MacroScope

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.

Real exchange rates in Latin America are now stronger than those required to promote economic development, reducing corporate earnings in export-oriented sectors intensive in labor, say the authors, adding: “There are in fact some hints indicating that tradable profit squeeze is negatively affecting the performance of manufacturing activities in Latin America”.

Frenkel and Rapetti focus on Brazil, where a currency appreciation trend that began in mid-2004 was followed by a relative worsening in industrial exports and value added since late 2005. “The case of the Brazilian manufacturing sector illustrates what in our view is the main threat that Latin American countries are currently facing with the sustained real exchange rate appreciation”, says the paper.

Krugman’s legacy: Fed gets over fear of commitment

Jonathan Spicer contributed to this post

An important part of the Federal Reserve’s recent decision to embark on an open-ended quantitative easing program was a fresh indication that the central bank will leave rates low even as the recovery gains steam. According to the September policy statement:

To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.

Just why does the Fed believe promising to keep policy stimulus in place for a long time might help struggling economies recovery? Mike Feroli, chief U.S.economist and resident Fed watcher at JP Morgan, traces the first inklings of the idea to the work of Paul Krugman, the Nobel-prize winning economist and New York Times columnist.

Olympics provided gold for Team GB, but not the economy

Britain’s Olympic and Paralympic teams may have brought home more medals than organisers had dreamed possible but the Games themselves have probably failed to lift the economy as much as the government had hoped.

The country’s gross domestic product will grow 0.6 percent in the current quarter, according to the latest Reuters poll, revised down from a 0.7 percent prediction in an August poll.

That is enough to drag Britain out of its second recession in four years but most of the bounceback is from an extra working day and better weather in the quarter.

Weak manufacturing orders tend to precede U.S. recessions

U.S. manufacturing activity shrank for a second straight month in July as recent economic weakness spilled into the third quarter, according to the Institute for Supply Management’s closely watched index. But that wasn’t the worst of it: new orders, a gauge of future business activity, also shrank for a second month, albeit at a slightly slower pace.

Tom Porcelli at RBC explains why the status quo may not be good enough to keep the economy expanding:

The historical record back to 1955 suggests a rather ominous outcome when ISM new orders remain at 48 or less for two straight months. In fully 75% of those instances we were hurtling toward recession. The recent headfakes occurred in 1995 during the mid-cycle slowdown and in 2003 shortly after the recession ended and when the housing boom was in its infancy. Our call remains that we’ll (barely) skirt a recession but with evidence mounting that the economic headwinds are placing significant downward pressure on economic output, we find it striking that forecasters – as bearish as we’ve been told they are – still expect growth to average 2.2% in the second half of the year.

Euro zone may struggle with its own Lost Decade

Additional Reporting by Andy Bruce and polling by Rahul Karunakar and Sumanta Dey.

As Europe’s crisis drags on, the prospect of a Japanese-style lost decade of economic malaise is becoming increasingly real, according to a new poll. Half of the bond strategists and economists surveyed by Reuters are now expecting just such an outcome.

Many market participants have dismissed the fall of two-year German bond yields below their Japanese counterparts as being merely a result of a crisis-fueled flight to quality bid. Two-year German yields are now close to zero, offering returns of only 0.02 percent. By contrast, equivalent Japanese bonds are yielding 0.11 percent.

Shifting euro zone sands

A telling moment. Before pretty much every showdown EU summit since the debt crisis exploded into life, the leaders of France and Germany have got together beforehand to agree a common strategy. It is a truism that the European motor only works efficiently when its two biggest powers are in accord.

This time, following the election of Francois Hollande as French president, there has been no such meeting. Instead he will talk with Spanish premier Mariano Rajoy in Paris before they head to the Brussels summit.
There, Hollande will press for the currency bloc to start issuing joint euro zone bonds and will run into implacable German opposition that will squash the plan for now.
But the plates are shifting and German Chancellor Angela Merkel looks somewhat isolated.

On euro bonds, Hollande can call on the support of Italy’s Mario Monti and the European Commission among others.
Nonetheless, Angela holds the purse strings so while we will see some modest pro-growth measures agreed (and no doubt trumpeted), there will be no pump-priming that requires extra deficit spending, certainly no mutualising of debt and probably no hint that the likes of Greece and Spain will be given longer to make the cuts demanded of them (though that policy’s time could soon come, depending on how the June 17 Greek elections go).

Euro election fever

We will return on Monday knowing whether the Greeks have elected a pro-bailout government and probably to find socialist Francois Hollande – the man leading the growth strategy charge – as the new French president. 

An Hollande victory could cause some jitters given his rhetoric about the world of finance. But we’ve looked at this pretty forensically and there may not be much to scare the horses. Yes he is making growth a priority (but even the IMF is saying that’s a good idea) yet his only fiscal shift is to aim to balance the budget a year later than incumbent Nicolas Sarkozy would. Contrary to some reports, he is not intent on ripping up the EU’s fiscal pact and of course the bond market will only allow so much leeway.

The heavyweight Economist magazine may have labelled socialist Hollande “dangerous” but the reality is likely to be that he will rule from the centre and his demands for a dash for growth — and a change to the ECB’s mandate to aid it — will be tempered. Spain has shown everybody that too much fiscal loosening will be pounced upon by the bond market and while there is a lot of talk about a growth strategy for Europe, what we’ve heard so far amounts to tinkering.

“There are human beings involved” in austerity debate

The inventors of democracy and its greatest 18th century champions both go to the polls this weekend. Greek and French voters will try to elect governments they hope will help release their economies from the grips of the euro zone debt crisis.

While exercising their democratic vote, Europeans will also be contemplating another key issue: their basic economic survival.

That is why the debate about austerity versus growth has become so important.

Financial markets see fiscal discipline as crucial to get the euro zone’s debt burden back to sustainable levels. They are going into the Greek elections favoring triple-A rated bonds over peripheral counterparts.

Europe in recession – an interactive map

Spain has become the latest European country to slip into recession joining the Belgium, Cyprus, The Czech Republic, Denmark, Greece, Italy, The Netherlands, Ireland, Portugal, Slovenia and the United Kingdom.

Click here to view an interactive map.

*Updated to include Romania and Bulgaria

 

Euro zone goes Dutch

So the euro zone debt crisis morphs again and there is a hint of schadenfreude about the Dutch, who lectured and hectored the Greeks, now falling into the same mire.

The Dutch premier, Mark Rutte, will probably try to cobble together an unholy alliance in parliament in order to meet an April 30 EU deadline for it to present budget plans for the next year. But with elections not until late June at the earliest, there will be an unnerving period of vacuum for the markets and no guarantee that opposition parties will play ball and allow a budget to be put together.

Given all that, today’s Dutch bond auction, not normally a cause for alarm or excitement, is thrown into sharp relief. Expect yields to spiral although the small amount on offer means the paper will be sold. Italy is selling zero-coupon and inflation-linked bonds while Spain,  which remains front and centre despite the Netherlands’ travails, will probably see borrowing costs double when it sells up to 2 billion euros of 3- and 6-month treasury bills. Spanish 10-year yields poked above the pivotal 6 percent level again yesterday as the Dutch government collapse rocked markets. The Bank of Spain confirmed on Monday that a new recession has taken hold.