Monday, July 15, 2013

Phisix: How Sustainable is the Bernanke Put?

“Highly accommodative monetary policy for the foreseeable future is what's needed…If financial conditions were to tighten to the extent that they jeopardized the achievement of our inflation and employment objectives, then we would have to push back against that…
The above statements[1] made by US Federal Reserve Chairman Dr. Ben Bernanke this week had been enough to power or push the previously uncommitted global financial markets into a risk ON environment and to the setting of records for US stock markets[2]. 

If this is so, then why does the mainstream adamantly insist that prices in the financial markets are supposedly set by the conventional notion of fundamentals such as “valuations” or statistical “economics” rather than by monetary policies?

The implication is that the monetary landscape determines the conventional notion of “fundamentals” and that the corollary—drastic changes in the monetary environment—will radically alter “fundamentals”.

Thus a financial and economic environment nurtured by easy money will have almost been entirely dependent on the continuity of such dynamic; such that, to reiterate, a reversal of which translates to a massive dislocation or a withdrawal “shock” from which the current financial and economic environment has been implanted on.

Of course the basic question is how sustainable are these free lunch monetary policies?

As previously pointed out, the recent riots in the global bond markets seem as signs of the unintended consequences or a growing backlash from these policies[3].

Yields of US long term bonds have gradually been ascendant since July 2012. The Fed’s QEternity last September (which had only a 3 months effect), Kuroda’s Abenomics in April and the ECB’s interest rate cut have all failed to stem rising yields.

Yet the rate of increases only intensified when the financial markets selectively ‘focused’ on the ‘tapering’ aspect of the rather ambivalent Fed’s communiqué last May[4].

The US bond market rout quickly cascaded into a pandemonium in the stock and bond markets particularly in the emerging markets, as well as parts, of the US fixed income markets.

And given the estimated $225 trillion capital markets where 78% comprises the interest rate sensitive bond and loans markets, combined with the $490 trillion interest rate swap derivatives markets, a sustained spike in bond yields will only aggravate the bedlam in the global financial markets[5].

Thus, the Fed’s signaling channel or communications strategy or inflation expectations management fiasco has immediately been remedied by promises to contain interest rates by the announcement of “forward guidance” by Mark Carney of the Bank of England, the jettisoning of the non-committal stance by the European Central Bank where Mario Draghi declared low levels for an “extended period of time” and finally Dr. Bernanke’s “highly accommodative monetary policy for the foreseeable future”. 

This time the steroid starved markets focused on Dr. Bernanke’s missives while ignoring the fact that in the minutes of the FOMC meeting about half of the participants wanted to halt the $85 billion in monthly bond purchases by year end[6].

The predicament is that what seems as diminishing marginal efficiency or returns and of the narrowing window of impact of such policies, it remains to be seen if jawboning alone will be enough to sustain the risk ON environment based on the Bernanke Put.

Greater Risks from China’s Selective Interventions

The hunger for policy steroids has infected China too.

Rumors floated that China’s government may soften her stance on monetary policy, which prompted for a one day 3.23% surge on the Shanghai Composite index.
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The following day China’s economic data showed of mixed outlook in terms of monetary affairs.

Money supply growth showed of a marginal decline. M2 rose by only 14% in June from May’s 15.8% growth. Meanwhile, new currency loans soared by 860.5 billion yuan in June vastly up from 667.4 billion yuan in May. This according to the Bloomberg[7], accounted for about 83 percent of aggregate financing last month. 

Yet a big part of this credit expansion has been coursed through China’s four biggest state owned banks which stood at an “unusually large 170-billion yuan ($27.7bn) in the first week of July”[8].

Friday, the Shanghai composite index gave up about half of the Thursday’s gains, but still posted a positive 1.61% return for the week.

The Chinese government’s declared measures of stamping out the shadow banking system but at the same time expanding loans via state owned banks extended to mostly State Owned Enterprises and politically connected firms will most likely backfire as political distribution of money will only compound on the existing distortions[9] on the marketplace by increasing the yield chasing phenomenon that increases systemic risks via further inflation of the debt driven property bubble.

One clue of this is that given China’s underdeveloped capital markets or with the limited options for the average Chinese to invest, falling stock markets has prompted for a record flows into the shadow banking system’s wealth management products[10] during the last two weeks of June.

And my guess is that some, if not a big portion of these funds, will also flow into the shadow banking system.

The Chinese government can control the stock of money issuance, but they will not be able to control the flows of money.

The Chinese government’s selective targeting of monetary interventions has already been affecting her merchandise trade activities as exports and imports jointly fell last June[11]. 

In addition, the cash crunch has prompted many car dealers to have reportedly withheld shipments without upfront payments[12]. The cash squeeze has also caused a drought on sales of dollar-denominated junk bond or Chinese speculative-grade companies[13].

Meanwhile consumer price inflation rose 2.7% beyond median estimates at 2.5%, even as producer prices fell by 2.7%[14], which shows of the stagflation setting the Chinese economy has transitioned into.

The distribution of credit by political means where the incumbent Chinese government expands credit via state owned banks will likely be policy trend going forward. Such interventions are likely to heighten risks of a disorderly adjustment in China’s highly fragile debt laden economy.

As Columbia University finance and economics Professor Charles Calomiris wrote in a 2009 paper on banking crises[15]
This pandemic of bank failures has been traced empirically to the expanded role of the government safety net, as well as government involvement in directed credit. Government protection of banks and government direction of credit flows has encouraged excessive risk taking by banks and created greater tolerance for incompetent risk management(as distinct from purposeful increasesing risk). The government safety net, which was designed to forestall the (overestimated) risks of contagion, ironically has become the primary source of systemic instability in banking.
The more the interventions, the more the risks of a policy error.

ASEAN Stocks: Sharp volatilities hardly mean stabilization

Another huge beneficiary from Dr. Bernanke’s “highly accommodative monetary policy for the foreseeable future” has been ASEAN bourses.

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Thursday, Bernanke’s announcement prompted Thailand’s SET to fly 4.22% (upper window) while Indonesia’s Jakarta Composite Index jumped by 2.8% (lower window). Both bourses[16] were up this week by .86% and .66% respectively. The marginal weekly gains reveal of the sharp volatilities experienced by both equity markets which means earlier steep losses were recouped from Dr. Bernanke’s blandishments.

I noted in the past that one consolation from the recent bear market foray by the Phisix has been that none of our neighbors has touched the bear market.

I wrote back then[17],
A consoling factor has been that the stock markets of Thailand and Indonesia has not fallen into the bear market zone…at least not yet. If these three major ASEAN markets will synchronically submit into the domain of the bears, then the bigger the risks of a full bear market cycle.
But charts of the SET and the JCI has not been comforting, while the SET has managed to slightly break above the downtrend, it is unclear if this can be sustained.

On the other hand, the JCI can be interpreted two ways depending on one’s bias, a descending triangle (bearish) and a potential double bottom (bullish).

The point being, the sustainability of momentum molded from the Fed’s policy guidance seems uncertain. This will most likely be determined by actions of the global bond markets.

And amidst the bond market turmoil, the Indonesian government managed to raise US $1 billion of dollar bonds last week which media cheered since this has been “twice oversubscribed”. But this comes with a catch; they were oversubscribed because of significantly higher rates.

From the Jakarta Post[18] (bold mine)
Investors were attracted by the 10-year dollar securities’ high yields, which reached 5.4 percent — the highest in three years. The yield, which is 282 basis points below the premium US treasuries, was also significantly higher than the government’s last global bonds auction on April, which offered the 10-year dollar notes at 3.5 percent.
So yes, one can still raise money but at significantly higher yields.

Developments in the bond markets continue to cast a pall over the stock markets.

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Sharp volatilities hardly mean stabilization.

The Phisix posted a modest 1.13% gain over the week. But this comes after three days of sluggishness which resulted to a little over 3% loss. Bernanke’s guarantees incited a remarkable two day 4.17% snapback which reversed the weekly losses. Overall the Phisix endured a pendulum swing by about 7%. Simply amazing.

Yields of 10-year Philippine bonds also significantly retrenched while the Peso was unchanged for this week which are positive signs.

Again given the immense volatilities in the financial markets here and abroad, external developments are likely to influence market movements more than by internal dynamics.

In short, the Phisix will likely move in the direction along with her regional peers as influenced by the direction of global bond markets.

Excessive volatility also translates to a risky environment.










[8] Business Day Live South Africa Global equities rise on US Fed comments July 11, 2013







[15] Charles W. Calomiris BANKING CRISES AND THE RULES OF THE GAME NBER Working Papers October 2009



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