Global Investing

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.

But Turkey’s economy too faces headwinds, most of all from the euro zone where it sends most of its exports. Growth is slowing and there are signs the central bank as well as exporters are getting a bit restless about the currency (the lira is up 5 percent this year versus the dollar). UBS strategist Manik Narain says:

The bias is for looser policy but there is no real need to cut the policy rate. They may reduce the ceiling of their overnight rates corridor to indicate they are starting to feel discomfort with the lira’s strength but for the time being their policy tools are doing their job for them.

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:

Olympic medal winners — and economies — dissected

The Olympic medals have all been handed out and the athletes are on their way home.  Which countries surpassed expectations and which ones did worse than expected? And did this have anything to do with the state of their economies?

An extensive Goldman Sachs report entitled Olympics and Economics  (a regular feature before each Olympic Games) predicted before the Games kicked off that the United States would top the tally with 36 gold medals. It also said the top 10 would include five G7 countries (the United States, Great Britain, France, Germany and Italy), two BRICs (China and Russia), one of the developing countries it dubs Next-11  (South Korea), and one additional developed and emerging market. These would be Australia and Ukraine, it said.

Close enough, except that Hungary took the place of Ukraine as the emerging economy in the Top 10 and the United States actually took 46 gold medals — more than Goldman had predicted.

Russia: a hawk among central bank doves?

This week has the potential to bring an interesting twist to emerging markets monetary policy. Peru, South Korea and Indonesia are likely to leave interest rates unchanged on Thursday but there is a chance of a rate rise in Russia. A rise would stand out at a time when  central banks across the world are easing monetary policy as fast as possible.

First the others. Rate rises in Indonesia and Peru can be ruled out. Peru grew at a solid  5.4 percent pace in the previous quarter and inflation is within target. Indonesian data too shows buoyant growth, with the economy expanding 6.4 percent from a year earlier. And the central bank is likely to be mindful of the rupiah’s weakness this year — it has been one of the worst performing emerging currencies of 2012.

Korea is a tougher call. The Bank of Korea stunned markets with a rate cut last month, its first in three years. Since then, data has shown that the economy is slowing even further after first quarter growth eased to 2008-2009 lows. Exports are falling at the fastest pace in three years. But most analysts expect it to wait it out in August and then cut rates in September. Markets on the other hand are bracing for a rate cut as yields on 3-year Korean bonds have fallen well under the central bank’s main 7-day policy rate.

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:

Emerging debt default rates on the rise

Times are tough and unsurprisingly, default rates among emerging market companies are rising.

David Spegel, ING Bank’s head of emerging debt, has a note out, calculating that there have been $8.271 billion worth of defaults by 19 emerging market issuers so far this year — nearly double the total $4.28 billion witnessed during the whole of 2011.

And there is more to come — 208 bonds worth $75.7 billion are currently trading at yield levels classed as distressed (above 1000 basis points), Spegel says, while another 120 bonds worth $45 billion are at “stressed” levels (yields between 700 and 999 bps).   Over half of the “distressed” bonds are in Latin America (see graphic below).  His list suggests there could be $2.4 billion worth of additional defaults in 2012 which would bring the 2012 total to $10.7 billion. Spegel adds however that defaults would drop next year to $6.8 billion.

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:

10%-plus returns: only on emerging market debt

It’s turning out to be a great year for emerging debt. Returns on sovereign dollar bonds have topped 10 percent already this year on the benchmark EMBI Global index, compiled by JP Morgan.  That’s better than any other fixed income or equity category, whether in emerging or developed markets. Total 2012 returns could be as much as 12 percent, JPM reckons.

Debt denominated in emerging currencies has done less well . Still, the main index for local debt, JPM’s GBI-EM index, has  racked up a very respectable 7.6 percent return year-to-date in dollar terms, rebounding from a fall to near zero at the start of June.  Take a look at the following graphic which shows EMBIG returns on top:

Fund flows to emerging fixed income have been robust. EPFR Global says the sector took in  $16.2 billion year to date.  JPM, which tracks a broader investor set including Japanese investment trusts, estimates the total at $43 billion, not far off its forecast of $50-60 billion for the whole of 2012.

More EM central banks join the easing crew

Taiwan and Philippines have joined the easing crew. Taiwan cut interbank lending rates for the first time in 33 months on Friday while Philippines lowered the rate it pays banks on short-term special deposits. Hardly surprising. Given South Koreas’s shock rate cut on Thursday, its first in over three years, and China’s two rate cuts in quick succession, the spread of monetary easing across Asia looks inevitable. Markets are now betting the Reserve Bank of India will also cut rates in July.

And not just in Asia. Brazil last week cut rates for the eighth straight time  and Russia’s central bank, while holding rates steady,  amended its language to signal it was amenable to changing its policy stance if required.

Worries about a growth collapse are clearly gathering pace. So how much room do central banks have to cut rates? Compared with Europe or the United States, certainly a lot.  And with the exception of Indonesia and Philippines, interest rates in most countries are well above 2009 crisis lows.  But Deutsche Bank analysts, who applied a variation of the Taylor rule (a monetary policy parameter stipulating how much nominal interest rates can be changed relative to inflation or output), conclude that in Asia, only Vietnam and Thailand have much room to cut rates. Malaysia and China have less scope to do so and the others not at all (Their model did not work well for India).

Korea shocks with rate cut but will it work?

Emerging market investors may have got used to policy surprises from Turkey’s central bank but they don’t expect them from South Korea. Such are the times, however, that the normally staid Bank of Korea shocked investors this morning with an interest rate cut,  the first in three years.  Most analysts had expected it to stay on hold. But with the global economic outlook showing no sign of lightening, the BoK probably felt the need to try and stimulate sluggish domestic demand. (To read coverage of today’s rate cut see here).

So how much impact is the cut going to have?  I wrote yesterday about Brazil, where eight successive rate cuts have borne little fruit in terms of stimulating economic recovery. Korea’s outcome could be similar but the reasons are different. The rate cut should help Korea’s indebted household sector. But for an economy heavily reliant on exports,  lower interest rates are no panacea,  more a reassurance that, as other central banks from China to the ECB to Brazil  ease policy, the BoK is not sitting on its hands.

Nomura economist Young-Sun Kwon says:

We do not think that rate cuts will be enough to reverse the downturn in the Korean economy which is largely dependent on exports.