BRICS risk 'sudden stop' as dollar rally builds

By Ambrose Evans-Pritchard

9:01PM BST 22 May 2013

The stock of capital flowing into emerging markets has doubled from $4 trillion to $8 trillion since the Lehman Crisis, chasing a catch-up growth story that looks tired and has largely sputtered out in Brazil, Russia and South Africa.

Propaganda Wall Poster Shanghai China 1982
A Chinese propaganda poster from 1982. Stripped bare, the BRICS miracle is really about China, and even the Politburo has run into diminishing returns after ramping up credit from $9 trillion to $23 trillion in four years 

"Every emerging market blow-up that I have seen was preceded by a rise in the dollar," said Albert Edwards for Societe Generale.

"Investors overlook how vulnerable these countries are to a dollar shock. The whole process of excess liquidity and foreign reserve build-up goes into reverse. It acts like monetary tightening and turns into a vicious circle. Markets look for the  weak link with the worst current account deficit, and then the dominoes start to fall," he said.
Fed chairman Ben Bernanke told Congress on Wednesday that "premature tightening" could abort the US recovery. There will be no "tapering" of quantitative easing until the fourth quarter. But passive tightening has begun. America's broad M3 money supply has been flat for months.

Former IMF official Stephen Jen, now at SLJ Macro Partners, foresees a "sudden stop", the moment when funding for emerging markets dries up abruptly and investors run for the exits.
Mr Jen said the flow of money before 2007 was "pulled in" by a genuine growth story, but what has happened since is different. Money has been "pushed out" of the West by QE in the US and Britain, or by the emergency stimulus in Europe, with liquidity washing through the global system.

It is of "inferior quality", "fickle", and likely to be "fully reversed" as the Fed hoovers up excess money. The timing is in the hands of Bernanke, but the screws are already tightening for some in Asia, Latin America and the Mid-East as commodities deflate.

The cumulative inflow of capital has been 60pc of GDP in Lebanon, 58pc in Bulgaria, 56pc in Hungary, 50pc in Ukraine, 48pc in Poland, 42pc in Chile, 39pc in Romania, 32pc in Malaysia, 28pc in Thailand and 26pc in Turkey, to name a few. It can be good or bad. The devil is in the detail. But the overall level is what you see at cycle peaks. The IMF says the flows have been "ample but not alarming", yet also warned of a "sudden change in global market sentiment".

You can take a contrarian view, seeing the 12pc fall in the MSCI Index of emerging market stocks since early 2011 as a chance to pick up bargains. Bank of America says the sector "typically" beats the S&P 500 and Eurostoxx when the mood is this bearish. It depends whether you think the two-year drought is "typical", or the end of the road for a whole catch-up model.

South Africa has already become the first of the "BRICS" quintet to graduate from routine trouble to what looks like an old-fashioned Third World crisis. The current account deficit is 6pc of GDP. The rand plunged to a four-year low against the dollar this week, and 10-year bond yields have lost their footing.

Clearly a risk that all of us see is a sudden change in sentiment. Once there have been good inflows there might be unanticipated outflows,”said finance minister Pravin Gordhan.

The fear is that South Africa is becoming ungovernable, with no end in sight to violent strikes by miners. Police opened fire on protesters at Lonmin's Marikana mine last year in a clash that killed 34 people.

Brazil has not yet lost its halo but it has all the signs of stagflation, and remains stuck where it has been for half a century in the "middle income trap". Manufacturing output is lower today than in 2008, more like Italy than China. It is the result of an over-mighty real during the iron ore and agro-boom, and a bad case of the "resource curse".
Fiscal policy was too loose, countered by tight money, so the real soared. Dilma Rousseff's government tried to blame others with talk of "currency war". Now it is dabbling in protectionism. We have seen this story before in Latin America.

Brazil's global ranking is 107 for infrastructure, 123 for roads, and 135 for ports, according to the World Economic Forum. The country never really overcame its bad habits. And much the same could be said of Russia, another resourse casualty that bet too heavily on oil and gas in the shale-shaken energy universe.

Russia is not in crisis. Growth is sputtering along at 1.6pc. Manufacturing is up 1.2pc over the past year. But the BRICS story is essentially dead, a "Bloody Ridiculous Investment Concept", says Mr Edwards.

It is true that India has embraced free markets - sort of - and ditched the suffocating Hindu Model. Yet the old India is still there, grappling with power blackouts, a current account deficit of 6.7pc of GDP and a central and local budget deficit near 10pc of GDP.

Stripped bare, the BRICS miracle is really about China, and even the Politburo has run into diminishing returns after ramping up credit from $9 trillion to $23 trillion in four years. At best China will have settle for more pedestrian growth, but it too is at the mercy of the Fed.
By pegging its currency to the dollar it risks an exchange rate surge against the rest of Asia, compounding the effects of a 30pc rise against Japan's yen since last summer.

This looks all too like the mid-1990s, when the yen crashed against the dollar and gave China a brutal deflationary shock. China's $3.4 trillion foreign reserves will prove no defence. To deploy reserves the would entail conversion back into yuan, causing the currency to rise. It would exacerbate the shock.

To cap it all, this is happening just as China's trade surplus vanishes and American firms switch plant back to US soil for cheaper power and better labour productivity. The wheel is turning full circle.

Local stock markets have already priced in the new reality.

Shanghai is off 70p from its 2008 peak in real terms. But foreigners who shovelled $8 trillion into their love affair with BRICS and bricklets have yet to adjust. European banks have lent $4.4 trillion to the bloc. Something to ponder.

These cycles of emerging market exuberance are as old as capitalism. They happened episodically all through the 20th Century, and all through 19th Century before that, usually ending with a cold douche. It should be no great shock if it happens yet again.

Commodities traded in a mixed fashion this week. Natural gas took the lead position, while gold and silver rebounded modestly. On the other hand, copper and oil sagged along with stocks. The S&P 500 shed more than 1%, taking its year-to-date gain down to 15.5%.

Macroeconomic Highlights

Fed commentary dominated the headlines this week. On Wednesday, minutes of the Fed's May 22 meeting showed that a number of Fed officials were contemplating paring back or ending the central bank's quantitative easing (QE) programs as soon as June, assuming the economy showed signs of sustained growth.

At the same time, in his testimony in front of Congress, Ben Bernanke sent a mixed message. The Fed chairman said that ending QE prematurely would "carry a substantial risk of slowing or ending the economy recovery." However, he conceded that the bond purchases could end by this fall if the job market continues to improve. "If we see continued improvement, and we have confidence that it is going to be sustained, we could in the next few meetings take a step down in our pace of [bond] purchases," said Bernanke.

The U.S. 10-year bond yield spiked to two-month highs above 2% in response to the Fed news. In other interest rate movements, Japan's 10-year government yield spiked as high as 1%, more than doubling from 0.44% a month ago, on concerns about the Bank of Japan's unprecedented monetary policies. That helped push Japanese stocks down by 7% on Thursday. Finally, HSBC's China Flash Manufacturing PMI fell from 50.4 to 49.6 in May. The decline puts the index below the 50 mark that separates contraction from expansion.

Commodity Wrap

Commodity Weekly Return YTD Return
Natural Gas 4.43% 26.57%
Soybeans 2.21% 4.37%
Wheat 2.20% -10.28%
Gold 2.13% -17.12%
Silver 1.26% -25.77%
Corn 1.07% -5.44%
Platinum -0.27% -5.76%
Copper -0.90% -9.86%
Palladium -1.65% 2.92%
Brent -1.83% -7.55%
WTI -1.98% 2.50%

Gold rebounded this week after prices failed to break down below the April lows at $1,322. Prices dipped into the mid-$1300 range on several occasions, but buyers emerged each time. On the flip side, gold has had trouble breaking above $1,400. In the very short term, that puts gold in a narrow $1,350 to $1,400 range, and a break past either level would be a signal of which way the yellow metal will head next. A breakdown would likely lead to a test of $1,322 and an eventual move to much lower levels, while a break higher would lead to another run at the $1,485 and $1,525 levels.





Crude oil sagged amid this week's broad-based concerns about Fed monetary policy. If stocks continue to pull back, look for Brent to fall toward its April low near $97 (see also "Oil's Underperformance Signals Much Lower Prices When Stocks Correct").



Grains managed to rally, despite the fact that farmers made significant progress in the pace of plantings over the past week. On Monday, the USDA said that corn plantings were 71% complete, up from 28% last week but behind the five-year average of 79%. Soybeans plantings were 24% complete, up from 6% a week ago.

Overall, the sector is range-bound, as can be seen from the charts below:




Copper was dragged lower by familiar China growth concerns. The sub-50 reading on the HSBC Flash Manufacturing PMI weighed on sentiment.


Natural gas was the top-performing commodity this week. Much-warmer-than-normal temperatures and strong structural demand should keep prices climbing toward the $4.40 resistance mark (and higher), as we explained in a report this week (see "Small Inventory Builds Put Natural Gas Bull Back On Track, Prices Poised To Break Above $4.40").

Natural Gas

Kuroda's Gambit

May 24, 2013

by Doug Noland

Air leaks from Japanese stocks and bonds and global Bubbles suddenly appear more vulnerable

For centuries, economic thinkers have grappled with money and Credit. Invariably, analytical interest ebbs and flows right along with boom and bust cycles. And during periods of keenest interest, there’s a common recurring question that’s been asked through the ages: “How could a period of economic advancement and prosperity that looked so promising and enduring come to such a dreadful end?” The answer too often is some variation of how money and Credit run amuck over the course of the boom.

It’s a challenge to place contemporary monetary analysis into historical context. After all, we’re talking about extraordinary financial and economic innovation; unmatched integration of global economic and financial systems; unprecedented global financial excess and imbalances; experimental central bank doctrine and unprecedented monetary stimulus. It’s uncharted waters virtually across the board, which naturally evokes quite divergent views and analytical perspectives. Surging asset markets have largely squelched one side of the debate, while providing a fancy megaphone to the other.

Increasingly, “enlightened” is used to describe today’s experimental central bank policymaking, especially in the context of using open-ended quantitative easing operations to support asset prices and economic activity. I’ll take the other side of the analytical debate. I view contemporary central bank doctrine as essentially an experiment in attempting to contain the monetary instability that has consistently sealed the fate of boom-time prosperity over many generations. Especially during the past nine months, this whole endeavor of suppressing monetary disorder has begun to run amuck.

What began with the Greenspan Fed’s pegging of short-term rates and accommodating non-bank Credit growth during the early-nineties has evolved into massive global central bank debt monetization of and the injection of Trillions of liquidity into international securities markets. What was a $40bn hedge fund industry to begin the nineties has morphed into a multi-Trillion global pool of speculative finance and a remarkably sophisticatedleveraged speculating community.”

Last month I titled a CBBThings Have Gone Too Far,” a week after “Kuroda Leapfrogs Bernanke.” I and others view the Bank of Japan’sshock and awereflationary strategy as an historic Gambit. Mr. Kuroda seeks to jumpstart economic growth by using the prospect of an inflationary jolt to spur spending and investment. The Bank of Japan has appeared to support a much weaker yen, while believing its aggressive bond purchases would place an ongoing ceiling on bond yields. But with debt approaching 240% of GDP and its financial institutions large (leveraged) holders of low-yielding government debt, a spike in market yields would both impair Japan’s financial system and thrust its fiscal position into precarious debt trap dynamics. Playing with fire.

Initially, the global speculators were not too concerned with eventual outcomes. Their focus was on the BOJ’s massive liquidity injections, yen weakness and prospects for Japanese institutions and retail investors to flee Japan in search of higher returns elsewhere. Suddenly, another $80bn or so was combined with the Fed’s $85bn monthly quantitative easing for liquidity injections unlike anything ever experienced by booming global markets. Global equities went into melt-up mode, global sovereign yields in melt-down and risk premiums generally collapsed to multi-year lows – in the face of a weakening global economic backdrop and mounting fragilities. Corporate debt issuance, already at record pace, inflated to even greater extremes – including deteriorating quality at record low yields!

Well, Financial Euphoria too often proves fleeting. The current bout may have already begun to dissipate. Monetary policy that was to propel securities prices higher is suddenly viewed in somewhat different light. The Wall Street Journal went with the headlineFed Leaves Market Guessing” for John Hilsenrath’s take on Bernanke’s testimony and the plethora of conflicting comments from various Fed officials.

Best I can tell, the Fed may begin to “taper” or they may instead choose to increase the size of QE. Could be soon but maybe not. It’s “data dependent,” although that data may be the unemployment rate or GDP or CPI or something else. When the Fed eventually decides to “taper” – they may then decide to reverse course depending, again, on various factors that no one can clearly articulate because there’s no consensus view as to how to manage this phase of the monetary experiment.

And the higher stock prices climb, the more convinced participants are that the Fed will not allow a market accident. The more euphoric the market backdrop, the greater marketplace confidence that the securities markets are “too big to fail” – that the Fed will be there providing liquidity abundance irrespective of the data. As always, monetary inflations are as seductive as they are difficult to control.

I’ll stick with the view that the Bernanke Fed told a fib last summer when it tied QE to the unemployment rate. They were responding to heightened global financial and economic fragility, while justifying their astonishing money printing operation by linking it to the high jobless rate and the notion of lost economic potential. The Fed and global central banks fueled asset Bubbles that further diverged from weak economic fundamentals. As a result, monetary policy is now even more securely entrapped by financial and economic fragilities. And while the financial media was fixated on Bernanke and confusing Fed communications, perhaps a bigger near-term market risk began to unfold this week in Tokyo.

Japan’s Nikkei equities index was hammered 7.3% on Thursday. After trading as high as 15,943 mid-week, the index briefly touched 14,000 on Friday before ending the week at 14,612. Notably, the Japanese government debt market has of late made their equity market appear relatively stable. Trading as low as 55 bps early in the month, Japan’s 10-year JGB yields traded briefly at 1.0% Thursday before aggressive BOJ buying forced yields back down to 82 bps by week’s end.

Some headlines were of the type that makes traders edgy.Japan Economy Chief Warns Against Panic Over Stock Sell-off.” “Kuroda Struggles with Communication as Japan Rates Rise.” “Kuroda Promises to Stabilize Bond Market.” The triggering of circuit breakers in the JGB market is becoming a hallmark of Kuroda’s brief tenure, and I would not be surprised if extreme market volatility persists for some time to come.

When a fledgling central bank chief - in the midst of a radical and untested experiment in monetary inflation - promises to stabilize a nearly $14 TN bond market, well, it is time to begin worrying. And my guess is that’s exactly what some of the hedge funds and sophisticated leveraged players began to do this week. Time to begin taking some chips off the table.

The Kuroda Gambit was seen unleashing enormous amounts of liquidity upon global markets. At least this perception was spurring a collapse of sovereign yields and risk premiums around the globe. Those caught short melting up risk markets were forced to run for cover - virtually everywhere. Those hedging various risks were forced to throw in the towel, while those cautiously underinvested in rapidly rising markets had little choice but to throw caution to the wind (“capitulate”). Radical BOJ measures pushed already over-liquefied, speculation rife and highly unsettled markets over the edge into speculative blow-off type dislocations.

If the Kuroda Gambit does not live up to the advertised global liquidity bonanza, then some major market adjustments will be in order. Importantly, there have been indications that the sophisticated market operators (and others) moved to front-run the onslaught of Japanese liquidity. European markets, in particular, were viewed as likely to be on receiving end of a Japanese flight out of yen into higher yielding debt instruments. Italian and Spanish 10-year yields collapsed about 100 bps during April, in the face of ongoing economic deterioration. Sinking yields supported strong rallies in Italian, Spanish and European equity markets. Credit default swap (CDS) prices collapsed throughout Europe - for sovereigns, corporates and financials.

Notably, Italy sovereign CDS prices dropped from 308 on April 1st to 219 as of Wednesday (May 22). CDS for Spain sank from 307 to 204. But as JGB yields late this week gyrated and Japanese stocks reversed sharply lower, the ill-effects were transmitted immediately to Europe. During Thursday’s and Friday’s sessions, Italy CDS surged 32 bps and Spain CDS jumped 31 bps. Portugal CDS jumped 37 bps in two sessions. In similarly sharp reversals, bank and financial CDS prices jumped sharply to end an unsettled week. Italian stocks were hit for 3.7% in two sessions and Spanish stocks fell 2.3% (3.7% for the week). And after spiking to record highs on Wednesday, Germany’s DAX equities index reversed course and sank 2.6% in two sessions.

Financial Euphoria-induced perceptions of endless liquidity are prone to abrupt market reassessment. As such, a few Friday Bloomberg headlines caught my attention: “Dealers Absorbing Junk Bonds as ETF Demand Drops”; “Corporate Bond Sales Slow in Europe on Fed Stimulus Speculation”; “Dollar Bond Sales Slump in Asia as Costs Leap on Stimulus Doubts.” “Glencore Leads Company Bond Sales in U.S. as Issuance Falls 36%.”

No analysis of unsettled global markets would be complete without addressing ongoing currency market volatility. Thursday and Friday sessions saw the yen rally 2% against the dollar. Generally, the emerging currencies continue to trade poorly. The Colombian peso fell 2.0% this week, with the Chilean peso and Mexican peso 1.5% lower. The Indian rupee fell 1.4%, the South Korean won 0.9%, the Philippine peso 1.0% and the Peruvian new sol 1.4%. The so-called commodities currencies remained under pressure. The South African rand was hit for another 1.8%. The Brazilian real fell 0.8%, the Australian dollar 0.8% and the Canadian dollar 0.4%.

The unfolding Chinese slowdown and fragility story saw additional corroboration. China’s manufacturing PMI fell back below 50 (contracting) for the first time in seven months. There were, as well, several news items (see “China Bubble Watch”) pointing toward an unfolding government crackdown on currency speculation and financial excess. Chinese government officials are now working on a tightrope as they attempt to contain runaway Credit and speculative excesses while not pushing an already slowing (and deeply maladjusted) economy into a downward spiral.

Commodities prices generally remained under pressure. The Goldman Sachs Commodities index fell 1.2% this week, increasing 2013 declines to 3.4%. Crude oil dropped 2.2%. Curiously, Lumber futures declined another 2% this week, having now dropped about a third from March highs. Nickel, Soybeans, Cocoa, Palladium and Coffee all declined this week.

Here at home, the stock market was resilient, while a few indicators pointed to tinges of heightened risk aversion. Ten-year Treasury yields jumped above 2.0% for the first time since March. Curiously, benchmark MBS yields jumped 13 bps to the highest level in a year. After beginning the month at 2.28%, MBS yields ended the week at 2.82%. And after dropping to the lowest level since 2007, junk bond CDS prices ended the week 29 bps higher.

There is little doubt that Fed policies have again fostered huge amounts of speculative leveraging throughout the U.S. Credit system. The spike in MBS yields and the widening of MBS spreads may portend a more cautious approach to risk in a very important segment of the U.S. Credit market. Moreover, a pronounced de-leveraging in MBS (and, potentially, other Credit instruments) would counterbalance the Fed’s $85 billion monthly injections.

It’s no surprise that investors/speculators in U.S. equities are determined to stick with the bullish thesis and disregard global macro issues (it’s worked to this point!). Yet this unfolding Kuroda Gambit drama could prove too significant to ignore. The perception holds firm that the Fed’s $85bn will ensure ample bull market liquidity for at least the next several months.

The overall bullish take on marketplace liquidity could prove too complacent if things begin to unwind in Tokyo. And by unwind I mean that Japanese bond market fragility forces a change of tack by the Kuroda BOJ. A spike in yields could prove highly destabilizing, with a bond and stock market crash not out of the question. Or perhaps the BOJ will work out an agreement with major Japanese institutions to ensure their support for low yields. The BOJ may need institutions to fall in line and stop selling bonds and the yen. Such an understanding might support a stronger yen, with less liquidity seeking higher yields overseas.

It would appear that there are now viable scenarios that are potentially problematic for the leveraged players - and for the Financial Euphoria that erupted around the globe. Perhaps an overdue bout of de-risking and de-leveraging actually commenced this week. At the minimum, the markets were reminded that there is as well a downside to all this central bank dependency and Bubble-inducing liquidity.