Rising yields of USTs will have an impact on the policies of central banks whom has dovetailed their policies with that of the US Federal Reserve configured on zero bound rates
At the basic level, rising yields of USTs will compel for an adjustment in the respective contemporaneous ‘yield spread’ of domestic bond markets relative to the USTs that will get reflected on monetary policies.
What has made the adjustment disorderly, particularly for Emerging Markets has been the overdependence of specific economies on the zero bound regime, principally due to economic growth structured on credit expansion rather than economic reforms.
The relative yield spread adjustments has only exposed on the distinct vulnerabilities of these economies thereby leading to massive outflows.
The idea that the emerging market selloffs has passed days of turbulence neglects the importance of the fundamental relationship between respective pre-Taper/Abenomics ‘yield spreads’ of distinct EM nations with that of the USTs.
I pointed out last week how the direction of the Phisix seems to have found an anchor on the actions of USTs, where each time yields of 10 year USTs close in at 3% this seem to have spurred weakness or a spontaneous selloff in Philippine stocks.
It would seem that the same relationship holds true for ASEAN currencies. Since September 2013, where the yields of 10 year USTs (TNX, below chart) approached 3%, ASEAN currencies TWICE—particularly the USD-Philippine peso (red orange), US-Indonesian rupiah (orange), USD-Thai baht (green) and the USD-ringgit (red)—suffered convulsions from what should be normal yield spread adjustments.
Moreover, the second episode has led to greater (and not lesser) volatility where all four currencies broke beyond the September 2013 highs. So it would seem misguided to impulsively conclude that the emerging Asia’s woes have been short lived or has passed. Such assumption will have to be premised on a sustained decline of the TNX. However as pointed above, declining TNX has, of late, been accompanied by falling US stocks. And a steep drop in US stocks has likewise had a negative impact on local and regional stock market performance.
It is true that all of the region’s currencies have been rallying during the past two weeks. This has also been accompanied by buoyancy in the region’s equity markets. And again that has been largely because the TNX has dropped steeply. Nonetheless, the lull in ASEAN’s markets may be temporary as TNX has been climbing again (red ellipse).
Notice that when the TNX peaked in September, the two month of tranquil space permitted the region’s financial markets to somewhat recover. However it is a question if the TNX has found a bottom. If it has, then it means a narrowing of the time span covering the previous peaks of September and December. This may imply that the ascent of the TNX may be accelerate or intensify. A fresh record breakout by US stocks can easily power the TNX to new highs.
Yet the current rally of domestic bonds of emerging Asia has hardly been impressive. Additionally, while regional currencies have bounced back, they are far from the lows of the post September levels. ASEAN currencies are rallying in lesser degree than during the post September lows.
The question now is if the TNX should continue to climb or spike, will the impact be devastatingly larger this time?
Presently even the mainstream has come to notice the recent bout of volatilities has exposed on the price inflation predicament of ASEAN[1]. But the emerging stagflation ogre has been seen as a supply side driven predicament rather than a credit inspired demand side imbalance. Debt exists nowhere in mainstream analysis.
Yet debt has been the anchor of any potential transmission mechanisms for a contagion
For instance, US and European banks have been found to have chased yield by having bigger exposure on EM’s the Fragile Five.
Philip Coggan of the Buttonwood Blog fame at the Economist quotes Erik Nielsen[2]
According to the BIS, US banks’ exposure to the “Fragile Five” increased by 37% to $212bn, while their exposure to the Eurozone periphery declined by 17% to $164bn. UK banks’ exposure to the Fragile Five increased by 29% to $291bn – while their exposure to the periphery declined by 30% to $277bn. German banks expanded their exposure to the Fragile Five by 34% to a relatively modest $69bn – while shrinking their exposure to the periphery by an eye-watering 50% to $354bn. French banks increased their Fragile Five exposure by a modest 15% (to $69bn) – while chopping their Eurozone peripheral exposure by 43% to $514bn. Italian banks doubled their exposure to the Fragile Five – but to a total of just $11bn, while cutting their exposure to the periphery (excluding Italy itself) by 46% to $33bn. And Spanish banks increased their exposure to the Fragile Five by 26% to $185bn, while chopping their peripheral exposure (ex Spain) by 29% to $105bn.
So mainstream western banks flocked into the Fragile Five when the PIGS crisis surfaced.
And the powerful argument presented by Mr. Coggan has been to debunk the use of accounting identities in denying the above risk. Mr. Coggan writes, “the fragile five got that tag because they have current account deficits, but such deficits require, as an accounting identity, capital inflows. Someone had to lend these countries money so they could buy imports.”
In short behind all the smoke screens thrown by the consensus to defend the status quo via statistical figures and accounting identities, everything else will all boil down to sustainability or unsustainability of DEBT operating under the presence of the bond vigilantes.
[1] Wall Street Journal Real Time Economics Blog, In Asia, Concerns About Inflation Re-Emerge, February 11, 2014
[2] Buttonwood, The money has to go somewhere February 10, 2014
No comments:
Post a Comment