Global Investing

Liquidity needs to pick up in EM

Emerging markets have seen heavy selling in the past few months, with political and economic crises hitting the region’s currencies and asset markets.

The obvious question now is: Is all the bad news in the price?

London-based CrossBorder Capital, who publishes monthly liquidity and risk appetite data for developed and emerging economies, thinks not.

“It is probably too early to buy the EM sector right now, certainly not until liquidity picks up again,” Michael Howell, CrossBorder’s managing director, says.

The firm’s Global Liquidity Index reading (which ranges from 0-100) for emerging markets stands at 13.3, up from 12.1 in the previous month, weighed down by tighter liquidity in China. This compares with 75.3 for developed markets while even frontier markets have a liquidity score of 70.3, CrossBorder says. The index measures liquidity data from central banks, private sector, cross-border flows and financial conditions.

“Our long-held mantra is that ‘every EM crisis is first-and foremost a currency crisis’, and to-date EM only looks to be some half-way through,” Howell said. “A large EM currency devaluation may be needed to lift EM liquidity.”

Pension funds’ hedging dilemma

Pension funds have no shortage of concerns: their funding deficits are rapidly growing in the current low-return environment, and ageing populations are stretching their liabilities.

But a recent survey of pension funds trustees by French business school EDHEC has found that their biggest worry, cited by nearly 77% of the respondents, is the risk that their sponsor — the entity or employer that administers the  pension plan for employees – could go bust. Yet 84% of respondents fail to manage the sponsor risk.

So how do you hedge against such a risk?

You could buy credit default swaps of the sponsor company or buy out-of-the-money equity put derivatives to seek protection. But both options are costly and illiquid. Moreover, it might send a negative signal to the market: after all, if the company’s pension fund is seen effectively shorting the company in an aggressive manner, investors may wonder “What do they know that we don’t?”

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.

Calling CCCs

Junk bonds have enjoyed a rally since the start of the year but investors are facing a dilemma.

Should you buy larger, more liquid bonds that have already risen significantly, or buy smaller, illiquid bonds that have an attractive price?

Barclays Capital says triple-C rated bonds — the riskier segment of the junk space — are beginning to catch up with less risky issues because higher rated bonds have increasingly run into “call constraints”.

It’s the exit, stupid

Ghoul

Anyone wondering what ghoul is most haunting investors at the moment could see it clearly on Tuesday — it is the exit strategy from the past few years’ central bank liquidity-fest.

Germany came out with a quite positive business sentiment indicator, relief was still there that Greece had managed to sell some debt a day before, and Britain formally left recession – albeit in a limp kind of way.

But what was the main global market mover? It was China implementing a previously announced clampdown on lending.

The Big Five: Themes for the Week Ahead

Five things to think about this week:

CENTRAL BANKERS IN A HOLE
– The global economy and financial system appear on the road to recovery but that is in large part due to unprecedented official stimulus that will have to be withdrawn at some point – the questions investors want answered are when, and how.  Central bankers no longer appear to be quite as shoulder to shoulder with one another on coordinated policy as they were last year in the aftermath of Lehman’s collapse.
 

CHINA STOCK WATCHING
–  It is August, liquidity has dried up with the summer holiday season in full swing, and investors are palpably more cautious about the economic outlook now than they have been for months. It is against this backdrop that that the Chinese stock market is emerging as the focal point and driver of all other asset markets. The Shanghai Composite technically slipped into bear market territory earlier last week, shedding 20 percent in the two weeks from Aug. 4 to Aug. 19 on profit taking from the 90 percent surge this year. There is no major Chinese economic data scheduled for release this week, leaving thin markets at the whim of sentiment in what is a notoriously volatile stock market.
 

GROWTH FOUNDATIONS
– The United States, Britain and Germany unveil revised estimates of Q2 economic growth. Revised GDP figures rarely garner much attention but with initial estimates from Germany, France and Japan earlier this month all showing that these countries exited recession in the last quarter, investors will be looking for further evidence the world economy has turned the corner. The hard data is stronger now than it has been for some time but is the global economy building a solid base for recovery, or is it more likely to buckle were authorities to begin withdrawing the massive fiscal and monetary stimulus?
 

Call that a money market fund?

Attempts to tidy up the European money market funds (MMFs) sector after last year’s turmoil have stirred up a hornets’ nest, with some providers arguing that the new definitions from trade bodies IMMFA and EFAMA don’t go far enough.

2008 was a testing time for the sector which sells a promise of providing instant liquidity with a little yield. In recent years so-called enhanced or dynamic MMFs promised extra yield by investing in securities with longer dated maturities or asset-backed securities that quickly became illiquid in the credit crunch.

When investors panicked and made a run on these funds, some broke the buck – like the US’s Reserve Primary Fund, whilst others had to suspend redemptions – such as BNP Paribas’s Parvest Dynamic ABS.