Global Investing

Will Poland have an “ECB moment”?

When Poland stunned markets in May with a quarter-point rate rise, analysts at Capital Economics predicted that the central bank would have an “ECB moment” before the year was over, a reference to the European Central Bank’s decision to cut interest rates last year, just months after it hiked them. A slew of weak economic data, from industrial output to retail sales and employment, indicates the ECB moment could arrive sooner than expected. PMI readings today shows the manufacturing business climate deteriorated for the fourth straight month, remaining in contraction territory.

With central banks all around intent on cutting rates, markets, unsurprisingly, are betting on easing in Poland as well. A 25 bps cut is priced for September and 75 bps for the next 12 months, encouraged by dovish comments from a couple of board members (one of whom had backed May’s decision to raise rates). Bond yields have fallen by 60-80 basis points.

Marcin Mrowiec, chief economist at Bank Pekao says:

The market should continue to expect that the (central bank) will unwind the rate hike delivered in May.

There are two hurdles. One is inflation. Price growth is running at 4.3 percent, well above the 2.5 percent target set by the  inflation-targeting central bank. That was what triggered the May rate rise.

Second, in Poland, as in Hungary, the central bank cannot afford to let the currency weaken much. A third of government and corporate debt is hard currency, while half of all mortgages are in Swiss francs. A fall in the zloty, caused by a rate cut, could raise defaults and problems for the banks. (See here for a story on Poland’s Swiss franc loan problem).

India, a hawk among central bank doves

So India has not joined emerging central banks’ rate-cutting spree .  After recent rate cuts in Brazil, South Korea, South Africa, Philippines and Colombia, and others signalling their worries over the state of economic growth,  hawks are in short supply among the world’s increasingly dovish central banks. But the Reserve Bank of India is one.

With GDP growth slowing to  10-year lows, the RBI would dearly love to follow other central banks in cutting rates.  But its pointed warning on inflation on the eve of today’s policy meeting practically sealed the meeting’s outcome. Interest rates have duly been kept on hold, though in a nod to the tough conditions, the RBI did ease banks’ statutory liquidity ratio. The move will free up some more cash for lending.

What is more significant is that the RBI has revised up its inflation forecast for the coming year by half a  percentage point, and in a post-meeting statement said rate cuts at this stage would do little to boost flagging growth. That, to many analysts, is a signal the bank will provide little monetary accommodation in coming months. and may force  markets to pedal back on their expectation of 100 basis points of rate cuts in the next 12 months.  Anubhuti Sahay at Standard Chartered in Mumbai says:

Risks loom for South Africa’s bond rally

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.

South Africa’s joins the rate cutting spree

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.

Doves to rule the roost in emerging markets

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:

Food prices may feed monetary angst

Be it too much sun in the American Midwest, or too much water in the Russian Caucasus, food supply lines are being threatened, and food prices are surging again just as the world economy slips into the doldrums.

This week, Chicago corn prices rose for a second straight day, bringing its rise over the month to 45%, and floods on Russia’s Black Sea coast disrupted their grain exports.  Having trended lower for about nine-months to June, the surge in July means corn prices are now up about 14% year-on-year. And all of this after too little rain over the spring and winterkill meant Russia, Ukraine and Kazakhstan’s combined wheat crop would fall 22 percent to 78.9 million tonnes this year from 2011.

But as damaging as these disasters have been for local populations, their effects could be much more widely felt.

Next Week: Big Black Cloud

Following are notes from our weekly editorial planning meeting:

Not unlike this year’s British “summer”, the gloom is now all pervasive. Not panicky mind, just gloomy. And there is a significant difference where markets are concerned at least. The former involves surprise and being wrongfooted — but latter has been slow realisation that what were once extreme views on the depth of the credit swamp are fast becoming consensus thinking. The conclusion for many now is that we’re probably stuck in this mire for several more years – anywhere between 5 and 20 years, depending on your favoured doom-monger. Yet, the other thing is that markets also probably positioned in large part for that perma-funk — be it negative yields on core government debt or euro zone equities now with half the p/e ratios of US counterparts. In short, the herd has already  hunkered down and finds it hard to see any horizon. Those who can will resort to short-term tactical plays based on second-guessing government and central bank policy responses (there will likely be more QE or related actions stateside eventually despite hesitancy in the FOMC minutes  and Fed chief Bernanke will likely give a glimpse of that thinking in his congressional testimony next week); or hoping to surf mini econ cycles aided by things like cheaper energy; or hoping to spot one off corporate success stories like a new Apple or somesuch.

So has all hope been snuffed out? The reason for the relapse mid-year depression is only partly related to the political minefield frustrating a resolution of the euro crisis – in some ways, things there look more encouraging policywise than they did two months ago. It stems as much from a realization of just how broken the banks credit creation system remains – a system that had hinged heavily on extensive collateral chains that have now largely been broken or shortened and starved of acceptable high-quality collateral. Curiously, QE – by removing even more of the top quality collateral – may even be exaggerating the problem. Some even say the extreme shortage of this quality “collateral” may require more, not less, government debt in the US and UK and would also benefit from a pooling of euro debt  – but everyone knows how easy all that’s going to be politically.

Despite all this, global markets have remained fairly stable over the past week – in part due to policy hopes underpinning risk markets and in part because there’s not many places left to hide without losing money in “safe-haven” bunkers. World equities are down about 2 percent over the past week,  but still up more than 6 percent from early June. Risk measured by volatility indicesis a smidgen higher too. Oil has firmed back toward $100pb, disappointing everyone apart from oil exporters. Spanish and Italian 10-yr yields are a touch higher. And at least part of the caution everywhere is ae vigil ahead of Chinese Q2 GDP data on Friday – numbers that now almost rival the U.S.  monthly payrolls in global market impact.

Oil price slide – easy come, easy go?

One of the very few positives for the world economy over the second quarter — or at least for the majority of the world that imports oil — has been an almost $40 per barrel plunge in the spot price of Brent crude. As the euro zone crisis, yet another soft patch stateside and a worryingly steep slowdown in the BRICs all combined to pull the demand rug from under the energy markets, the traditional stabilising effects of oil returned to the fray. So much so that by the last week in June, the annual drop in oil prices was a whopping 20%. Apart from putting more money in household and business purses by directly lowering fuel bills and eventually the cost of products with high energy inputs, the drop in oil prices should have a significant impact on headline consumer inflation rates that are already falling well below danger rates seen last year. And for central banks around the world desperate to ease monetary policy and print money again to offset the ravages of deleveraging banks, this is a major relief and will amount to a green light for many — not least the European Central Bank which is now widely expected to cut interest rates again this Thursday.

Of course, disinflation and not deflation is what everyone wants. The latter would disastrous for still highly indebted western economies and would further reinforce comparisons with Japan’s 20 year funk. But on the assumption “Helicopter” Ben Bernanke at the U.S. Federal Reserve and his G20 counterparts are still as committed to fighting deflation at all costs, we can assume more easing is the pipeline — certainly if oil prices continue to oblige.  Latest data for May from the OECD give a good aggregate view across major economies. Annual inflation in the OECD area slowed to 2.1% in the year to May 2012, compared with 2.5% in the year to April 2012 – the lowest rate since January 2011. While this was heavily influenced by oil and food price drops, core prices also dipped below 2% to 1.9% in May.

JP Morgan economists Joseph Lupton and David Hensley, meantime, say their measure of global inflation is set to move below their global central bank target of 2.6% (which they aggregate across 26 countries)  for the first time since September 2010.

India rate cut clamour misses rupee’s fall-JPM

Indian markets are rallying this week as they price in an interest rate cut at the Reserve Bank’s June 18 meeting.  With the country still in shock after last week’s 5.3 percent first quarter GDP growth print, it is easy to understand the clamour for rate cuts. After all, first quarter growth just a year ago was 9.2 percent.

Yet,  there may be little the RBI can do to kickstart growth and investment.  Many would argue the growth slowdown is not caused by tight monetary conditions but is down to supply constraints and macroeconomic risks –the government’s inability to lift a raft of crippling subsidies has swollen the fiscal deficit to almost 6 percent while inhibitions on foreign investment in food processing and retail keep food prices volatile.  

The other side of the problem is of course the rupee which has plunged to record lows amid the global turmoil. Lower interest rates could  leave the currency vulnerable to further losses.

Three snapshots for Thursday

The Bundesbank is preparing to stomach higher German inflation than it likes, above the European Central Bank’s target level, because of the euro zone crisis, a source at the central bank said on Thursday.

Although the Bundesbank still wants stable prices across the euro zone, its latest comments show the bank recognises that upward pressure on German wage costs and property prices suggest its inflation is likely to rise above the bloc’s average.

As this chart shows, historically the Bundesbank was quick to react to any signs of inflation: