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The answer to "What's going to give the Fear Index a boost ?" was staring us in the face all along .... The threat of Thermonuclear War,...

August 11, 2017

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Be careful about generalising EMs : Taking a look at China, Brazil and Russia ..... individually

June 13, 2018

 

In all honesty, we have nothing new or specific to say today in advance of the Fed's likely decision to hike rates ..... or their more eagerly awaited statement which may or may not be replete with clues about future policy. We'll just wait on that along with everyone else and pick it up later ..... and we'll probably do the same with the ECB's turn in the monetary policy spotlight tomorrow.

 

Actually, we're just going to recommend three articles in today's Markets & Investing Section in the Financial Times. Each one offers a take on a major emerging market, and certainly two of them revolve around the wider ramifications of Fed policy . Of course all EMs are heavily affected by the Fed's decisions and what they do to US rates and the dollar (well, isn't everybody ?), but the different emphasis of the three pieces seems to illustrate the weakness in casually lumping very different economies into one handy, catch-all category.

 

"Dollar debt leaves China companies vulnerable if Fed tightens further" , Henny Sender , Markets Insight

 

We talk a lot about the obvious difficulties that EM countries loaded with dollar-denominated debt face from rising US rates and a strengthening dollar, though few are ever very detailed about it. Bank of America Merrill Lynch reckons that there has been about $10 billion of net outflows from EM debt and equities over the last six weeks alone. Back in 2016, a large part of the great Chinese market wobble was about debt but investors have been much more relaxed about it since. Ms Sender suggests that it's more than time to start paying attention once again.

 

One of the reasons why markets have been relatively unconcerned about China's dollar debt is that unlike some other emerging market nations, the currency (the Yuan) has been solid. In fact, although the dollar has been gaining since mid-April the Yuan is still up 2% in 2018. But the focus is returning (or should be) to the amount of dollar-denominated debt that Chinese companies have been racking up in recent years, and the pace at which they continue to do so even now. As ever, when you talk about levels of Chinese corporate debt an unhealthily large slice of it is in the property sector, something that should be of no comfort whatsoever to investors. According to Eric Moffett of T. Rowe Price in Hong Kong, virtually none of it is currency-hedged. What's worse, much of the debt will fall due over the next two years.

 

For those rather frightening specifics we were talking about, check out the article. It includes an account of how one US fund has put on a trading strategy that profits from Chinese property companies getting into serious trouble, but not actually defaulting. Now that's specific.

 

"Brazil's central bank seeks to repel foreign exchange attack" , Analysis, Currencies

 

To some degree or other, investor concern usually manifests itself in a weakening currency but it is most obvious in those of emerging markets. We've recently seen attacks on the Turkish Lira, the Indonesian Rupiah, the Argentinian Peso, the South African Rand ..... the list goes on. The Brazilian Real has weakened from just over 3.00 per US dollar nine months ago to a high of over 3.90 last week.

 

The combative (and highly qualified) governor of Brazil's central bank, Ilan Goldfajn, thinks he got the answer to it , though. By using dollar swaps (effectively a bet against the dollar settled in local currency), Mr Goldfajn intends to give speculators against the Real a bloody nose. First impressions might suggest it's working, too. From last week's high, USD / BRL was back down to 3.71 yesterday, and Mr Goldfajn has pointed out that since the central bank has only issued about a third of the instruments that it issued during the 2016 run against the currency, AND it has $380 billion in reserves, it has plenty of ammunition to defend the Real.

 

Sounds good ..... except that there are good reasons why the currency is being hit. Brazil is Latin America's second-worst performing economy and investor confidence has been severely damaged by the rout in neighbouring Argentina. Perhaps even more to the point, history suggests it is very rare that on any longer-term basis central bank intervention can defeat a market intent on breaking its resilience. Ultimately, intervention needs to be supported by monetary and/or fiscal policy.

 

Mr Goldfajn believes that monetary policy is a tool for the control of inflation, not exchange rates, and many would agree that with inflation at two decade-lows and an under-capacity economy now is not the time to be ramping up interest rates a la Argentina. So that would leave fiscal policy, then ..... and that means politics.

 

The government of President Michel Temer has generally been seen as pro-market, but when he caved in to striking truckers and offered them costly fuel subsidies it was seen by investors (and currency speculators) as a move from the bad old days, and one directly in contradiction to the kind of tough fiscal reform urgently needed. What's more, there's another General Election coming up in October and populist parties lead in the polls. As we said the other day, they are definitely not going to embrace any fiscal discipline unpopular with their core vote.

 

"Russia stands out from EM pack as it weighs rate cut" , Tail risk, by Roger Blitz

 

Mr Blitz points out that it may be pretty toxic for western politicos to get close to Russia ( think Crimea, Syria, election meddling and assassinations), but investors can be less sniffy. Well, unless and until the politicians start punishing them for it, that is.

 

When sanctions were reintroduced against Russia in April, the Rouble dropped 8.5% in three days. Since that time however, the currency has held steady as other high-profile EMs have come under the hammer. The most important factor in that is of course the rising price of oil and Russia's status as a large exporter. That means that although Russia does indeed run a large current account deficit, which needs financing from capital flows, it also runs a large trade surplus. Compared with other EMs, Russia is in a pretty comfortable place for investors.

 

That's a feeling reinforced by the identity of the governor of the Russian central bank Elvira Nabiullina. Investors are fans of Ms Nabiullina because of her tough stance against Russian "banking banditry", but mostly because of her overseeing a remarkable fall in inflation from 15% three years ago to just 2.4% now. And that achievement means that Russia can contemplate growth-stimulative rate cuts just when other EMs are having to jack up rates to defend their currency against the strengthening dollar.

 

If you take the geopolitical view that Russia's unprincipled actions thoroughly merited the impositions of sanctions in April, then you might well also think that it's equally unprincipled for investors to be sending money in that direction. But let's face it, investors are not often motivated by such binary ethical questions and there are reasons why even top-drawer US banks are reinstating "Long Rouble" positions. 

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