MacroScope

from Global Investing:

The hryvnia is all right

The fate of Ukraine's hryvnia currency hangs by a thread. Will that thread break?

The hryvnia's crawling peg has so far held as the central bank has dipped steadily into its reserves to support it. But the reserves are dwindling and political unrest is growing. Forwards markets are therefore betting on quite a sizeable depreciation  (See graphic below from brokerage Exotix).

 

The thing to remember is that the key to avoiding a messy devaluation lies not with the central bank but with a country's households. As countless emerging market crises over decades have shown, currency crises occur when people lose trust in their currency and leadership, withdraw their savings from banks and convert them into hard currency.  That is something no central bank can fight. Now Ukraine's households hold over $50 billion in bank deposits, according to calculations by Exotix. Of this a third is in hard currency (that's without counting deposits by companies).  But despite all the ruckus there is no sign of long queues outside banks or currency exchange points, scenes familiar to emerging market watchers.

So what are the reasons?  First, households and businesses seem confident of a muddle-through scenario (this view is shared by most, though not, foreign analysts). Possibly, the optimism is based on the central bank's  track record this year on defending the hryvnia. It also seems likely that with some foreign aid (bits and bobs garnered from Russia, China and the EU) and by using the remaining reserves, Ukraine can hold it together until 2015 elections are past and the government can finally knuckle down to the rigours of an IMF aid programme.

Second, people will not find it easy to turn their backs on the 14-25 percent annual rate they can earn on their bank deposits. In smaller, lower quality banks, bank deposits might earn up to 27-28 percent a year.  Inflation meanwhile is running below zero.  David Hauner, head of EEMEA fixed income strategy at BofA-Merrill Lynch Global Research, says:

Slow motion coalition

Angela Merkel’s CDU and the centre-left SPD will begin formal coalition talks in Germany this week after a meeting of 230 senior SPD members gave the go-ahead on Sunday.

To win the vote, the SPD leadership pledged to secure 10 demands it called “non-negotiable”, including a minimum wage of 8.50 euros per hour, equal pay for men and women, greater investment in infrastructure and education, and a common strategy to boost euro zone growth.

That means thrashing out a policy slate with Merkel’s party is likely to take some time so the betting is an administration won’t be in place until late November at the earliest. SPD chairman Sigmar Gabriel said the aim was to have a functioning government by Christmas.

Euro chat resumes

After the summer lull, euro zone and EU finance ministers meet in Lithuania. The “informal Ecofin” can often be quite a big deal but with German elections only nine days away, it’s hard to see that being the case this time.

During the election campaign German Finance Minister Wolfgang Schaeuble let slip that Greece would need more outside help which would not include a haircut on Greek bonds held by euro zone governments and the ECB.

Since then, European Central Bank policymaker Luc Coene has said Athens might need two bouts of further assistance and Estonia’s prime minister told us yesterday the popular bailout fatigue he flagged as a danger last year had now faded and he was open to aiding Greece with a third bailout and helping other troubled euro zone nations too.

Fed taxonomy: Lacker is a hawk, not a bull

Not to mix too many animal metaphors but, generally speaking, monetary policy hawks also tend to bulls on the economy. That is, they are leery of keeping interest rates too low for too long because they believe growth prospects are stronger than economists foresee, and therefore could lead to higher inflation.

That is not the case, however, for Richmond Fed President Jeffrey Lacker, a vocal opponent of the central bank’s unconventional bond-buying stimulus program, particular the part of it that focuses on mortgages. He reiterated his concerns last week, saying the Fed should begin tapering in September by cutting out its mortgage bond buying altogether.

But when I asked him whether upward revisions to second quarter gross domestic product reinforced his case, Lacker was surprisingly skeptical of forecasts for a stronger performance in the second half of the year.

Brazil’s foreign reserves are not all that big

Traumatized by several currency crises in the past, Brazil has made a dedicated effort in recent years to amass $374 billion in foreign reserves as China bought mountains of its iron ore and soybeans. When the next crisis came, policymakers figured, the reserves would act as Brazil’s first line of defense.

It turns out that those reserves, which jumped from just $50 billion in 2006, may still not be large enough, Bank of America-Merrill Lynch analysts found in a report on the increased volatility in foreign exchange markets as the U.S. Federal Reserve prepares to scale back part of its monetary stimulus.

Using central bank monthly data on the stock of foreign investments in Brazil, David Beker and Claudio Irigoyen estimated that foreigners hold about $1.2 trillion in Brazil. While most ($785 billion) of that amount consists in longer-term direct investments, portfolio investments such as equities and debt still far exceed the central bank’s reserve cushion at $415 billion.

Obama’s second chance to reshape the Fed

Lost in the bizarre Yellen vs. Summers tug-of-war into which the debate over the next Federal Reserve Chairman has devolved, is the notion that President Barack Obama is getting a second shot at revamping the U.S. central bank.

The perk of a two-term president, Obama will get to appoint another three, potentially four officials to the Fed’s influential seven-member board of governors in Washington. This may buy the president some political wiggle room when it comes to his pick for Fed chair, since he might be able to placate Republicans with one or two “concession” appointments. Every Fed governor gets a permanent voting seat on the policy-setting Federal Open Market Committee.

Elizabeth Duke, the last George W. Bush appointee, is already on her way out. So is Sarah Bloom Raskin, who after a relatively short stint at the board is moving to the Treasury, to be Jack Lew’s Deputy Secretary. Then there’s the awkward suspicion that, if Obama passes up Fed Vice Chair Janet Yellen, by far the favorite for the top spot, she will also step down after a long career in the Federal Reserve system, including many years as head of the San Francisco Fed.

St. Louis blues: Fed’s Bullard gets a sentence

Ellen Freilich contributed to this post

Talk about getting a word in edgewise. St. Louis Federal Reserve Bank President James Bullard got almost a full sentence in the central bank’s prized policy statement.

Some background: Bullard dissented at the Fed’s June meeting, arguing that, “to maintain credibility, the Committee must defend its inflation target when inflation is below target as well as when it is above target.” The latest inflation figures show the Fed’s preferred measure at 0.8 percent, less than half the central bank’s target.

Fast-forward to yesterday’s policy statement, which included the following new language:

Turkey and Hungary – tales of unorthodoxy

A big moment for Turkey. After desperate attempts to shore up the lira by burning through its reserves, the central bank must decide whether to raise interest rates instead.

Prime Minister Tayyip Erdogan, fearing an economic slowdown ahead of elections next year, will not want to see a sharp tightening of policy. Instead, he is blaming shadowy forces for his country’s plight.
But a rate rise might be what is required to prevent a full run on the currency and if that is the case, the earlier it is done the better to calm investor nerves. The central bank sent a strong signal last week that it was minded to push up at least some of its key rates regardless of the political pressure.

The odds are on it raising the overnight lending rate by something between 50 and 150 basis points even though testimony by Federal Reserve chairman Ben Bernanke last week has calmed markets about the speed and scale of U.S. withdrawal of stimulus and allowed emerging markets, including Turkey’s, to settle down somewhat.

Turkish trouble

How much time does massive central bank currency intervention buy? About a day at a time in Turkey’s case. It spent $1.3 billion of its reserves yesterday to stop the lira going into freefall having thrown a record $2.25 billion at the market on Monday.

So far this year, the central bank has burned over $6 billion of its reserves which have now dropped below $40 billion. So that can’t go on for long, meaning an interest rate rise which a slowing economy really doesn’t need must be on the cards. The lira hit a record low versus the dollar on Monday.

Much of this is to do with the global emerging market sell-off sparked by the Federal Reserve’s exit plan from money-printing but Ankara has sown the seeds of crisis too, first with the very public standoff with protesters in its main cities who railed against what they see as Prime Minister Tayyip Erdogan’s increasingly authoritarian rule.

Small rays of hope brightened Canada’s economic outlook last week

 All data released last week point to a far better first quarter growth in Canada than previously expected, prompting economists to revise up their predictions.

In a Reuters poll conducted early last month, forecasters predicted that Canada’s economy expanded by just 1.6 percent on an annualised basis in the first three months of this year.

But that consensus could prove to be too low, with many now expecting growth to be close to 2 percent or even higher, likely a welcome sign for Stephen Poloz who was named Bank of Canada’s new governor last Thursday and will replace Mark Carney on June 3.