What goes in also can go out …
Joanna Slater of the Wall Street Journal notes that many countries that were resisting pressure for upward appreciation are now selling dollars to defend their currencies. I very much agree with the quote from Lisa Scott-Smith:
Earlier this year, many governments in emerging markets were worried that their currencies were too strong, partly because foreigners kept plowing money into their economies.
Since then, investor sentiment has shifted sharply. Fears of inflation have combined with worries over a world-wide economic slowdown. Commodity prices have fallen, bad news for countries that export everything from oil to metals, and the U.S. dollar has mounted a powerful rally. In some cases — like Russia, Thailand and Pakistan — turmoil at home or nearby has spurred further unease.
As investors retreat from places they used to favor, many of them emerging markets, it creates a new worry for central banks in these countries.
When too much capital was flowing in, their main problem was that such flows put upward pressure on their currencies. A stronger currency makes exports more expensive abroad, harming trade competitiveness. To curb currency appreciation, central banks would buy dollars, and that led to a large accumulation of reserves.
Now “that is unraveling the other way,” says Lisa Scott-Smith of Millennium Global Investments, a London currency manager with $13 billion in assets. With investors unloading local stock and bond holdings, central banks find themselves “on the other side of the trade, trying to smooth currency weakness instead of strength.”
As Slater’s article notes, I expect emerging market reserve growth to slow from a level that was well above the emerging world’s current account surplus to a level that is more in line with the emerging world’s surplus. It might even dip below the emerging world’s combined surplus for a bit, as some of the money that went in earlier comes out. In some cases the pace of the reversal in flows has surprised me: I would have thought that high levels of reserves in the periphery might damp down volatility a bit more.
A couple of bits of data will be key to understanding how strong this shift is:
China’s July and August reserve growth
And Saudi Arabia’s reserve growth for those months.
Both still have a large trade surpluses, so there should still be an underlying dynamic of reserve growth. But the pace of their reserve growth likely has slowed in line with broader moves in global markets.
Speaking of Saudi Arabia, let me recommend Robin Wigglesworth’s reporting on Saudi Monetary policy. Wigglesworth reports that the unwinding of speculative bet on the riyal has created a cash squeeze in Saudi Arabia — pushing up local interest rates. And it so happens that the Saudi Monetary Agency is quite happy to see rates rise, as they want to cool lending to help curb inflation.
Earlier this year, funding costs in the interbank market were subdued by international capital inflows. Local currencies had slumped due to their peg to the dollar, and ambiguous comments from some central bankers around the turn of the year led international banks and hedge funds to bet on currency revaluations to help curb inflation. This helped to subdue borrowing costs for regional financial institutions, but also led local banks to ignore the need to build deposits to match hyperactive lending.
The dollar’s rally this summer also increased the value of Gulf currencies such as Saudi’s riyal, cutting the cost of imports and easing pressure on authorities to revalue their dollar pegs.International banks therefore started to reverse speculative revaluation bets, withdrawing local currency deposits and draining away capital that had helped keep spreads between the money market and benchmark rates low.
Subsequently, Gulf banks have had to turn to local money markets to finance lending, causing interbank rates to climb far above the central banks’ benchmark interest rates. Rather than try to ease the liquidity squeeze, authorities have welcomed more expensive funding costs in the fight against inflation, even abetting it in the case of Saudi Arabia.
Interesting. Reports of capital outflows from the Gulf suggest that Saudi reserve growth won’t be quite as high as one might expect based on the price of oil in July and August. The Saudis also seem have a bit more monetary autonomy when money is going out than when it is coming in — as they can allow the outflows to push up rates.
Even so, I fully agree with an anonymous Treasurer at a Gulf bank:
“the monetary policy appropriate for the faltering US economy is far from ideal in the Gulf, which has other concerns. Inflation and credit growth are soaring, but “we have monetary policies as if we were in a recession”, says the head of treasury at a top Gulf bank.
Pegging to the dollar isn’t quite as painful when the dollar is rising, but the dollar is still a poor fit for the Gulf’s economy. The Gulf would benefit from a currency that moved in the same way as oil — not one that often moves in the opposite direction.
“The Gulf would benefit from a currency that moved in the same way as oil — not one that often moves in the opposite direction.”
The only ones I can think of would be their own. Maybe they need the gold standard to keep FDI from driving them up?
You just can’t believe anything OPEC says. After deciding officially that $100 sounds like the right price for oil, and the Saudis are in charge of cuts, the Saudis say they are ignoring the decision and will pump as much as they see fit.
So it looks like the Saudis still see their role as being a stabilizing influence on the world economy. Unless this is some sort of convoluted PR.
http://www.nytimes.com/2008/09/11/business/worldbusiness/11oil.html?_r=2&ref=worldbusiness&oref=slogin&oref=slogin
But more oil at a significantly lower price means lower reserve growth.
And if the US consumer decides to do something with the gasoline savings besides buy Chinese stuff, then we should see lower reserve growth for China.
Those two things would be bad for Happy Hank, who seems like he or his successor might need something around $750B next year. Up to $4 Trillion if they think they are going to reflate the housing market back to where it was. But first things first.
I think the other big factor in dollar strength and the reversal in surplus CB strategies is that corporations doing currency hedging are a major factor in the currency markets. Everyone was on the same side of the trade (short dollar) and there has to be a lot of unwinding going on there.
Interest rate futures markets have a lot of influence on decision making there, and presently they give a sort of near term probability of a quarter point hike by the Fed, and half point cut by the ECB.
Personally I don’t believe it because I think Ben will play every card he has and actually give us another rate cut, while concurrently nationalizing the entire financial sector, leaving a gapping hole in the S&P 500.
And Euro and Japanese exporters just got a 10% hike in corporate profitability, so biz confidence should get a boost from that.
“With investors unloading local stock and bond holdings, central banks find themselves “on the other side of the trade, trying to smooth currency weakness instead of strength.””
At least I hope the CBs are making money on the trade, since they should have sold on the high and are buying lower. Or not – ?
Here’s a forex note on todays US data releases. They are starting to talk of a Fed cut now too.
It’s not real clear how the other of half of the twin deficit gets financed, now that HEW has gone away. As of July it’s $62B. August read on that not out yet so cheap oil should help on the import side, but then we don’t have a weak dollar helping exports.
========================================
US Inflation Pressures Cool And Trade Shortfall Grows
Thursday, 11 September 2008 12:48:26 GMT
Written by John Kicklighter, Currency Strategist
Speculation of an approaching recession and return to dovish monetary policy may be stepped up today (slightly). The economic docket offered three notable economic releases, and each disappointed in comparison to economists, and more importantly traders’, consensuses. Measuring the steps to a possible recession in the second half of this year, both trade and employment numbers worsened. The physical trade balance for July dropped to a $62.2 billion deficit against forecasts of a $58.0 billion shortfall. This was worst trade reading for the US in 16 months as oil imports soundly overwhelmed a 3.3 percent jump in exports. The appreciation in the dollar through the month is not likely to have yet been reflected in trade figures (at least at notable levels). Taking a measure of employment, first time unemployment claims grew (from the originally reported figure) to 445,000 while total filings hit another near-five year high. Though a modest economic release, this nonetheless offers a very disappointing outlook for consumer spending (accounting for an estimated 70 percent of growth). Finally, upstream inflation pressures have tappered off as expected. A 3.7 percent drop in import prices over the month of August was the biggest drop on records going back 19 years. It comes as no surprise, petroleum products plunged 12.8 percent and industrial supplies fell 8.4 percent. Altogether, this data had limited impact on the dollar; but it certainly curbs hopes of a near-term rate hike and draws a recession state closer.
http://www.dailyfx.com/story/market_alerts/fundamental_alert/US_Inflation_Pressures_Cool_And_1221137366922.html
Brad,
I’m wondering about the effect on Agencies and Treasuries from what you’ve reported here. I’m not a finance or economics person, so please excuse me if this question is stupid.
If foreign CBs have fewer dollars because they continue to sell them, could demand for and purchases of Agencies and Treasuries continue to weaken such that their interest rates suddenly spike?
From CNBC, U.S. facing Economic Depression
the continued US taxpayer bailouts of politically-connected Wall Street banks will push the United States into a “Depression”.
http://www.cnbc.com/id/26656750
” The end result of the global economic slowdown may be the U.S. announcing national bankruptcy as the government cannot afford the bailouts that it promised and the market will not bail out the government, Martin Hennecke, senior manager of private clients at Tyche, told CNBC on Thursday.
“We expect a depression in the United States. We expect a depression, very possibly, also in Europe,” Hennecke said on “Worldwide Exchange.”
The estimated $300 billion cost of the Fannie/Freddie bailout will probably be considered as a loss that the government will have to take, therefore passing it on to taxpayers, he explained.
“We already have $3 trillion of debt, as far as the U.S. government is concerned. These debt figures across the U.S. economy are rising very sharply.”
When the government can no longer pass the United States’ “immense debt” on to taxpayers, it will turn to the holders of U.S. dollars, leading to the eventual downfall of the currency, Hennecke said.
“Definitely, it (the dollar) is not a safe place to be invested in, as real inflation is closer to 10 or 11 percent than the actual inflation numbers given by the U.S. government,” Hennecke said on “Worldwide Exchange”.
“many countries that were resisting pressure for upward appreciation are now selling dollars to defend their currencies. I very much agree with the quote from Lisa Scott-Smith:”
Well, somebody is buying. They pushed the dollar back above 80.
[...] o desempenho da economia brasileira, mas à situação desesperante das empresas americanas. Fuga que não é só aqui, Brasil, mas [...]