A brief surge of optimism, in the form of a short-lived rally in the belegured Turkish Lira and South African rand after their central banks raised interest rates to try to halt the plunge in currency values, has fizzled. And the Fed reducing its dosage of market tonic, in the form of QE, only soured investors’ already bad mood.
The defensive measures simply goosed the currencies briefly and they’ve now resumed their slides. A key observation from a Bloomberg report:
“Turkey would appear to have received the worst of both worlds,” Michael Shaoul, the New York-based chairman and chief executive officer of Marketfield Asset Management LLC, which oversees $21 billion, said in e-mailed comments. “Local economic activity can be expected to be constrained by massive monetary tightening, while foreign investors are hardly likely to be enticed by increased yields given the volatility and downside potential of the currency.”
Recall that the San Francisco Fed, in a presentation last November, highlighted the predictable outcome: that defensive measures are futile and simply feed a vicious circle:
1. Sharp steepening of local currency yield curve
2. Currency depreciation, corporate distress, freeze in corporate CAPEX, slowdown in growth
3. Runs of wholesale corporate deposits from domestic banking sector
4. Asset managers cut back positions in EME corporate bonds citing slower growth in EMEs
5. Back to Step 1, and repeat…
I suspect “sharp steepening of the local currency yield curve” is charitable, that longer-term financing has dried up (as in any quotes are indicative and there’s no meaningful funding even for stellar credits and/or the locals can’t afford those longer-term rates anyhow). In a crisis, anything but short term financing dries up pronto, and what financing there is become very expensive.
The tone of media coverage has been and remains that advanced economies should not be affected much by the emerging markets tsuris. After all, the IMF raised its growth forecast! The US is anticipated to have GDP growth of 2.8%, up 0.2% from earlier forecasts! Consumer confidence is rising and most corporations beat earnings expectations. Never mind that many lowered guidance during 4Q, so beating a phony new goal isn’t exactly a resounding accomplishment. And the central bank also seems remarkably unperturbed about the lousy state of the job market (the FOMC statement called the latest labor market data “mixed” and noted that the housing “recovery” had softened a tad. But hey, Japan’s going to grow 0.4% faster!
The reality is the central bank seems belatedly to have come to the recognition that QE was not doing anything for the real economy. In fact, a strong case can be made that is was hurting it, by lowering interest payments on safe assets, which many retirees rely on for spending. But it certainly juiced asset prices. And now that financial regulators think the banks are healthier, the Fed seems to believe they can withstand whatever losses they might take from wrong-footing bond positions.
So in the face of a supposed “recovery,” the US central bank announced it’s cutting QE even more in February, to $65 billion. US stock market investors were not happy, with losses on the day rising after the Fed’s announcement.
And as for blowback to emerging markets, the Fed has been consistent in its lack of interest for their welfare. It was unresponsive to BRIC and other central bank complaints about how hot money was distorting their economies when QE was launched. And since, as the San Francisco Fed analysis indicated, the biggest source of funds to emerging economies was international fund managers and not banks, the central bank apparently figures they and their investors can take their lumps. (Keep in mind that there can still be blowback to the banking system to the extent some of these investors were using bank funding to lever their positions, say hedge funds using prime broker lending. But until the Fed sees any shoes drop, the Fed is unlikely to let emerging markets woes factor into its decision-making).
As we stated before, the impact of QE is likely to proven to be asymmetrical. While it did quite a lot for stock prices, and provided indirect stimulus by allowing consumers to refinance mortgages at record low rates, the main effect was likely the confidence fairy. But if you don’t have meaningful financial markets assets or appreciating real estate, the reality of a tough job market and not so hot demand is going to be much more in your face. I’ve been briefly in Dallas, and even though that economy is relatively strong, the pretty-well-off locals who own businesses and talk to other local entreprenuers aren’t seeing great demand. I saw more McMansions for sale in one well-off community that I expected, and also had a buddy who is looking for an upscale rental that landlords are very willing to cut deals. So if this is how Dallas looks for the top 10% ex the 1%, it confirms the two-tier nature of this “recovery”.
Thus the Fed withdrawing QE has the potential to do more damage than whatever the benefits were. We’ll only know for sure with the fullness of time. But for the moment, Mr. Market has woken up to the fact that the Greenspan/Bernanke and presumably Yellen put is temporarily on hold, and they actually need to be mindful of downside risk for a change. That’s such a novel concept that the investors seem to be having trouble wrapping their minds around it.