Is It Time to Buy Emerging Markets?

  • The dismal performance of emerging market equities during the past three years (a total of -20%) suggests that a rebound may lie around the corner.
  • Yet, country-specific factors aside, three key global factors argue otherwise: 1) insufficiently attractive EM valuations, 2) the structural deterioration in EM balance sheets and the resulting vulnerability to 3) tightening global monetary conditions.
  • The latter in particular far surpasses the small 25bps hike the Fed delivered in December 2015. The end of QE3 is estimated to be equivalent to a 300bps tightening, while the sharp decline in foreign holdings of US Treasury securities further adds to a vicious cycle of tightening monetary conditions.
  • In the short term, rising commodity prices provide non-trivial support to EM assets, but the persistent structural economic weakness and the risk of a shock to market expectations of Fed hikes implies that investors should fade rallies, rather than buy into them.

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Third Time Unlucky or The New Sino-American Symbiosis

  • The global economy is facing its third deflationary shock in succession.
  • After the US economy and the Eurozone, China is the epicenter of the latest crisis.
  • The erstwhile Sino-American Symbiosis resurfaces in a new, more nefarious form. The causation runs from reserve declines, to global monetary tightening. to slowing credit expansion and private consumption. This process is only just beginning.

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China’s FX Rate: Strategy & Opportunism

  • China’s latest FX adjustment is neither a “competitive devaluation” nor the opening shot in a “currency war”. Given the negative contribution of net exports to growth as of late, it is also unrelated to efforts to boost growth.
  • Instead, the weakening of the exchange rate represents the unavoidable resolution of a policy conflict which saw the PBoC simultaneously tighten (to maintain the FX regime) and ease monetary policy (to combat deflation). Conveniently, it also aligns the PBoC’s tools better with market principles.
  • All China has to do now is to prevent the slide from becoming disorderly. For the moment, it has ample tools to do so.

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Three Simple Reasons Why the New Greek Government Will Blink

As the positions between the Greek government and the Troika harden, it appears that an agreement to extend the current bail-out program or secure some other form of official financing becomes ever more elusive. Yet, it is highly unlikely that the Syriza government will disengage from official financing, default or exit the Eurozone. Why? To put it succintly: Beggars can’t be choosers. For more, read on. Continue reading

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Russia’s Ruble Let Loose Prematurely

  • Russia’s central bank yesterday abandoned its policy of unlimited FX intervention in support of the ruble. This precipitates the shift to a freely floating exchange rate regime which was due to commence only in 2015.  The move came in response to continued capital outflows, which had led to a 35% decline against the USD since June, a $71 bn loss in reserves (-15%) from October 2013 and a rise in interest rates by 400bps to 9.50% since the start of the year.

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A Glide Path for the Fed: Earlier, But More Predictable and Flexible Tapering

  • The Fed began the process of ending QE and thereby kicked off the end of a 30-year long cycle of progressively easier monetary conditions.
  • In starting the tapering process earlier than expected, the Fed has traded off incremental adjustments in the pace of its asset purchases against greater predictability and flexibility in its policy.
  • While beginning the “Long March Back” from experimental policy, the Fed provided detailed and explicit Forward Guidance, enhancing its conventional interest rate toolkit.
  • Successfully convincing markets of a self-sustaining recovery while maintaining a supportive monetary stance could create a “sweetspot” for risk-based assets and EM in 2014.

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A Bad Idea Returns: Negative Deposit Rates

  • As ECB policy rates skirt the zero bound, expectations for the use of alternative tools, such as negative deposit rates are again on the rise. However, this is  an ineffective and potentially harmful policy option.
  • Several problems may arise: transmission across other rates in the financial system is not guaranteed, bank profitability would almost certainly suffer, logistical problems could arise from a massive shift into physical cash and , most importantly, the ECB’s balance sheet would contract, just when the opposite is required.
  • More useful would be measures aimed at the de-fragmentation of EZ financial markets, such as a selective asset purchases or lending against a differentiated set of collateral rules.
  • Yet, it is questionable whether policies targeted at reigniting lending are sensible at all when the private sector is in a de-leveraging phase and impediments to growth are primarily structural.

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