BIS Warns (Again) on Strong Dollar’s Impact on Emerging Markets, Deep Dependence on Central banks!

The central bank of central banks, the Bank for International Settlements just can’t get enough from dishing out warnings after warnings on global risk. Obviously they are doing this because the consensus ignores them.

A month ago, I posted here the BIS chief Jaime Caruana’s ‘debt trap’ speech.

Now from the BIS’s December Quarterly Review we read of more warnings.

From BIS chief economist Claudio Borio

On the central bank put during the sharp recovery from the October meltdown: (bold mine)

At the same time, a more sobering interpretation is also possible. To my mind, these events underline the fragility - dare I say growing fragility? - hidden beneath the markets' buoyancy. Small pieces of news can generate outsize effects. This, in turn, can amplify mood swings. And it would be imprudent to ignore that markets did not fully stabilise by themselves. Once again, on the heels of the turbulence, major central banks made soothing statements, suggesting that they might delay normalisation in light of evolving macroeconomic conditions. Recent events, if anything, have highlighted once more the degree to which markets are relying on central banks: the markets' buoyancy hinges on central banks' every word and deed.

The highly abnormal is becoming uncomfortably normal. Central banks and markets have been pushing benchmark sovereign yields to extraordinary lows - unimaginable just a few years back. Three-year government bond yields are well below zero in Germany, around zero in Japan and below 1 per cent in the United States. Moreover, estimates of term premia are pointing south again, with some evolving firmly in negative territory. And as all this is happening, global growth - in inflation-adjusted terms - is close to historical averages. There is something vaguely troubling when the unthinkable becomes routine.

On crashing oil and the strong US dollar.

These developments will be especially important for emerging market economies. The spike in market volatility in October did not centre on these countries, unlike at the time of the taper tantrum in May last year and the subsequent market tensions in January. But the outsize role that commodities and international currencies play there makes them particularly sensitive to the shifting conditions. Commodity exporters could face tough challenges, especially those at the later stages of strong credit and property price booms and those that have eagerly tapped equally eager foreign bond investors for foreign currency financing. Should the US dollar - the dominant international currency - continue its ascent, this could expose currency and funding mismatches, by raising debt burdens. The corresponding tightening of financial conditions could only worsen once interest rates in the United States normalise.

Unfortunately, there are few hard numbers about the size and location of currency mismatches. What we do know is that these mismatches can be substantial and that incentives have been in place for quite some time to incur them. For instance, post-crisis, international banks have continued to increase their cross-border loans to emerging market economies, which amounted to $3.1 trillion in mid-2014, mainly in US dollars. And total international debt securities issued by nationals from these economies stood at $2.6 trillion, of which three quarters was in dollars. A box in the Highlights chapter of the Quarterly Review seeks to cast further light on this question, by considering the securities issuance activities of foreign subsidiaries of non-financial corporations from emerging markets.

Against this backdrop, the post-crisis surge in cross-border bank lending to China has been extraordinary. Since end-2012, the amount outstanding, mostly loans, has more than doubled, to $1.1 trillion at end-June this year, making China the seventh largest borrower worldwide. And Chinese nationals have borrowed more than $360 billion through international debt securities, from both bank and non-bank sources. Contrary to prevailing wisdom, any vulnerabilities in China could have significant effects abroad, also through purely financial channels.

I have been repeatedly saying here that strong US dollar-weak Asian currencies will pose as a significant headwind to the region’s financial assets and economies

As of this writing based on Bloomberg data, Malaysia’s ringgit, Indonesia’s rupiah, Australian dollar and New Zealand dollar are being crushed!