Global Investing

Indonesia has just given the go-ahead for another leg down in the rupiah. It has cut its forecasts for the exchange rate to 9,700 per dollar compared to the 9,200 level at which the central bank used to step in. The currency has duly weakened and nervous foreigners have rushed to hedge exposure — 3-month NDFs price the rupiah at almost 10,000 to the dollar. The  rupiah last week hit a three-year low, its weakness coming on top of a dismal 2012 which saw it fall 6 percent as the current account deficit worsened. Traders in Jakarta are reporting dollar hoarding by exporters.

All that is spooking foreigners who own more than 30 percent of the domestic bond market. The currency weakness hit them hard last year as Indonesian bonds returned just 6 percent, a third of the sector’s 16 percent average (see graphic).

The central bank does not seem perturbed by the currency weakness. Luckily for it, inflation rates are still benign, which means a weak currency will probably remain in favour.

The big question is how will investors react?

A test will come on Tuesday, when the government will try to raise $724 million via an auction of domestic bonds and T-bills.  There has been some flight by bond investors in recent days  but most have stayed put – after all they are earning a 5-6 percent carry on bonds and currency exposure can be hedged.  Above all, people are betting the central bank is capable of stemming any big falls in the currency.  (They are probably right: Deputy Governor Hartadi  Sarwono assured investors last week that if the rupiah weakened too much, the bank would “definitely respond to it via interest rate policy”).  UBS strategist Manik Narain points out the central bank has $112 billion in its coffers while interest rates are at a record low 5.75 percent:

The central bank has a considerable arsenal. They haven’t even started to raise rates yet and if we were to see some monetary tightening, investors will quickly pay attention and come back.  They can also deploy some of their considerable reserves.

A raft of Argentine provinces and municipalities suffered credit rating downgrades this week after one of their number, Chaco, in the north of the country, ran out of hard currency on the eve of a bond payment. Instead it paid creditors $260,000 in pesos. Now Chaco wants creditors to swap $30 million in dollar debt for peso bonds because it still cannot get its hands on any hard currency.

The episode is a frightening reminder of Argentina’s $100 billion debt default 10 years ago and unsurprisingly has triggered a surge in bond yields and credit default swaps (CDS). But broader questions also arise from it.

First, will debt “pesification” by some Argentine municipalities snowball to affect international bonds as well? And second, is municipal debt likely to become a problem for other emerging markets in coming months?

Emerging market corporate debt is in high demand, as we pointed out in this article yesterday.  But we noted headwinds too, not least the amount of debt that will fall due in coming years as a result of the current bond issuance bonanza.

David Spegel, head of emerging debt research at ING in New York is highlighting a new danger — that of the exponential increase in speculative grade debt, especially from developed markets, that is up for rollover in coming years. A swathe  of credit rating downgrades for European companies this year mean that many fund managers who bought high-grade assets, have now found themselves holding sub-investment grade paper.  He calculates in a note this week that $47 billion of “junk” rated European paper will find itself up for refinancing in the first half of next year, more than double the levels that were rolled over in the first half of 2012.

It gets worse. The big danger now is that as Spain and Italy tumble into the junk-rated category (Ratings agency S&P on Wednesday cut Spain to BBB-, just one notch above junk) their blue-chip companies may well have to follow suit.  Spegel estimates over $100 billion in Spanish and Italian BBB rated corporate bonds are due next year. If these slip into speculative grade, it would triple the amount  of high-yield paper that needs refinancing in the first six months of 2013.

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.

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:

It’s just over a month until everyone winds down for a Christmas break — this means the season for the 2012 outlook briefings by various managers is starting.

Among the first I went to was ING Investment Management, which held the briefing this morning. Eric Siegloff, global head of strategy and tactical allocation, reckons the next year’s key theme affecting asset classes is summarised as CCC — crisis, contagion and credibility.

He believes 2012 is going to be an uncertain environment with the crisis in the banking system and the foundations of the euro zone threatening to spread beyond EU (contagion), hitting credibility of policymakers.

Michael Chiu, senior investment manager at ING Investment Management, has China Mobile as its biggest holding, and is overweight the banks as it plays down the potential impact of NPLs.

As head of the world's largest custodian of financial assets, Robert Kelly is paid to be alert to buying opportunities. So it's interesting to hear Kelly, chairman and chief executive of Bank of New York Mellon, tell reporters in Beijing that financial assets in Europe are more attractive than those in Asia and that, as a consequence, the bank is refocusing its businesses.

European financial institutions were hit harder by the global economic crisis than their global peers, and U.S. banks are in a better position to mount takeovers in Europe after going through a government-led process of consolidation and capital-raising, he said. "What you will see in coming quarters is that U.S. financial markets and banks are stronger than the European banks now," he said.

If some European banks were to sell businesses to raise capital, BoNY would be interested in buying, he said. If timing counts for anything, Kelly's interest has probably been piqued by Dutch bancassurer ING, which said on Monday it would split in two, transforming itself into a smaller European lender.