NEW$ & VIEW$ (30 AUGUST 2013)

This is a long post but I think well worth reading during the long week-end.

 

Second-Quarter GDP Revised Upward

The U.S. economy entered the second half of the year on firmer footing than previously estimated, with stronger growth, an uptick in corporate profits and consumers feeling better amid a rebound in housing.

[image]Strong exports, improved business investment and solid consumer spending helped U.S. gross domestic product grow at a 2.5% rate in the second quarter, the Commerce Department said Thursday. That marked a significant improvement both from the first three months of the year, when the economy grew at a 1.1% annual rate, and from the government’s earlier, preliminary estimate of second-quarter growth of 1.7%. The latest report means U.S. per capita economic output has finally—four years after the end of the recession—returned to the pre-crisis peak it reached in late 2007.

BMO Capital offers a good summary:

The good news is, the U.S. economy grew more than initially expected a month ago. The first stab at the Q2 real GDP on July 31st was 1.7% a.r. Then the trade numbers came out and wow, the view changed and it looked like GDP grew in the neighborhood of 2½% a.r. Then, as the
days went by, more data on inventories and consumer spending caused estimates to be trimmed, leaving consensus and us at around 2.2%-to-2.3% for the second quarter. Now, gentle reader, it looks like we should’ve stuck with the trade data as real GDP did rise 2.5% a.r. in Q2, the largest increase in nearly one year. That and the fact that consumer spending wasn’t revised at all (still 1.8% a.r.) is encouraging. Exports were revised up nicely, and inventories added more to the bottom line.

But perhaps the biggest surprise was the huge swing in nonresidential investment in structures (factories, buildings, etc)—initially pegged at 6.8% and is now looking like 16.1%. One should, perhaps, regard this with some skepticism, particularly as private nonresidential construction spending has been soft over the past year. Offsetting all of these pluses was a larger-than-estimated drop in government spending.

But aside from the stronger headline, underlying demand isn’t what I’d describe as … fabulous. It’s alright, but not fab. Final domestic demand (GDP excluding inventories and net exports) was trimmed to +1.9% a.r. from +2.0% but this also takes into account government cutbacks. Private final sales (GDP excluding inventories, net exports  and government) was unchanged at 2.6%, which is not fabulous but still decent.

Doug Short illustrates the difference between “fabulous” and “alright”. Quite a step down from a 3.3% cruising speed to 1.8%.

image

The only thing not revised up was consumer spending, 70% of the economy. There, the downshifts were from 5.5% in the late 1990’s to 3-4% in the mid-2000’s to the current 2% pace.

image

But that is in spite a real disposable income per capita no longer growing. How long can a 2% spending pace be sustained without income growth?

image

image

In the second half of 2012, consumer spending got support from a sharp drop in gas prices. Ain’t happening just yet.image

Could that help? Saudi Arabia Set to Pump 10.5M Barrels of Crude a Day

Saudi Arabia is set to pump 10.5 million barrels a day of crude in the third quarter, a million bpd increment over the second quarter and its highest quarterly level of production ever, leading U.S. energy consultancy PIRA said. (…)

“This is the tightest physical balance on the world oil market I’ve seen for a long time.” PIRA reported its estimate to clients earlier this week.

Libyan oil output has fallen from 1.4 million bpd to just 250,000 bpd after protesters shut oilfields. (…)

Ross said about 400,000 bpd of the incremental supply would go to feed domestic Saudi power usage during peak summer demand for air conditioning. (…)

U.S. Prepares for Solo Strike Against Syria

The Obama administration laid the groundwork for unilateral military action, a shift officials said reflected the U.K.’s abrupt decision not to participate and concerns Bashar al-Assad was using the delays to disperse military assets.

France ready for Syria strike without UK
Hollande to discuss next move with Obama
 

Hmmm…

This morning:

Consumer Spending in U.S. Increase Less Than Forecast as Income Gains Slow

Consumer purchases, which account for about 70 percent of the economy, rose 0.1 percent after a revised 0.6 percent increase the prior month that was larger than previously estimated, the Commerce Department reported today in Washington.

Sad smile Adjusting consumer spending for inflation, purchases were unchanged in July compared with a 0.2 percent increase the previous month, according to today’s report.

The Commerce Department’s price index tied to spending, a gauge tracked by Federal Reserve policy makers, increased 1.4 percent in July from the same period in 2012. The core price measure, which excludes volatile food and energy categories, rose 1.2 percent from July 2012.

U.S. HOUSING COOLING?

Bidding Wars Continue to Tumble as Housing Market Rebalances

Competition in the US residential real estate market dropped for the fourth consecutive month in July, underscoring the market’s overall trend towards balance. Nationally, the percentage of offers written by Redfin agents that faced multiple bids fell to 63.3 percent in July, down from 68.6 percent in June, and 75.7 percent at the peak in March.image

The slide in competition reflects multiple factors that are beginning to erode sellers’ market dominance across the nation:

Buyer Fatigue: First and foremost, Redfin agents report that buyers in the nation’s most competitive markets are growing weary. (…)

Budgets: The combined effect of rising prices and mortgage rates continues to price buyers out of the market, reducing competition for available inventory. Nationally, the median home price per square foot for single-family homes was up 18.7 percent in July from the year before and average weekly 30-year fixed mortgage rates in July were up about one percentage point from May. For a $250,000 mortgage, this jump in prices and mortgage rates translates to a rise in mortgage payments of more than $300 per month.image

Growing Inventory: Rising prices and mortgage rates are also driving homeowners to list their homes in greater numbers, which is boosting options for buyers. As of June, the number of single-family homes for sale in Redfin markets was up 7.8 percent from March and the national months of supply of inventory grew from 2.7 in May to 3 in June. Some homeowners who were underwater on their mortgages are becoming more confident that their homes can fetch a fair price and are deciding to list. Furthermore, our agents in San Francisco and Chicago report that mortgage rates are also leading homeowners to list. Homeowners, too, want to capitalize on historically low rates and move up before rates increase further. (…)

Further Cooling on Tap for Autumn: Looking forward, we expect that bidding wars will continue to cool slightly during the autumn months. The real estate market was atypically hot during autumn of 2012 because buyers were rushing to lock in low mortgage rates once home prices stabilized. Now that rates are higher, home prices continue to rise, and more inventory is coming available, buyers are likely to battle for homes less often.(…)

EUROTURN?

 

Euro-Zone Adds 15,000 Jobs

The number of people unemployed in the euro zone fell in July for the second month in a row, adding to tentative signs that a modest recovery under way in the currency bloc’s economy is starting to erode its sky-high levels of joblessness.

Eurostat said the annual rate of consumer-price inflation fell to 1.3% in August from 1.6% in July, putting it considerably below the central bank’s target area of a little below 2%.

Sad smile  German Retail Sales Unexpectedly Drop in Sign of Uneven Recovery

German retail sales unexpectedly fell for a second month in July, signaling an uneven recovery in Europe’s largest economy.

Sales adjusted for inflation and seasonal swings dropped 1.4 percent from June, when they declined 0.8 percent, the Federal Statistics Office in Wiesbaden said today. Economists predicted an increase of 0.6 percent, according to the median of 27 estimates in a Bloomberg News survey. Sales climbed 2.3 percent from a year earlier.

These are big drops!

Fingers crossed Eurozone sales rise marginally in August

Retail sales in the eurozone rose for the first time in nearly two years in August, Markit’s retail PMI® data showed. The value of retail sales increased since July, albeit only marginally. Employment at retailers also rose slightly following a 16-month sequence of decline. National differences in sales trends remained, however, as Germany registered further strong growth, France achieved a back-to-back modest rise and Italy posted an ongoing sharp decline.

image

Germany’s retail sector continued to drive the overall increase in eurozone retail sales. Sales rose on a monthly basis for the fourth successive survey, the longest sequence of growth in 17 months.
Moreover, the rate of expansion was little-changed from July’s two-and-a-half year high.

Retail sales in France rose for the second month running in August, and at the strongest rate since October 2011. Prior to July, sales had fallen for a survey-record 15-month period.

Italy remained the weak link in the eurozone retail recovery mid-way through Q3. Sales fell for the thirtieth successive month, and the rate of
contraction remained sharp despite easing since July.

image

Retail sales in the eurozone continued to decline on an annual basis. That said, the rate of contraction eased to the slowest since October 2011. A further sign of the nascent recovery in the eurozone retail sector was a rise in employment in August. This mainly reflected recruitment at German retailers, while retail employment in France stabilised following a prolonged period of cuts and Italian retailers shed staff at the slowest rate since August 2010.

Pointing up imageAverage purchase prices paid by retailers for new goods rose at a sharper rate in August. By product sector, food & drink again posted the steepest rate of inflation, followed by clothing & footwear. Among the three national retail sectors covered, Germany posted the steepest increase in average input costs. Meanwhile, gross margins across the eurozone retail sector declined at the slowest rate since April 2011.

Note that the retail PMI is barely above 50 and has shown a very high volatility in recent years. The German engine remains fairly sound but the Italian and French engines remain unreliable. See below on France.

DOUCE FRANCE from BloomberBriefs:

President Francois Hollande’s pension reforms will probably fail to eliminate the pension deficit or make the French economy more
competitive. France’s government spends the most in the euro area relative to its GDP and has the third-highest labor costs.

People under the age of 40 will have to work beyond 62 to earn a full
pension. Contributions by both workers and employers will increase by
0.3 percentage point in 2017, though the government will cut other payroll charges in an effort to contain labor costs. The pension system is still likely to have a deficit of 13.6 billion euros in 2020, instead of 20.7 billion euros, even if all the announced measures are adopted, according to the French pension council.

The proportion of population over the age of 65 is forecast to climb to 18
percent next year from 17.1 percent in 2012. France has the third-highest
share of labor costs allocated to employers’ social contributions, according to Eurostat, at 34.2 percent, compared with 21 percent in Spain. The nation is ranked the 21st most competitive economy in the world, compared with sixth for Germany, according to the Global Competitiveness Index.

image

The government may be forced to introduce additional spending cuts and
tax increases to meet its commitment to balance the budget by 2017. It is
likely to miss the target of narrowing the deficit to 3.7 percent of GDP this
year from 4.5 percent, having abandoned the original target of 3 percent.
France has failed to balance its budget since 1974, and the shortfall has
averaged 3.9 percent of GDP over the last decade.

image

The government claims two-thirds of its austerity measures will come
from changes to the tax system this year, with 20 billion euros in tax
increases planned, compared with 10 billion euros in spending cuts. Taxes
accounted for 45.9 percent of GDP in 2011, compared with a euro-area
average of 40.8 percent. Public spending in France amounts to 57 percent
of GDP, the highest level in the euro region.

Red heart EPSILON THEORY: CENTRAL BANK COMPETENCE OR LACK THEREOF

U.S. equity markets have done well recently against flattening earnings, stable inflation rates and higher interest rates. Rising investors confidence has translated into absolute P/E ratios that are 10% above their historical mean and Rule of 20 readings that are unfavourable from a risk/reward ratio standpoint.

Earnings expectations for Q3 and Q4 look increasingly vulnerable. Can confidence stay high enough to offset “natural”, more dependable forces?

Ben Hunt’s latest note is highly relevant here:

(…) The shift in perceptions of Fed competence is being driven by opinion leaders’ public statements questioning the Fed’s communication policy. Here’s the critical point from an Epsilon Theory perspective: these public statements are not questioning the content of Fed communications; they are questioning the USE of communications as a policy instrument in and of itself. In exactly the same way that a magician immediately becomes much less impressive once you know how he does his trick, so is the Fed much less impressive once you start focusing on HOW policy is being communicated rather than WHAT policy is being implemented.

For example, this past Saturday Jean-Pierre Landau, a former Deputy Governor of the Bank of France and currently in residence at Princeton’s Woodrow Wilson School, presented a paper at Jackson Hole focused on the systemic risks of the massive liquidity sloshing around courtesy of the world’s central banks. For the most part it’s a typical academic paper in the European mold, finding a solution to systemic risks in even greater supra-national government controls over capital flows, leverage, and risk taking.  But here’s the interesting point:

Pointing upZero interest rates make risk taking cheap; forward guidance makes it free, by eliminating all roll over risk on short term funding positions. … Forward guidance brings the cost of leverage to zero, and creates strong incentives to increase and overextend exposures. This makes financial intermediaries very sensitive to “news”, whatever they are.”

Landau is saying that the very act of forward guidance, while well-intentioned, is counter-productive if your goal is long-term systemic stability. There is an inevitable shock when that forward guidance shifts, and that shock is magnified because you’ve trained the market to rely so heavily on forward guidance, both in its risk-taking behavior (more leverage) and its reaction behavior (more sensitivity to “news”). This argument was picked up by the WSJ (“Did Fed’s Forward Guidance Backfire?”) over the weekend, and it continues to get a lot of play. It’s an argument I’ve made extensively in Epsilon Theory, particularly in “2 Fast 2 Furious.”

Landau’s paper is probably the most public example of this meta-critique of the Fed, but I don’t think it’s been the most powerful. Highly influential opinion leaders such as David Zervos and John Mauldin have recently written in their inimitable styles about the Fed’s use of words and speeches as an attempt at misdirection, as an ultimately misguided effort to hide or sugarcoat actual policy. FOMC members themselves are starting to question the Fed’s reliance on communications as a policy instrument, as evidenced by the minutes released last week. Combine all this with the growing media focus on the “battle” between Yellen and Summers for the Fed Chair – a focus which will create policy disagreements between the candidates in the public’s perception even if no such disagreements exist in reality – and you have a recipe for accelerating weakness in perception of Fed competence.

The shift in perception of non-Fed central bank competence, especially of Emerging Market central banks, is even more pronounced. Actually, “competence” is the wrong word to use here. The growing Narrative is that Emerging Market central banks are powerless, not incompetent. The academic foundation here was made in a paper by Helene Rey of the London Business School, also presented at Jackson Hole, where the nutshell argument is that global financial cycles are creatures of Fed policy … period, end of story. Not only is every other country just along for the ride, but Emerging Markets are kidding themselves if they think that their plight matters one whit to the US and the Fed.

Just as malcontents with the exercise of Fed communication policy may be found within the FOMC itself, you don’t have to look any further than Emerging Market central bankers and finance ministers themselves for outspoken statements protesting their own impotence. Agustin Carstens, Mexico’s equivalent to Ben Bernanke, gave a speech on the “massive carry trade strategies” caused by ZIRP and pleaded for more Fed sensitivity to their capital flow risks. Interesting how the Fed is to blame now that the cash is flowing out, but it was Mexico’s wonderful growth profile to credit when the cash was flowing in. South Africa’s finance minister, Pravin Gordhan, gave an interview to the FT from Jackson Hole where he bemoaned the “inability to find coherent and cohesive responses across the globe to ensure that we reduce the volatility in currencies in particular, but also in sentiment” now that the Fed is talking about a Taper. Christine Lagarde got into the act, of course, calling on the world to build “further lines of defense” even as she noted that the IMF would (gulp!) have to stand in the breach as the Fed left the field. To paraphrase Job: the Fed gave, and the Fed hath taken away; blessed be the name of the Fed.

I’ll have a LOT more to say about all this in the weeks and months to come, but I thought it would be useful to highlight these shifts in Narrative structure in real-time as I am seeing them. Informational inflection points in the market’s most powerful Narratives are happening right now, and this is what will drive markets for the foreseeable future.

Right on cue:

India’s Central Bank Governor Concedes to Missteps

It is rare for officials to admit that their policies have been less than perfect, but India’s central bank governor Duvvuri Subbarao did just that late Thursday, in his last public speech as head of the Reserve Bank of India.

Mr. Subbarao, whose five-year term as RBI governor ends Sept. 4, said the bank could have done a better job of explaining the intentions behind the various steps it has taken in the last three months to support India’s declining currency.

“There has been criticism that the Reserve Bank’s policy measures have been confusing and betray a lack of resolve to curb exchange-rate volatility,” Mr. Subbarao said at a lecture in Mumbai. He said that the RBI is unequivocally committed to curbing volatility in the rupee. “I admit that we could have communicated the rationale of our measures more effectively,” he added.

Ghost Über-bear Albert Edwards will scare you even more, courtesy of ZeroHedge:

(…) The fabulously entertaining Zero Hedge website keeps running the charts showing that the evolution of bond yields and equity markets this year resembles closely what happened in 1987 (see below). Now we should all take these comparisons with a pinch of salt, but what if…

I remember the 1987 crash well. I was working at Bank America Investment Management as an economist/strategist at the time. Of course, the immediate trigger for the equity crash was the fear of US recession caused by the fear that the US would have to hike rates sharply to defend the dollar. Those fears were triggered by Germany raising rates at a time when the G6 had recently agreed to stabilise the US dollar at the February 1987 Louvre Accord, after two years of sanctioned dollar weakness. Investors got into a tizzy about recession, jumping many steps ahead of the game. But, in the wake of a run-up in US bond yields that year, equities were richly priced and so very vulnerable to recession fears, however unfounded. And then the machines took over. That couldn’t possibly happen again, or could it?

Therein lies one of the key lessons I learnt in my 30 years in the markets. Pointing up It is not just to try to predict what will happen, but to second-guess what the markets fear might happen. Indeed a recession did not ensue and the 1987 crash turned into a tremendous buying opportunity.

Edwards then links with the EM debacle:

But another shoe will surely drop soon. China has gone off the radar in the last month, as the data have firmed, but it is set to return centre stage. Our China economist Wei Yao, thinks “this sudden turn-around is similar to that during Q4 2012, when the multi-quarter deceleration trend reversed shortly after the policy stance shifted to “cautious” easing. But that growth pick-up did not last for more than one quarter.” A continued slowdown in credit growth will strangle the current buoyancy of house price inflation (see charts below), with property sales growth having already peaked. Wei expects the Chinese data to relapse in Q4.

“Many people are writing about a Chinese credit crunch and banking crisis. I disagree. The authorities will have a choice as to whether to accept such a crunch or devalue and launch a new credit cycle to keep the balls in the air once again. Devaluation is the preferred option…..So the (recent) spike in SHIBOR was not a tremor indicating the earthquake of a banking crisis, but a tremor of a forthcoming RMB devaluation.” That will be the biggest domino of all to fall. And, as with the 1987 crash, markets will react to the fear of the devaluation and the deflation it will bring to the west, rather than the event itself. (…)

The emerging markets “story” has once again been exposed as a pyramid of piffle. The EM edifice has come crashing down as their underlying balance of payments weaknesses have been exposed first by the yen’s slide and then by the threat of Fed tightening. China has flipflopped from berating Bernanke for too much QE in 2010 to warning about the negative impact of tapering on emerging markets! It is a mystery to me why anyone, apart from the activists that seem to inhabit western central banks, thinks QE could be the solution to the problems of the global economy. But in temporarily papering over the cracks, they have allowed those cracks to become immeasurably deep crevasses. At the risk of being called a crackpot again, I repeat my forecasts of 450 for the S&P, sub-1% US 10y yields and gold above $10,000. Ghost

Indian Growth Slows to Four-Year Low as Rupee Drop Dims Outlook

Gross domestic product rose 4.4 percent in the three months through June from a year earlier, compared with 4.8 percent in the prior quarter, the Statistics Ministry said in New Delhi today. The median of 44 estimates in a Bloomberg News survey was for a 4.7 percent gain.

Emerging Markets Raise Rates

Indonesia raised its benchmark rate by half a percentage point on Thursday, one day after a half-point increase by Brazil and a week after a rate increase by Turkey. Other developing economies are under mounting pressure to tighten credit to support their weakening currencies. Brazil’s central bank hinted at further increases to come.

image

(…) The value of India’s rupee has fallen by a fifth against the U.S. dollar since the beginning of May. The Reserve Bank of India’s initial response was to stop easing monetary policy, holding benchmark interest rates steady in June and July. When the rupee kept falling, the RBI limited the amount of money banks could borrow from it.

Investors saw that as effectively raising interest rates, at a time when India’s economy was growing at its slowest pace in a decade. Bonds and stocks sold off after the RBI’s steps. Yields on both short- and long-term rupee bonds jumped.

Some analysts say the incoming Indian central-bank governor may have no choice but to raise interest rates sharply, much as Fed Chairman Paul Volcker did in the U.S. in the 1980s.

South Africa is in a similar bind. Authorities want to halt declines in its currency, which has lost nearly a quarter of its value against the dollar over the past year but are reluctant to smother already weak growth.

Inflation reached an annual rate of 6.3% in July, but when South African central-bank officials meet to discuss rates again next month, they will be loath to raise rates in an economy struggling to meet forecasts for 2% growth this year, analysts say.

Some investors worry that they could see a repeat of the Asian financial crisis of 1997-98, or the stampede out of emerging-market currencies a decade later in 2008. But there are reasons to believe it won’t be that bad.

Pointing up Most emerging-market currencies today are allowed to float, so central-bank officials don’t have to defend a fixed exchange rate as they did during the Asian crisis. The government debt levels of countries like Indonesia, India and Brazil aren’t particularly high and are denominated mainly in local currency.

Not just in the U.S.: Elections Complicate Economic Decisions for India,Indonesia Upcoming elections in India and Indonesia, two of the countries hardest hit by the selloff in emerging-market assets, are making it more difficult to make the tough decisions both countries need.

Pointing up  Ft Alphaville has a great post on the EM situation:

From a recent Citi presentation, a chart stressing the potential risk of negative-feedback loops in the options available to those emerging market countries now trying to stem capital outflows and defend their currencies:

The chart makes an important point and is self-explanatory, but it isn’t comprehensive.

Notably excluded is the imposition of capital controls on outflows, which thus far have been mostly resisted with the exception of some limited measures in India. (…)

Also unmentioned is the option to lobby the central banks of developed countries, encouraging them not to tighten policy too quickly. This option appears to have been pursued with some vigour at Jackson Hole last weekend, but probably won’t carry much weight at the next FOMC meeting.

So the immediate options, at least those of a sweeping nature, are unattractive. And the possibility that emerging market central banks and governments will overreact and excessively tighten policy is a singular concern. (…)

But the broader issue is that it remains quite difficult to gauge the severity of the year’s EM currency and asset selloff — and to know whether it is more attributable to an acute market crisis versus a more fundamental economic shift.

Among the various possible causes normally cited are the Fed’s talk of tapering; the unwinding of carry trades; Chinese rebalancing; the pass-through effects of this rebalancing on commodity-exporters (Australia, South Africa, various countries in South America); the end of the commodity super-cycle generally; the limits to growth in countries that procrastinated on necessary structural changes; continued sluggishness by developed-country consumers; and dwindling investor patience with widening current account and budget deficits.

The causes aren’t mutually exclusive, of course, and some influence the others in various ways.

It’s also tough to know, at least for the inexpert or non-obsessive follower of international economics, how prepared the affected countries are to handle it.

The current situation — has it reached the level of “crisis” yet? — inevitably will have a similar feel to the crises of the 1990s given the reversal of hot money flows, the threat from speculators attacking various currencies, and even the involvement of some of the same countries. But so much is different, and most of the differences are positive.

As our colleagues David Pilling and Josh Noble wrote in Wednesday’s FT:

Back then, many countries had fixed exchange rates and their companies were heavily exposed to foreign debt. As currencies came under pressure, central banks desperately spent reserves to defend them. When the peg finally broke, currencies collapsed and companies’ foreign-denominated debts soared.

Thailand, Indonesia and South Korea had to seek help from the International Monetary Fund. Partly as a result of now largely discredited IMF austerity packages, they subsequently plunged into deep recession. Indonesia, the worst affected, lost 13.5 per cent of GDP in a single year. Suharto, the dictator, was toppled.

Today the picture is very different. Asian economies have flexible exchange rates, much higher reserves and sounder banking systems. India, for example, has reserves to cover seven months of imports compared with only about three weeks when it had its own “come-to-IMF” moment in 1991.

Nor, this time around, has India’s central bank wasted much firepower on defending the currency. Instead, it has largely allowed the rupee to slide. A weaker currency should boost exports and slow imports, closing the current account deficit automatically.

And so it might, hopefully without much lasting damage. We would also note the still-favourable growth differentials between developed and emerging market countries, which didn’t exist in the 1990s.

Admittedly this doesn’t preclude a new crisis or crises of a different flavour, and do read the full FT piece for the thoughts of more-pessimistic commentators, with careful attention to the points of Ruchir Sharma. Still, for the moment the problems seem at least endurable, if not actively manageable.

And although these countries’ immediate choices are regrettably limited, there is also a more hopeful longer-term story that can be told about this year’s events.

It’s mainly about how (some of) the lessons of the 1990s and the recent developed-world financial crisis have been heeded. In addition to the ability of emerging market currencies to respond to market forces, the relevant Asian countries also better understand the need for multi-lateral coordination and support during crises.

Furthermore, as economists from Standard Chartered explained, it’s likely that investors have become more discerning about the details of countries’ external funding problems. The economists looked at the short-term external debt situations for India, Indonesia, and Thailand — the three countries involved running a current account deficit — and found that “in all three cases the vast majority of the debt due within one year does not come with serious financing risk”.

More broadly, we’ve been especially interested in tracking the continued expansion of local-currency debt and capital markets, where tremendous progress has been made in the last decade and a half, especially in sovereign and corporate bond markets.

They’re important for a few reasons.

Companies in emerging markets find it easier to borrow in their own currencies, and are better able to hedge their debt if they rely on imports denominated in foreign currencies. Currency swings therefore become less threatening. (…)

Emerging market governments with sophisticated capital markets also have less need to build up massive stores of foreign currency reserves, a process that exacerbated the unnatural problem of global imbalances in the decade prior to the crisis of 2008 — when too much capital flowed from developing countries to developed countries rather than the other way round.

And of course, robust local-currency debt and equity markets, when accompanied by sound governance practices, reduce the dependence on foreign bank lenders and lead to a more diversified base of stakeholders. (…)

International trade and capital flows collapsed after the financial crisis of 2008. Within Europe the balkanisation of financial markets has mostly remained in place. But as both Citi’s presentation and a helpful McKinsey report explain in detail, by 2012 capital inflows to emerging markets had returned nearly to their pre-crisis levels.

These inflows returned, however, mainly in the form of foreign direct investment and investments via capital markets rather than bank lending.

Foreign direct investment is already considered to be a more stable kind of inflow. And the progress in developing local-currency capital markets also indicates that the growth in portfolio flows will be less worrying in the future, if certainly not yet.

These were favourable trends. Despite the present slowdown, in time they are likely to resume course given the disproportionately shallower financial markets in developing countries.

Investors in local-currency emerging market debt have been shellacked this year, and clearly the FX markets are spooked. Maybe the selloff will accelerate and new balance of payments crises really are imminent. We don’t know: much depends on policy still being decided, especially given the recent introduction of heightened geopolitical risks. We certainly don’t mean to dismiss the possibility of a terrible outcome, especially for an individual country.

Fingers crossed For now, however, the problems appear both different in nature and smaller in scale, and unlikely to spread uncontrollably. If we’re right about that, then a plausible explanation is that the lessons of the 1990s haven’t gone entirely ignored. And if a number of emerging market countries are about to enter a grinding period of slower growth and structural adjustments, or to experience new financial strains, at least they do so better prepared. (…)

Japan inflation highest in five years
Weaker yen pushes up cost of fuel and electricity

Consumer price inflation in Japan rose to an annual rate of 0.7 per cent in July, its highest level in almost five years, as the effects of a weaker yen pushed up the cost of fuel and electricity.

Excluding fresh food, the all-items index rose by 0.7 per cent from a year earlier and by 0.1 per cent from June.

But excluding the cost of energy from the calculation brings the yearly CPI to minus 0.1 per cent. The prices of items such as housing, furniture, medical care and culture and recreation all fell from a year earlier, while charges for fuel, light and water rose by 6.4 per cent.

Other data released on Friday morning were positive. The jobless rate dropped to 3.8 per cent, from 3.9 per cent in June, while industrial production rose by 1.6 per cent on a yearly basis and 3.2 per cent on the previous month.

Household spending edged up 0.1 per cent from a year earlier, from a 0.4 per cent fall in June.

Signs of Japanese Investment Uptick Investment by Japanese companies has been a laggard in the nation’s economic recovery. But things could be turning, data showed Friday.

Industrial production jumped 3.2% on month in July, reversing a 3.1% downturn in June.

The government was keen to point out that much of the production seems to show companies are spending more on increasing production.

The output of capital goods, which includes machinery, was at its highest level on a seasonally-adjusted basis since May 2012, a Japanese official said. The official also pointed toward big jumps in the output of goods such as steam turbines and equipment used in the plastics industry – tentative signs that companies are investing in increasing capacity. (…)

Other data today added to a sense that companies’ optimism is returning. Japan’s Purchasing Managers’ Index rebounded to 52.2 in August from 50.7 in July. That’s not far off a high of 52.3 in June. New orders, a sign of renewed corporate activity, were strong.

Have a good one!

 

Leave a Reply

Your email address will not be published. Required fields are marked *