Submitted by Raúl Ilargi Meijer of The Automatic Earth
Price Discovery and Emerging Markets
I got to admit, Paris and Charlie have thrown me off a bit. Can’t be just me who noticed how well the French CAC 40 was doing since Charlie Hebdo got shot, can it? Up some 2%, I don’t quite recall, Wednesday, the day of the attack, and 3.59% yesterday. Doesn’t that strike you as odd? It did me. It’s maybe the perfect example of how alienated the financial world has become from the real world, from you and me. And it doesn’t even surprise us anymore, it doesn’t hardly seem worth mentioning anymore. But I thought I’d do just that: mention it. The CAC 40 lost 1.9% today, but still.
“Fed bullish” said yesterday’s headlines. Of course they did. But France? What have traders in Paris seen in the killings and blood stains that made them so jubilant they got all the way to +3.59%? And where are the ethics hiding in that number? I see no ethics. Should we accept that the financial part of our world has none? That it’s a kind of a parallel universe? That it doesn’t reflect anything that happens to us, and ours?
Today the equally jubilant US jobs report has the Dow down almost a full 1%. Maybe nobody believes anything anymore, any more than the financial world reflects the real one. And maybe nobody cares anymore either. We just go about our days knowing that jobs reports are nonsense, that price discovery has been put six feet under, and that if we’re really smart, we can still make money off of other people’s misery. And isn’t that what Darwin said the purpose of life is? Or was that Ayn Rand? I’m sorry, Charlie threw me off a bit.
Still, we did rediscover price discovery, to an extent, didn’t we? We found out what oil is worth, and even more what it’s not. And I have a hunch that that will lead to more ‘discoveries’. And that they will come from emerging markets – since we can’t seem to be able to be honest about our own, they will have to do it for us. They will, in spectacular fashion. As I wrote 3 weeks ago:
... in the wake of the oil tsunami, which is a long way away from having finished washing down our shores, there’s the demise of emerging markets. And I’m not talking Putin, he’ll be fine. It’s the other, smaller, emerging countries that will blow up in spectacular fashion, and then spread their mayhem around. The US dollar will keep rising more or less in and of itself, simply because the Fed has ‘tapered QE’, and much of what happened in global credit markets, especially in emerging markets, was based on cheap and easily available dollars. There’s now $85 billion less of that each month than before the taper took it away in $10 billion monthly increments. The core is simple.
This is not primarily government debt, it’s corporate debt. But it’s still huge, and it has not just kept emerging economies alive since 2008, it’s given them the aura of growth. Which was temporary, and illusionary, all along. Just like in the rest of the world, Japan, EU, US. And, since countries can’t – or won’t – let their major companies fail, down the line it becomes public debt.
One major difference from the last emerging markets blow-up, in the late 20th century, is size: emerging markets today are half the world economy. And we can all imagine what happens when you blow up half the global economy … [..]
This is the lead story as we go into 2015 two weeks from today. Oil will help it along, and complicate as well as deepen the whole thing to a huge degree, but the essence is what it is: the punchbowl that has kept world economies in a zombie state of virtual health and growth has been taken away on the premise of US recovery as Janet Yellen has declared it.
It doesn’t even matter whether this is a preconceived plan or not, as some people allege, it still works the same way. The US gets to be in control, for a while, until it realizes, Wile E. shuffle style, that you shouldn’t do unto others what you don’t want to be done unto you. But by then it’ll be too late. Way too late.
As I wrote just a few days ago in We’re Not In Kansas Anymore , there’s a major reset underway. We’re watching, in real time, the end of the fake reality created by the central banks. And it’s not going to be nice or feel nice. It’s going to hurt, and the lower you are on the ladder, the more painful it will be.
But that’s just me. The revered Jim O’Neill has his own take on the issue:
Brazil and Russia’s membership of the BRICs may expire by the end of this decade if they fail to revive their flagging economies, according to Jim O’Neill, the former Goldman Sachs chief economist who coined the acronym. Asked if he would still group Brazil, Russia, India and China together as emerging market powerhouses as he did in 2001, O’Neill said in an e-mail “I might be tempted to call it just ’IC’ or if the next three years are the same as the last for Brazil and Russia I might in 2019!!”
The BRICs were still booming as recently as 2007 with Russia expanding 8.5% and Brazil in excess of 6% that year. The bull market in commodities that helped propel growth in those nations has since ended[..] China growing at 7% will add about $1 trillion nominally to global output every year, O’Neill said. When measured by purchasing power parity, China’s growth adds twice as much as the U.S.’s, he said. India expanding at 6% will add twice as much as the U.K. in those terms, he said.
“Their consumption is increasingly key for global consumption and which markets were amongst the world’s strongest in 2014? China and India both were up significantly,” he said. “So many investors are herd like, they probably have already forgotten the BRIC’s but it is silly. They are the most important influence in the world.”
Hmm. Sure, Russia and Brazil are already tanking, but China is in a much less comfy spot than Jim seems to believe. That’s not just me, the analyst team at Bank of America think so too:
A credit crunch in China is “highly probable” this year as slowing economic growth prompts a surge in bad debts, Bank of America Merrill Lynch predicts. Chinese president Xi Jinping this week trumpeted the “new normal” referring to slower growth as the government tries to rein in the credit boom – which has led to a debt pile of $26 trillion [..] BoAML: “Few countries that had grown debt relative to GDP as fast as China did over the past few years escaped from a financial crisis in the form of significant currency devaluation, major banking sector recap, credit crunch and/or sovereign debt default (often a combination of these).”
The analysts believe that the government has unlimited resources to bail out banks and other organisations as the debts are mostly in renminbi, and the country’s central bank can always print more money. They argue: “We suspect that the most likely scenario for China is a bad debt surge as growth slows, followed by a credit crunch in the shadow banking sector as investors become risk averse, and followed by a major financial system recap engineered by the government [..]
The US investment bank’s research report– “To focus on the three Ds: Deflation, Devaluation and Default” – notes that China had to pump money into the banking sector to the tune of 15% of GDP in the mid 2000s after a smaller debt surge in the late 1990s. [..] China will publish 2014 growth figures on 20 January that are set to miss the government’s economic target for the first time since 1998. Economists forecast the country grew 7.3%, below the target of 7.5%, with growth likely to slow further this year.
The central bank can ‘always print more money’? Is that so? And if it is, what would the effect be? What has money printing done in the west, other than paint an illusion? And what else could it possibly achieve in China? Shouldn’t Beijing simply adapt to the fact that as world markets shrink, so does its domestic and international growth potential? For that matter, how far removed from its published growth numbers are the data Xi and Li find on their breakfast plate every morning? If consumer inflation numbers – as silly a parameter as it is – prints 1.5%, how can GDP still grow by 7%? And how can it when producer prices are actually deflating? How does that work, and how does it rhyme? It’s perhaps not impossible in theory, but come on…
China’s factory-gate prices extended a record stretch of declines, with the sharpest drop in two years in December, suggesting room for further monetary easing. The producer-price index slumped 3.3% from a year earlier[..] The slide has yet to be fully reflected in consumer prices, which rose 1.5%, matching the median estimate. Tumbling oil and metal prices have extended the run of producer-price declines to a record 34 months, adding to deflationary pressures worldwide as China’s export prices drop.
“The oil price drop is one factor, but the more important factor of the PPI decline is the weakness of the global economy – look at Europe and Japan,” said Larry Hu, head of China economics at Macquarie Securities Ltd. in Hong Kong. “With trade and other inflation transmission methods, the whole world is facing disinflation pressure.” Factory-gate prices of oil and gas slumped 19.7% from a year earlier in December, while coal tumbled 12.2% and ferrous metals 19%, according to a statement on the NBS website.
What is supposed to have China grow at 7% or more today? It can’t be the west, Europe is shrinking, Japan is suffocating and America is fooling itself. It can’t be other emerging economies, they’re all in various stages of trouble. So it would have to be domestic. But have you seen Chinese housing numbers and other data recently? No 7% growth there.
China’s consumer inflation ticked up slightly in December, keeping price increases for the year well below the government ceiling, but a further slide in factory prices raised new concerns over weak demand in the world’s second-largest economy. [..] The consumer-price index gained 1.5% year-over-year in December compared with a 1.4% increase in November [..]
n December, the producer-price index, which measures prices at the factory gate, slipped 3.3% from a year ago for its 34th month in a row of declines, with the fall accelerating from the 2.7% drop in November. For 2014 as a whole, the producer-price index fell 1.9%. Excess capacity, particularly in heavy industry, has been blamed for much of the drop. [..] Economic growth in the third quarter of last year was 7.3%, the poorest showing in over five years.
Emerging economies are no longer emerging. Vanishing would be a better term. And it’s going to get worse, fast. Because of the Fed, and the dollar. And interest rates on at least $1 trillion in bonds.
The soaring U.S. dollar is squeezing companies in emerging markets from Brazil to Thailand that now face higher costs on roughly $1 trillion in bonds sold to investors before the greenback’s surge. For 2014, the dollar is on track to gain more than 7% compared with a group of emerging-market currencies [..] it is causing particular pain at firms in emerging markets that issued bonds in dollars instead of local currency. The dollar’s rise means it costs more to make regular bond payments and pay off outstanding bonds as they mature. “The investor community is becoming very much one-way or crowded toward retrenching to the U.S.,” says Nikolaos Panigirtzoglou, global markets strategist at JP Morgan.
In 2014, companies in emerging markets issued a record-high $276 billion of dollar-denominated bonds [..] Such sales soared after the financial crisis as borrowers took advantage of rock-bottom interest rates set by the Federal Reserve and other central banks. Countries also have flocked to dollar-denominated bonds, saddling those governments with higher debt-service costs as the dollar rises.
Overall, companies and sovereign-debt issuers have $6.04 trillion in outstanding bonds, up nearly fourfold since the 2008 financial crisis [..] Many emerging markets also are being pummeled by falling prices for commodities such as oil and slower economic growth. Bond markets in emerging-market countries recently suffered one of their worst selloffs since the financial crisis [..]
The Indonesian rupiah, Chilean peso, Brazilian real and Turkish lira are near multiyear lows. Mexico’s central bank bought pesos earlier this month to keep the depreciating currency from pushing the economy into a funk. [..] More pressure will come if the Fed raises interest rates next year for the first time since 2006.
The stronger dollar also pushes the cost of new borrowing higher. Prices for bonds issued by Russia’s TMK, one of the world’s largest pipe makers, that are due in 2018 are down by more than 30% since late October. [..] Top officials at the IMF and the BIS have warned that the exchange-rate turmoil could lead to corporate defaults and asset-price busts around the globe. [..] overall investments in emerging markets by outsiders have grown so huge that it would be hard during a jolt for investors to sell without pushing those markets sharply lower [..].
Just you wait till the Fed hikes rates. There’ll be mayhem in the streets, all around the globe. And Wall Street banks are going to make a killing. Which is why the Fed WILL raise rates. From Fed oracle/media whisperer/bullhorn Jon Hilsenrath:
If lower long-term rates are a reflection of investors pouring money into U.S. dollar assets, flows that could spark a U.S. asset price boom, it might prompt the Fed to push rates higher sooner or more aggressively than planned. The latter interpretation is less conventional, but it is one that New York Fed President William Dudley made at length in a speech in December. He argued the Fed had the wrong reaction to lower long rates in the 2000s, a mistake that might have contributed to the housing boom that ended disastrously.
Here is a key passage: During the 2004-07 period, the (Fed) tightened monetary policy nearly continuously, raising the federal funds rate from 1% to 5.25% in 17 steps. However, during this period, 10-year Treasury note yields did not rise much, credit spreads generally narrowed and U.S. equity price indices moved higher. Moreover, the availability of mortgage credit eased, rather than tightened.
As a result, financial market conditions did not tighten. As a result, financial conditions remained quite loose, despite the large increase in the federal funds rate. With the benefit of hindsight, it seems that either monetary policy should have been tightened more aggressively or macroprudential measures should have been implemented in order to tighten credit conditions in the overheated housing sector.
Mr. Dudley’s conclusion was that the pace of the Fed’s short-term interest rate moves this time around ought to be dictated in part by whether the rest of the financial system is moving with or against the Fed’s intentions when it decides it ought to start restraining credit creation:
When lift-off occurs, the pace of monetary policy normalization will depend, in part, on how financial market conditions react to the initial and subsequent tightening moves. If the reaction is relatively large—think of the response of financial market conditions during the so-called “taper tantrum” during the spring and summer of 2013—then this would likely prompt a slower and more cautious approach. In contrast, if the reaction were relatively small or even in the wrong direction, with financial market conditions easing—think of the response of long-term bond yields and the equity market as the asset purchase program was gradually phased out over the past year—then this would imply a more aggressive approach.
…a stronger dollar and rising – albeit volatile – stock prices suggest the U.S. is attracting foreign capital which could charge up U.S. financial conditions and prompt an early or more aggressive Fed move.
The Fed – and its media handlers – are setting up the case for rate hikes. As everyone claims they wouldn’t dare. A 5% GDP growth print makes little sense at best when Japan is sinking and Europe is rudderless, but it’s accepted as gospel. So is today’s jobs report, which is as flimsy as its predecessors once you lift the veil. There is no critical journalism left in the US, and the rest of the world isn’t doing much better in that regard.
But then things like a 50%+ drop in oil prices happen. Which at some point will lead more people to wonder what the real numbers are. For emerging nations, those numbers will not be pretty for 2015. They’re going to feel like they’re being thrown right back into the Stone Age. And they’re not going to like that one bit, and look for ways to express their frustration. Volatility is not just on the rise in the world of finance. It also is in the real world that finance fails to reflect. At some point, the two will meet again, and Wall Street will mirror Main Street. It will make neither any happier. But it’ll be honest.