Posts Tagged ‘Federal Reserve System’

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Asia is in crisis mode. Europe, or so it appears, is in recovery mode. In Asia we are set to see a re-run of 1997, or so they say, when Asia suffered one very nasty crash. In Europe years of pain are set to pay dividends, or once again so they say. Yet, look beneath the surface and things look different. Asia today is nothing like Asia in 1997. Parts of Europe on the other hand do.

Déjà vu. We all get it from time to time, but presumably it is an illusion. It has been theorised that we may get that feeling of that having done or said something before, because our subconscious can perceive something before our conscious. Déjà vu when applied to Asia may be an illusion too.

At the moment many are trying to draw a lesson from the 1990s. In 1994, the US Federal Reserve began a cycle of tightening monetary policy. As US interest rates increased, money flowed from the so-called tiger economies of South East Asia into the US. The 1997 Asian crisis resulted. The IMF stepped in. Some countries, that had previously seemed to be on an unstoppable road to riches, suffered a very nasty recession/depression.

Many fear a repeat of this today. The Fed is set to tighten. The biggest victim to date has been India. Brazil, Turkey and Indonesia have also seen sharp currency losses. Indonesia’s central bank has responded by increasing rates four times in just a few months. Don’t forget, however, that despite the severity of the 1997 crisis, within a short time frame output across South East Asia had passed the pre-1997 peak. It will be like that again. Indeed Indonesia, perhaps along with the Philippines, is one of the most interesting territories in the world right now – from an investor’s point of view that is. This time around savings rates are higher in South East Asia, while external debt – especially in the case of Indonesia, the Philippines and India – is relatively modest.

Contrast this with what is happening in the euro area, where many countries in the region are facing the tyranny of a fixed exchange rate, which is causing the recession/depression to drag on and on.

But the latest Purchasing Managers’ (PMIs) Indices relating to Europe look promising. The PMI for Spain hit a 29 month high, for Italy it was at a 27 month high. Ireland’s PMI was at a 9 month high. For Greece the story is sort of better still; the PMI is now at a 44 month high.

However, the Greek PMI still points to recession. In Spain, Italy and Ireland the growth looks only modest. Just remember that these countries have massive levels of unemployment – especially in Spain and Greece. For them to cut government debt to the levels required, they have to impose austerity for years and years.

And just consider what might happen, if the markets expect an even higher return on the money they lent to troubled Europe as rates rise in the US.

The markets are panicking over Asia. They should perhaps be looking towards Europe.

© Investment & Business News 2013

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It happened in 1997, and some think it is happening again. Back in 1994 the US Federal Reserve upped interest rates, and so begun a cycle of tightening monetary policy. Money flowed from East to West, and in 1997 crisis was the watch word. The so called tiger economies of South East Asia in particular saw their economies look distinctly like a certain fruit – a pear. It was an important episode. Some say that the Asian crisis of 1997 sparked off a chain of events that led to the 2008 finance crisis. And now it seems to be happening all over again. Or is it?

Many economists say that the tragedy of the Asian crisis was that it was not the fault of the countries that were the victims. Cheap interest rates in the US meant money flowed from the US and Europe into South East Asia. Not all governments in the region wanted it. But – or so Nobel Laureate Joseph Stiglitz, who was chief economist at the World Bank at the time alleges – the IMF urged governments to welcome the influx of money. It is just that when money flows fast, not all of it is used wisely. Bubbles are born. Then in 1994 things began to change. Slowly the Fed increased rates. By 1997, the interest rates in the US were attractive to investors, and money flowed back. Bad Asian businesses were exposed. Good businesses were caught out too. The IMF came riding in to the rescue, but not all agreed with how it reacted. Critics say the IMF was more concerned about finding ways to ensure the West got its money back than helping the countries of South East Asia cope with the crisis.

And in so doing seeds were sown. Many countries in South East said never again, and vowed to ensure they were never again reliant on overseas capital. China watched events with alarm, and its policy of keeping a cheap yuan, and pushing for growth off a trade surplus was born. Many economists say this policy helped to contribute to global imbalances, which may have been an underlying cause of the 2008 crisis.

But by trying so hard to save the West, the IMF and –what Stligtz calls the Washington Consensus – western banks got off lightly, It happened again in 1998 with the Russian crisis and the collapse of LTCM, for which Fed Chairman Alan Greenspan managed to orchestrate a rescue which avoided a western banking crisis. But the rescue meant moral hazard because western banks did not learn their lesson. They repeated their errors until they became too big for even the Fed to sort them out in 2008.

Now let’s come up to date. We appear to be entering a new period of rising interest rates. The Fed and Bank of England have tried to persuade us that rates will not rise for some time, but the markets are not buying it. Every piece of good news, every

piece of okay news on jobs in the UK and the US, makes the markets more certain that rates will be rising sooner rather than later. On the back of this, yields on US government bonds have hit two year highs. It is not so much that money is flowing from Asia back into the US, but that the markets fear this will happen. And the fear is having an effect. The Indian Rupee fell to all-time low against the dollar yesterday (19 August). But emerging market currencies saw sharp falls across the board.

So far this year has been disastrous for the South African Rand, the Brazilian Real, and now the Indian Rupee. Last week data revealed that Russia is in recession. Yesterday data emerged indicating that Thailand is in recession. The Indonesian stock market saw sharp falls as markets took fright over the size of its current account deficit. Indonesian government debt is rising too. Yet there are reasons to think that some of these countries are being wrongly punished by the markets, and the ultimate loser will be the markets themselves.

This time around many of the larger countries of South East Asia are far less reliant on overseas money. Savings ratios are high.

In Indonesia the ratio of credit to GDP is 30 per cent, against an average of nearer 100 per cent for the region. More interestingly, in Indonesia a smaller proportion of credit has funded projects in the property sector, relative to Hong Kong and Vietnam, for example. As a result there is little hint of a property bubble in the making. Instead, much of the credit has funded infrastructure and manufacturing. In 1997 around 50 per cent of Indonesia’s credit was funded by foreign currencies. Today that level is nearer 15 per cent.

Indonesian domestic credit to the private sector is just 33 per cent, compared to 203 per cent in the US. The ratio is just 33 per cent in the Philippines too. It is even lower in Mexico, which may, by the way, benefit from re-shoring as manufacturers move closer to the US market.

As far as emerging markets are concerned, the markets are in panic mode. In such times they are lousy at picking the wheat from the chaff. When they become more rational, certain emerging market countries will see equities boom.

© Investment & Business News 2013

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It is the new way of doing central banking. It is called forward guidance. It means that central bankers are telling us what they are going to do in the future under different circumstances. In one fell swoop they have done away with an industry; an industry called predicting interest rates. It has become a game, and in some cases a business. The media fill their pages with predictions on which way interest rates are going next. Now we know, if the data says one thing, rates will go in a certain direction. Yet here we are, just a few weeks into the era of forward guidance, and already cracks are appearing. As for the markets, rather than becoming more stable and predictable, they have become more nervous than ever.

“I guess I should warn you, if I turn out to be particularly clear, you’ve probably misunderstood what I’ve said,” or so once and somewhat famously said the former Chairman of the US Federal Reserve Alan Greenspan. This was the era when Mr Greenspan was set on a pedestal so high that it is a wonder he didn’t need an oxygen mask and climbing ropes. What the markets really loved was the way in which Mr Greenspan had a veneer of knowing something they didn’t know; of having a plan – a cunning plan if you will – that always worked the way it was supposed to.

The finance crisis of 2008, and the fact that we appeared to miss a meltdown in capitalism by a whisker did leave Mr Greenspan’s reputation a little in tatters. Ben Bernanke, his replacement at the Fed, made a great play of saying what he thought; of letting us in, as it were, on his rationale. At first it didn’t go down well. The markets concluded he didn’t really seem to know what he was doing. It is the tragedy of the modern age. All of us stumble around in the dark most of the time, but we just don’t like to admit to it. And when our leaders admit to it, we think they are weak and uncertain.

These days, however, Ben’s stock is high. It was he, first among the central bankers, who came up with the idea of forward guidance, when he revealed that the Fed would keep pumping money into the economy via QE for as long as unemployment remained high. Now they are all at it. The Bank of England – under the leadership of Mark Carney – is now saying that rates will stay at half a per cent as long as unemployment is over 7 per cent.

It is just that the minutes from the latest Bank of England Monetary Policy Committee (MPC) meeting revealed that one member of the committee – Martin Weale – voted against the policy. It was not so much the idea of forward guidance he was against, it was the perceived timing. He appeared to fear that the 7 per cent target was too loose. Er, or maybe you could say that actually he was against forward guidance, because he wants a policy that one might describe as always flexible.

His dissent is important, because it rather put a question mark over the viability of the policy. You can interpret the Bank of England as saying if the economy does this, we will definitely do that, unless, that is, we change our mind. There are also hints that UK unemployment is set to fall much more rapidly than has been assumed. A survey from the CIPD and the latest Purchasing Managers’ Index both point to positive changes in UK unemployment in the pipeline. See: The UK jobs market boost . This has led to speculation that rates might be rising much sooner than the Bank of England has been suggesting.

It appears that the industry that grew up predicting what the MPC might do next has changed into one predicting what unemployment will do. If nothing else, jobs have become a more important economic indicator – and maybe that is no bad thing; after all common sense suggests it should be the most important indicator.

In the US, recent data has pointed to a sharp improvement in the jobs outlook, with the latest survey suggesting US unemployment is now at its lowest level since October 2007.

So let’s review the situation. The signs, both in the form of hard data and from surveys, point to a labour market that is improving faster than many had dared to hope for. That means monetary policy might be tightened faster than many had feared. The markets are spooked by it all. ‘Better than they dared hope for’ jobs data turned out to be less of a boon than ‘rates rising faster than they had feared’, – at least that is what they are saying at the moment.

But then the markets are fickle and how they react one day can be quite different on another. If you think the markets are making themselves clear, it probably means you “misunderstood what they are saying”.

© Investment & Business News 2013

Phew, that was close. UK inflation was 2.9 per cent in June, which was 0.1 percentage points less than expected and 0.2 percentage points less than feared, and some might say it was a relief.

If inflation had been 3.1 per cent, as some dreaded, then poor old Mark Carney, new in his job, would have been obliged to write a letter to the chancellor.

Even so, 2.9 per cent isn’t very good. In fact it is the highest rate of inflation since April 2012.

So here is the dilemma. The Fed is slowly moving towards tightening monetary policy. If it does this, the pound may come under pressure. The Bank of England has made it clear that it is in no hurry to follow the Fed, but can the UK afford inflation of around 3 per cent, and then for the pound to fall?

Remember, between February 2013 and April 2013 total pay (including bonuses) rose by just 1.3 per cent year on year, which was much less than inflation. If the pound falls, inflation will rise, and real wages will fall even further.

A cheap pound may help the UK’s long awaited export led recovery, but the UK also needs households’ real income to rise.

© Investment & Business News 2013

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“I think I should warn you,” said Ben Bernanke, “if you think I am making myself clear, then that means you have probably misunderstood me.” Witty, and a tad daft. It is just that actually those words were not spoken by Mr Bernanke at all; rather they were spoken by his predecessor as the Fed chairman Alan Greenspan.

In fact, when Ben took over at the Fed he went to great lengths to say he was not one for cryptic remarks. He would say it as he saw it. He promised to be something of a blunt speaker. (Ay up lad, I say wat I mean tha noes). Last week, however, he seemed to do an impressive impersonation of Mr Greenspan. His lips and eyes, or his statement and his inference, seemed all seemed out of sync.

Don’t get confused,” said the Fed Chairman, “The overall message [from the Fed’s rate setting committee] is accommodation.”

His words had been eagerly awaited. Last month Ben suggested the Fed may be tightening monetary policy soon. This time he said they will be doing no such thing. Rather that we may see a “gradual and possible change in the mix of [monetary] instruments.”

So what does that mean? A change in mix suggests the details are different but the overall thrust the same.

So that’s the headline.

What about the substance?

The latest minutes from the Fed said that many members of the FOMC – that’s the Federal Open Market Committee – “indicated that further improvement in the outlook for the labour market would be required before it would be appropriate to slow the pace of asset purchases.” Again this needs translating. “Many” is supposed to be code for slightly over half. Subsequent to the meeting of the FOMC to which these minutes relate, job data on the US has seen another big improvement. That rather suggests that more than half of the men and women who determine monetary policy are on the cusp of agreeing to “slow the pace of asset purchases.”

So Ben says one thing, and the minutes say something else.

The minutes also said that ‘some members’ wanted to see evidence that GDP growth was picking up before they agreed to tighten policy. So let’s decode that. In this case, “some” means fewer than half. The data on GDP is not expected to be so good in Q2. In other words, fewer than half are not ready to tighten policy.

Would you believe it? The markets loved all this. Somehow they concluded that the Fed is not going to tighten monetary policy as quickly as they had feared, so they went out and bought, pushing the Dow and S&P 500 to new all-time highs.

Capital Economics took a look at the Fed’s words and concluded that they suggest QE will be reduced somewhat in September, will cease altogether in 2014 and rates will rise in 2015. This is actually pretty much the same as what it was saying before the Fed released its minutes.

In other words, all that has really changed is that the Fed is saying much the same thing as it was a few weeks ago; it is just using more ambiguous words to say it.

And that was enough to get the markets all bullish again.

© Investment & Business News 2013

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The US economy has not been good at exporting for some time. Recent data shows that its imports of goods and services still lag way behind exports. Yet there is one thing the US is good at exporting and that is economic news. And of late it has been exporting good economic news. So what is it; why; is it for real, and does that give us reason for hope?

Sometimes recoveries seem to be built on hot air. Sometimes they are down to confidence, and confidence creates growth, and growth creates confidence. During the boom years of the noughties, economic boom was built on debt. Households borrowed because house prices were up, and they rose partly because interest rates were so low, and partly because credit was so easy to come by, but there was something wrong.

The boom was built on foundations as shaky as a shaky house built of shaky match sticks, sitting on top of shaky hill made from quick sand. This time the recovery seem to sit on foundations that are a lot more robust. Yet still the doubters say it is all a lie.

So why the reason for cheer?

First and foremost, US households have cut debt. US household debt has fallen from $12.7 trillion in 2008, to $11.2 trillion at the end of last year. In fact, according to IMF data, US household debt to income has fallen from a ratio of 1.3 in the mid-noughties to around 1.05. In fact, the ratio is now higher in the Eurozone. At the same time, the value of US household assets have risen. According to Capital Economics: “Every $1.00 of debt is now backed by $6.30 of assets, whereas before the recession it was backed by $4.80 of assets.” Capital Economics, for so long a bear on the US economy, recently said that the US consumer is now well placed to drive “a faster period of economic growth.”

Secondly, US banks are in better shape. Q1 saw record profits for US banks, while their deposit-to-liabilities ratio recently hit a 20-year high of 84.6 per cent. See: US banks see biggest profits ever: is the US back? 

Thirdly, the US fiscal deficit this year is expected to be $642 billion, or so estimates the Congressional Budget Office. To put that in context, last year the deficit was $1.1 trillion. It will, in fact, be the first time since 2008 that the US deficit is less than $1 trillion. And, by the way, not so long ago the Congressional Budget Office was projecting a deficit of almost $200 billion more than that.

As for those who say the US sits on a financial and demographic time bomb, and that surging health care costs alone are sure to bankrupt the world’s largest economy there are some reasons to be cynical about such cynicism. See: The scaremongers are wrong: the US is not even vaguely close to going bust  and US medicare time bomb begins to look more like a pretty time piece 

US consumer confidence recently hit a five and half year high. US house prices are rising, and, unlike in the UK, they are rising from a point where the average price to income is below the historical average of 1.2 million, with June seeing a rise of 195,000.

Given all this evidence, why are many so cynical?

Some cynicism seems to be built on genuine concerns, while others seem to be cynical for its own sake.

One challenge is that this year US government spending will be falling while taxes are rising. This may be good for cutting government debt, but it may yet prove disastrous for the economy, and indeed the IMF has slated the US government for relaxing its fiscal stimulus too soon. But then that is what you get when you have a political system made up of two parties that seem to be hell bent on putting self-interest over national interests.

Partly as a result of the US fiscal stimulus’ going into reverse, recent  Purchasing Managers’ Indices (PMIs) have been disappointing, with the latest PMI tracking US non-manufacturing falling to a three year low. The latest PMIs suggest the US will grow at around 1 per cent in Q2 on an annualised basis. By recent standards, that is poor. But then these are problems with the short term.

Another challenge relates to the very difficult balancing act that the Fed has to manage. It is now talking about cutting back on its quantitative easing or QE programme quite soon – September being the date expected by the markets. The Fed has been buying $85 billion worth of bonds every month. To begin with the Fed will not stop QE, but merely slow down. The feeling is that it won’t stop altogether until next year, and rates won’t rise until 2015.

Not all see why. For one thing US inflation is modest, and appears to pose no threat at all. Fears that were commonplace a year or so ago, that QE would lead to runaway inflation currently look somewhat silly. So they ask: why cut rates so soon?

A more serious concern relates to ways in which the actual data may be misleading. So sure, US employment may be up, US unemployment may be falling, but US employment to the US population is not much less today than during the height of the recession. In part this is down to more people retiring, but it appears this is also partly down to some people pretty much giving up, and falling off the unemployment stats.

Then there are some who voice concern over student loans in the US. The big critic here is Nobel Laureate Joseph Stiglitz. See: Student Debt and the Crushing of the American Dream

This all leaves two big pluses.

The first plus is shale gas. This has led to falling energy costs, handing US households more disposable income after paying for energy. The second is signs of a kind of renaissance in manufacturing. This shows up in many ways. Both Apple and Google, for example, have recently announced that certain products will be made in the USA.

As US productivity rises, unit labour costs fall, and unit labour costs in China rise, the gap with China improves in favour of the US. More exciting is the potential of 3D printing, which may yet create a new kind of local craftsman, as is suddenly becomes viable for consumers to have bespoke products designed especially for them, or for just a small number of people.

A sustained US recovery is not guaranteed, but the odds are about as favourable as they have been for a very long time.

© Investment & Business News 2013

There have been times in the past when the markets got it into their collective head that it was time for buying, even though there were good reasons to think it was really a time for panicking. Take 2007: in that year, the Dow Jones passed a new all-time high, and the FTSE 100 came close to passing its all-time high.

These promising stock market peaks occurred after the run on Northern Rock; after the phrase ‘credit crunch’ crept into popular parlance. Back then the markets were in the mood for interpreting all news – good or bad – as if it was a reason to buy. Their logic went like this: if the news was bad that meant interest rates might fall, so buy; if the news was good, they bought because, well… because the news was good.

There have been times since when it felt a bit like that all over again, but this year, it has been rather odd.

The Dow Jones began 2013 with a score of 13,104, peaked at 15,409 on May 28 (the previous all-time high was 14,164 set in 2007). The index then fell back, falling to under 15,000 and at the time of writing stands at 15,135.

For the FTSE 100 things were a lot more volatile. The index began 2013 with a reading of 5,897, peaked on May 22 with a reading of 6,804 (against an all-time high of 6,930 set on December 30 1999), before falling back to 6,029 on June 24, and at the time of writing is at 15,135.

In Japan things have been more even extreme. With the Nikkei 225 rising from 10,401 on January 1, to 15,627 on May 22 and then 12,834 a week or so ago.

It is not hard to find an explanation but it is harder to find one that makes sense.

Because the news out of the US has been so good, the Fed is now talking about reining-in QE, and upping interest rates in 2015.

The markets do not like it.

The jury is out on how much QE has had to do with equities surging so high. QE has driven asset prices upwards, but then valuations to earnings, especially in the UK, do not look excessive.

One of the worries is that while the US economy may boom, the more indebted regions of the world simply cannot afford higher interest rates.

The Bank of England and the ECB recently went out of their way to emphasise that they have no plans to tighten monetary policy and that what they do is not dictated by the Fed.

But, supposing interest rates rise in the US, and money therefore flows into the US from the rest of the world. In response and to stop currencies falling too sharply against the dollar, we may see other central banks up rates. To make matters worse, the Central Bank in China seems to be tightening monetary policy. This may be a good thing for China, and indeed for the global economy in the long term, but for much of the world the timing is not good.

Some have had a nasty attack of déjà vu. When the Fed upped rates in 2004, one eventual consequence was money flooding out of South East Asia into the US, which led to the Asian crisis of 1997.

But then again there are differences this time. In Asia, especially among the so-called ASEAN countries of Malaysia, Indonesia, the Philippines and Thailand, internal savings are much higher and the countries are less reliant on overseas credit.

Across the world some countries are more vulnerable than others. Brazil may be the most vulnerable of the BRICS; Turkey seems to have high exposure, and worryingly – given the political situation – so does Egypt.

Many countries in emerging Europe seem exposed, as do the PIIGs – of course, and so do Sweden and the Netherlands. Household debt and house prices are high in Canada and Australia, and then there is the UK. See: Is that a sword of Damocles hanging over the UK housing market? 

Interest rates seem set to rise in the US, and for other reasons they may rise worldwide. See: The Great Reset 

This is down to good news, and is largely positive, but for some countries, companies and people, the news is not so good – not at all.

© Investment & Business News 2013