Carry currencies to tempt central banks
Central bankers as carry traders? Why not.
As we wrote here yesterday, FX reserves at global central banks may be starting to rise again. That’s a consequence of a pick up in portfolio investment flows in recent weeks and is likely to continue after the U.S. Fed’s announcement of its QE3 money-printing programme.
According to analysts at ING, the Fed’s decision to restart its printing presses will first of all increase liquidity (some of which will find its way into central bank coffers). Second, it also tends to depress volatility and lower volatility encourages the carry trade. Over the next 12 months these two themes will combine as global reserve managers twin their efforts to keep their money safe and still try to make a return, ING predicts, dubbing it a positive carry story.
The first problem is that yields are abysmal on traditional reserve currencies. That means any reserve managers keen to boost returns will try to diversify from the dollar, euro, sterling and yen that constitute 90 percent of global reserves. Back in the spring of 2009 when the Fed scaled up QE1, its move depressed the dollar and drove reserve managers towards the euro, which was the most liquid alternative at the time. ING writes:
This time, however, we are not looking for the same kind of euro pick-up that we saw in 2009. FX reserve managers typically invest in securities rated AA or higher. Even if they extend durations out to the 5-year area of sovereign curves, an average of AA/AAA Eurozone yields only pays 0.75% – exactly the same as Treasuries.5-year UK gilts are not much better at 0.9 % while Japan pays a measly 0.2% on 5-year bonds.
Instead ING analysts reckon FX reserve managers will go for currencies such as the Australian and Canadian dollars. Thanks to slightly better yields, and large, liquid bond markets, a carry basket invested in the Australian, Canadian, Norwegian and Swedish currencies and funded out of the dollar, euro, sterling and yen will have an annualised carry pick up of 1.6%, the analysts say. That sounds pretty modest but according to ING, FX outperformance can deliver returns of over 10% on this basket. They write:
If a major new bout of FX reserve accumulation is to take place, we’re convinced that 90-95% concentration in core currencies has to fall.
International reserve managers are likely to opt in greater numbers for higher-yielding currencies such as the Australian dollar in their bid to diversify their holdings. Join DiscussionEmerging market FX reserves again on rise
One of the big stories of the past decade, that of staggering reserve accummulation by emerging market central banks, appeared to have ground to a halt as global trade and economic growth slumped. But according to Bank of America/Merrill Lynch, reserves are starting to grow again for the first time since mid-2011.
The bank calculates that reserve accumulation by the top-50 emerging central banks should top $108 billion in September after strong inflows of around $13 billion in each of the first two weeks. Look at the graphic below.
So what is the source of these inflows? As BoA/ML points out global trade balances are at their cyclical lows and that is reflected in the dwindling current account surpluses in the developing world. But as risk sentiment has improved in the past six weeks, there has been a pick up in fixed income and equity investment flows to emerging markets, compared to the developed world.
These portfolio flows are likely to increase even more following the Fed’s announcement of an open-ended $40 billion-a-month money-printing programme. BoA/ML writes:
After a gap, emerging markets may again be seeing a rise in central bank reserves. Join DiscussionThe data show that investment capital is being rotated out of developed markets to EM, supporting our view that the financial account has been increasing, even if the current account has not…..Real money flows explain a large share of the recent growth in reserves.
No BRIC without China
Jim O’ Neill, creator of the BRIC investment concept, has been exasperated by repeated calls in the past to exclude one or another country from the quartet, based on either economic growth rates, equity performance or market structure. In the early years, Brazil’s eligibility for BRIC was often questioned due to its anaemic growth; then it was the turn of oil-dependent Russia. Over the past couple of years many turned their sights on India due to its reform stupor. They have suggested removing it and including Indonesia in its place.
All these detractors should focus on China.
China’s validity in BRIC has never been questioned. Aside from the fact that BRI does not really have a ring, that’s not surprising. China’s growth rates plus undoubted political and economic clout on the international stage put it head and shoulders above the other three. And after all, it is Chinese demand which drives a large part of the Russian and Brazilian economies.
But its equity markets have not performed for years.
This year, Russian and Indian stocks are up around 20 percent in dollar terms while China has gained 9 percent and Brazil 3 percent. In local currency terms however China is among the worst performing emerging markets, down 5 percent. Brazil has risen 9 percent.
Over the past five years, MSCI China. which makes up 40 percent of the BRIC index, has lost 18 percent, Thomson Reuters data shows. That has pushed the broader BRIC into a negative return of almost 10 percent in this period.
The BRIC equity losses and BRIC funds’ poor returns are now causing many to question the validity of the BRIC concept itself, a topic we explored in this recent article. But clearly the problem with BRIC equities lies with China and as the economy slows, more losses are likely in the short-term. The Shanghai market has taken little cheer from the Fed’s money printing-announcement, focusing instead on falling property prices locally and potential problems at Chinese banks.
BRIC equities have fared poorly as a bloc in recent years but the worst performing member of the quartet has been China which makes up 40 percent of the BRIC index. But there is no need to rule China out just yet. Join DiscussionCompetitive, moi? Turkey jumps up the league
Switzerland tops the World Economic Forum’s competitiveness league for the fourth year running, according to the latest survey out today, while the United States is slipping down the table because of political and economic problems.
But quite a few emerging market countries are jumping up the league.
Charles Robertson at Renaissance Capital highlights Turkey and Nigeria as some of the best performers in the last year, rising 16 and 12 places respectively in the index, which is based on 12 measures, including infrastructure, macro-economic environment, and market size.
Turkey has moved into 43rd place, above Brazil and India. Nigeria has only reached 115th, but it trumps other sub-Saharan African countries like Mozambique and Uganda.
Turkey’s stockmarket has risen a staggering 32 percent this year (where broader emerging markets are only up 2 percent), despite well-documented troubles within the euro zone, the country’s main trading partner, and a civil war in neighbouring Syria.
“From a top-down view, Turkey does not look very good,” says Xavier Hovasse, fund manager at Carmignac. But Hovasse adds that the country has been quick to shift some of its export sector away from the euro zone and towards the more buoyant Middle East, and has successfully competed there with exporters from countries like South Korea.
Turkey scores well in the league on its large market and intense local competition, but has an inefficient labour market.
Turkey and Nigeria are among emerging market countries jumping up the world competitiveness league table. Join DiscussionNo policy easing this week in Turkey and Chile
More and more emerging central banks have been embarking on the policy easing path in recent weeks. But Chile and Turkey which hold rate-setting meetings this Thursday are not expected to emulate them. Both are expected to hold interest rates steady for now.
In Chile, the interest rate futures market is pricing in that the central bank will keep interest rates steady at 5 percent for the seventh month in a row. Most local analysts surveyed by Reuters share that view. Chile’s economy, like most of its emerging peers is slowing, hit by a potential slowdown in its copper exports to Asia but it is still expected at a solid 4.6 percent in the third quarter. Inflation is running at 2.5 percent, close to the lower end of the central bank’s percent target band.
Turkey is a bit more tricky. Here too, most analysts surveyed by Reuters expect no change to any of the central bank rates though some expect it to allow banks to hold more of their reserves in gold or hard currency. The Turkish policy rate has in fact become largely irrelevant as the central bank now tightens or loosens policy at will via daily liquidity auctions for banks. And for all its novelty, the policy appears to have worked — Turkey’s monstrous current account deficit has contracted sharply and data this week showed the June deficit was the smallest since last August. Inflation too is well off its double-digit highs.
But Turkey’s economy too faces headwinds, most of all from the euro zone where it sends most of its exports. Growth is slowing and there are signs the central bank as well as exporters are getting a bit restless about the currency (the lira is up 5 percent this year versus the dollar). UBS strategist Manik Narain says:
Turkey and Chile, the two emerging market central banks holding policy meetings this week, are expected to leave interest rates unchanged. Join DiscussionThe bias is for looser policy but there is no real need to cut the policy rate. They may reduce the ceiling of their overnight rates corridor to indicate they are starting to feel discomfort with the lira’s strength but for the time being their policy tools are doing their job for them.
Pay votes update… Spring takes a fall?
A few months ago, at the height of the British AGM season, we ran some numbers on shareholder protest votes over executive pay.
It seemed striking at the time that despite all the talk of revolution, the average vote against FTSE 100 companies’ remuneration reports had only edged higher, to 8.2% from 8.0% in 2011.
This week I’ve been catching up on the AGMs which have taken place since May, giving us a decent quorum of 92 companies, and the results are even more startling.
The average protest vote in 2012 now stands at 7.6% — less than it was last year. Abstentions (or ‘witheld’ votes, in the language of the proxy form) were also down, at 2.5% against 3.6% in 2011.
As we noted previously, this doesn’t blow out of the water the idea of proactive, emboldened investors. Aviva’s Andrew Moss and WPP’s Martin Sorrell would take issue with that, and it’s worth noting that the 2012 number would likely have been higher without some scrambling by Boards to placate grumbling investors as it became clear that revolution was in the air.
It does, however, help tell a more level-headed story about the nature and extent of any uprising by the grey-suited fund managers of the City.
For the completists, you can get in touch with me on Twitter via @reutersJoelD to receive a spreadsheet full of deeply exciting data.
Updated numbers on pay revolts at UK company AGMs are a further challenge to the 'shareholder spring' narrative. Join DiscussionShadow over Shekel
Israel’s financial markets had a torrid time on Monday as swirling rumours of an imminent air strike on Iran caused investors to flee. The shekel lost 1.4 percent, the Tel Aviv stock exchange fell 1.5 percent and credit default swaps, reflecting the cost of insuring exposure to a credit, surged almost 10 percent.
There has been a modest recovery today as the rumour mills wind down. But analysts reckon more weakness lies ahead for the shekel which is not far off three-year lows. Political risks aside, the central bank has been cutting interest rates and is widely expected to take interest rates, currently at 2.25 percent, down to 1.75 percent by year-end. Societe Generale analysts are among the many recommending short shekel positions against the dollar. They say:
Expect the dovish stance of the Bank of Israel to remain well entrenched for now.
That’s not all. Investors have been pulling cash out of Israel’s financial markets for some time (Citi analysts estimate $1.6 billion fled in the first quarter of the year). After running current account surpluses for more than 8 years, Israel now has a deficit (the gap was $1.7 billion in the first three months of this year, double the previous quarter) .
Looking behind the scenes, a key factor behind shekel performance is the relative performance of Tel Aviv stocks versus the U.S. market, says Citi analyst Neil Corney. Last year, Tel Aviv fell more than 20 percent and it hasnt recovered this year. New York’s S&P500 on the other hand has rallied 12 percent so far in 2012 and outperformed last year as well. Corney tells clients:
Local investors in Israel always have a massive home bias but have been investing abroad for a number of years now. However, whilst the local market was outperforming the U.S. markets, they generally would hedge their exposure back to shekels. The inflows into the local real money accounts are strong and growing and the recent underperformance of the local market has led us to a ….phenomena of investing abroad but without the currency hedge. The general rule of thumb that I followed was at least one quarter of underperformance would cause local real money to increase their offshore investments and increase their short shekel position.
Quite simply, these outbound investors are betting the shekel will at best not strengthen much in the short-term, so it makes sense for them to stay unhedged.
After running current account surpluses for more than 8 years, Israel now has a deficit Join DiscussionPut down and Fed up
Given almost biblical gloom about the world economy at the moment, you really have to do a double take looking at Wall Street’s so-called “Fear Index”. The ViX , which is essentially the cost of options on S&P500 equities, acts as a geiger counter for both U.S. and global financial markets. Measuring implied volatility in the market, the index surges when the demand for options protection against sharp moves in stock prices is high and falls back when investors are sufficiently comfortable with prevailing trends to feel little need to hedge portfolios. In practice — at least over the past 10 years — high volatility typically means sharp market falls and so the ViX goes up when the market is falling and vice versa. And because it’s used in risk models the world over as a proxy for global financial risk, a rising ViX tends to shoo investors away from risky assets while a falling ViX pulls them in — feeding the metronomic risk on/risk off behaviour in world markets and, arguably, exaggerating dangerously pro-cyclical trading and investment strategies.
Well, the “Fear Index” last night hit its lowest level since the global credit crisis erupted five-years ago to the month. Can that picture of an anxiety-free investment world really be accurate? It’s easy to dismiss it and blame a thousand “technical factors” for its recent precipitous decline. On the other hand, it’s also easy to forget the performance of the underlying market has been remarkable too. Year-to-date gains on Wall St this year have been the second best since 1998. And while the U.S. and world economies hit another rough patch over the second quarter, the incoming U.S. economic data is far from universally poor and many economists see activity stabilising again.
But is all that enough for the lowest level of “fear” since the fateful August of 2007? The answer is likely rooted in another sort of “put” outside the options market — the policy “put”, essentially the implied insurance the Fed has offered investors by saying it will act again to print money and buy bonds in a third round of quantitative easing (QE3) if the economy or financial market conditions deteriorate sharply again. Reflecting this “best of both worlds” thinking, the latest monthly survey of fund managers by Bank of America Merrill Lynch says a net 15% more respondents expect the world economy to improve by the end of the year than those who expect it to deteriorate but almost 50 percent still believe the Fed will deliver QE3 before 2012 is out. In other words, things will likely improve gradually in the months ahead and if they don’t the Fed will be there to catch us.
What could possibly go wrong?? Well, lots — obviously. As Vanguard’s European CIO Jeff Molitor told us here this week: “No one can see around corners.” And the euro crisis of course remains top of the list of bogeymen. But here too the ECB has constructed its own “policy put” of sorts as ECB chief Draghi has pledged to bolster euro sovereign debt markets via the banks’ first ever bout of QE in the event of a request for a support progamme from ailing giants such as Spain and Italy. What else? Hard landing signs in China? Fresh banking stress globally? All possible. But — all likely to be met with substantial policy reaction from the Fed at least if they hit the US economy badly again and threaten to push already-high unemployment back up.
So calm is justified then?
Enter November’s U.S. Presidential election. The “Bernanke put”, as with the “Greenspan put” before it, is rooted in the Fed’s dual mandate to pursue both full employment as well as price stability — a critical post-Depression orientation of the country’s entire macroeconomic policy approach that many economists insist has served the United States well over the past half century but which also riles many others, not least Paul Ryan, Republican presidential candidate Mitt Romney’s newly-appointed running mate for the position of Vice President.
Ryan, chair of the House Budget Committee, has many criticisms of the Fed, feels QE is storing up inflation for the future and is a supporter of some form of congressional oversight of audit of Fed policymaking. But, crucially, he’s also in favour of removing the full employment part of the Fed’s dual mandate — leaving it with a sole focus on price stability and inflation.
The "Fear Index" last night hit its lowest level since the global credit crisis erupted five-years ago to the month. Can that picture of an anxiety-free investment world really be accurate? Join DiscussionNorwegians piling into Korean bonds
One of the stories of this year has been the stupendous rally on emerging local currency debt, fuelled in part by inflows from institutional investors tired of their zero or negative-return investments in Western debt. Norway’s sovereign wealth fund said last week for instance that it was dumping some European bonds and spending more of its $600 billion war chest in emerging markets.
Quite a bit of that cash is going to South Korea. Regulators in Seoul recently reported a hefty rise in foreigners’ bond holdings (see here for the Reuters story) and Societe Generale has a note out dissecting the data, which shows that total foreign holdings of Korean bonds are now worth around $79 billion — back at levels seen last July. Norwegians emerged as the biggest buyers last month, picking up bonds worth 1.5 trillion won ($1.3 billion) , almost double what they purchased in the entire first half of 2012. Norway’s holdings of Korean Treasuries now total 2.29 trillion won, up from just 190 billion won at the end of 2011.
The growing interest from overseas investors would seem logical — South Korea stands on the cusp between emerging and developed markets, with sound policies, a current account surplus and huge currency reserves. And Socgen analyst Wee-Khoon Chong says the Norwegian crown’s recent strength against other currencies makes such overseas trades more attractive (the crown is up 6 percent versus the euro this year and has gained 5.3 percent to the Korean won). “Norwegians are the newbies into the KTB market,” Chong says. “They are probably recycling their FX reserves.”
All the interest from overseas (along with the central bank’s switch to monetary easing) have pushed yields on benchmark 5-year Korean bonds to record lows under 3 percent, after starting the year at 3.4 percent. Yet that is significantly higher than what’s available in the “safe” Western markets such as Germany, United States and Britain — 5-year bonds in these countries offer 0.5-0.7 percent.
Norwegians are becoming enthusiastic buyers of South Korean bonds. Join Discussion
Emerging corporate debt tips the scales
Time was when investing in emerging markets meant buying dollar bonds issued by developing countries’ governments.
How old fashioned. These days it’s more about emerging corporate bonds, if the emerging market gurus at JP Morgan are to be believed. According to them, the stock of debt from emerging market companies now exceeds that of dollar bonds issued by emerging governments for the first time ever.
JP Morgan, which runs the most widely used emerging debt indices, says its main EM corporate bond benchmark, the CEMBI Broad, now lists $469 billion in corporate bonds. That compares to $463 billion benchmarked to its main sovereign dollar bond index, the EMBI Global. In fact, the entire corporate debt market (if one also considers debt that is not eligible for the CEMBI) is now worth $974 billion, very close to the magic $1 trillion mark. Back in 2006, the figure was at$340 billion. JPM says:
The international primary market for EM has transformed into a corporate debt market, with sovereign issuance now less than one-third of total EM external issuance.
JP Morgan expects the $1 trillion milestone to be hit by year-end, when the total stock of sovereign dollar bonds will stand at $700 billion.
There are many reasons for this explosive growth. First, sovereigns are issuing less dollar debt, resorting instead to local bond markets where they can raise funds in their own currencies. Last year, governments raised $566 billion at home, compared to just $70 billion on dollar bond markets. Their space has been filled by companies which have been emboldened by investors’ enthusiasm for emerging markets and the prospect of cheaper capital than at home. And most recently, the syndicated loan market, previously the main funding source for corporates, has dried up — JPM says loan volumes are down 90 percent from 2011.
Emerging market corporate bonds, once a tiny sector, have grown massively. For the first time ever, they have outstripped government debt on JP Morgan's dollar debt index. Join Discussion