MacroScope

from Global Investing:

If China catches a cold…

China has defied predictions of a hard economic landing for some time now so it is somewhat unsettling to see  investors positioning for a sharp slowdown in the world's second-largest economy.

Over the last 10 years, the world has become accustomed to Chinese annual GDP growth of above 9 percent. A seemingly insatiable demand for commodities from soya beans to iron ore has catapulted the Asian giant to near the top of the global trade table. China is the biggest trading partner for countries on nearly every continent, from Angola to Australia.

But many are now fretting that an unhappy coincidence between stuttering global demand and domestic strains in the property and banking sectors could knock Chinese growth to below 7 percent (the level commonly identified as a 'hard landing'), with grave implications for the rest of the world.

"It used to be the case that if the US sneezes, the rest of the world catches a cold. But with the US already confined to the emergency room since 2008 thequestion is what happens if China catches a cold," says Citi in a recent report.

Many are now preparing for the first sneeze.

Commodity exporters are expected to bear the brunt of a sharp Chinese slowdown. Investors have pared back exposure to Brazil, Russia, Chile and South Africa, citing fears over China.

Bernanke and bank rules: lessons sort of learned

Fed Chairman Ben Bernanke on Wednesday gave a speech on the lessons about sustained growth that can be gleaned from the experience of emerging markets. Bernanke said not all of the “Washington consensus” policies pushed by multilateral lenders in the 1990s had proven fruitful. In particular, he said the Asian financial crisis showed the risks of opening up financial markets to foreign capital flows until a country has implemented measures to strengthen banks and regulation.

Yet Bernanke missed an opportunity to link his speech back to the recent experience of the United States. For while his message was tailored for the developing world, he may as well have been describing the U.S. banking sector in the run-up to the 2008-2009 financial crisis:

Dismantling controls on the domestic financial industry has proven counterproductive when important complementary factors — such as effective bank supervision … were absent.

from Global Investing:

Emerging consumers’ pain to spell gains for stocks in staples

Food and electricity bills are high. The cost of filling up at the petrol station isn't coming down much either. The U.S. economy is in trouble and suddenly the job isn't as secure as it seemed. Maybe that designer handbag and new car aren't such good ideas after all.

That's the kind of decision millions of middle class consumers in developing countries are facing these days. That's bad news for purveyors of everything from jeans to iphones  who have enjoyed double-digit profits thanks to booming sales in emerging markets.

Brazil is the best example of how emerging market consumers are tightening their belts. Thanks to their spending splurge earlier this decade, Brazilian consumers on average see a quarter of their income disappear these days on debt repayments. People's credit card bills can carry interest rates of up to 45 percent. The central bank is so worried about the growth outlook it stunned markets with a cut in interest rates this week even though inflation is running well above target

The thin line between love and hate

The opinion on Turkey’s unorthodox monetary policy mix is turning as rapidly as global growth forecasts are being revised down.

Earlier this month, its central bank was the object of much finger-wagging after it defied market fears over an overheating economy by cutting its policy rate. It defended the move, arguing that weaker global demand posed a greater risk than inflationary pressures.

Investors were not persuaded. When I told one analyst about the Turkish rate move, he practically sputtered down the phone: “You’re not kidding?!”

Don’t fight the Turkish central bank

Stop fighting the Turkish central bank. Since a shock interest rate cut earlier this month, the front end of Turkey’s bond yield curve has collapsed over 80 basis points, with two-year yields hitting seven-month lows of 7.84 percent. The curve is flattening as the 10-year sector starts feeling the heat as well. Whether it reflects investors’ faith in the central bank’s ability to safeguard economic growth while bringing down a record wide current account gap is another matter altogether. Bond investors have in fact been uneasy with the central bank’s experiments, fearing that overly loose monetary policy will cause an inflation shock down the road. But with more rate cuts clearly on the cards, investors are finding that Turkish rates, especially at the front end, are too attractive to miss. Especially as the central bank is shoring up the lira with daily dollar sales.

“Its difficult to go against the central bank. It’s been six months of mixed policy and finally international investors are getting the message,” says Luis Costa, head of CEEMEA currency and debt strategy at Citi. “Logically you should be paying long-end rates but it’s a challenging environment for that as the central bank bank is forcing the curve to be extremely flat.”
Markets are now pricing in another interest rate cut next week. How will markets react? The difference from the surprise rate cut on Aug. 3  is that other emerging central banks, fearful of a growth collapse, also now appear to be gearing up for policy easing. A dimming euro zone outlook means a poor outlook for exports from Turkey and other emerging markets. “There’s some realisation that the Turkish central bank may not be all that wrong,” says Zsolt Papp, who helps manage Swiss private bank UBP‘s emerging debt portfolio.

Investors have in fact realised Turkey is not overly concerned about inflation and that allows it more room to ease policy, Papp says, adding the moves in the Turkish curve indicate that is being priced in. Citi’s Costa agrees. “Policy is now clearly being driven by growth and that’s a massive game changer.”

Emerging markets: Soft patch or recession?

Could the dreaded R word come back to haunt the developing world? A study by Goldman Sachs shows how differently financial markets and surveys are assessing the possibility of a recession in emerging markets.
One part of the Goldman study comprising survey-based leading indicators saw the probability of recession as very low across central and eastern Europe, Middle East and Africa. These give a picture of where each economy currently stands in the cycle. This model found risks to be highest in Turkey and South Africa, with a 38-40 percent possibility of recession in these countries.
On the other hand, financial markets, which have sold off sharply over the past month, signalled a more pessimistic outcome. Goldman says these indicators forecast a 67 percent probability of recession in the Czech Republic and 58 percent in Israel, followed by Poland and Turkey. Unlike the survey, financial data were more positive on South Africa than the others, seeing a relatively low 32 percent recession risk.
Goldman analysts say the recession probabilities signalled by the survey-based indicator jell with its own forecasts of a soft patch followed by a broad sustained recovery for CEEMEA economies.
“The slowdown signalled by the financial indicators appears to go beyond the ‘soft patch’ that we are currently forecasting,” Goldman says, adding: “The key question now is whether or not the market has gone too far in pricing in a more serious economic downturn.”

Hungary’s central bank in policy bind

Pity Hungary’s central bank. If ever there was a country that needed an interest rate cut, here it is.  With the euro zone in the doldrums, the Hungarian economy is taking a big hit, with April-June growth coming in at a measly 1.5 percent on an annual basis, well below expectations. Quarter-on-quarter growth was in fact zero. Data last week showed annual inflation at two-year lows last month. Despite a cut to personal income tax rates this year, household consumption is stagnating. Unemployment is running at 11 percent. 

Yet the central bank’s hands are tied. A rate cut would weaken the forint currency and that would hurt the Hungarian families, municipalities and companies that are struggling with tens of billions of dollars in Swiss franc-denominated loans. The surging franc has already lopped half a percent off  Hungarian growth this year as families cut back on consumption to keep up loan repayments, Nomura analysts calculate. Another reason Hungary cannot really afford a weaker forint at this stage is its dependance on imports — they make up some 75 percent of GDP, far higher than in neighbouring Poland, says Neil Shearing at Capital Economics

Bond markets are betting on a rate cut — swaps are pricing in a half point cut over the next year. But will the central bank bite the bullet any time soon? ING Bank analysts think not. Hungary could need the protection of high interest rates in event of a global market selloff, they note. Hence the bank can afford to cut rates only next year. Shearing of Capital Economics agrees: “The central bank is in a bind. Provided the euro zone doesn’t melt down, there could be room for one or two rate cuts next year but at the moment its hands are tied by the currency issue.”

from Global Investing:

Counting the costs of Hungary’s Swiss franc debt

The debt crises in the euro zone and United States are claiming some innocent bystanders. Investors fleeing for the safety of the Swiss franc have ratcheted up pressure on Hungary, where thousands of households have watched with horror as the  franc surges to successive record highs against their own forint currency. In the boom years before 2008,  mortgages and car loans in Swiss francs seemed like a good idea --after all the forint was strong and Swiss interest rates, unlike those in Hungary, were low.  But the forint then was worth 155-160 per franc. Now it is at a record low 260 -- and falling -- making it increasingly painful to keep up repayments. Swiss franc debt exposure amounts to almost a fifth of Hungary's GDP. And that is before counting loans taken out by companies and municipalities.

Hungarian families could get some relief in coming months via a government plan that caps the exchange rate for mortgage repayments at 180 forints until the end of 2014.  But the difference will have to be paid -- with interest -- from 2015.  Meanwhile, the issue threatens to bring down Hungary's banks which must pick up the cost in the meantime and will almost certaintly see a rise in bad loans --  no wonder shares in Hungary's biggest bank OTP are down 25 percent this month.  "(The franc rise) suggests a massive jump on banks' refinancing requirements going forward, " says Citi analyst  Luis Costa.

These overburdened banks will end up cutting lending to businesses, meaning a further hit to Hungary's already anaemic economic growth. ING analysts earlier this month advised clients to steer clear of Hungarian shares, "given the burden from (forint/franc) depreciation not only on loan-takers but also the implications this has for the domestic growth story."

Give me liberty and give me cash!

Come back Mr Fukuyama, all is forgiven.

In his 1992 book “The End of History and the Last Man”, American political scientist Francis Fukuyama famously argued that all states were moving inexorably towards liberal democracy. His thesis that democracy is the pinnacle of political evolution has since been challenged by the violent eruption of radical Islam as well as the economic success of authoritarian countries such as China and Russia.

Now a study by Russian investment bank Renaissance Capital into the link between economic wealth and democracy seems to back Fukuyama.

Looking at 150 countries and over 60 years of history, RenCap found that countries are likely to become more democratic as they enjoyed rising levels of income with democracy virtually ‘immortal’ in countries with a GDP per capita above $10,000.

The iPod – the iCon of Chinese capitalism

Walking past Apple’s sleek shop along London’s Regent Street on Sunday, my wife asked me what I wanted for Father’s Day.

“An iPad?” I ventured, half-jokingly.

“Are you sure you want one? Don’t you care how they’re made?” came her disapproving reply.

She was, of course, referring to the rash of suicides among Chinese workers at Foxconn, the Taiwanese manufacturer of Apple’s much desired iPads and iPhones.