``In sum, the world is approaching a turning point after nearly a decade of growth without serious emerging market crises. It has benefited enormously from the specialisation of parts of the developed world, primarily the US, in the output of non-traded goods and the specialisation of emerging markets in traded goods. The US, with its strong institutions and impeccable credit, was thought to be in a good position to handle this specialisation, though the financial crisis shows that even it has its limits. As the US reduces its current account deficit, a transition in specialisation will have to take place. In the medium term, this will create opportunities in emerging markets, while also increasing risks.-Raghuram Rajan professor of finance at the Graduate School of Business, University of Chicago, is a former chief economist of the International Monetary Fund, Emerging markets must shift their focus inwards
The Philippine Peso dropped .6% over the week to Php 45.92 against the US dollar, this despite the Bangko Sentral ng Pilipinas’ recent move to raise its policy rates by 25 basis points (Bloomberg). So much for the argument of interest rate rate differentials.
Dollar bulls earlier claimed that the reason why the Philippine Peso has been recently clobbered was due to “rising consumer price inflation”. Now that signs of “food price” driven “inflation” has been moderating as we expounded in Philippine Peso Wilts Under The Unwinding Short US Dollar Carry Trade!, the argument has shifted towards a “weakening economy”.
US-Philippines Economic Growth Differential Mirage
While true enough the Philippines accounted for a sharp deceleration in terms of economic growth, 4.6% in the 2nd quarter (compared to 8.3% over the same period last year) at the time when consumer goods inflation reached 12.2% last July (to our guess the peak of the present cycle), US economic growth which surprisingly accelerated to 3.3% over the same period is still far below the present Philippine growth rates.
Yet what appears to have driven US economic growth in the 2nd quarter has been mostly “improved demand for exports” which according to CNNmoney.com, “added 3.1% to GDP, compared to just 0.8% in the advanced reading.”
Yet looking forward, gains from such progress look questionable,
Figure 6: Northern Trust: Deteriorating Corporate Profits
According to Northern Trust’s Asha Banglore, ``However, corporate profits from the rest of the world on a quarter-to-quarter basis have now dropped for two quarters in a row. Moreover, the recent rally of the dollar casts doubts about the ability of corporate profits from the rest of the world to help trim the decline in overall corporate profits.”
Why? From a theoretical standpoint a faltering global economy isn’t likely to give a lift to the already moderating export growth clip which should equally translate to declining corporate profits from exports going forward, as shown in figure 6.
This soft environment essentially translates to an adverse feedback loop that could drag US economic growth lower over the coming quarters.
On the other hand, the Philippine growth had been likewise boosted by ironically a resurgence of “exports” in the face of supposed deterioration of trade linkages, aside from remittances and the outperformance in agriculture. This from the Inquirer.net, ``Only the agriculture, fisheries and forestry (AFF) sector posted a faster growth at 4.9 percent from 4.2 percent. The faster rise in the AFF sector was due to higher demand for domestically produced food because of the country’s growing population and the rising cost of imported food.”
Why our emphasis on the agriculture? Because from the “inflation” standpoint, food accounts for the biggest chunk or nearly half of the Filipinos’ headache when reckoning in terms of the expenditure basket. And the growing output from agriculture related industries will likely mitigate statistical inflation aside from redirecting wealth to the countryside.
So what has weighed on the Philippine economy aside from “inflation”? The answer from the industrial viewpoint is in services (communications and transport) and industry particularly mining. While it is easy to blame “inflation”, it is unclear what has prompted such a slowdown and if these had been merely hiccups.
Overall, even based from the recent significant deceleration in Philippine growth, the US economy isn’t likely to outgrow the Philippines enough to justify the Peso’s weakness in terms of growth differentials. This also shows that monetary policy isn’t likely to favor the US too, because stronger economic growth allows more leeway for the local central bank to raise interest rates enough to widen the interest rate spread between the Peso and the US dollar.
US Dollar As Safehaven? Not In The Context of Iraqi Bonds or China’s Anxieties Over Fannie and Freddie
And again we simply can’t buy the hokum that the US dollar should function as “safehaven” in today’s global financial crisis; especially not when the source or origin or epicenter of today’s stresses –a diffusion of the deeply rooted US credit crisis emanating from an insolvent financial industry-is from the US.
Take a look at this news account…
From the Financial Times, ``Bank of China has cut its portfolio of securities issued or guaranteed by troubled US mortgage financiers Fannie Mae and Freddie Mac by a quarter since the end of June.
``The sale by China’s fourth largest commercial bank, which reduced its holdings of so-called agency debt by $4.6bn, is a sign of nervousness among foreign buyers of Fannie and Freddie’s bonds and guaranteed securities.”
Does China’s queasiness over the fate of its $376 billion holdings of Fannie and Freddie Mac securities signify US assets or the US dollar as a safehaven status?
…or how about this…Iraq bonds are now considered as “safer” than some US banks!
From the Bloomberg (emphasis mine),
``Iraq's bonds are delivering the biggest returns in emerging markets as oil export revenue bolsters government finances and violence declines.
``The country's $2.7 billion of 5.8 percent bonds due 2028 gained 45 percent since August 2007, according to Merrill Lynch & Co. indexes. Investors demand 4.84 percentage points more in yield to own the debt instead of Treasuries, down from 7.26 percentage points a year ago. The spread is narrower than for notes of Ohio banks National City Corp. and KeyCorp, suggesting Baghdad may be safer for bond investors than Cleveland…
``Iraq provides some insulation from the market,'' Brown said. ``The risks are so idiosyncratic that it trades on its own drivers.''
The “Iraq is safer than Ohio bonds” doesn’t seem to support the US dollar as “safehaven” status, does it? Or maybe there has been a sudden epiphany for global investors to reckon Iraq bonds as the alternative “safehaven” asset? Moreover, I thought I heard someone utter “decoupling is a myth” argument?
In Taleb’s Black Swan rule, a single contradictory observation is enough to demolish a long held, deeply entrenched and popular espoused generalization.
Portfolio Outflows As Evidence
If there is anything that supports the case of a strong US dollar is that today’s forcible liquidations-in efforts to monetize liquid assets and shore up capital for the wobbly US financial industry-seems to be one of the main reasons behind the weakness of the Peso see figure 7.
Figure 7 DBS bank: Net foreign Selling in Philippines
The underperformance of the Philippine Peso and the Phisix relative to its Indonesian counterparts (JKSE and the Rupiah) can be partially explained by portfolio outflows for the Philippines and inflows in Indonesia.
But this isn’t just based on relative dimensions but seen from even across the region see figure 8.
Figure 8: EPFR Global: Asia ex-Japan least favored among EM regions; clear preference for commodities exporting regions EPFR Global says that fund flows have favored commodity exporters. But generally, reckoned from a year-to-date basis, international portfolio funds have been net sellers of Emerging Markets, except for EMEA or Europe Middle East and Africa (green line).
And again this seems to be the invisible knot that ties the so called “recoupling” theory. Beleaguered companies or institutions embroiled in the credit crunch sell their most liquid assets to raise capital. Since many of these have accumulated significant overseas assets especially based on former favorite themes, thus the selling activities seem to be global and synchronic in nature.
Albeit, the outperformance of Middle East and Africa also seems to be buttressed by the rotation of portfolio flows. And we can’t discount momentum; liquidity constrains could have also introduced the sell EM Asia and buy Middle East Africa arbitrage. Yet as a puzzle the EMEA’s markets seem to be immune from the inflation story even when “inflation” seems to be relatively higher than Asia.
As an aside, Saudi’s Stock Exchange (Tadawul) is set to open its doors to foreigners (Economist). Will the sagging Tadawul index get the much needed shot in the arm from foreign investors? Perhaps. If today’s preferential flows to the Middle East and Africa will continue. If foreign investors will remain blinded by market momentum even as the inflation story has been much more entrenched in the region.
Big Brother Is All Over
But again such appears to be just part of the major movers, the other, we suspect comes from the unwinding of the paired trades possibly triggered by government intervention as previously argued in Philippine Peso Wilts Under The Unwinding Short US Dollar Carry Trade!
Recently the Bloomberg quoted on Japan’s Nikkei English News which reported of a long planned coordinated exercise by the officials of the US, Japan and Europe to support the US dollar.
From the Bloomberg, ``Finance officials from the U.S., Japan and Europe in mid-March drew up plans to strengthen the U.S. dollar following troubles at Bear Stearns Cos., Nikkei English News reported, citing unnamed sources.
``The intervention designed by the U.S. Treasury Department, Japan's Finance Ministry and the European Central Bank called for the central banks to purchase dollars and sell euros and yen, with Japan providing the yen needed for the currency swap if the greenback's value dropped significantly, the news service said.”
So present activities may have reflected government’s strong arm tactics.
Aside, chatters of market manipulation hasn’t been restricted to the US dollar, but to gold markets as well.
Some has speculated that governments through several banks have tried to suppress oil prices to shape conditions of an improving economic environment as the Presidential election nears.
According to the Moming Zhou of CBS,
``Recent heat from Congress and regulators, along with public speculation, over whether commodity prices are being manipulated has also reached gold pits, where the debate was stirred by a surge in bets last month that gold prices would fall…
``Three unidentified U.S. banks held 86,398 short positions, or bets that gold prices will fall, in the COMEX gold market as of Aug. 5 -- 10 times more short positions than a month earlier, a government report showed.
``The report by the Commodity Futures Trading Commission, which regulates U.S. futures markets, also showed short positions held by three U.S. banks in silver futures had increased more than four times during the same period…
``Mendelsohn said he believes the government has tried to make the U.S. economy, oil, and markets appear in better shape and also to temporarily curb the immediate effects of the slumping housing market, of bad home loans and of the credit crisis.
With US government hands evidently seen in almost every corner of the financial sphere working feverishly to avoid what seems to be for them the menace of a catastrophic “deflationary” crash, it isn’t farfetched to also intervene for political purposes.
Epilogue
So, for us, issues germane to 1) statistical inflation, 2) economic growth differential, 3) interest rate differentials, 3) higher risk aversion landscape or lastly 4) US dollar as safehaven seem to be unconvincing fundamental reasons behind the recent US dollar’s rebound.
We are more convinced of the dynamics of 1) momentum 2) global capital raising activities partly via forcible liquidations by the developed world financial industry and most importantly 3) the tweaking of government hands of the financial markets for political and financial reasons.
However, continued US government support for the financial industry (Fannie and Freddie, growing bank closures) plus clamors for expanding Federal rescue to other industries like the Detroit automakers, aside from vastly expanding fiscal deficits combined with baby boomers claims on unfunded liabilities are likely to weigh on US balance sheets and is expected to reflect on the US dollar.
