As most know by now, over the past month or so, pressure on the currencies of EM deficit countries has intensified again. Goldman's EM research group, however, remains negative on EM FX, bonds, and even stocks suggesting using any strength, like this week's exuberance to add protection or cover any remaining longs. Central banks in most of these countries have become more active in attempting to stem pressure in the last two weeks. But with a Fed decision on ‘tapering’ looming, investors have also become more cautious and are now focused on the parallels with prior crisis periods. In what follows, Goldman provides some concise answers to the questions on the EM landscape that we encounter most often, confirming their longer-held bearish bias.
September is likely to be dominated by a number of key event risks, in addition to ongoing uncertainty around the US growth outlook, the Fed’s reaction function and heightened EM volatility. We highlight the major events and likely market implications.
The JGB market was completely unfazed by the news that the prime minister’s office was reconsidering the planned consumption tax hike. While the tax hike is unlikely to be changed; in BNP's view, the market’s lack of response to tail risk looks like proof that its function has been impaired by the BoJ’s massive buying. Even if the Abe regime is opting for financial repression to reduce the public debt, however, BNP warns that some degree of fiscal reform is needed to control the long-term interest rate. If the unfazed market is deemed to mean that fiscal reforms can be shelved without fear of a bond-yield spike as long as massive BoJ buying continues, serious problems could ensue.
Something is way off: either the unemployment data is very much wrong and the real unemployment rate is far higher especially when normalized for the collapsing labor participation rate and the surge in part-time and temp workers, or the GDP calculation is incorrect and the economy is growing at a 4%+ rate. (It isn't). The scarier implication is that in addition to all other seasonally adjusted economic data points which have become painfully unreliable, daily Treasury tax receipts must also now be added to the docket of meaningless and corrupt data points. The question of just how the Treasury could explain a massive (and deficit boosting) cash discrepancy could only be answered if somehow the Fed is found to be parking cash directly into the Treasury's secret basement.
We have discussed the idea of a VaR shock (driven by Abe/Kuroda's loss of control) a number of times recently but as Saxo's Steen Jakobsen fears, reality is about to hit as the marginal cost of capital normalizes. The world, so far, has been kept in artificial equilibrium by the way quantitative easing (QE) and fiscal policies bring support and endless liquidity to the 20 percent of the economy that mostly comprises large and already profitable companies and banks with good credit and good political access. The premise for supporting these companies is based on the non-existent wealth effect which unfairly culminates in supporting the haves to the detriment of the have-nots. However, as Jakobsen notes below, things are rapidly changing; the recent increase in yields has happened despite no real improvement in the underlying data. The the next few days are potential major game changers – the bloated VaRs will make people hedge and over hedge, and the normalization process of rising risk premiums and higher real rates (higher yield plus lower inflation) will lead to more selling off of those trades that have "worked so far"... and increase volatility in their own right.
Take a good look at the chart of the Nikkei below. Supposedly this is the same chart that the new BOJ head, Haruhiko Kuroda, was looking at when he was responding to Japanese lawmakers during a session of the upper-house budget committee, where he flatly rejected an opposition-party member's argument that the recent rapid rise in the Tokyo stock market is out of line with Japan's real economy. "At this moment I do not think they are in a bubble," Kuroda said. And everyone believes him, just Because central bankers are so good at objectively observing how contained subrpime is big the asset bubbles their ruinous policies create.
Gluskin Sheff's David Rosenberg exclaims we are currently are witnessing the Potemkin rally (the phrase Potemkin villages was originally used to describe a fake village, built only to impress). The term, however, is now used, typically in politics and economics, to describe any construction (literal or figurative) built solely to deceive others into thinking that some situation is better than it really is. Ben Bernanke, recently proclaimed “The Hero” by Atlantic Magazine, is the “Wizard of Potemkin.” Since 2009 Bernanke has engage in massive monetary experiments. These experiments lead to future dislocations. There is no doubt that the Fed wants inflation. The problem is they may get more than they ask for. We are currently witnessing the slowest economic recovery of any post-WWII period. However, It is important to challenge your thought process. Read material that challenges your views. Here are David's rules...
It is hard to make sense of the markets these days. For instance, gold showed no support while the geopolitical situation in Asia deteriorated, Japan embarked in the mother of all monetization programs, and a member nation of what is supposed to be a monetary union was imposed controls on the movement of capital. Or take the case of the Euro, which jumped from $1.2750 to $1.2950 on the day of one of the most confusing and embarrassing press conferences the president of its central bank ever gave. However, in a faraway land, where there is no shadow banking, leverage or even capital markets, economic fundamentals still hold, which can help us, inhabitants of the developed world, visualize a dynamics lost in the shelves of our collective memory. The land we are referring to is Argentina, but not Argentina of 2001. Today, we want to write about Argentina of 2013, and no, we will not discuss their legal battles with Mr. Singer.
Over the past four years one of the dominant "deflationists" has been Gluskin Sheff's David Rosenberg. And, for the most part, his corresponding thesis - long bonds - has been a correct and lucrative one, if not so much for any inherent deflation in the system but because of the Fed's actual control of the entire bond curve and Bernanke's monetization of the primary deflationary signal the 10 and certainly the 30 Year bond. The endless purchases of these two security classes, coupled with periodic flights to safety into the bond complex have validated his call. Until now.
It would appear that even though the relative dovishness of the FOMC has increased, a realization that the party has to stop sometime is dawning on the PhDs - though for now, the printing will continue until morale improves...
- SEVERAL FOMC PARTICIPANTS SAID EASING MAY PROMPT EXCESSIVE RISK
- MANY FOMC PARTICIPANTS VOICED CONCERN ABOUT RISKS OF MORE QE
- SEVERAL ON FOMC SAID FED SHOULD BE PREPARED TO VARY PACE OF QE
- FOMC PARTICIPANTS SAID ECONOMY WAS ON 'MODERATE GROWTH PATH'
- SEVERAL FOMC PARTICIPANTS SAW IMPROVED U.S. CREDIT CONDITIONS
- A NUMBER OF FED OFFICIALS SAID TAPERING QE MAY BECOME NECESSARY
Pre-FOMC: ES 1521.00, 10Y 2.01%, EUR 1.3337, Gold $1580, WTI $94.18
After trending gently higher for the first half of the week, the euro has been sold to new three week lows in response to the disappointing Q4 GDP figures. The GDP figures are of course backward looking and more recent data, such as the PMI figures and German factory orders suggest the regional economy is stabilizing here in early Q1.
There is a middle step to go from the GDP figures to the euro and that is the interest rate channel. There has been some speculation that the passive tightening of the euro area financial conditions (including the shrinking of the ECB's balance sheet) and the strength of the euro would prompt the ECB to cut the refi rate later in Q1. The poor GDP readings bolster such expectations and this can be seen in short-term interest rates. The March Euribor futures contract is now implying 0.24% rate, having matched the lowest rate since Jan 23, or before the early repayment of LTRO I was announced.
Following yesterday's G-7 announcement which sent the USDJPY soaring, and its embarrassing "misinterpretation" clarification which undid the entire spike, by an anonymous source in the US who said the statement was in fact meant to state that the Yen was dropping too fast and was to discourage "currency wars", it was only a matter of time before another G-7 country stepped into the fray to provide a mis-misinterpretation of the original G-7 announcement. That someone was the BoE's outgoing head Mervyn King who at 5:30 am eastern delivered his inflation reporting which he said that "it’s very important to allow exchange rates to move," adding that "when countries take measures to use monetary stimulus to support growth in their economy, then there will be exchange rate consequences, and they should be allowed to flow through." Finally, King added that the BOE will look through CPI and relentless UK inflation to support the recovery, implicitly even if it means incurring more inflation.
The main events of this week, monetary policy meetings at the BoE and the ECB on Thursday, are not expected to bring any meaningful changes. In both cases, banks are expected to keep rates on hold and to hold off on further unconventional policy measures. While significant economic slack still exists in the Euro area, and although the inflation picture has remained relatively benign, targeted non-standard policy measures are more likely than an interest rate cut. As financial conditions are already quite easy in the core countries, where the monetary transmission mechanism remains effective, the ECB’s first objective is to reverse the segmentation of the Euro area’s financial markets to ensure the pass-through of lower rates to the countries with the most need for further stimulus.
How does one of the best strategists view the world as we close the page on 2012, and look toward 2013? Find out with the help of these 35 charts.
What causes hyperinflations? The answer is: Quasi-fiscal deficits (A quasi-fiscal deficit is the deficit of a central bank)! Why have we not seen hyperinflation yet? Because we have not had quasi-fiscal deficits! Essentially, hyperinflation is the ultimate and most expensive bailout of a broken banking system, which every holder of the currency is forced to pay for in a losing proposition, for it inevitably ends in its final destruction. Hyperinflation is the vomit of economic systems: Just like any other vomit, it’s a very good thing, because we can all finally feel better. We have puked the rotten stuff out of the system.