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Dec 9, 2013
Much at stake for EM on jobs Friday: James Saft (James Saft is a Reuters columnist. The opinions expressed are his own) By James Saft (Reuters) – Emerging markets will have a great deal at stake when Friday’s U.S. jobs figures are announced.
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If the data is good and a Federal Reserve taper seems more likely, emerging markets will fall, hard, while if hiring was disappointing we can count on an outsized rally. In part, this is for no more complicated a reason than emerging markets are at the riskier end of the investment spectrum. Bond buying works by exchanging cash for ‘safe’ assets and forcing a new investment decision with lower returns for safety. That is intended to prompt risk-taking and the riskier an investment the more, proportionally, it benefits. But going beyond this there are structural reasons why now may be a particularly poor time for many emerging markets to be faced with tighter global monetary conditions. First, many, notably India and South Africa, must attract investment to make up high current account deficits. With QE on, that money flows easily, but, as we saw last summer, if a bond-buying taper is in prospect, investors will quickly do new calculations. Secondly, a number of key emerging markets are actually showing signs of the risk of stagflation – slowing economic growth but high inflation. That’s a classic recipe for misery, both in terms of the economy and for investors. Growth in Brazil, India and Russia is decelerating but inflation remains uncomfortably high. Brazil, for example, contracted by a half a percent in the third quarter but has inflation of 5.8 percent. Combine rocky local conditions with QE and you have what we’ve experienced: a sell-off, a bleeding, but nothing hugely violent. Take those conditions and add in a taper and you might just get something a bit worse. All of this is to say that emerging markets are vulnerable to the inevitable taper by the Fed. But inevitable is not the same as ‘now’ or even ‘soon’. If the Fed carries on at the current rate it will own far too much of the bond market this time next year but it is possible that the U.S. central bank will contrive different ways to keep conditions loose. As for tomorrow’s numbers, even if they are better than expected they won’t push the Fed to act before year-end. While ADP reported that private sector employment climbed by 215K in November, the best showing in a year, there are still reasonable grounds for some delay. MAKING A CHANGE OR MARKING ONE?
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▼ 2013 (17) ▼ December (17) Much at stake for EM on jobs Friday: James Saft Taper on tap, sweeteners at ready Yellen delivers; tougher times ahead: James Saft Column – Yellen delivers; tougher times ahead: Jam... Taper on tap, sweeteners at ready: James Saft Slow growth and the knowledge economy: James Saft Households borrow while business stints: James Saf... Individual bonds are an investment, not an Ark Amazon, drones and low
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The larger vulnerabilities of emerging markets are arguably structural. A Fed taper won’t so much cause these issues as expose them to wider public view.
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“Emerging market growth from 2000 to 2012 was atypically high and we might be back in a situation that is more reminiscent of the early 1980s. The growth of the last 12 years was neither sustainable nor likely to last,” Anders Aslund, economist at the Peterson Institute, wrote in a recent paper. (here)
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For those of you who don’t remember a time before the heyday of BRICS, the 1980s were not a kind period for emerging market growth. Interest rates were on the rise and commodity prices were falling. Both trends may well reappear and be joined by a longrunning theme of re-shoring of manufacturing.
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If a taper marks a turning of a longer credit cycle it will hurt emerging markets disproportionately and do the most damage to those which need the most financing. As well, there are reasons to suspect that the next decade or so of global growth will be less resource-intensive than the ones just past. Re-shoring of manufacturing, to take advantage of new technology, of cheaper energy in the U.S., and other trends, would feed this. That re-shoring would be a double blow to emerging markets, hurting those, like Brazil, which export raw materials and those, like China, which may find their manufacturing base threatened.
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An emerging market investment landscape with slower growth, worse global competition and higher interest rates might be a recipe for multi-year underperformance. Again, none of this has to kick off on Friday, or really any time soon. A number of economists, notably Larry Summers, have argued that the U.S. itself is in a bit of a structural trap, an analysis which implies that rates need to stay low and deficits high indefinitely. And certainly incoming Fed chief Janet Y ellen seems well aware of the employment part of her mandate. Still, whether the signal for a taper comes out of tomorrow’s data or waits six or eight months, the taper is likely to arrive in 2014, making it a difficult year for emerging markets.
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(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. Y ou can email him at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft) (Editing by James Dalgleish)
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Taper on tap, sweeteners at ready (James Saft is a Reuters columnist. The opinions expressed are his own) By James Saft (Reuters) – If you want to know what Janet Y ellen will do as Fed chair, ignore her congressional testimony and watch Ben Bernanke’s lips. Y ellen, approved Thursday by the Senate Banking Committee, will get the job, but the real action is in speeches by Bernanke, who is less inhibited as he is on the way out, and in the Fed minutes, released Wednesday. Here is how it is going to go: The Fed will taper, probably early next year, and will try to grease the skids by offering some kind of forward guidance to ease the pain. A bit of fiddling with the interest rate paid by the Fed to banks on reserves is possible too, but a lot less likely. Forward guidance is fancy central banker talk for making a sort of a promise, or pledge, to keep rates at a particular level in the future if particular conditions prevail. In this case,
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the forward guidance will probably be to keep rates near zero until unemployment falls below the current trigger level of 6.5 percent, perhaps as low as 5.5 percent. “Even after unemployment drops below 6.5 percent … the Committee can be patient in seeking assurance that the labor market is sufficiently strong before considering any increase (in the fed funds rate),” Bernanke said in a speech this week. As for the why, no one is being that specific, but it looks as if Federal Reserve officials are a bit in doubt about bond buying’s efficacy while having some concerns about its attendant risks. Bond buying, Bernanke said, has “drawbacks not associated with forward rate guidance, including the risk of impairing the functioning of securities markets and the extra complexities for the Fed of operating with a much larger balance sheet.” The Fed is concerned that its pre-taper communications this summer were incorrectly read, with many investors seeing the move as a tightening in monetary policy. That seems to be behind the idea of pairing a tapering with stronger forward guidance. The Fed hopes it will dull any market effects of the taper, effectively allowing a low-friction way for the central bank to back slowly away from bond buying. One other possibility is that the Fed will also make adjustments to the interest it pays on reserves, potentially keeping open some facility to allow it to pay less to banks for the money they keep on deposit while not gumming up the vital money market system. One advantage of this is that it represents an actual action, rather than simply a promise. That said, it is not likely in itself to have a profound effect on bank behavior. A FEW LOCAL DIFFICULTIES So, tapering with a sweetener, but probably not until March. While Bernanke will hold a press conference after the December FOMC meeting, he may well wish to defer the decision, and the explanation, to his successor. Y ellen will have to live with the program, and as forward guidance is all about effective communication, it makes good sense to allow her to be present and in control when it is paired with tapering.
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There are, of course, a few small problems with the whole plan. The Fed worries that, as when it promised to taper last time, markets will see this as a tightening. They hope forward guidance will work to keep rates low even as they stop buying the bonds. Markets tightened, sending long rates higher, not simply because they didn’t understand the Fed but because they gave precedence to what the Fed was going to do – buy fewer bonds – over what it said it wanted to see. The point of QE isn’t simply to push people into taking on risk and spending some of their paper gains, it is to make the price of securities with more risk attached rise. The reverse of that implies higher rates for riskier securities, including longer-dated bonds. Moreover, the whole premise of forward guidance is that central bankers will say something and markets take them at their word. That’s nice in theory, but in practice investors understand that the woman making the promise today is a different one than will be called upon to honor it in a couple of years’ time. Asked to weigh the value of real dollars going to buy real bonds versus verbal promises about future states none of us can truly know I am betting that markets give primacy to the money, not the pledge. Tapering may make great sense, but it will not be without friction and costs. (At the time of publication, Reuters columnist James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns by James Saft, click on)
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Yellen delivers; tougher times ahead: James Saft Nov 14 (Reuters) – On the standards by which these things are judged, Janet Y ellen’s confirmation hearings went well, meaning markets rallied with little volatility. Speaking before the U.S. Senate Banking Committee, the Federal Reserve Chair nominee was dovish, but not so much as to scare the horses. “I consider it imperative that we do what we can to promote a very strong recovery,” Y ellen, currently the Fed’s vice chair, told the panel. Considering that the current recovery, though long in the tooth, has only produced tepid jobs growth and below-target inflation, a “very strong” recovery is going to require the continued administration of stimulants. For risk assets that was good but not unexpected news. The S&P 500 rose a half a percent, 10-year U.S. government bond yields fell by a couple of basis points, or about 1 percent. All in all a creditable performance in markets, especially considering Y ellen has good reason to not appear too dovish ahead of her confirmation votes. While Y ellen gave the impression that she and the FOMC would certainly considering tapering before too long, she didn’t seem to be in a great, tearing hurry about it. “It’s important not to remove support especially when the recovery is fragile and the tools available to monetary policy should the economy falter are limited,” she said. “I believe it could be costly to withdraw accommodation or to fail to provide adequate accommodation.”
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That statement is both true and perhaps a bit worrying. Y ellen is acknowledging that, as monetary policy is scraping at the lower bound of the possible, her arsenal is not well stocked. At this point that arsenal would boil down to doing more of what you’ve already done (with mixed results) or saying you will do more, or do it for longer, or do it with less regard to the risks. If the Fed did taper and found the economy listing into a recession, it could buy more bonds, it could buy other assets, as the Bank of Japan is doing, or it could pledge to buy bonds and hold rates lower for longer. None of those is tried and tested, so the Fed has good reason, it seems, to let things run for a bit. SPRING CLEANING? That probably means the Fed will not announce a taper in December. March is the next logical target date. Y ellen will be in the chair, and a press conference at which the reasons could be explained is already scheduled. One thing we did not learn much about at the hearing is the possibility that the Fed introduces some new form of forward guidance, essentially promising to keep rates lower for longer, perhaps, as suggested in recent Fed research, by tying a rise to a move down in the unemployment rate to as low as 5 percent. Y ellen did show some skepticism about the unemployment rate, acknowledging that it perhaps flatters the employment situation by undercounting discouraged workers. open in browser PRO version Are you a developer? Try out the HTML to PDF API
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by undercounting discouraged workers. The idea, though, of taking away bond buying slowly while softening the blow with forward guidance has some attractions. Bond buying is not only unproven, it is a large redistribution of wealth upward, one which is having a diminishing effect on the real economy. And, as Steven Englander, foreign exchange strategist at Citigroup, points out, there will be some real limitations on how long the Fed can carry on buying $85 billion of bonds per month. If the Fed carries on buying $45 billion per month of Treasuries, it will be buying a large portion of all of the longer-dated debt the U.S. issues next year. With the Fed already holding more than 40 percent of the longer-term (five years maturity and over) Treasuries in existence, this leaves them open to charges that they are affecting fiscal policy and distorting the market. So a taper, then, in March, with the Fed buying fewer Treasuries while pledging to keep rates lower for longer could, from several points of view, offer advantages. More of its firepower would be ‘reaching’ Main St, via subsidizing mortgage borrowing and concentrating on employment. That’s not to say this will work well, or is wise. Forward guidance is a policy which rests on the premise that markets will believe what the Fed tells it, which is further premised on the idea that the Fed knows what it ought to tell markets. Look at Britain, where the Bank of England has had to revise its forward guidance, bringing closer the date of an expected
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hike, after an unexpectedly (to the bank) quick recovery in employment. The problem is the markets never believed the BOE in the first place, and were pricing in a rate rise sooner than it was promising one. The Fed arguably has both more power and credibility than the BOE, but may find itself with both threatened if it relies too much on them as an easy tool. (At the time of publication, Reuters columnist James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns by James Saft, click on ) (Editing by James Dalgleish)
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