Tag Archives: emerging markets

Stagflation in Emerging markets and is the Fed responsible?

So far, there has been a lot of turbulence in global markets surrounding a few interesting developments.  For the past few months, investors have felt that there was a possibility that US stocks  were overvalued and as a result switched to safer assets.  While the effects have been somewhat worrisome, it is an understandable position considering that several market analysts have felt this way about the market.  This might however not be the biggest concern that the US economy may face in the near future.

A few days before the FOMC announced their intention to cut an additional $10 billion from its asset purchasing program, the Turkish and South African central banks aggressively raised short-term interest rates.  On January 28th, Turkey raised their one-week lending rate from 4.5% (pretty reasonable for an emerging market) to a staggering 10% overnight.  While this was a very strong move by the Turkish central bank, it is certainly not the first to occur in a developing economy.  The article also references how India raised their interest rates unexpectedly, albeit the rate increase was not as drastic.

The key question to ask is why is all of this happening, and more importantly why is it happening now?  The current pattern for emerging markets is that while they all experienced very high rates of growth, continuing despite the worldwide financial crisis, they have also had high levels of inflation.  Inflation though was not considered problematic until 2012.  To use Turkey as an example, growth was an impressive 8.9% in 2011 but that dropped sharply in 2012 to 2.2%.  A similar situation has occurred in Brazil where growth slowed down dramatically but inflation continued to persist and as a result their central bank raised rates to 9%.  High inflation and slow growth was commonly associated with most of the Western World back in the 1970s as industrial sectors slowed down and the current situation in emerging markets looks to be taking that shape. In fact Euromoney and the Royal Bank of Scotland believe that Brazil risks falling into stagflation given their current economic symptoms of slow growth, high inflation, and resulting high interest rates threatening to derail a system that was geared towards enhancing consumer growth.  They surmise that there needs to be more of a push towards investment as opposed to consumption.  The same can be said of several emerging markets who are struggling, including Turkey, South Africa, and India.  The only real cure to stagflation is a pretty bad trade-off between maintaining growth or curbing inflation at growth’s expense.

So how does the Fed come into this?  Analysts believe that the Fed took an “Emerging Markets be damned” stance as they decided to cut an additional $10 billion from their asset purchases; however, the Fed cannot really be blamed for the slowdown and high inflation.  Their job isn’t to respond solely to market chatter or global turmoil.  Unless it immediately falls into the context of the dual mandate, the Fed would not have considered these effects.  Besides, the only apparent link between the Fed’s recent monetary policy decisions and emerging markets was when QE3 was in full-effect.  In that case, emerging markets would have seen their export sectors suffer a little; however, as indicated above, the problems in emerging markets are of much greater concern than exporting based on an exchange rate. Inflation appears to be here to stay in emerging markets and how they deal with it is out of the Fed’s control.

The Pain QE Tapering Can Cause: First Emerging Markets, Now Developed Economies

In my most recent post I discussed the effects the Fed’s QE tapering would have on emerging markets, specifically Russia. Tapering has really hurt EMs as yield-seeking investors moved their money from relatively high-risk investments in emerging markets to less volatile assets such as U.S. treasury bonds. It’s also worth noting that lots of the negative EM buzz has been fueled by doubts in the speed of the growth of the largest emerging market– China (more on that a bit later).

As it turns out, though, EMs aren’t the only ones hurting. The suffering has spread to developed nations as well. Many developed nations’ currencies have been hit hard:

Early in the day, the Canadian dollar hit a 4 1/2-year low of 1.1225 Canadian dollars to the U.S. currency, though it later recovered in late New York trading to C$1.1130. The euro slumped to $1.3479 intraday, its lowest since November, while the Norwegian krone traded above 6.3 to the dollar for the first time since 2010, and traded at 6.2793 per U.S. dollar late in New York. The greenback rose more than 1% against the New Zealand dollar to US$0.8086 and was up 0.5% against the Australian dollar at US $0.8756.”

It’s strange to see developed nations, especially countries like Norway and Australia, who have had stable, positive GDP growth (both hovering around 2-3%) in the past decade, experience such a hit. The reason lies in the fact that developed economies like Norway and Australia depend on commodities exports. With investors questioning China’s ability to keep growing at the double-digit rates it has in the past, investors fear that the demand “for Norway’s oil, Australia’s iron ore, and New Zealand’s dairy products” will be weakened.

The euro has seen better times as well, falling to its lowest rate against the dollar since November. And with the ECB planning to highten QE measures, U.S. bonds are looking more and more attractive even to proud European investors.

All this investor doubt is causing capital to flow into safe havens like the U.S. and Japan, but my prediction is that this flow is only a temporary happening. The buzz and speculation the Fed’s announcements create cause investors to become over-paranoid about the riskiness of their investments abroad. I think that after some of the media attention subsides, investors will start to realize that the dollar and other safe haven currencies are overvalued, causing capital to flow back out to emerging markets. It may not be in the amounts that were there originally, but at least some of the damage will be undone.

Damn Taper, You Scary! Or: Coordination Problems in International Finance

So we’ve all been dissecting the Fed’s decision to continue to taper, and why that might or might not be justified. I don’t think I have much to add on that front. Yes, a lot of work remains to be done; GDP is on the rise while unemployment is still high. And that makes tapering less attractive. However, if the Fed is extraordinarily concerned about unwinding the assets it acquired under QE too quickly and causing distortions and bubbles, it might be doing the right thing. Or rather, it might be doing the rational thing given its beliefs (that unwinding will be really difficult, for example).

I’d say if that’s the case, the Fed is being overly cautious, because it has the tools to stop the economy from overheating (and there’s no special case analogous to the ZLB in that direction). And if anyone doubts whether interest rate hikes are effective: ask the Turkish (also a great argument for having an independent central bank, by the way). Still, drastic increases in interest rates are never fun. Also, don’t forget that there are others who are tasked with promoting US economic performance and national welfare. While you can argue that monetary policy is easier to implement than fiscal policy (and avoids the political economy problem of reducing spending in booms), it’s not the only tool in the shed (although it may often be the sharpest). Reducing unemployment while GDP is rising may require a more hands-on approach than monetary policy. Especially interesting is that the US will retain a federal funds rate at or near zero for the foreseeable future; some would argue that this makes fiscal policy extremely effective (and efficient).

What I mainly wanted to talk about is the Fed’s impact on emerging markets. As mentioned above, Turkey, South Africa, India and a few others are seeing major impacts on their exchange rates. Yes, those economies will face increased capital outflows. However, a lot of them are already net capital exporters. Which means that they aren’t dependent on foreign capital (or at least that there’s some leeway).

By the way, it’s not as though any of the economic fundamentals of these places changed overnight. If you thought that they looked strong before the Fed announced that it would taper, there’s no reason you should suddenly change your mind and conclude that actually, those countries look really unsafe. I know that won’t stop investors from going all-out animal-spirits-herd-behavior bonkers, and that might spell trouble indeed. I am in fact a little worried about how much weight people are putting on the reactions of our oh-so-efficient stock markets to the tapering. The WSJ predicts havoc of biblical proportions. That kind of irrational fear and irrational belief in “as goes January, so goes the year” is a real issue, and a blind (sun-)spot for many economists. So yes, if everybody in the market coordinates on believing that the emerging markets are all going down the drain and that everybody needs to pull their money out as quickly as possible, that’s what’s gonna happen. It’s also avoidable, and a grade A example for collective stupidity.

But maybe, just maybe, investors can decide to stay calm. Here’s an interesting idea: what if the Fed tapered because it’s afraid that safely unwinding its assets will be really, really hard (as I asserted above). Then it’ll unwind those assets very slowly, to mitigate whatever negative effects it believes unwinding will have. In that case, it’s pretty obvious that emerging markets will get a chance to gradually adjust to the new global equilibrium that persists without QE. At the same time, that makes whatever horror stories investors are coming up with about how everything’s doomed a lot less credible. So in that case, emerging markets may still be worse off than if QE had simply continued, but they’ll certainly not be doing as badly as some people now predict they will.

In essence, I see this as a classic multiple-equilibria-coordination-problem story. There’s one equilibrium where financial markets go nuts and we have huge capital shifts in a very short time, with unclear consequences for everybody involved (including the US). Or, they manage to be collectively reasonable about this (as opposed to just individually rational), and we get a slow, gradual change and a much better equilibrium outcome.

Which is more likely? I believe that people, in general, have a tendency to be reasonable, albeit sometimes they have difficulties realizing that. That probably holds even for investment bankers, who, after all, are really smart people (or so I’m told). So I think there’s a good chance that they can keep it together, and we can all leave this taper behind us and focus on the ongoing problems we’re still facing. If that’s not what happens, well… at least we’ll get some good data for papers in international finance (and some behavioral economics, too).

Fed Ignore Emerging Market Slump

The Federal Reserve followed expectations on Wednesday and voted unanimously to taper the current quantitative easing scheme, from $75 billion in January to $65 billion in February.  The Fed also extended their reverse repo experiment at the New York Fed and reiterated their commitment to short term interest rates being zero for the near future.  Although these policy actions were in line with expectation, some had been calling for the Fed to halt tapering to prevent the current crisis in foreign markets from getting any worse; however, the Fed ignored the current slump in foreign markets, highlighted by the weakening Turkish lira and South African rand.

A weakened currency hypothetically should help the net exports of these emerging markets by making the products cheaper to foreign buyers.  However, a weakening currency also make foreign debts larger in terms of domestic currency, and thus harder to pay.

Although the slump was certainly a complex mix of many factors, the planned reduction in quantitative easing is being blamed as a factor for the capital outflows from emerging markets.  The idea behind these claims is that as the government reduces the amount of stimulus through QE, investors will have higher available profits in the domestic markets, because the government won’t be driving up prices as steeply.  Thus, investors will take money out of the the riskier emerging markets to the more stable returns of the domestic market.

By continuing with the intended tapering policy, the Fed made a decision not to consider the potential adverse effects of their decision on foreign markets.  In fact, “Fed officials made no mention of these trends in the statement released Wednesday.”  In recent years, this has been the general strategy of the Fed, with chairman Ben Bernanke stating in 2011, “It’s really up to emerging markets to find appropriate tools to balance their own growth.”  Foreign central banks have taken this policy to heart in recent days, with the Turkish central bank raising it’s overnight lending rate over 400 basis points , and other small central banks enacting similar policies.  While their policies haven’t been very effective, these emerging markets clearly understand that the U.S. will not shape their policy to accommodate them.

I believe that the Bernanke and the Fed made the correct decision not to react to the fluctuations in the foreign markets in their policy decisions.  Some critics believe that many of these emerging markets had entered into a sort of bubble spurred on by high liquidity and large capital inflows, and thus a weakening in the markets were only natural.  Also, today, the emerging market currencies that were hit hardest last week have now recovered slightly, and are trending in a direction favorable to foreign governments.

Furthermore, I believe that the Fed should enact the monetary policy that is best for the U.S. economy.  Since the U.S. economy is not highly dependent on emerging markets, the Fed probably shouldn’t put too much thought into how their policy will affect emerging markets.  Also, if the U.S. economy improves overall, the foreign markets stand to benefit; what is good for the U.S. economy is good for the emerging markets.


The Fed Tapering and Emerging Markets

After the Federal Open Market Committee met earlier this week, they decided to continue their tapering policies. They are sticking with their plans and come February they will reduce bond purchase from $75 Billion to $65 Billion. The purchase is $20 Billion less than the Fed has been purchasing since September of 2012. The Fed purchases bonds to increase the dollars available in the US. With an increase in cash availability, banks and other financial institutions are able to lend at a lower rate. Low interest rates makes money more accessible to borrowers, and also stimulates spending, as people are able to make bigger purchases at small interest rates, and in the long run costing them less. Now that the Fed is cutting back bond purchases, interest rates are expected to rise. It has been speculated that an increase in interest rates could have a negative effect on the stock market.

Aside from the Fed announcing to cut back its bond purchases, the stock market has already been declining decreased to a handful of negative forecasts about the emerging markets. Stocks continue to tumble, ever since about last Friday. The emerging markets are tanking due to a few different sources. The first is the Chinese manufacturing forecast which was negative for the first time in six months. Other reasons include weak foreign currencies. Investors turned from risky assets in the emerging markets for more sound, and longer term investments.

With both these potential negative impacts occurring at similar times, one may wonder if the entire market will be taking a hit for a while. It is definitely a reasonable expectation to fear the market will decline. However I do not believe that people should fear the market tanking for a long time. I think that the Feds tapering is also a sign of the economy being out of recession. I predict that analyst will see the economy recovering to outweigh the hike in interest rates. Initially I could see the market declining in the first few days in February from the initial decline, however I predict it will recover to where it was, within ten days of the change of policy. When it comes to emerging markets, I think the negative effect from the poor forecasts will last longer than the announcement of the Fed policy change. I think that the market will take much longer to recover to the level it was at on January 8th, before the forecasts were announced. I also think that stocks in emerging markets will never recover to the level they were at, even if the entire markets reaches its previous level.


Turkey Lira in Trouble Again

The central banks in many of the emerging market countries (Turkey, South Africa, India) have jacked up interest rates in an attempt to stop the slide in their currency’s value relative to the dollar. Idealistically, rate increases will stabilize the market and draw buyers back in.

The sell off by investors started last week after Chinese manufacturing reported a slowdown and has continued since then. Turkey made headlines last night after their midnight meeting concluded when they spiked up the emergency interest rate from 4.5% to 10%. While recovery seemed hopeful at first, the currency issue did not see much improved after a few hours.

First a little back story:

Turkey’s economy has been booming up until now. For approximately 20 years before Prime Minister Recep Tayyip Erdogan took office, inflation was very high in the country. Many Turks were generally unfateful of their currency and would usually exchange/invest in the US Dollars or rare minerals like gold or silver with the intention of  protecting themselves from inflation. In 2005, Erdogan put policies to stabilize inflation. The lira faced renomination, erasing six zeros essentially, followed by some inflation controlling policy. The Turkish people gained confidence once again with the lira and everything was fine with a fast growing economy and a below $2 exchange rate with the U.S. With the recent shift once again, the Turkish people’s expectation for inflation may skyrocket, repeating the fresh-in-mind problem that many of them had suffered 20 or so years before. So in addition to this short-term problem, Turkey may fall into a much greater heap of troubles. Erdogan, in his third term, hopes to instill confidence to prevent a loss of trust in the lira. Erdogan has been publicly against an “interest rate lobby” despite the recent gusty spike, worried that it will choke Turkish growth.

Paul McNamara, a large emerging-markets debt portfolio manager at GAM in London, showed a lot of uncertainty by sharing generic information. He cites when the Euro was in trouble in 2012 and Mario Draghi reassured investors that the European central bank would do whatever it takes to keep the Euro.

“This is definitely not a Draghi moment that changes everything. It’s not 100% clear that this will work; stresses in Turkey are driven by fundamental factors. It takes Turkey in the right direction, but this could be grotesquely painful for the domestic economy. The chance of a run on Turkey is significantly lower, but it is still possible.”

Francesc Balcells, same job as McNamara but with more assets at Pacific Investment Management Co., shared much more insightful information saying:

“The rate hike makes more difficult for people to sell the lira, but this doesn’t mean necessarily people are coming in.”

“Let’s face it, the external environment is not generous with heavy borrowers with large current-account deficits. The Turkish central bank did the right thing but ultimately this was necessary but not sufficient.”

Hopefully, Turkey won’t fall back into another high inflation time and the emerging markets recover sooner than later.

QE Tapering and its Effect on Emerging Markets: Russia’s Hands-Off Policy

As many have mentioned in their blog posts already, the Federal Reserve did not surprise anybody today by cutting back its bond-purchasing program by $10 billion, just as it said it would. Coincidentally, I had an interview with both Bank of America and Deutsche Bank today. Needless to say, that was a main topic of discussion during the interviews. Thanks to writing these blog posts each week, I was prepared.

One of the things that has been emphasized and is something I talked about a lot in the interviews is the effect QE tapering would have on emerging markets. I expected interest rates would rise after the Fed’s announcement, but due to increased investor demand the yield on 10-year U.S. Treasury bonds hit its lowest point since November (2.685%). The main reason is that investors seem to be shying away from risky investments in troubled emerging markets, in favor of less risky U.S. bonds. Even U.S. stocks took a tumble as the S&P 500 fell 0.38%.

An interesting case study for analysis of the effect of QE tapering on EM’s is Russia. Contrary to most emerging markets who are desperately trying to increase interest rates in order to stabilize their dwindling currencies, Russia isn’t even putting up a fight, letting the markets pull the ruble down without restraint.

At first glance this strategy seems unwise. As the article states, a weaker ruble means:

  1. Russian imports become more expensive, making it difficult for Russian companies to upgrade technology because equipment imports rise in price.
  2. Russian spending power abroad is slashed.
  3. Increased doubt of the ruble could significantly increase demand for foreign currencies, weakening the ruble even further and causing a surge in an already high inflation rate.

However, after closer inspection Russia’s hands-off policy has some validity.

‘A weaker ruble acts as a useful shock-absorber,’ said Ivan Tchakarov, economist at Citibank in Moscow, adding that letting the ruble slide gives the central bank a way to ease the impact of slowing global demand for Russia’s main commodity exports without risking higher inflation.”

Not only do Russia’s commodity exports become more attractive abroad, but also one of the main arguments against a weak ruble- high inflation- is avoided. The reason? In an already frail Russian economy, producers cannot afford to pass on the higher costs they are facing to consumers. They’d lose more revenue by increasing their prices than by absorbing the costs of a weak ruble. Although this isn’t by any means sound long-term monetary policy, I can understand why Russia is acting the way it is given its circumstances. A 6.5% inflation rate coupled with a shrinking current account surplus doesn’t give Russia much leeway to pursue quantitative easing or similar policies.

Turkey’s Woes

Turkey’s economy has seen large growth throughout the past few years due the Fed keeping US interest rates low.  Investors fled US treasury bonds in search for higher yields in Emerging markets, leading many emerging market countries to live outside of their means due to increases in foreign investment and borrowing.  With the Fed announcing recently to further increase tapering, leading to rising interest rates in the US, that easy capital and investment that was flowing to markets like Turkey, Indonesia and South Africa, is now leaving just as quickly as it arrived.  The flight of capital from these countries have led to the speculative bubbles in emerging-market currencies to finally pop, leading to a rapid drop in emerging market currencies versus the dollar.  The Turkish Lira has recently weakened to 2.244 per dollar even after the Turkish Central Bank increased interest rates from 4.5% to 10% and overnight lending from 7.75% to 12%.  South Africa and India have also recently increased interest rates in hopes of stemming the weakening of their respective currencies.  A lot of people place the blame of capital flight to and from emerging markets at the feet of the Fed due to their low interest rate policies after the recession and the tapering that is now being undertaken.  I believe though that Turkey’s issues stem more from its political and social unrest and its poor macroeconomic conditions and as the global economy improved, countries who were living beyond their means due to the slow down of developed economies, would eventually come crashing back to reality.

Turkey’s economy though has faced corruption allegations and political unrest following its economic slowdown in 2012.  Normally, interest rate hikes can help stabilize currencies, but Turkey’s political unrest has led to investors to ignore the rate hike and focus more on the political situation and slowly growth instead.  Investors are weary that the government will put pressure on Turkey’s central bank while it is trying to create support for the government while it is embattled with corruption charges.  The central bank increasing interest rates would lead to slowing growth which would lead to job and prosperity issues as well as falling consumer demand which would likely cause Turkey’s government to lose more of the public’s sympathies.  The fight now in Turkey is what’s more important, the Government winning elections in 2015 or protecting Turkey’s long term economic viability by protecting its currencies.  We will see which one plays out as the month continues.  If Turkey’s central bank can withstand political pressure from the government, then there is a chance for a painful, but safer recovery due to maintaining a stable currency and inflation by manipulating the interest rate.  Unfortunately, I believe that Turkey’s government and president have too much power and will continue to cause investors to flee Turkey.  Right now, Turkey’s political unrest is the main reason investors are still fleeing even though the interest has been increased.

A tale of three markets

There are some interesting feedbacks on FED’s tapering from three markets: stock market, debt market, and emerging market.

Ignoring the felling stocks market triggered by a global selloff of emerging market assets, the Federal Reserve concluded its two-day policy meeting with a decision to continue tapering its stimulus program, cutting another $10 billion from its monthly bond-buying program. They are now buying “only” $65 billion a month in bonds.

The central bank did this because it’s confident in the pace of recovery and growth prospects in the U.S. The unemployment rate targets of 6.5% and inflation targets of 2% are met, so there is no reason not to fulfill its earlier promise.

Although emerging markets had been hoping FED would not add more salt to the wound by tapering at this particularly hard time, they have no reason to complaint if FED does so(which it did). Fed officials respond that they can’t be asked to take responsibility for economies outside of their mandate.“It’s really up to emerging markets to find appropriate tools to balance their own growth,” Mr. Bernanke said in 2011, when the Fed was being blamed for sparking higher food and energy prices abroad.

Why Fed would ignore the falling stocks market? The FED seemed to put less emphasis on the recent decline in stocks caused by emerging market selloff, because it believe it is only temporary.  Moreover, FED’s dual mandates does not include protecting stocks markets from falling, either. The reason why FED tapering might be hated by so many stocks investors is because more investors would now switch to less risky assets. Even if they like risk, they had better not to miss out the potential gain on the reviving debts market, which is now generating quiet a hectic.  

CFOs wrestling with whether to issue fixed- or floating-rate debt. Investors have been snapping up floating-rate bonds because they offer protection from rising rates.For companies, these bonds can reduce borrowing costs and diversify their investor base. The risk, however, is that if interest rates rise faster than expected a company might pay more than if it had sold fixed-rate debt.

Nonetheless tapering is a hard pill to swallow for emerging markets, since the hot money that fled from safety years ago will now fly back to safety.  Assets related to emerging markets will now be even more unfavorable. China, the benchmark for emerging market, has not respond significantly to this news.  But the overall impacts tapering has on China is not to be ignored. Hot money fleeing China will surely reduce the upward pressure on RMB, a good news for exporters. However, the housing market that have been sustained by hot money will face a significant cash out to the extend that the bubble might burst eventually. If the housing market crashes down, shadow banking issues will also reach to a new stage where large scale defaults is unpreventable.

As for now, much of the China is still asleep. We can only wait and see how China will react to this lunar new year gift signed “Federal Reserve Bank”.


All Eyes on Fed: From Emerging Markets to U.S. Investors

The decline in stocks last week places additional focus on this week’s Federal Reserve policy meeting, where Fed officials will consider whether to continue winding down their stimulus measures.

Last week, financial markets have undergone a large selloff of emerging market assets, an event induced by worries over weak economic data from China (a historical low of GDP growth of 7.7%), protests in Ukraine, and sliding currencies in Turkey and Argentina. Layered on top are worries that as the Fed reins in its bond buying, the flow of credit in emerging markets will be stanched.(From WSJ)

Fed’s QE has made the emerging market assets more favorable than the fixed income assets in U.S. (such as 10 yrs treasury bonds), whose yields were essentially zero over the bonds- purchasing periods. “Emerging-market leaders would appreciate it if the Federal Reserve opts against further tapering of its bond purchases this week.” (From WSJ) Now as the recent bad news of emerging market selloff appearing on the head lines of all major media, they would even more eager to see FED slow down taper. Tapering would lead to a huge retreat of money from emerging market that had help them survive through the financial crisis.

However what FED will do would not based on what foreign country would hoped. I think FED’s final decision on whether or not to further taper depends which one of the two forces discussed below will win. One force is the money that is now in emerging market. If tapering is announced, huge amount of money will surely flyback to U.S, driving down ten years treasury bonds yields. If this force is big enough, U.S. stocks market will continue the buoyancy of 2013, and housing market will also perform well in Spring sell. Another force is from local investors. If, when tapering is announced, investors from U.S. Stock market, housing markets and other risky assets react faster, or more evidence suggest that they tend to believe treasury bonds yield will not be drive down by the return of money form emerging markets, they will cash out and turns into treasury bonds buying. Thus the falling of U.S. stocks might prompt companies to grow cautious all over again.

Ultimately, which force is going to win depends not on exactly which forces is stronger, but depends on what market believe which force is stronger.

I also pondered on the effect of FED might have on China. Once tapering is announced, “hot money will flee China, which will leads to a reshuffle of the current economy situation. Since a large portion of money were invested in the housing market, the housing bubble might burst once these money retreat for safety. Shadow banking problem in China might also reached a turning point where default risk will raised as the housing market crashed down ( A huge amount of lending from shadow banks went into housing markets). But there is also good news for China if we seek opportunity out of this crisis. As rich countries recovered from recessions, export of China might restore. It is also good to see some of the hot money that caused inflation in China squeezed out of circulation.  Crashing down of shadow banks and housing bubble will be a short term pain, but will eventually bring about a more healthier economy if Chinese government seize the opportunity to carry out reforms that are long overdue.