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:
The Bank of England voted on Thursday not to give the struggling economy another injection of cash as concerns over stubbornly high inflation outweighed the risk of a prolonged recession.
The number of Americans submitting new applications for jobless benefits edged down last week, easing concerns the labor market was deteriorating after April’s weak employment growth.
South African bond rush
It’s been a great year so far for South African bonds. But can it get better?
Ever since Citi announced on April 16 that South African government bonds would join its World Government Bond Index (WGBI), almost 20 billion rand (over $2.5 billion ) in foreign cash has flooded to the local debt markets in Johannesburg, bringing year-to-date inflows to over 37 billion rand. Last year’s total was 48 billion. Michael Grobler, bond analyst at Johannesburg-based brokerage Afrifocus Securities predicts total 2012 inflows at over 60 billion rand, surpassing the previous 56 billion rand record set in 2o1o:
The assumption..is based on the fact that South Africa will have a much larger and diversified investor base following inclusion in the WGBI expanding beyond the EM debt asset class
Currently South African bonds are restricted to emerging local bond indices. The most-widely used, JPMorgan’s GBI-EM, has less than $200 billion benchmarked to it and South Africa’s weighting is 10 percent. But the WGBI is a different matter altogether — around $2 trillion is estimated to track this index which currently includes just 22 countries, only three of them emerging markets. An expected 0.44 percent weighting for South Africa implies inflows of $5-$9 billion, analysts estimate.
Some of that cash has already come. How much more could roll in this year? Optimists point to Mexico – foreign ownership of the local debt market there rose to 31 percent from 24 percent over 2010, the year the country joined the WGBI, with $11 billion flowing in. But the picture in South Africa is in fact not that rosy. Inflows will undoubtedly pick up, benefiting both bonds and the rand but many reckon positioning in South African bonds is already pretty crowded – about a third of the market is in foreign hands already, analysts at Morgan Stanley reckon. Worse, the country faces a possible credit ratings downgrade this year (all three rating agencies have cut its ratings outlook to negative in recent months).
Kieran Curtis, a fund manager at Aviva Investors upped his holdings of South African local bonds after the WGBI news but is reluctant to go overweight, betting the market will benefit less than Mexico did two years ago. He cites two reasons — first South Africa’s budget deficit has been creeping higher and it follows that debt issuance will too. Second, the external backdrop is less supportive today than two years ago when the Fed was in full money-printing mode:
I wouldnt say I detect a very strong commitment in South Africa to restoring the budget to balance and those debt numbers can rise quickly when you have a 5-6 percent deficit. Also Mexico’s inclusion came at a time when U.S. Treasury yields were falling fairly quickly but now, with Treasury yields rising we may not get the same support for South Africa.
Poland, the lonely inflation targeter
Is the National Bank of Poland (NBP) the last inflation-targeting central bank still standing?
The bank shocked many today with a quarter point rate rise, naming stubbornly high inflation as the reason, and signalling that more tightening is on its way. The NBP has sounded hawkish in recent weeks but few had actually expected it to carry through its threat to raise rates. Economic indicators of late have been far from cheerful – just hours after the rate rise, data showed Polish car production slumped 30 percent in April from year-ago levels. PMI numbers last week pointed to further deterioration ahead for manufacturing. And sitting as it does on the euro zone’s doorstep, Poland will be far more vulnerable than Brazil or Russia to any new setback in Greece. Its action therefore deserves praise, says Benoit Anne, head of emerging markets strategy at Societe Generale.
(Poland’s central bank) is one of the last orthodox inflation-targeting central banks in the global emerging market central bank universe. They are taking action because they are seeing inflation creeping up and have decided to be proactive.
The rate rise is especially notable given many central banks in developing countries appear effectively to have surrendered their inflation-fighting mandate. Nowhere is the push for lower interest rates more pronounced than in Brazil where the government last week announced plans to scrap fixed-rate savings deposits in a move that is seen paving the way for more agressive rate cuts. Clearly there is tolerance here for higher inflation, which will still end 2012 well above target.
But many analysts such as Manik Narain at UBS consider Poland’s decision a high-risk one given the growth issues. Narain sees it possibly motivated by the need to signal Poland will not welcome further currency weakness (the zloty like most emerging currencies has shed much of its early-2012 gain) Therefore a prolonged monetary tightening cycle is unlikely, he says. Indeed many reckon the NBP may find itself, like the European Central Bank last year, reversing an ill-considered rate rise. Analysts at Capital Economics write:
If we are right in expecting growth and inflation to slow by more than most expect over the second half of this year then this may well be the NBP’s “ECB moment”. Recall that having hiked rates twice in the first half of 2011, the ECB was forced to start loosening policy once again by November as the economy weakened. In Poland’s case, we think there is a good chance that today’s rate hike will be reversed by the end of the year.
Trading the new normal in India
After a ghastly 2011, Indian stock markets have’t done too badly this year despite the almost constant stream of bad news from India. They are up 12 percent, slightly outperforming other emerging markets, thanks to fairly cheap valuations (by India’s normally expensive standards) and hopes the central bank might cut rates. But foreign inflows, running at $3 billion a month in the first quarter, have tapered off and the underlying mood is pessimistic. Above all, the worry is how much will India’s once turbo-charged economy slow? With the government seemingly in policy stupor, growth is likely to fall under 7 percent this year. News today added to the gloom — exports fell in March for the first time since the 2009 global crisis.
So how are fund managers to play India now? According to David Cornell, who runs an India portfolio at specialist investor Ocean Dial, they must simply get used to the “new normal” — subpar growth and high cost of capital. In this shift, Cornell points out, return on assets in India has fallen from a peak of almost 14 percent in 2007 to less than 10 percent now. While that is still higher than the broader emerging asset class, the advantage has dwindled to less than 1 percent as companies suffer from margin compression and falling turnover. Check out these two graphs from Ocean Dial:
Cornell is playing the new normal by focusing on three sectors — consumer goods, banks and pharmaceuticals. These companies, he says, have pricing power and structural barriers to entry (banks); provide access to still-buoyant demand for services such as mobile phones (consumer goods) and are well-run and profitable (pharmaceuticals). And the export-oriented pharma sector is also an effective hedge against the weakening rupee.
If cost of capital is high, you want to avoid leverage, you want to be in banks which have pricing power. In pharmaceuticals you have 20 percent earnings growth and transparent accounting. In an uncertain environment these sectors should perform well. (Cornell says)
The “least worst” option?
Western governments saddled with mountainous debts will “repress” creditors and savers via banking regulation, capital controls, central bank bond buying and currency depreciation that effectively puts sovereign borrowers at the top of the credit queue while simultaneously wiping out real returns for their bond holders. So says HSBC chief economist Stephen King in his latest report this week called “From Depression to repression”.
Building on the work of U.S. economist Carmen Reinhardt and others, King’s focus on the history of heavily indebted governments applying “financial repression” to creditors arrives at several interesting conclusions. First, even though western governments appeared successful in using these tactics to reduce massive World War Two debts alongside brisk economic growth during the 1950s and 1960s, King argues that the debt was cut mainly by the impressive economic growth and tax revenues during that “Golden Age” – and this was mostly down to the once-in-a-century period of relative peace that involved unprecedented integration and cooperation among western governments also engaged in a Cold War with the Soviet Union. Compared to this boost, the financial repression was a “sideshow”, he reckons. To show t
Instead, King says governments will adopt this repression tactic anyway just to stave off draconian austerity now and prevent a destabilising surge in economy-wide borrowing rates. This will effectively reduce the amount of credit to the rest of the private sector, or at least elevating its cost, while reducing the pressure on governments to cut the debt levels quickly. The net result, then will likely be “persistently lower growth”, whatever your conclusion about the desirability of state or the market allocation of resources.
And, in the absence of an obvious alternative, repression may also be the “least worst” option, King argues.
Renihart is exactly right. But there is a darker theory yet: that Fed policy is just part of a government-wide strategy of practicing “financial repression” to escape from the consequences of the debt explosion. The leading expert on financial repression is Carmen Reinhart of the Peterson Institute. She defines it as a situation in which “governments implement policies to channel to themselves funds that in a deregulated market environment would go elsewhere.”
Low or negative real interest rates are among the oldest examples. Call this monetary repression. Reinhart points out that it was practiced on a large scale by governments after World War II. She asserts that it accomplished by stealth the effective cancelation of government debt without resort to orthodox spending and tax policies for which governments knew then and now that they cannot get the electorate’s consent.
A similar debt predicament today implies that monetary and other forms of repression are again on the cards, especially in the United States. Wainwright has attempted to measure it, but estimates of real interest rates and monetary repression are fuzzy and contentious, especially because the government as¬serts control over the method by which inflation is measured.
Nevertheless, the company’s research, estimates that the Fed’s interest-rate policy in 2007-11 has cut the real interest rate from a normal 2 or 3 percent to an aver¬age of minus 7 or 8 percent. That’s a diversion of about ten percentage points a year to the Treasury and other borrowers—just about enough to fund the current budget deficit. Genius…
Luis de Agustin
Three snapshots for Tuesday
U.S. consumer confidence came in slightly weaker than expected but the ‘jobs-hard-to-get’ index – historically a good lead indicator of the unemployment rate - fell to 37.5 in April.
Spanish equities in price terms are near their 2009 lows but valuations are still some way above:
Australian consumer prices rose by less than expected last quarter while key measures of underlying inflation showed the smallest rise in more than a decade, paving the way for a cut next week and suggesting further cuts were possible.
Three snapshots for Tuesday
Argentina’s debt insurance costs rose after the country moved to seize control of leading energy company YPF on Monday, Madrid called the move on YPF, controlled by Spanish company Repsol, a hostile decision and vowed “clear and strong” measures, while the EU’s executive European Commission warned that an expropriation would send a very negative signal to investors. Of the countries in the MSCI Frontier equities universe Argentinian equities are the worst performer this year.
German analyst and investor sentiment rose unexpectedly in April. The Mannheim-based ZEW economic think tank’s monthly poll of economic sentiment rose to 23.4 from 22.3 in March, beating a consensus forecast in a Reuters poll of analysts for a fall to 20.0.
India’s first interest rate cut in three years may be its last for a while. The central bank cut rates on Tuesday by an unexpectedly sharp 50 basis points to boost the sagging economy, but warned there was limited scope for more cuts, with inflation likely to remain elevated and growth on track to pick up, albeit modestly.
Three snapshots for Wednesday
Saudi Arabia has repeated publicly it would prime its pumps to meet any shortfall in exports from fellow OPEC member Iran, this chart shows their production since 1980:
Unwelcome news for British finance minister George Osborne ahead of today’s budget – February public sector borrowing comes in at £15.2bn against expectations for £8bn.
Along with the rise in bond yields, expectations for interest rates at end 2013 and 2014 have started to pick up:
Central banks and the next bubble (2)
In the previous bubble blog earlier in the week I wrote that G4 central bank balance sheets are expanding to a whopping 26% of GDP.
In what Nomura’s Bob Janjuah called “Monetary Anarchy”, some analysts worry that central bank liquidity expansion is a timebomb which if/when it explodes would have very negative consequences.
Swiss private bank Lombard Odier, weighing in on the debate, warns that not only has the quality of central bank balance sheets deteriorated, there has been no visible impact on the real economy.
Stephanie Kretz, member of the investment strategy team for private banking at Lombard Odier, points out that a sharp fall in the money multiplier, defined as the ratio of broad money (M3) to the monetary base, means the impact on the real economy has been almost non-existent.
What about the real economy? Ballooning and riskier central bank balance sheets will not generate sustainable growth or reduce unemployment and debt levels, but could well induce at a later stage unintended consequences that include bouts of hyper-inflation, loss of trust in fiat money and loss of central banks’ credibility as to their capacity to maintain strong currencies and stable prices.
The huge increase in the monetary base has not flowed into the real economy, and is sitting in the excess reserves of still reluctant-to-lend banks whilst the world is deleveraging, thus capping the demand for credit.
What happens when a recovery eventually kicks in, interest rates go up, the velocity of circulation of money comes back and real economy is flooded with paper currency that does not correspond to real human production? Monetary base expansion will need to be reversed in large, non-incremental steps if it is to be non-inflationary. This is uncharted territory for central banks and poses significant longer-term policy risks.
How Turkey cut interest rates but didn’t really
How do you cut interest rates without actually loosening monetary policy? Turkey’s central bank effectively did that today.
I wrote this morning that the bank and its boss Erdem Basci were gearing for rate cuts, thanks to the lira’s steady rise (see the graphic) that should help tame inflation later this year (provided the global investment feel remains positive). But I also said a rate cut was unlikely to happen today. I was wrong — and right too. The central bank cut its overnight lending rate by 100 basis points to 11.5 percent while keeping the one-week repo rate — the main policy rate — steady at 5.75 percent.
So why is this not a real cut? Note that the former overnight rate hasn’t been used for over a month. Instead the central bank has been using the “corridor” between the lending and borrowing rates to adjust policy on an almost daily basis. The upper end of the corridor is in fact used more to tighten policy when there is a need to defend the lira, analysts point out. And most importantly, the central bank has already been providing funds at the cheaper 5.75 percent rate.
Morgan Stanley analyst Tevfik Aksoy writes:
This, in our view, did not come as a surprise, and should not be seen as a significant change in the monetary policy stance….The move, in our view, is not monetary easing but an adjustment to changing conditions…..We think that the difference between 12 percent and 11 percent are sufficiently high to stem currency depreciation in case global sentiment turns sour in coming weeks.
According to economist William Jackson at Capital Economics:
Clearly the central bank’s decision is a nod towards the more favourable external financing conditions
