Submerging markets

Submerging markets

Given the rapid rise of the U.S. deficit, if the Fed doesn't respond by slowing plans to shrink its balance sheet, Treasurys will absorb such a large share of dollar liquidity that a crisis in the rest of the dollar bond markets is inevitable
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Are the storm clouds abating in emerging markets? Over the last two weeks, the iShares J.P Morgan U.S. Dollar Emerging Market Bond ETF has steadied itself after falling to multi-year lows on May 9, and the broad Dollar Index is off by about 1% from the interim highs reached on May 29.

While the price action has improved (or at least stopped deteriorating), news flow continues to suggest that investors should keep a close eye on countries that might have been known as “waste places” in the early 20th century.

For Argentina and Turkey, whose currencies have both stabilized after plunging to record lows against the dollar in May, an uneasy status quo has settled in. Argentina, which was obliged to turn to the IMF for help as the peso legged lower again the greenback, is making progress towards loosening the purse-strings of the supranational body. This morning, IMF director Alejandro Werner proclaimed that: “Talks are well advanced.” That follows a May 31 prediction from Argentine President Mauricio Macri that a deal would be reached “in the next few days.”

Turkey, which has raised its benchmark interest rate by 600 basis points to 19.5% since May 23, saw May CPI rise by 12.2% year-over-year, the second highest reading since 2008.  The latest inflation figure further complicates an uncomfortable dynamic for Turkey’s central bank: Hot inflation, rising government bond yields and a faltering currency. This constellation of facts argues for higher rates, while President Recep Erdogan (no wallflower to be sure) demands the opposite.

For another potentially instructive sign of the times, we turn to Malaysia. Today, Finance Asia reports that the newly elected government headed by the 92-year old President Mahathir bin Mohamad cancelled a high speed rail project that was to connect Kuala Lumpur and Singapore due to poor economics.

That deals a blow to China, which sponsored the venture as part of its Belt and Road Initiative.  More such Belt and Road projects, including the $13.6 billion East Coast Rail Link, could be on the chopping block. Prior to his election, Mahathir proposed two alternatives for the Belt and Road undertakings: “Renegotiate,” or “even cancel . . . and pay compensation.

A common thread exists between these IMF bailouts, chunky rate hikes and cancelled spending projects: Tighter monetary conditions. For that, our emerging-market brethren can largely thank the Federal Reserve, according to Bank of India governor Urjit Patel In an opinion piece in today’s Financial Times. Patel calls on the Fed to arrest its current QT policy:

The recent upheaval stems from the coincidence of two significant events: the Fed’s long-awaited moves to trim its balance sheet and a substantial increase in issuing U.S. Treasurys to pay for tax cuts. Given the rapid rise of the U.S. deficit, the Fed must respond by slowing plans to shrink its balance sheet.

If it does not, Treasurys will absorb such a large share of dollar liquidity that a crisis in the rest of the dollar bond markets is inevitable.

Fed chairman Jerome Powell evidently begs to differ. Powell told conference attendees at a May 8 event hosted by the IMF and Swiss National Bank that: “There is good reason to think that the normalization in advanced economies should continue to prove manageable for emerging market economies.” Powell went on to add, somewhat ominously: “Some investors and institutions may not be well positioned for a rise in interest rates, even one that markets broadly anticipate.”

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Image result for emerging markets

Are the storm clouds abating in emerging markets? Over the last two weeks, the iShares J.P Morgan U.S. Dollar Emerging Market Bond ETF has steadied itself after falling to multi-year lows on May 9, and the broad Dollar Index is off by about 1% from the interim highs reached on May 29.

While the price action has improved (or at least stopped deteriorating), news flow continues to suggest that investors should keep a close eye on countries that might have been known as “waste places” in the early 20th century.

For Argentina and Turkey, whose currencies have both stabilized after plunging to record lows against the dollar in May, an uneasy status quo has settled in. Argentina, which was obliged to turn to the IMF for help as the peso legged lower again the greenback, is making progress towards loosening the purse-strings of the supranational body. This morning, IMF director Alejandro Werner proclaimed that: “Talks are well advanced.” That follows a May 31 prediction from Argentine President Mauricio Macri that a deal would be reached “in the next few days.”

Turkey, which has raised its benchmark interest rate by 600 basis points to 19.5% since May 23, saw May CPI rise by 12.2% year-over-year, the second highest reading since 2008.  The latest inflation figure further complicates an uncomfortable dynamic for Turkey’s central bank: Hot inflation, rising government bond yields and a faltering currency. This constellation of facts argues for higher rates, while President Recep Erdogan (no wallflower to be sure) demands the opposite.

For another potentially instructive sign of the times, we turn to Malaysia. Today, Finance Asia reports that the newly elected government headed by the 92-year old President Mahathir bin Mohamad cancelled a high speed rail project that was to connect Kuala Lumpur and Singapore due to poor economics.

That deals a blow to China, which sponsored the venture as part of its Belt and Road Initiative.  More such Belt and Road projects, including the $13.6 billion East Coast Rail Link, could be on the chopping block. Prior to his election, Mahathir proposed two alternatives for the Belt and Road undertakings: “Renegotiate,” or “even cancel . . . and pay compensation.

A common thread exists between these IMF bailouts, chunky rate hikes and cancelled spending projects: Tighter monetary conditions. For that, our emerging-market brethren can largely thank the Federal Reserve, according to Bank of India governor Urjit Patel In an opinion piece in today’s Financial Times. Patel calls on the Fed to arrest its current QT policy:

The recent upheaval stems from the coincidence of two significant events: the Fed’s long-awaited moves to trim its balance sheet and a substantial increase in issuing U.S. Treasurys to pay for tax cuts. Given the rapid rise of the U.S. deficit, the Fed must respond by slowing plans to shrink its balance sheet.

If it does not, Treasurys will absorb such a large share of dollar liquidity that a crisis in the rest of the dollar bond markets is inevitable.

Fed chairman Jerome Powell evidently begs to differ. Powell told conference attendees at a May 8 event hosted by the IMF and Swiss National Bank that: “There is good reason to think that the normalization in advanced economies should continue to prove manageable for emerging market economies.” Powell went on to add, somewhat ominously: “Some investors and institutions may not be well positioned for a rise in interest rates, even one that markets broadly anticipate.”

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