Never mind the Brics or the Fragile Five — the Picts is the new emerging market group investors should worry about as they look ahead to US interest rate rises.
Analysts are divided on whether the Greek crisis will have much lasting impact on EM assets, though few doubt it has racked up the tension. What they do agree on is that the overriding focus for markets in the second half of the year will be the US Federal Reserve.
Predicting what the Fed will do and how investors will react has thrown up its own sub-genre in the business of EM research.
JPMorgan set the standard during the “taper tantrum” of 2013 by identifying the Fragile Five, also known as the Biits — Brazil, India, Indonesia, Turkey and South Africa — that were most exposed to the beginning of the end of the Fed’s $85bn a month asset buying programme, or quantitative easing. They were marked out by having large or poorly financed current account deficits, high rates of inflation and other imbalances.
Richard Iley, chief EM economist at BNP Paribas, added to the genre last week by telling investors to beware the Picts — Peru, Indonesia, Colombia, Turkey and South Africa — which he says are now the most vulnerable as the Fed, having done with QE, prepares to raise interest rates for the first time since 2006. He ranked 16 big emerging markets from 1 to 16 on 20 macroeconomic variables and totted up the scores. The Picts came out the worst.
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The Bank of England should be ready to raise borrowing costs as early as August, a member of its Monetary Policy Committee said, in a sign that the body may soon face a split over the timing of the first rate rise since the financial crisis.
Martin Weale, one of the MPC’s most hawkish members, said rising wages and low unemployment pointed to a tightening labour market that was likely to require a response, even if low oil prices kept inflation down for longer than expected.
His comments, made in an interview with the Financial Times, are the strongest signal that a BoE policy maker is backing a rate rise since inflation tumbled last year on the back of the slump in the oil price.
However, with the majority of the committee still minded to hold rates at their record low of 0.5 per cent, they are unlikely to rise at least before the autumn.
Stating that he was one of the two MPC members who were on the brink of voting for a rate rise in the June meeting, Mr Weale said the labour market was now more inflationary than when he was voting for higher rates last year. >> Read More
With the stock market nearing all-time highs and the Federal Reserve hinting that it would not raise interest rates, former US Congressman Ron Paul warned that the Fed’s policies have put the market on the verge of a massive collapse.
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Working at the usual blistering pace, WSJ’s Fed mouthpiece Jon Hilsenrath cranked out 648 words in the space of just four minutes on the heels of today’s FOMC announcement. “The Federal Reserve signaled it was moving toward interest rate increases in the months ahead now that signs of a dip in economic activity early in the year are waning,” Hilsy notes, confirming that stocks are indeed still set for a rendezvous with 1937.
The Federal Reserve signaled it was moving toward interest rate increases in the months ahead now that signs of a dip in economic activity early in the year are waning, but the path of rate increases could be less steep than officials anticipated before.
For now, the Fed said, a benchmark interest rate near zero “remains appropriate.”
But in forecasts the Fed made public about its interest-rate outlook, 15 of 17 officials said they expected to start raising short-term interest rates before the end of 2015. The projections suggest officials are gravitating toward one or two quarter percentage point interest rate increases by December. That would move the Fed’s benchmark interest rate up from near zero, where it has been since December 2008.
The last time the Fed made such projections, its consensus appeared to be building around two rate increases this year. Fed officials also nudged down their rate projections for 2016 and 2017 by a quarter percentage point. The shifts suggested officials have become less certain about the longer-run vigor of the U.S. economy and its capacity to withstand much higher rates. Expansion of output is on track again in 2015 to undershoot the Fed’s expectations.
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Federal Reserve officials heading into this week’s policy meeting have recently offered nuanced guidance about the outlook for interest rates. They’ve made clear they won’t raise their benchmark short-term rate from near zero this week, and many indicated they still expect to move some time this year. But they haven’t provided much guidance on when exactly that first rate increase is likely to occur, other than to say it will depend on the economy’s health. Their recent comments reflect a modestly more optimistic view than at their April meeting, when many were troubled by the economy’s dreadful start to the year and uncertain about whether it would give way to a decent rebound. Notably, no policy makers have recently called for a rate rise this week, heralding what could be a snoozer of a meeting.
Here we share some highlights of their recent public remarks.
(Note: The presidencies of the Philadelphia and Dallas Fed banks remain vacant.) >> Read More
ONE of the most common bullish arguments for equities is that interest rates are low. The value of a share is the sum of its future cashflows, discounted back to the present day; as rates fall, the discount rate declines, so the present value must rise.
Rather than get bogged down in the theory straight away, let us start with the practice. At a recent Economist conference, we were lucky enough to have a talk from Elroy Dimson (pictured), best known for this work at the London Business School, but now at Cambridge’s Judge School. Professor Dimson is well-respected for his work in market history and he produced this data on the relationship between real rates and future equity returns. The numbers cover 20 separate countries over a period of 113 years (1900-2012) and so are pretty authoritative. He split the data into eight sections; the lowest 5% and the highest 5% of real rates and the six bands of 15% between. The figures below show the subsequent annualised real returns from equities over 5 years.
1. Lowest 5% -1.2% 2. Next 15% 3.0% 3. Next 15% 3.6% 4. Next 15% 3.9% 5. Next 15% 4.9% 6. Next 15% 7.3% 7. Next 15% 9.3% 8. Highest 5% 11.3%
So it is high real interest rates, now low rates, that are good for equity investors (the same pattern applies to government bonds, too). The first three bands of the table all relate to periods when real rates were negative; returns were disappointing. The highest band covers periods when real rates averaged 9.6%; subsequent equity returns were outstanding.
In the Credit Suisse 2013 global investment returns yearbook in which the data appeared,
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The flurry of central bank announcements in the coming week are likely to be overshadowed by one from the Federal Reserve, as investors await the first increase in US rates in nearly a decade.
Investors will also keep their eyes on negotiations between Greece and its creditors, as a deadline looms for the country to agree an accord.
Here’s what to watch for in the coming days:
Policymakers at the Federal Reserve begin two-days of deliberations on Tuesday, with a decision due on Wednesday at 2pm in Washington. The Fed is set to release updated economic forecasts along with its closely scrutinised dot plot, in which each dot represents a policymakers view of where the central bank’s Fed funds rate is expected to be in the future.
Janet Yellen, chair of the central bank, is also set to speak after a decision is released. Economists do not expect the Fed will increase interest rates until September and are watching to see if Ms Yellen is concerned about low inflation, which could keep the central bank from moving.
“The Fed is quite unlikely to hike at the June [Federal Open Market Committee] meeting but September should remain in focus, in our view, as recent activity data have improved on net,” economists at Bank of America said. >> Read More
Capital flows to emerging markets will fall to their lowest level since 2009 this year, hit by disappointing economic growth in many EMs and by the prospect of rising US interest rates, the Institute of International Finance said on Thursday.
The IIF said in a report that it expected all flows from foreign investors — including investments in bonds and equities, direct investment and official flows — to slow to $981bn in 2015, down from $1,048bn in 2014. It predicted an upturn in 2016, with flows rising to $1,158bn, on expectations of only gradual interest rate rises by the US Federal Reserve, a pickup in EM economic growth and reduced global political uncertainties. The chart below shows the IIF’s predicted four-quarter moving averages for EM growth and flows.
But the report stressed that a recovery in flows was at risk from a continued stagnation in global growth and from more aggressive rate rises by the Fed, potentially prompted by further tightening in the US labour market, which it noted could happen “even in the face of moderate growth due to a weakening on the supply side of the US economy”.
The IIF’s report is one of many recent warnings of rising aversion to emerging markets among global investors. Figures published this week by eVestment, a data provider that tracks the behaviour of global institutional investors with about $37tn under management, said such investors withdrew $3.9bn from EM debt and $947m from EM equities in the first quarter of this year, after withdrawals of $9.4bn and $1.4bn respectively in the previous quarter. >> Read More
Charles Biderman, founder of the research firm TrimTabs spots a warning sign in the drop of the commodity prices and mistrusts the paper money of the centrals banks.
In every market supply and demand are determining the price. Charles Biderman uses this simple logic as the foundation for his investment philosophy. The outspoken founder of the research firm TrimTabs is convinced that stock prices are a function of liquidity—the amount of shares available to buy and the amount of money available to buy them—rather than fundamental value. Therefore, he carefully tracks the announced actions of companies. In his view they are among the biggest players in the stock market and the driving force behind today’s bull market. For now, Biderman thinks that this trend will push stock prices even higher. For the medium term though, he cautions that the financial markets are poised for a severe crash. He spots the first signs of a global recession in the drop of the commodity prices and warns of the moment when people don’t trust the paper money of the central banks anymore.
Mr. Biderman, once again the economy is not doing well. Nevertheless, the stock market in the United States seems to be in record setting mood. What’s behind the rally?
What’s present in the stock market in the moment are companies, their transactions, buyers and sellers of stock. That’s all what happens in the market. So if you count the number of shares available and how much money is available you might get a sense of what’s going to happen. Since 2011, the amount of shares in the market has been declining every year. Even though individuals are taking money out of the market, companies have spent around $1.6 Trillion in cash on takeovers and stock buybacks.
And what does that mean for stock prices? >> Read More
Just like footballers before the World Cup final, central bankers in emerging markets are readying themselves for the biggest test of their careers: the first rate increase in nearly a decade by the US Federal Reserve.
The timing of this momentous event is uncertain, and disappointing data since the start of the year has made US monetary policy makers more cautious than they were just a few months ago. However, Janet Yellen, Fed chairwoman, remains confident the economy will strengthen and rates are likely to go up this year.
When the Fed eventually moves, economists believe a rate rise is bound to provoke large capital outflows away from Latin America and Asia. This will test the defensive strategies local policy makers have built throughout the long era of ultra-low rates.
“I don’t think emerging market central bankers can ever be properly prepared,” says Simon Quijano-Evans, emerging markets analyst at Commerzbank. “They have accepted that if it does happen, they will just have to deal with it.”
Their first line of defence includes interest rates, which central bankers can increase to persuade investors to stay put rather than moving their money to the US. >> Read More