The Real Tapering Threat Is Not The Fed, but China

by Michael J. Howell25. January 2014 11:50
Emerging Market weakness is supposedly all down to Washington and the threatened tapering of QE policies by the US Fed. Simple but wrong. The evidence from our regular studies of World capital flows tells a very different story. Of course, no one should suggest that Fed tapering when it comes will be positive for EM, but the underperformance is caused by something bigger. 15 years ago EM economies were tied into the US consumer cycle and US policy mattered a lot. Lately EM have moved to supply the Chinese capital goods cycle. In short, Chinese monetary policy now matters and the tapering by China's PBoC (Central Bank) over the past 18 months has had a devastating effect on EM. Chinese policy makers are still struggling to contain the excesses of a boom launched five years ago at the time of the 2007/08 World financial crisis: they may have to wrestle well into 2015 before the tide turns. The result is weak Chinese capex; a fast-slowing economy and continuing fall-out across EM. If the culprit was genuinely American monetary policy surely the smaller Frontier Markets, which are more dependent on dollar capital flows, would now be in the eye of the storm? Yet they like Wall Street have been booming. The EM puzzle is explained by Chinese tapering not Fed, and it may last another year!

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September FOMC: Bernanke's Eastern Put

by Michael J. Howell19. September 2013 17:02

The Fed surprised markets by deciding not to start 'tapering' its QE programme at its September meeting. What does this mean? Markets read it bullishly, that the Fed will continue to buy bonds and pump in cash, probably because they sense policy-makers are concerned by recent weak-ish economic numbers. However, whatever the FOMC's internal doubts and debates, the Fed has been striving all year to divide 'forward guidance' on interest rates from 'tapering' of QE, arguing both publically and privately that the former is more important overall and anyway set more in line with economic prospects. Meanwhile, QE is thought to be more important for the finance sector, and some Fed policy-makers have been concerned over recent months by bubbles and a 'reach for yield'. This argues for tapering now. Therefore, the Fed's latest decision is puzzling because if they are concerned about economic growth they could have hinted at lower future 'forward guidance', while still making a token gesture towards some tapering. Something else may be up? This could be EM. July/ August saw a rout in several EM currencies and EM equity and bond markets because of the upcoming threat of tapering. The fragile state of EM may have convinced US policy-makers to hold fire on tapering for another couple of months. So, overall no real change in view. On balance a bit more bullish if the Fed is truly an implicit protector of EM, and on this read the Fed may not be as concerned about the US economy as some fear. Therefore, keep selling those bonds; buy back some dollars and bottom fish in EM. The Bernanke Put may have just shifted Eastwards!

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Tapering ... Bah!

by Michael J. Howell15. August 2013 09:34
'the money here is awful ...and such small flows...' is a Groucho Marx-like reflection on the growing debate over Fed tapering. Fact #1 is that QE3 is no QE1 and never was. The $85 billion monthly Fed injections could easily be trimmed to $75 bn at the September FOMC, but these flows are anyway being swamped by buoyant private sector liquidity inflows. These private flows, not the Fed, explain the firm US dollar; the rebounding US economy and rising bond yields. In short, policy-makers have been fooling the markets this year with their power. Fact #2 most of the Fed cash is effectively going to support the still fragile wholesale money markets. Given the vast increase in OTC bond issuance/ trading since 2008, these wholesale markets are probably still vital in providing funding for market makers. Fact #3 the Fed is internally worried by growing speculative activity and needs to show its hand. We know that the key decision makers anyway prefer 'forward guidance' to 'QE', so the latter is an easy sacrifice. Bottom line? Expect a September move to reduce QE. This will not derail the economic recovery, but it is likely to help the US dollar climb higher, and most importantly it will be yet another factor leading to greater market volatility over the next 12 months. Tapering matters, but not that much.

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by Michael J. Howell12. December 2012 18:27

Todays Fed Statement and the similar tone taken by a recent speech from in-coming BoE Governor Carney both show the shift of thinking away from inflation and towards employment as the general 2013-14 policy goal. The Fed as expected emphasised the 'US$85 billion' monthly figure of new injections of cash and cleared any doubts that it might be compromised by the slated end to 'Operation Twist'. It may be a moot point whether this constitutes an increase on the previous QE3 and so can rightly be labelled a QE4. Whichever, investors must view these collective statements by policy-makers as events in 2012 but as processes for 2013. The two key things to focus on are (1) starting point and (2) future delivery. The starting point in 2012 is from a relatively low liquidity point, ie on our measures the Fed is still quite tight. Thus we are fed up of seeing the now standard Central Bank balance sheet graph in the Press showing strong rises since 2008. We simple cannot compare the Fed the BoJ the BoE and he ECB by their absolute balance sheet sizes without taking into account their institutional structures. In short our measures confirm that CBs have much room to ease. Second, promises are one thing and delivery is another. The previous post touched on why the Fed has not delivered yet. Therefore, see this renewed QE3 as a general easing process through 2013. Moreover others will join. Next up the BoJ?

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Where's Our QE3? -- Update

by Michael J. Howell6. December 2012 09:54
Fact: the US Fed balance sheet has barely expanded since Ben Bernanke's much trumpeted QE3 announcement on September 13th 2012. It should, according to our estimates now be ahead by a net US$150-200 billion from this date, but has mustered a puny US$34.7 billion. The bulk of Fed balance sheet movements are driven by changes in the size of the SOMA account. At end-November it touched US$2598.6 billion. It has barely changed since the September QE3 statement, and the slated $40 billion monthly step-up in MBS (mortgage-backed securities) purchases does not appear to figure. Rather than buying at this clip, the SOMA data show that the end-November the Fed has only purchased $40 billion of MBS in total. Does this mean that QE3 is not working? Or, more worryingly, that the Fed has somehow changed its mind and now, may be, awaiting clearer political progress on the 'fiscal cliff'? Both are possible, but we must also take into account the typically long settlement times involving in purchasing MBS (up to 180 days) because the SOMA and the Fed balance sheet are reported on a settlement basis. In short, 'in transit' bonds do not appear. However, we can get a handle on the potential rise by looking at reported 'commitments to buy'. This does show a large step-up confirming that US policy-makers are keeping to some of their promises. The figures highlight, again since mid-September, actual MBS purchases of $39.8 billion and new commitments of $47.3 billion. If it is fair to add these together, and it may not be, the indicated and inferred (to use a mining analogy) totals $87.1 billion, or some 85% of the slated target programme to date. The plain fact is that in terms of hard cash the QE3 has delivered only 39% of the MBS purchases the markets expected and taken overall, in terms of overall Fed balance sheet expansion the QE3 has produced a measly 18% of the promised $85 billion per month that the Fed hinted would be the net expansion after re-invested coupons were taken into account. This net increase is outside the Fed’s Maturity Extension Programme ('Operation Twist') that to date has sold US$595.7 billion US Treasuries of less than 3¼-year maturities and purchased US$622.1 billion of more than 6-year maturities. The bottom line in that QE3 is not delivering. Liquidity conditions in US markets may be OK but they are not expanding along the lines investors once hoped. This likely explains why the US dollar gold price has slipped back below US$1700/oz and why there has been some, but not enough yield curve steeping. These are two unambiguous liquidity signals and we closely watch them to confirm our more detailed analysis of Central Bank operations.

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Why Is Gold Weak?

by Michael J. Howell5. December 2012 12:47

The US dollar gold price has retreated back to test its long-term support line at circa $1700/oz. Gold is a pure liquidity phenomenon and its weakness tells us alot about how little new liquidity policy-makers are creating. We have noted in recent weeks that the US Fed has broken its QE3 'promise' stated on Sept 13th to add some US$85 billion per month to its balance sheet. It may ultimately 'catch up' thereby fuelling a 'Risk On' rally in 2013. But why has it stalled? The explanation may lie in Chairman Bernake's speech in early November to the New York Economic Club where he appeared to tie QE to progress on resolving the 'fiscal cliff'. In short, he is keeping his powder dry untill either he sees fiscal progress, or may be is forced to act by market turmoil. Gold is a convenient benchmark of this QE, as is the 10-2 yield curve. Investors can afford to wait until both indicators turn higher. It may be a jittery few weeks. Traditionally, the period between Election and Inauguration in the US has seen roughly twice normals level of market volatility, and that without a 'fiscal cliff'.

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