MacroScope

A week before emerging-market turmoil, a prescient exchange on just how much the Fed cares

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The last seven days has been a glaring example of fallout from the cross-border carry trade. That’s the sort of trade, well known in currency markets, where investors borrow funds in low-rate countries and invest them in higher-rate ones. Some $4 trillion is estimated to have flooded into emerging markets since the 2008 financial crisis to profit off the ultra accommodate policies of the U.S. Federal Reserve, Bank of Japan, European Central Bank and the Bank of England. Now that central banks in developed economies are looking to reverse course and eventually raise rates, that carry trade is unraveling fast, resulting in the brutal sell-off in emerging markets such as Turkey and Argentina over the last week.

The Fed’s decision on Wednesday to keep cutting its stimulus effectively ignores the turmoil in such developing countries. And while the Fed may well be right not to overreact, it makes one wonder just how much attention major central banks pay to the carry trade and its global effects — and it brings to mind a prescient exchange between some of the brightest lights of western economics, just a week before emerging markets were to run off the rails.

On January 16, minutes before Ben Bernanke took the stage for his last public comments as Fed chairman, the Brookings Institution in Washington held a panel discussion featuring former BoE Deputy Governor Paul Tucker, Harvard University professor Martin Feldstein and San Francisco Fed President John Williams. They were asked about the global effects of U.S. monetary policy:

Williams:

“These countries have been affected, no question, affected in a major and important ways by these flows and have adapted their policies and their approaches to better insulate them from some of those effects… That said, at the end of the day, we live in a modern and global financial system.. Monetary policy in the U.S. obviously has effects outside the U.S. and we need to study those, we need to understand those, and we need to coordinate or communicate more effectively with our colleagues around the world.”

Feldstein:

“The only thing I would add is that the Fed doesn’t take those effects on other countries into account.”

China at a crossroads on yuan internationalization project

As China marks the third anniversary of the first ever bond sale by a foreign company denominated in renminbi, questions are rife on what lies next for the offshore yuan market.

Since hamburger chain McDonalds sold $29 million of bonds on a summer evening just over three years ago, China’s yuan internationalization project has notched up impressive milestones.More than 12 percent of China’s trade is now denominated in yuan from less than 1 percent three years ago, Hong Kong – the vanguard of the offshore yuan movement – has more than one trillion yuan of assets in bank deposits and bonds and central banks from Nigeria to Australia have added a slice of yuan to their foreign exchange reserves.

China’s aim to internationalize the yuan has two major objectives: One, to ensure that its companies do not have to shoulder the foreign exchange risk of swapping yuan into dollars in global trade. The second is that as China gradually makes the transition from a current account surplus nation to a deficit country, it would, like the United States, want its debt to be denominated in its own currency.

Latin America: the risks of being too attractive

Ironically, an increase of capital inflows to Latin America in the last few years due to unappealing ultralow yields in industrialized countries and the region’s relative economic success is posing a threat for development, according to a recent paper that provides wider background to BRIC criticism of the latest U.S. Federal Reserve´s quantitative easing.

The article, written by Argentine economists Roberto Frenkel and Martin Rapetti for the World Economic Review – an international journal of heterodox economics –  warns about the possibility of a Latin American variant of the so-called “Dutch Disease”. This is a situation where a country suddenly finds a new source of wealth that makes its currency more expensive, hurting local exports and causing traumatic de-industrialization.

“Our concern is that massive capital inflows to Latin America may have pernicious effects via an excessive appreciation of the real exchange rates, which could lead to a contraction in output and employment in tradable activities with negative effects on long-run growth”, says the paper.

When the euro shorts take off

Currency speculators boosted bets against the euro to a record high in the latest week of data (to end December 27) and built up the biggest long dollar position since mid-2010, according to the Commodity Futures Trading Commission. Here — courtesy of Reuters’ graphics whiz Scott Barber, is what happens to the euro when shorts build up:



from Global Investing:

Euro exit-ology

Whether or not it's likely or even a good idea, talk of Greece leaving the euro is no longer taboo in either financial or political circles.  What is more, anxiety over the future of the  single currency has reached such a pitch since the infection of the giant Italian bond market that there are many investors talking openly of an unraveling of the entire bloc. But against such an amplified "tail risk",  it's remarkable how stable world financial markets have been over the past few turbulent weeks -- at least outside the ailing sovereign debt markets in question.

Yet, focussing on the possible consequences for Greece of bankruptcy and euro exit has now become an inevitable part of investment reseach and analysis. In a note to clients on Tuesday entitled "Breaking Up is Hard to Do", Bank of New York Mellon strategist Simon Derrick sketched some of the issues.

One issue he pointed out,  and one raised in the September Spiegel online report, was the chance of invoking Article 143 of the Treaty on the Functioning of the European Union, which permits certain countries to "take protective measures" and which could be used to allow restrictions on the movement of capital in order to prevent a flight of capital abroad.

from Amplifications:

Why the euro needs to fall

By Kenneth Rogoff
The opinions expressed are his own.

Although I appreciate that exchange rates are never easy to explain or understand, I find today’s relatively robust value for the euro somewhat mysterious. Do the gnomes of currency markets seriously believe that the eurozone governments’ latest “comprehensive package” to save the euro will hold up for more than a few months?

The new plan relies on a questionable mix of dubious financial-engineering gimmicks and vague promises of modest Asian funding. Even the best part of the plan, the proposed (but not really agreed) 50% haircut for private-sector holders of Greek sovereign debt, is not sufficient to stabilize that country’s profound debt and growth problems.

So how is it that the euro is trading at a 40% premium to the US dollar, even as investors continue to view southern European government debt with great skepticism? I can think of one very good reason why the euro needs to fall, and six not-so-convincing reasons why it should remain stable or appreciate. Let’s begin with why the euro needs to fall.

from Jeremy Gaunt:

When things stagnate

Goldman Sachs researchers have been hitting the history books again, trying to divine what happens to currencies when economies stagnate. Answer:  Not as much as you might think

Looking at exchange rates for years before and during "stagnation", Goldman found that year-to-year FX volatility in such periods is lower than in normal periods. But a lot of it depends on the type of stagnation.

First, an average stagnation -- a period of sub-par economic growth lasting for at least six years:

from Jeremy Gaunt:

#ThingsStrongerThanTheKenyaShilling

Twitter does have some very strange Trends. These are the things that appear on the right-hand side of the page that show what people are talking about. They more they talk, the more likely it is that something will get listed.  More often than not they are about celebrities such as Justin Bieber.

But today's Worldwide  Trends was particularly unusual.

#ThingsStrongerThanTheKenyaShilling was right up there near the top.

As the graph here shows, the shilling has taken a heavy beating since the Lehman Brother collapse. This is one reason for the Twitter outburst.  "Kenyans are getting fed up," said @oreo_junkie, whose Twitter feed states it is from Nairobi.

And judging by some of the other "answers" to the trendline, it is not a matter for levity in Kenya. "Government's resolve to fight Corruption" was one;  "Stupidity of Kenyans to  reelect the same MPs" was another.

APEC’s robots stealing the show

robot

A guide at the “Japanese Experience” exhibition talks to Miim, the Karaoke pal robot, on the sidelines of the APEC meetings in Yokohama, Japan on Nov. 10. REUTERS/Yuriko Nakao

    Miim is one of the more popular delegates at the APEC meetings in Yokohama Japan. She sings. She dances. She tosses her shoulder length hair. She may not be able to spout an alphabet soup of APEC acronyms like the other Asia-Pacific delegates. But she’s still pretty lively. For a robot.

    This week’s meetings of the Asia-Pacific Economic Cooperation forum have been earnest and most comprehensive . Foreign and trade ministers issued a 20-page statement about all the things they talked about — a giant free trade zone, protectionism, the Doha round, easing restrictions on businesses, simplifying customs procedures, promoting green industries, cooperating on health and security, you name it. They also have been, and pardon my French here, excruciatingly dull. So far, the meetings and their stupefying statements have been a testimonial to Japan’s skill at stating the ambiguous. Call it the opaque meetings. Journalists from around the Pacific rim have been desperately trying to find news as the 21 APEC leaders gather for their annual pow-wow this weekend.

Giant FX market now $4 trillion gorilla

Global foreign exchange has always been one of the biggest markets in the world but its exponential growth keeps accelerating. The triennial survey by the Bank for International Settlements shows global foreign exchange market turnover leapt 20 percent to $4 trillion, compared with $3.3 trillion three years ago.

FXBIS

The increase in turnover was driven by growth in spot transactions, which represent 37 percent of FX market turnover.  Turnover was driven by trading activity by “other financial institutions” — a category that includes hedge funds, pension funds and central banks, extending a trend seen in the past several years where buyside firms are increasingly trading currencies themselves, via prime brokerage, rather than turning to interbank dealers.

Also notably, emerging market currencies are gradually increasing their share in the marketplace. Turnover of the Russian rouble has increased its share in total turnover to 0.9 percent of 200 percent (FX is double counted as transaction involves two currencies), up from 0.7 percent three years ago, while the Brazilian real rose to 0.7 percent from 0.4 percent. The Indian rupee’s share rose to 0.9 percent from 0.7 percent. The dollar keeps its dominance, although off its 2001 peak, with its share standing at 84.9 percent.