investors have been wary of boosting allocations to stocks — fearing that robust growth in emerging markets will not shield their export-oriented companies from the impact of a U.S. slowdown.

Addicted to Credit

The Federal Reserve’s expansionist monetary policies are the equivalent of giving an alcoholic another drink or the heroin addict another fix, according to Dr Marc Faber, also known as Dr Doom, and a fierce critic of Alan Greenspan and Ben Bernanke.

“This is not solving the problem – it is just treating the symptoms,” he said, speaking at the CFA Institute’s European Investment Conference in Frankfurt on Thursday.

Faber blames Greenspan’s decision to hold interest rates at artificially low levels for precipitating the housing bubble and sees Bernanke repeating the mistake in the current crisis. “The Fed seems to ignore the fact that one of the causes of this crisis was the amount of leverage in the system. This is a credit-addicted economy.”

from David Gaffen:

Fed Starts to Remove Candy; Market Demands More

The stock market's penchant for emotional reactions that remind one of a roomful of two-year olds can never be underestimated. Major world central banks are pulling back on their efforts to provide liquidity to the financial system, and the U.S. equity market has flipped out, with stocks falling sharply after the news.Volatility has spiked as well, even though the banks' move is largely administrative, with demand for certain borrowing programs already diminished. Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ notes that "demand for dollar liquidity at banks offshore is sharply reduced now that the crisis has blown through. The amount of dollar borrowing in offshore centers is down sharply."

But equity markets aren't so easily swayed by reason. The move in stocks follows a similar sell-off late Wednesday, after the Federal Reserve's statement, which intimated that it would start to reduce the tools that it has employed in keeping things afloat. Joe Saluzzi of Themis Trading pegged the reaction as a predictable one from the notoriously self-interested stock market, saying that "now all the money printing crack addicts who are waiting for more of it are not getting their money printing and they are going to throw a hissy fit."

Housing sales fall, despite lower rates.

Housing sales fall, despite lower rates.

And this is with only the most gradual of responses from the Fed. Lou Crandall of Wrightson ICAP points out that the Fed, with the tweak to their statement Wednesday and today's action, is signaling its intention to shift away from life-support efforts, even though it is nowhere near raising interest rates.

The Big Five: themes for the week ahead

Five things to think about this week:

APPETITE TO CHASE? 
- Equity bulls have managed to retain the upper hand so far and the MSCI world index is up almost 50 percent from its March lows. However, earnings may need to show signs of rebounding for the rally’s momentum to be sustained. Even those looking for further equity gains think the rise in stock prices will lag that in earnings once the earnings recovery gets underway, as was the case in past cycles. The symmetry/asymmetry of market reaction to data this week — as much from China as from the major developed economies — will show how much appetite there is to keep chasing the rally higher. 

TAKING CONSUMERS’ PULSE 
- A better picture of the health of the consumer will emerge this week as U.S. retailers’ earnings coincides with the release of U.S. July retail sales data and the UK BRC retail survey comes out on the other side of the Atlantic. With joblessness still rising, the reports will show how willing households are to spend and whether deep discounts, which eat into retailers’ profit margins, are the only thing that will tempt them to shop — both key issues for the macroeconomic and corporate outlook. 

CENTRAL BANK WATCH 
- After last week’s Bank of England surprise, all eyes turn to what sort of signals the U.S. Federal Reserve and Bank of Japan will send on the outlook for their respective economies and QE programmes. After the BOE’s expansion of its QE programme the short sterling strip repriced how soon UK rates would rise. But the broader trend recently in the U.S., euro zone and the UK has been to discount rate rises in 2010 — and possibly as soon as this year in Australia. Benchmark interbank euro rates have risen for the first time in two months, and central bankers everywhere, including China, face the delicate balancing act of managing monetary tightening expectations in the months ahead. 

The Big Five: themes for the week ahead

Five things to think about this week: 

RESULTS RUSH 
- The early wave of Q2 earnings last week prevented any major risk shakeout but there are plenty more results this week, including from banking, technology (Apple, Microsoft), and other sectors (Lockheed Martin, Coke, McDonalds). Investors with bullish inclinations will be looking for the VIX to stay subdued after it fell last week to lows last seen in September 2008, especially if more pent up cash is to be released from money market funds. Bears will be thinking that what might be the S&P’s best weekly performance since mid-March could be setting the market up to be more sensitive to bad news.

BANKS – IS THE BEST PAST? 
-  It is hard to see how bank results this week can top the boost which Goldman and JPM gave stocks last week. More of a mixed bag is likely with the U.S. slate including Bank of New York Mellon, Morgan Stanley, Wells Fargo, Capital One, and American Express while Credit Suisse will be the first major European bank to report. Defaults and delinquencies will be in focus for banks more exposed to the retail sector — both for what it means for their outlook and for what it bodes for household solvency and spending. 

DRILLING DOWN 
-  The breakdown of company results this week (ABB, Texas Instruments, Caterpillar, DuPont, Boeing, 3M) will show the extent to which the inventory rebuilding story, which has helped lift world equities almost 40 percent from their March lows, can offer more sustainable support to stocks in the weeks and months ahead. Earnings this week will be closely scanned to see how inventories are stacking up verus orders. How deeply firms are cutting into costs to defend profit margins, as well as their business investment plans, will be key for unemployment and other macroeconomic data.