Negative rates are a risk investors have not seen before

It is virtually impossible to predict where the best place to put your money will be

Merryn Somerset Webb

© FT montage; Getty Images

Stocks are overvalued, and US stocks are particularly overvalued. Their prices are unusually high in comparison to sales, earnings, the value of their asset books, and relative to gross domestic product (that last is Warren Buffett’s favourite measure).

So you shouldn’t buy them. That’s hard to argue with. And it is why strategy group GMO’s latest estimate of the probable seven-year returns from stocks is profoundly gloomy: they reckon you will see a negative 3.8 per cent return from large US stocks and a negative 1 per cent return from small US stocks.

Go global and you might see a small positive return. But GMO predicts that you would have to put much of your money into risky emerging market value stocks if you want to see anything that comes close to the long-term average real return from US stocks of 6.5 per cent.

It all seems very straightforward. It isn’t. That is because the world’s most bizarre financial experiment ever, negative interest rates, continues. The European Central Bank currently charges banks minus 0.4 per cent on their deposits. The Swiss National Bank is even more out there, with minus 0.75 per cent.

Negative rates are becoming the norm for institutional deposits — having to see cash on hand as a cost has taken a bit of getting used to, but now passes almost uncommented on in board meetings. The same could be on the way for retail deposits. UBS is introducing a negative rate on large deposits and rivals are likely to follow. Yields on German government bonds are negative across all timeframes. The 10-year UK gilt yield is now below 0.5 per cent for the first time ever. US 10-year yields are not negative, but they are at an all-time low. In total, $16tn worth of government bonds now actively eat your money if you hold them to maturity.

Expect more of the same. Most analysts forecast monetary loosening in the US and the EU in September. Albert Edwards of Société Générale (one of the first to predict all this) says we could consider this to be a massive bond market bubble messing with our sanity. One could also argue that it is entirely normal: why shouldn’t investors pay to have cash stored? They already do so for stocks, classic cars, and art.

Perhaps, as former US Federal Reserve chair Alan Greenspan put it this month: “Zero has no meaning.” Or you could see it as something more terrifying; “an appropriate reaction” to the fact that the next recession will fast turn into a global deflationary bust. That would require a mix of extreme fiscal policy and helicopter money, driving rates down even further.

All this monetary drama can be easily overshadowed by the general political hysteria around the world. The latter is important, of course. The final stage of the Brexit battle matters to the UK: Boris Johnson and Leavers have (just) the upper hand, but hardcore Remainers have done a remarkably good job of foiling the result of the referendum so far. The vote to quit the EU was three years ago; it still hasn’t happened.

We still cannot be sure what to expect; that affects the economy in the short term. You can attribute the 0.5 per cent rise in UK GDP in the first quarter and the 0.2 per cent fall in the second to feverish preparations for the previous deadline for Britain to leave the EU of March 29.

The on-off nature of the US trade war (soon perhaps to be cold war) with China obviously makes a difference, too. A round of reshoring of manufacturing and other activity could conceivably be good for the US in the long term. The transition period might not be.

But these are political events, the likes of which developed countries with sound institutions have seen — and seen off — before. Negative rates are different. Paper money has been around for about 1,000 years. No one has, as far as we know, ever offered negative interest rates on it before. In theory, that makes it the first thing investors should be thinking about. In practice, it also makes it impossible to have any sense of certainty about what to do.

It might mean you should start looking to buy a nice safe: if it costs you to keep your money in the bank, why not save yourself a bit of cash and keep it at home? It might mean that you should buy bond funds. Central banks may be thinking, as the Fed’s Jay Powell suggested this week, about “whether we should expand our toolkit”. In a world overladen with debt and ageing populations, that means yields are going to keep falling and bond prices will rise — at least until inflation is finally unleashed.

It might also mean that you should keep piling into equities, any old equities: if they are the only asset class offering reliable and often rising income then maybe they remain the best asset class there is. There may be some real value around if you ignore the US and much-hyped tech stocks; look for the many equity funds on offer (in the UK at least) yielding 4 to 5 per cent.

However, the key thing to hold on to in our era of surprises is doubt. Too many investors (and definitely too many Twitter users) have an unwarranted level of certainty about too many things. They shouldn’t. Anyone who really thinks they can forecast what will happen over the next year — let alone the next decade — in this new negative yield world, is likely to end up disappointed.

The writer is editor of MoneyWeek

Repo Spike Signals Wrong Kind of Volatility

Wall Street trading desks will suffer as frightened clients retreat

By Telis Demos

Citigroup’s net interest revenue from fixed-income trading was down 4% through the year’s first half. Photo: timothy a. clary/Agence France-Presse/Getty Images 

A wild, mysterious ride in short-term funding markets isn’t good news for Wall Street trading desks.

Big global investment banks have a love-hate relationship with volatility. With the right kind of price swings, or so-called good volatility, clients see opportunities and start making trades. That is helpful to banks with trading operations. But with the bad kind of volatility, clients retreat from trading out of fear.

For Wall Street banks, a key question now is whether recent events—including the oil market’s reaction to the Saudi attack, a rotation from growth to value stocks and a two-day surge in repurchase agreement, or repo, rates—represent the right or wrong kind of volatility.

Wall Street’s typically opaque ways of making money make this hard to figure exactly. In stocks at least, this month’s sectoral rotation likely helped some trading desks.

But in the much bigger fixed-income, commodities and currencies business, things look less rosy. 

For one thing, it is clear that some clients somewhere are in trouble. The timing of the repo spike is noteworthy: When repo rates surge at the end of a quarter, it is often tied to banks trimming balance sheets for regulatory purposes. But this spike came two weeks before quarter-end. That suggests clients or dealers, not banks themselves, are driving the drama.

Corporations and investors have either pulled cash out of the market, helping exacerbate the repo squeeze, or are scrambling for cash to cover immediate needs. That could be related to what happened in oil. In any case, these clients aren’t putting on new positions, and thus aren’t generating revenue for desks.

Secondly, funding costs will likely rise for some desks. Banks have reduced their reliance on short-term funding since the financial crisis, but it is still a factor. In particular, broker dealers not affiliated with deposit-taking banks, including the U.S. operations of some European banks, are facing the prospect of having to fund positions at higher prices.

With trading desks already holding lots of low-yielding paper, this puts further pressure on net interest margins. Net interest revenue in fixed-income trading at Citigroup, the rare bank that gives detail on such results, was already down 4% from a year ago through the first half of the year.

Unlike the last time there was a funding squeeze in the repo market during the financial crisis, banks aren’t in any fundamental danger. And increased volatility in currencies, Treasurys, and commodities markets in this quarter from a year ago can be positive indicators for trading desks.

But some bank executives this month warned that clients remain anxious and said that September activity would determine the quarterly outcome on trading revenue. Events of the past two weeks won’t help make this picture any more appealing when banks report earnings next month.

Federal Reserve sees huge demand for cash after money market ‘shock’

Crunch in short-term borrowing market sends key policy rate above central bank’s target

Adam Samson in London and Joe Rennison in New York

Banks and investors rushed on Wednesday to gobble up $75bn in short-term cash the Federal Reserve made available in a second attempt to steady one of the world’s most important money markets.

Dealers submitted requests for over $80bn in overnight borrowing, exceeding the maximum amount the New York Fed had placed on offer. That amount far exceeded the $53bn demanded when the central bank stepped into the market on Tuesday for the first time in more than a decade.

In a sign of the crunch that has hit the short-term borrowing market, the Fed’s main policy rate, the federal funds rate, has jumped above the central bank’s 2 to 2.25 per cent target. Data released on Wednesday morning showed the rate rose to 2.3 per cent on Tuesday, from 2.25 per cent on Monday and 2.14 per cent at the end of last week.

The central bank has been forced to intervene after a severe imbalance in the so-called repo market sent the cost of borrowing cash overnight, known as the repo rate, surging to a historic peak.

The Fed had not previously used its repurchase agreement auction mechanism outside of small tests since the financial crisis in 2008 and encountered a hiccup on Tuesday as it attempted to open the facility for a large-scale operation.

“US funding markets were shocked this week as a combination of factors reduced the amount of cash available to fund securities positions,” said Alex Roever, head of US rates strategy at JPMorgan Securities, one of the two dozen primary dealers that act as trading counterparties for the Fed.

Analysts said the Fed’s dramatic intervention should be seen as a valve meant to release pressure on the repo market, in which banks and funds provide Treasuries and other securities in exchange for cash in transactions that reverse overnight.

Wednesday’s operation and this week’s market ructions come as policymakers on the rate-setting Federal Open Market Committee are meeting in Washington. The central bank is expected to reduce its main policy rate by a quarter of a percentage point as it seeks to stimulate the economy in face of growing global headwinds.

Highlighting the importance of the repo market to financial stability, Mr Roever said that while the money markets were functioning normally, the sharp rise in the repo rate had reverberated elsewhere, such as the short-term corporate borrowing market known as commercial paper, on Tuesday.

Joseph Abate, a managing director focusing on money markets at Barclays Capital, another primary dealer, said that a combination of “temporary pressures” had struck the crucial portion of the financial system in recent days.

Analysts specifically pointed to corporations pulling billions of dollars out of money market funds, which are typically major providers of cash in repo transactions, ahead of tax deadlines as a key component of the shock. It had been exacerbated, they said, by a flood of Treasuries hitting the market, something that sharpened dealers’ demand for cash via repo transactions.

Banks, which typically step into the repo market, also made less cash available because of a decline over the past several years in their excess reserves, said Mr Roever.

Given the short-term nature of repo transactions, analysts said, the cash being made available by the Fed should not be seen as a loosening of monetary policy or a cumulative injection of cash into the market.

“[The repo] operation says that the Fed is watching the markets and is willing to intervene on a temporary basis if conditions warrant,” said Mr Roever. He said the recent bout of volatility in the repo markets would “almost certainly” be a topic at the FOMC meeting, which concludes on Wednesday.

Money market analysts will also be looking for clues on whether the Fed plans to make the repo auctions a regular occurrence, or whether the bank will take other actions aimed at stabilising the market.

Mr Roever warned that this week’s events may be a “prequel to what could come at year-end when US banks significantly reduce their footprint in the money markets” to manage certain regulatory capital levels.

Debt securitisation rebounds to pre-crash levels

Commercial mortgage securities have bounced back — unlike the residential equivalent

Laurence Fletcher in London

A graphic with no description

A graphic with no description

Parts of Wall Street’s debt securitisation engine are back running at levels not seen since the pre-financial crisis boom.

Data group Dealogic’s indices of US securitisation activity show that issuance of collateralised debt obligations — structured products made up of bundles of bonds and loans — rose above its pre-crisis peak late last year and is currently back close to those levels this year.

The market for commercial mortgage-backed securities has also rebounded strongly since late 2008 and early 2009, when issuance completely seized up in the aftermath of the financial crisis. Activity in the asset class is now some way above its 2007 high.

In contrast, the data show little sign of a significant re-emergence of issuance of residential mortgage-backed securities — packages of US mortgages seen as helping precipitate the financial crisis — or asset-backed securities, both of which are fairly flat compared with 2008.

The data are based on the value of primary market transactions, the number of deals and their share relative to overall debt capital market issuance, equally weighted to form an index.

Tumbling yields on many traditional “safe haven” bonds to ultra-low or negative levels — supported by the European Central Bank’s renewed bond-buying programme announced last week — has forced income-hungry investors into other, riskier assets.

That has helped fuel a resurgence in some areas of securitisation, which involves packaging underlying debt instruments and selling it on to investors. But it has also raised questions as to whether some areas have become overinflated and could pose another threat to financial stability, if prices in the underlying markets start to fall.

As Dealogic’s global head of data science, Paul Sykes, puts it: “Are we in a world where lots of securitisation is fine, or is it a precursor to something worse?”

The End of the Afghan War?

There is no winning in Afghanistan, only perpetual engagement.

By George Friedman       

The U.S. seems to be nearing a withdrawal from Afghanistan. After nearly a year of talks, U.S. and Taliban negotiators have in hand a draft agreement for a peace deal to end the 18-year war. The Trump administration, which has long wanted to withdraw forces from the country, still wants to maintain some combat capability there. Reports over the weekend indicate that administration officials have suggested expanding the CIA’s presence in Afghanistan, but Langley is resisting an increased role for the agency there. The CIA, technically speaking, does not represent combat capability. But practically, it could serve as a liaison to factions opposed to the Taliban, providing tactical information for airstrikes and carrying out a range of strategic actions. This suggests that whatever withdrawal the U.S. is considering is a political one.

The U.S. main force will be withdrawn, but the U.S. will still know what’s going on tactically and will retain the ability to launch selective strikes. Uniformed troops will be replaced by ununiformed officials. This is, of course, certainly not the first time the U.S. has used CIA and special operations forces in collaboration with local forces to manage the situation in a country; the U.S. withdrew from Somalia and Lebanon but retained capabilities there. If we’re to learn anything from those instances, it’s that the level of violence will decline, but there will still be deaths, just with far less publicity.

Before the War
In all of this, we need to recall why the United States went into Afghanistan in the first place. On Sept. 10, 2001, the last thing anyone thought would ever happen was a U.S. invasion of Afghanistan. The United States had backed the mujahideen’s insurgency after the Soviet invasion of Afghanistan in 1979, and understood the terrain, the tribal rivalries and the difficulty of operating in that environment. The insurgency turned what the Soviets had expected would be an operation of surgical precision into a decadelong morass. The U.S. may very well have had to go into Afghanistan, but it had no right to be surprised at what happened next.

As the Soviets withdrew from Afghanistan, a complex civil war broke out in which, essentially, the Northern Alliance waged a war of resistance against the rising Taliban. Pakistan, which has long had a major interest in its northwestern neighbor, got involved; its intelligence service factored into the Taliban’s victory in the civil war. And as the Taliban, led by Mullah Mohammed Omar, deepened its control, it gave sanctuary to al-Qaida.

Still, the United States did not see Afghanistan as being of strategic interest. The Americans had come to see Afghanistan not as a prize but as a swamp. Any of its neighbors – from Iran and Pakistan to Tajikistan, Turkmenistan and Uzbekistan and even China – could chew off a piece, but trying to conquer the whole would simply bog you down permanently. Each of these countries’ intelligence services might probe here and there, and deals could be made, but nobody could possibly conquer and occupy the entire country. Even the Taliban at the height of its power could not control it all. From the American point of view, anyone who wanted to replicate the Soviet disaster was welcome to do so.
Into the Morass
What U.S. intelligence had missed was not al-Qaida; the U.S. undoubtedly knew its base was in Afghanistan. What it failed to understand was that al-Qaida had a cadre of operatives able to penetrate the U.S., maintain contact with al-Qaida, receive funding and obtain pilot training. That cadre went undetected right up until they executed a spate of planned, simultaneous hijackings and suicide attacks.

The problem for the U.S. was that its intelligence agencies clearly had no idea what else al-Qaida could do, given that the intelligence community did not detect the 9/11 plot. The only way the U.S. saw to disrupt al-Qaida operations was to attack the organization in Afghanistan. Since a full-scale invasion could not be launched in the timeframe imagined, it was the CIA, with its excellent contacts in Afghanistan, that purchased alliances with various groups and, supported by a fairly small force of Marines, conducted the main attack. Osama bin Laden, aware of the force being marshaled, escaped into Pakistan. Al-Qaida command was disrupted but not destroyed.

This was the critical point. Having sent in troops and reinforcements, the U.S. had no clear strategy for Afghanistan. The country was of interest only to the extent that al-Qaida operated from there. The concern, then, became that al-Qaida might return. The CIA, rather than the U.S. military, used its contacts and funds to build up a local force against al-Qaida. To some extent, that narrow operation was a success. But the attempt to occupy Afghanistan made almost no sense. In essence, the U.S. was willingly putting itself in the same position as the Soviets – who had failed.

The fear that al-Qaida would return to Afghanistan was understandable. But al-Qaida was mobile and had a flexible command structure. It didn’t require some massive control center, even for 9/11. To destroy al-Qaida would mean widespread warfare. But the U.S. did not have to occupy countries. As I have argued elsewhere, occupation warfare is the most difficult form of war; even the Nazis, with no limits on brutality, could never defeat Tito’s guerillas.

The defeat of a group like al-Qaida depended on intelligence and special operations forces. The group was built for dispersal because of its sparseness, and at any given time it could operate globally; the occupation of any one country could not destroy al-Qaida. Perhaps the core problem the U.S. had in Afghanistan was not that it forgot the lessons of the Soviet war but that it used the term “invasion” to describe how it dislodged al-Qaida. The U.S. did not disperse al-Qaida; it launched a covert operation that used money to motivate local forces familiar to the United States, backed by U.S. air power. The actual invasion was an attempt to turn sanctuary denial for a terrorist group into a conventional war.

It didn’t work. The U.S. had minimal interest in Afghanistan beyond al-Qaida, and al-Qaida was everywhere and nowhere. The U.S. could not impose its will on Afghanistan no matter how many divisions it brought in. But it was a passionate time in the U.S., and reasonably so. It was also an example of the dangers of passion.

So now we are back to where we began. The military will leave, and the CIA will take over with far more modest goals. The CIA is not going to try to engage in nation-building; rather it will try to maintain the flow of intelligence and carry out covert operations with special operations forces to keep the enemy off balance. As it was in the beginning, so it shall now be again. And, of course, the CIA is resisting. There will be no glory in winning – there is no winning in Afghanistan, only perpetual engagement. But without winning as an option, a much smaller investment is needed.

The Twilight of the Global Order

The recent G7 summit in Biarritz signaled a broader shift in international governance away from constructive cooperation and toward vague discussions and ad hoc solutions. The conclusion of the summit could be a marker of the world order’s future – ending not with a bang, but with a whimper.

Ana Palacio

palacio99_ Dylan Martinez - PoolGetty Images_g7 summit

MADRID – We live in an era of hyperbole, in which gripping accounts of monumental triumphs and devastating disasters take precedence over realistic discussions of incremental progress and gradual erosion. But in international relations, as in anything, crises and breakthroughs are only part of the story; if we fail also to notice less sensational trends, we may well find ourselves in serious trouble – potentially after it is too late to escape.

The recent G7 Summit in Biarritz, France, is a case in point. Despite some positive developments – French President Emmanuel Macron, for example, was praised for keeping his American counterpart, Donald Trump, in check – little was achieved. And, beyond the question of substantive results, the summit’s structure portends a progressive erosion of international cooperation – a slow, steady chipping away at the global order.

It is somewhat ironic that the G7 presages the future, because it is in many ways a relic of the past. Formed in the 1970s, at the height of the Cold War, it was supposed to serve as a forum for the major developed economies: Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States.

After the fall of the Soviet Union, the G7 continued to shape global governance on issues ranging from debt relief to peace operations and global health. In 1997, the G7 became the G8, with the addition of Russia. Still, the body epitomized an era of Western preeminence in an institutionalized liberal world order in full bloom.

That era is long gone. The 2008 financial crisis hobbled the body’s core members, which, together with the rise of the emerging economies, especially China, meant that the group no longer possessed the critical mass required to guide world affairs.

The larger and more diverse G20, formed in 1999, thus gradually overtook the G8, formally replacing the latter as the world’s permanent international economic forum a decade later. In an increasingly complex and divided global environment, the G20’s flexible policymaking style – including a preference for non-binding commitments – was regarded as more viable than the hard-law methods of older multilateral institutions.

The G8 drifted along as a mere caucus. When Russia’s G8 membership was suspended in 2014 – a response to its invasion of Ukraine and annexation of Crimea – it became even less weighty, though more cohesive, with its members sharing a more consistent worldview. (Some, including Trump, now call for Russia’s reintroduction to the group.)

But even that slight advantage was demolished with Trump’s election in 2016. His administration began attacking allies and rejecting shared rules, norms, and values. The situation reached a nadir at the 2018 G7 Summit in Quebec, where a petulant Trump criticized his host, Canadian Prime Minister Justin Trudeau, and publicly disavowed the summit’s final communiqué as soon as it was issued.

Against that backdrop, this year’s summit in Biarritz elicited great trepidation. With little hope for consensus on any consequential issue, the meeting’s French hosts focused on keeping up appearances, choosing expediency over impact. Goals were kept vague. In fact, Macron announced before the event that there would be no final statement, declaring that “nobody reads communiqués.”

But that decision represented a major loss. Final communiqués are policy documents, providing important signals about significant compromises to the international community. The 2018 declaration, which Trump rejected, was 4,000 words long, identifying a set of shared priorities and common approaches to addressing them.

The Biarritz summit, by contrast, ended with a 250-word statement that was so vague and anodyne as to be all but meaningless. On Iran, for example, G7 leaders could agree only that they “fully share two objectives: to ensure that Iran never acquires nuclear weapons and to foster peace and stability in the region.”

On Hong Kong, they reaffirmed “the existence and importance of the Sino-British Joint Declaration of 1984 on Hong Kong” and called hollowly “for violence to be avoided.” On Ukraine, France and Germany promised to organize a summit “to achieve tangible results.”

To be sure, some positive steps were taken in Biarritz. Iranian Foreign Minister Mohammad Javad Zarif’s surprise appearance created a potential opening for future US-Iran talks. Pressure was placed on Brazil to respond to the fires that are decimating the Amazon. And the US and France broke an impasse over a French tax on tech giants. But any high-level international gathering produces these kinds of limited actions, merely by facilitating interaction among world leaders.

Many have recognized the shortcomings of the latest G7 summit. But, drawn to calamity as we so often are, assessments often center on the body’s possible collapse next year, when the G7 summit will be hosted in the US by Trump, who will go nowhere near the lengths to which Macron went to hold the last one together. (On the contrary, Trump’s interest in the summit seems to revolve around his desire to hold it at his struggling golf resort in Doral, Florida.)

But this perspective fails to recognize the full implications of the Biarritz summit: it signals a broader shift in international governance away from concrete policy cooperation toward vague statements and ad hoc solutions. To some extent, the G20 pioneered this approach, but at least it had vision and a set direction. That can no longer be expected.

Unless leaders take stock of the current trend, the conclusion of the Biarritz summit will be a marker of the world order’s future – ending not with a bang, but with a whimper.

Ana Palacio is former Minister of Foreign Affairs of Spain and former Senior Vice President and General Counsel of the World Bank Group. She is a visiting lecturer at Georgetown University.

Dear prudence

Germany debates banning negative interest rates

Politicians want to protect savers. Banks are not impressed

“SAVE OUR savings, Frau Merkel!” begged Bild, a German tabloid, on August 26th. Articles blaming the European Central Bank (ECB) for keeping interest rates low, and seeking reassurances from banks that thrifty Germans will be spared Strafzinsen, or negative “penalty rates”, are proliferating. One in Die Welt in July feared that ECB stimulus would lead to the “ultimate expropriation” of the German saver.

German hostility to low interest rates is hardly surprising. The value of thrift has deep roots in the national psyche, going back to the Reformation. Households have €2.4trn ($2.6trn) stashed in bank deposits, almost as much as those in France and Italy combined. Last year they squirrelled away a tenth of their disposable income, twice the savings rate of Britons.

With markets pricing in a further cut at the ECB’s policy meeting on September 12th, the opposition in Germany is getting louder. Politicians spy a bandwagon. On August 21st Markus Söder, Bavaria’s premier, said his party would propose legislation to ban negative interest rates on retail deposits of less than €100,000. Olaf Scholz, the federal finance minister, has asked officials to look into the practicalities.

The ECB and its German critics have clashed before. Indeed, a lawsuit claiming that the bank’s quantitative-easing scheme overstepped its legal mandate is making its way through Germany’s constitutional court. But it is unusual for the finance ministry to tread on monetary-policy turf. It seems particularly so as Germany’s economy teeters on the brink of recession.

With unemployment at a record low and wages rising, though, Germans feel little need for stimulus just yet, says Marcel Fratzscher, the head of DIW, a think-tank. He sees the politicians’ proposals as “purely populist”. Regional elections are looming, so it pays to curry favour with savers.

And for all the sound and fury, negative rates for retail depositors appear some way off. The central bank’s deposit rate is -0.4%, meaning that rather than paying interest on the reserves kept with it by lenders, it charges to hold them. Some banks have passed those negative rates on to corporate clients, and a smaller fraction have done so to wealthy retail clients, many of whom appear reluctant to move their money elsewhere, even when squeezed.

But Vítor Constâncio, a former ECB official, told Der Spiegel he doubted whether banks would offer negative interest rates for ordinary retail depositors. That might be because those customers are bigger flight risks.

Banks themselves detest negative rates, which reduce the amount they can earn from interest.

The Association of German Banks (BDB) says lenders in Germany paid €2.3bn to the ECB last year, equivalent to nearly a tenth of profits for 2017. But it is also horrified by the prospect of the government setting a floor on retail interest rates.

That could restrict banks’ room for manoeuvre and, the BDB warns, cause financial disruption. (The ECB is considering other ways to ease the squeeze on banks’ interest margins, such as exempting some reserves from negative rates.)

The backlash may indicate that the ECB should be wary of the costs of cutting rates further.

The risk is that depositors stash their savings under mattresses rather than in banks. Even so, the ECB can reasonably feel irked by the stance of German officials. As Mr Constâncio pointed out, the root cause of low interest rates in the euro area is an excess of saving over spending. Germans’ obsession with frugality bears much of the blame.

The other inversion

China is calm as growth slows. But is it complacent?

Though the trade war is hurting, officials are reluctant to unleash stimulus

HALF A DECADE ago, if you had asked economists which number—five or seven—described China’s GDP and which its currency, most would have answered this way: growth will remain strong at around 7% annually, and the currency will strengthen until it takes just five yuan and change to buy a dollar. One measure of the impact of Donald Trump’s trade war on China is the inversion of these digits. As American tariffs bite, economic forecasters think that Chinese growth next year will slow to five-point-something percent. The yuan, for its part, has slumped to more than seven per dollar.

Mr Trump has crowed about the success of his tactics. “China has taken a very hard hit,” he said on August 26th at a news conference after the G7 summit in France. “They want to make a deal very badly.” But a more accurate reading of China’s policy stance is one of surprising calm in the face of the economic slowdown and, by extension, of stiffer resolve in the trade dispute.

The toll of tariffs on China’s economy is becoming more visible. Although exports to America account for just a small share of overall GDP, the uncertainty has bruised corporate confidence. Investment spending is on track to increase this year at its weakest pace in at least two decades. Factory prices have veered into deflation, a bad sign for industrial profits.

Economists at Morgan Stanley, a bank, now forecast that Chinese growth will fall to 5.8% next year; previously they had expected 6.3%.

In the past, whenever growth looked set to slow sharply, Chinese companies could count on a stimulus package to revive it. But this time officials have been much more restrained in their response, partly because of concern about adding to China’s hefty debt burden. On August 26th the central bank had a chance to lower funding costs for banks, but it refrained, bucking the global trend towards lower rates. On August 27th the State Council, or cabinet, issued an underwhelming 20-point plan to promote consumption. Some analysts had been hoping for targeted tax cuts or subsidies; instead, it made small-bore promises, such as more 24-hour convenience stores.

The Chinese government’s lack of panic about the economic outlook should give Mr Trump pause. “Its leadership now looks committed to a strategy of toughing out trade tensions,” says Andrew Batson of Gavekal, a research firm. It helps that China has procured insurance in letting its exchange rate decline to 7.1 yuan per dollar, the weakest since 2008, offsetting some of the drag from tariffs.

But some think the calm is verging on complacency. Not only has China’s government refrained from stimulus, but it has become more hawkish about the property sector, the engine of its economy. In line with President Xi Jinping’s oft-repeated warning that investors should not speculate on housing, regulators have curtailed lending to developers and sworn off cutting mortgage rates. “We would view stabilising growth by choking credit to the property sector as analogous to performing cardiac surgery without blood pumps, oxygen and anaesthesia,” says Lu Ting, an economist with Nomura, a bank. In other words, things could get ugly.

Fed can ease the supply of credit but it cannot boost demand

Markets may be overestimating central bank’s ability to reverse tumultuous events

Joe Rennison

By lowering the cost of borrowing, the Fed is encouraging companies and households to lever up © Reuters

Many investors hope that the Federal Reserve has their back. The US central bank has consistently said it wants to keep the economic expansion going, offering assurance to fund managers looking to the Fed to alleviate some of the discomfort expressed in markets by dramatically lower bond yields and a contorted yield curve.

But such faith in the Fed’s power to reverse August’s tumultuous events may be misplaced.

The primary tool the Fed has at its disposal, after all, is to cut interest rates. This is like turning on a tap to let the water flow through, only instead of water the Fed is opening up the spigots for credit. By lowering the cost of borrowing, the Fed is encouraging companies and households to lever up.

But it is doubtful whether encouraging more credit to flow will do the trick. Borrowing costs have been at or near historic lows for over a decade and most companies are hardly struggling to borrow what they want, judging by the rapid growth of US corporate debt markets.

Boosting spending is the real challenge. And here, the Fed has less control. Capital expenditure by US companies has slowed; expected to rise just 3.5 per cent this year, according to Citi, a sharp drop from a 4.2 per cent projection just a few months ago. The most common reason given is uncertainty over public policy, and more specifically over the ongoing trade war.

July’s durable goods data released this week seemed positive on the face of it, but digging into the underlying numbers revealed a different story. Stripping out a surge in aircraft and parts, core capital goods orders were down 0.3 per cent on a year-on-year basis — the weakest reading for several years.

Those bleak numbers arrived shortly after another set of data showed the US factory sector in a rare period of contraction. IHS Markit’s US manufacturing purchasing managers’ index slipped to 49.9 this month, falling below its neutral level of 50 for the first time since September 2009.

Bill Dudley, former head of the New York Fed, put his finger on another potential problem this week, arguing that further stimulus from the central bank could have the effect of encouraging the Trump administration to open up new fronts in its trade battle with China. In that scenario, the private sector might be even less likely to spend and invest.

Still, investors are pricing in a near-certain chance of a rate cut by the Fed in September and there are cries for even looser financial conditions. Pimco’s US economist Tiffany Wilding said on Thursday that the Fed should slash rates more aggressively than the market currently anticipates.

The Fed might be the obvious candidate for coming to the aid of markets in distress but its desire to help is not the problem. Its ability is.

Fed Steps Into Repo Market to Control Soaring Rates

New York Fed adds $53 billion into the banking systems via repurchase agreements after the benchmark fed-funds rate moved outside its target range

By Nick Timiraos and Daniel Kruger

The Federal Reserve Bank of New York bought repurchase agreements after strains surfaced in the short-term financing market. Photo: brendan mcdermid/Reuters 

For the first time in more than a decade, the Federal Reserve Bank of New York took steps Tuesday to relieve pressures that were pushing short-term interest rates higher than the central bank wanted.

Strains developed Monday in short-term financing markets that suggested the central bank could lose control of its federal-funds rate, a benchmark that influences borrowing costs throughout the financial system.

Bids in the fed-funds market on Tuesday morning reached as high as 5%, according to traders, well beyond the central bank’s target range, which is 2% to 2.25%.

The Fed moved Tuesday morning to put $53 billion of funds back into the banking system through transactions known as repurchase agreements. After the moves, the New York Fed said the effective fed-funds rate, or the midpoint of transactions in that overnight market, stood at 2.25%, up from 2.14% on Friday.

The pressures that had sent the fed-funds rate higher were related to shortages of funds for banks, stemming from rising government deficits and the central bank’s decision to shrink its securities holdings in recent years. Its reduced holdings have soaked up funds in the financial system, crimping liquidity.

The Fed is likely to continue to provide funding to ensure the smooth operation of the repo market for some time to come, although it isn’t clear how long that might be, saidGennadiy Goldberg,a fixed-income strategist at TD Securities.

“I think they’re going to be playing this one by ear,” he said. “This is in every way, shape and form an emergency measure.”

The Federal Reserve’s rate-setting committee began a two-day policy meeting on Tuesday at which officials are likely to lower the fed-funds range by a quarter-percentage point to cushion the economy from a broader global slowdown, a decision unrelated to recent funding-market strains.

The New York Fed hasn’t had to conduct such a transaction since 2008 because during and after the financial crisis, the Fed flooded the banking system with reserves when it purchased hundreds of billions of dollars of Treasurys and mortgage-backed securities in an effort to spur growth after cutting interest rates to nearly zero.

It has been draining reserves from the banking system since 2014, when it stopped increasing its securities holdings. The declines accelerated after the Fed began shrinking its holdings in 2017. Reserves have declined from $2.8 trillion to less than $1.5 trillion last week.

The Fed stopped shrinking its asset holdings last month, but because other Fed liabilities such as currency in circulation and the Treasury’s general financing account are rising, reserves are likely to grind lower in the weeks and months ahead.

The strains in funding markets this week have been driven by several factors.

First, reserves have been declining. Second, brokers who buy and sell Treasurys have more securities on their balance sheets due to increased government-bond sales to finance rising government deficits.

Then on Monday, these strains were aggravated by a series of technical factors. Corporate tax payments were due to the U.S. Treasury, and Treasury debt auctions settled, leading to large transfers of cash from the banking system.

Meanwhile, postcrisis financial regulations have made short-term money markets less nimble than they used to be. This didn’t matter as much when the banking sector was awash in reserves and could absorb the kind of swings witnessed this week.

“The issue here is not that the level of reserves is structurally too low. We’ve reached the level where the market doesn’t respond to temporary deposit flows as efficiently or fluidly,” saidLou Crandall,chief economist at financial-research firm Wrightson ICAP.

Monday’s tax payments and debt settlements “drained money from the system, and there was no cash sitting on the side waiting to come in,” said Mr. Crandall.

Banks are holding on to reserves because they don’t think they can part with them and still continue to conduct the normal operations of a bank, such as cashing checks, approving mortgages and allowing companies to draw on letters of credit, Mr. Goldberg said. “Even small confluences of events will start to have outsized effects,” he said.

What happens in this narrow sector of the financial market can be important because funding spikes create the risk of sudden and disorderly efforts by market participants to reduce debts given the lack of cheap and predictable short-term financing.

“This sort of thing can lead to substantial pullbacks, and that can create very unpredictable dynamics in markets,” said TD Securities’ Mr. Crandall.

Scott Skyrm,a repo trader at Curvature Securities LLC, said he had seen cash trade in the repo rate as high as 9.25% Tuesday.

“It’s just crazy that rates could go so high so easily,” he said.

On his trading screens, Mr. Skyrm said he could see traders with collateral securities that they were trying to exchange for cash. The rates they were offering would start to rise until an investor with cash available to trade would start to accept their bids, gradually driving repo rates down until investors had exhausted their cash, he said. Then rates would resume their climb.

While there are technical factors to explain why cash would be in high demand this week, including corporate tax payments, the settlement of recently issued Treasury securities and the approach of quarter-end, they didn’t seem to explain the “crazy market volatility,” Mr. Skyrm said.

“It seems like there’s something underlying out there that we don’t know about,” Mr. Skyrm said.

Forget trade war, a 20% move implies real war

By: Izabella Kaminska

This was the early-market response to news that Saudi oil facilities had been struck by a suspected Iranian/Yemeni rebel drone strike:

As the FT noted:

Oil prices rose as much as 20 per cent to above $71.00 a barrel — the biggest percentage spike in almost three decades — as markets reopened after an attack on Saudi Arabia’s oil infrastructure at the weekend cut more than half the country’s production.

That’s one of the biggest moves in Brent prices in dollar terms in a single session in a very long time, if not ever.* And for the commodity markets that’s a big deal. Huge, in fact.
Traders on the winning side of the bet will be laughing all the way to the bank right now. But there’s going to have been some serious fallout on the other side. We don’t know the extent to which natural producer hedgers and systematic funds will have been hit, but it’s likely that in the days and weeks to come some extraordinary details will emerge about the bloodbath that took place on the back of that single move.

The key point to remember about the commodity-oriented fund world is this: ever since Trump took over and started threatening Chinese trade wars, the “smart” money has become overly focused if not obsessed by the narrative that global demand will be hit by tariffs and a slowdown in trade. This has led to massively bearish sentiment in the oil futures market over the past year.

And yet, those obsessing about the impact of “trade wars” may have simply missed the wood for the trees. Specifically, that trade wars are irrelevant if there’s a chance the world will go to war.

That may sound hyperbolic but we think it’s essential that someone bluntly states matters for what they are.

And herein lies the contrast between real-world markets and virtual gambling markets. In bitcoinland a 20 per cent move means nothing at all. In commodity markets, it’s a potential signifier that we’ve reached the point of no return in terms of conflict acceleration.

What analysts should be noting now is not the scale of economic loss from Brexit or continued Chinese trade wars, but the degree to which wartime conditions have never favoured free-market norms. To the contrary, in such circumstances, economies turn repressive, protectionist and domestic-production oriented. They also become energy security obsessed.

The UK might be a basket case in many Brexit-related ways but the one thing it’s genuinely got over much of Europe is energy security (at least for as long as it’s got the Scots). And while US/China trade wars are likely to hurt the relevant economies more than help them, the fundamental Trump card held by the US remains... you’ve guessed it... energy security.

*We’re checking if it’s a record, but our data only goes back so far, and one always has to account for the first Gulf war which took place during a time when oil prices were a little less free than they are today, so comparatives are difficult.

The Geopolitics of Iran’s Refinery Attack

By George Friedman

A Yemeni rebel group aligned with Iran took credit for a drone attack against Saudi Arabia’s main oil refinery this weekend. The range, payload and accuracy of the attack, as well as the sophistication of the operation, suggest that the Houthis had a lot of help from their patron nation.

The Houthis are a Yemeni faction aligned with Iran. Indeed, Iran’s support runs deep. Last month, the ambassador the Houthis sent to Iran was accredited as a formal ambassador – rare for someone representing a faction outside the country’s formal government. It signaled that Iran regards the Houthis as a nation distinct from Yemen or that Iran recognizes the Houthis as the legitimate government of Yemen. Diplomacy aside, Iran is close to the Houthis, has the capability of fielding the kinds of drones used in the Saudi attack and providing targeting information, and has the motive to act in this way.

Understanding its motivation is critical. Iran is a country under tremendous pressure. It has built a sphere of influence that stretches through Iraq, parts of Syria, Lebanon and parts of Yemen. From Iran’s point of view, it has been constantly on the defensive, constrained as it is by its geography. It will never forget the 10-year war it waged against Iraq in the 1980s that cost Iran about a million casualties. It was a defining moment in Iranian history.

The strategy Tehran formed in response to this moment has been to build a coalition of Shiite factions to serve as the foundation of its sphere of influence and to use those factions to shape events to its west. The struggle between Iraq and Iran goes back to the Biblical confrontation between Babylon and Persia. This is an old struggle now being played out in the context of Islamic factionalism.

The Iranians’ sphere of influence may be large, but it is also vulnerable. Their control over Iraq is far from absolute. Their position in Syria is under attack by Israel, with uncertain relations with Russia and Turkey. Their hold on Lebanon through Hezbollah is their strongest, but it’s still based on the power of one faction against others. The same factional influence exists in Yemen.

Iran does not rule its sphere of influence. It has a degree of authority as the center of Shiite Islam. It derives some control from supporting Shiite factions in these countries in their own struggles for power, but it is constantly playing balancing games. At the same time, it is imperative for Iran not to let a Sunni power or coalition of powers form on its western frontier.

The farther west it pushes its influence, the more secure its western border and the more distant the threat of war becomes. Its strategy is forced on it by geopolitics, but its ability to fully execute this strategy is limited.

Iran’s problems are compounded by the United States, which has been hostile to the Islamic Republic from its founding with the overthrow of the shah. The American interest in the region, as opposed to the visceral dislike on both sides, is to prevent any single power from dominating the region. The historical reason used to be oil. That reason is still there but no longer defining. The geography of oil production has changed radically since the mid-1980s.

The United States has an interest in limiting the power of Islamist groups prepared to attack U.S. interests. In the 1980s, multiple attacks on U.S. troops in Lebanon caused substantial casualties and were organized by Shiite Hezbollah. After 9/11 the threat was from Sunni jihadists. The invasion of Iraq, followed by failed attempts at pacification, drove home the complexity of the problems to the Americans.

This has led the U.S. into something very dangerous in the region: a complex foreign policy, the kind that the region usually imposes on powerful outsiders. At the moment, the main concern of the United States is Iranian expansion. It is not alone. The Sunni world and Israel are in intense opposition to Iran. Turkey and Russia are wary of Iran but at the moment are content to see the U.S. struggle with the problem, while they fish in troubled waters. An extraordinary coalition has emerged with the support of the U.S., bringing together Israel, Saudi Arabia and other Sunni states under one tenuous banner.

This coalition is a threat to Iranian interests. The Israelis are attacking Iranian forces in Syria and exchanging mutual threats with Hezbollah. The Saudis and the United Arab Emirates are supporting anti-Iran forces in Yemen and conducting an air campaign. Iraq is under limited outside pressure but is itself so fractious that it is difficult to define what Iranian control or influence is. In other words, the Iranian sphere of influence continues to exist but is coming under extreme pressure. And Iran is aware that if this sphere collapses, its western border becomes once again exposed.

U.S. strategy has moved away from large scale American military involvement, which defined its strategy since 9/11. It has shifted to a dual strategy of using smaller, targeted operations against anti-U.S. groups in the Sunni world and economic warfare against Iran. This anti-Iran strategy follows from a broader shift in U.S. strategy away from the use of military power toward the use of economic power in places like China, Russia and Iran. The U.S. drive to end the Iran nuclear deal was less about fear of Iranian nuclear power and more about imposing a massive sanctions regime on the Iranian economy.

The sanctions strategy has badly hurt the Iranians. For a while, it seemed to threaten political unrest on a large scale, but that threat seems to have subsided somewhat. But the pain from sanctions constantly tightening and shifting, with unpredictable targets and methods of enforcement, has undermined the Iranian economy, particularly its ability to export oil. This, combined with the pressure it is facing from the anti-Iran collation the U.S. supports, has placed Iran in a difficult position.

It has already responded in the Persian Gulf, seizing tankers in the hopes of creating panic in the industrialized world. But this is not 1973, and the significance of a tanker war like the one that raged in the 1980s was not enough to spike oil prices or create pressure from Europe, Japan and others against the United States and its allies to release the pressure on Iran.

Iran now has two imperatives. It must weaken the anti-Iran coalition, protecting its allies in the region, and it must generate pressure on the United States to ease U.S. pressure on the Iranian economy. The weak link in the coalition is Saudi Arabia. Its government is under internal pressure, and it holds together its social system with money gained from oil sales. It is the part that is both vital to the coalition yet vulnerable to events. And nowhere is it more vulnerable than in Saudi oil revenue.

The strike at the Saudi oil refinery was well thought out on all levels. Not only did it demonstrate that the Saudi oil industry was vulnerable to Iranian attack but the attack significantly reduced Saudi oil production, inflicting real pain. It is not clear how long it might take to bring production back online, but even if it is done quickly, the memory will not fade, and if it takes time, the financial impact will hurt. It has imposed a price on the Saudis that others will note.

It is also intended to remind the Saudis and others that while in the past the U.S. had an overwhelming interest in protecting the flow of Middle Eastern oil, this is not a major interest of the United States any longer. Between massive American shale oil production and its reserves, the U.S. is not nearly as vulnerable as it once was to oil disruption. This also reminds U.S. allies in Europe and Asia that a dramatic shift has occurred. Where once all were obsessed with doing nothing to threaten oil supplies, now the United States is in a position to take risks that its allies can’t afford to take. The Iranians hope that with this attack they can split the American alliance over the oil issue.

That oil issue is also Iran’s problem. The U.S. has blocked sales of a substantial proportion of Iranian oil production as part of its economic war on Iran. In creating alarm over global oil supplies, the Iranians want to force U.S. allies to be more assertive in defying U.S. wishes on not only oil but other matters as well. The U.S. assurances of ample supplies played into the Iranians’ hands, causing major importers to start thinking about the U.S. position.

The attack on the refinery was both operationally skillful and strategically sound. It made the Saudis’ vulnerability and their weakest point manifest. It imposed a price on the Saudis for their alliance structure that, if it continues, they cannot pay. The attack also drove home to U.S. allies that their interest and the United States’ interest on oil diverge. Finally, and importantly, it will benefit other oil producers, particularly Russia, by potentially raising prices. And in American politics, anything that benefits Russia right now can be made explosive.

The United States cannot ignore the attack. As the greatest military power in the anti-Iran coalition, it is the de facto security guarantor. But if it strikes, it invites a response from the Iranians and resistance from its allies. If it does not strike, it weakens the foundations of the anti-Iran alliance and strengthens Iran. U.S. Secretary of State Mike Pompeo has recently alluded to the possibility that the U.S. was open to negotiations. The Iranians may have seen this attack as an important negotiating point.

It is difficult to see how the U.S. can respond without risking more attacks on Saudi Arabia. It is likewise difficult to see how the U.S. can avoid striking without losing the alliance’s confidence. Part of this will depend on how bad the damage to the refinery actually is. Part of it will have to do with the effectiveness of U.S. counterstrikes against drones in Yemen.

What is clear is that the Iranians are playing a weak hand as well as they can. But they are also playing a hand that could blow up in their face. The geopolitics of this clear. The intelligence capability of each side in follow-on attacks is the question – as is how lucky all the players feel they are.

The Fed’s Tail-Chasing Problem

The Federal Reserve’s current policy reasoning could push rates sharply lower in response to remote risks

By Justin Lahart

An ounce of prevention is worth a pound of cure,’ said Fed Chairman Jerome Powell. Photo: Associated Press 

The U.S. economy is probably going to be fine, but the Federal Reserve looks likely to lower rates this week anyway.

There is some sense to that: With all the potential economic threats out there, the Fed worries that staying on hold could be riskier than cutting rates. But the danger is that the Fed is entering a spiral where increasingly remote tail risks will lead it to keep lowering rates until it has next to no rate cuts left to give.

With the unemployment rate near a 50-year low, consumer spending solid and inflation beginning to perk up, it seems incongruous at the moment to cut rates. But trade tensions, a slowing global economy and, now, last weekend’s attack on Saudi Arabian oil facilities, all count as reasons to worry.

Those worries are magnified by the fact that the Fed’s current target range for overnight rates, at 2% to 2.25%, is already quite low. That leaves it with little ammunition if it is confronted by a recession—indeed in the past the central bank has had to cut rates by around 5 percentage points in response to a recession.

As a result, the Fed arguably should be readier than usual to lower rates in response to threats, and stave off the possibility of recession, than it might be otherwise. Or, as Fed Chairman Jerome Powell put it in June, “An ounce of prevention is worth a pound of cure.”

Say there is a one-in-five chance that global problems lead companies to reduce employment in the U.S. or spook consumers into spending less. If overnight rates were now set at 5%, the Fed might be more comfortable waiting to see how the situation develops than it is now.

By this logic, however, as the starting rate goes lower, the Fed needs to get even more aggressive responding to remote but worrying possibilities. If policy makers cut rates at the conclusion of their meeting Wednesday and then cut rates one more time this year, as most economists expect, the Fed’s target range will be 1.5% to 1.75% at the start of 2020.

If the Fed then perceives a one-in-10 danger, should it cut rates in response? Where does it end? Rates could end up slipping toward zero even before an actual downturn materializes.

Investors warn gold miners to keep lid on ambitions

Fears 6-year price highs will stoke repeat of previous boom’s doomed investments

Henry Sanderson and Neil Hume

Investors want gold producers to keep a lid on costs and take a more conservative approach to executive remuneration © Bloomberg

Gold miners are facing pressure from investors to keep their animal spirits in check as the precious metal trades at its highest levels in six years.

As the industry gathers this week for its annual gold conference in Denver, some of the sector’s largest investors have warned gold miners not to repeat the mistakes of the past.

“We don’t want to see the poor decisions that we’ve seen in previous cycles,” said Joe Foster, a fund manager at VanEck in New York. “The emphasis will continue to be on more conservative management styles, in terms of debt and financial management.”

Gold miners have outperformed this year, rallying 31 per cent according to the VanEck Gold Miners Exchange Traded Fund. The gold price has risen 17 per cent to about $1,500 a troy ounce.

But investors are fearful that soaring gold prices will lead to a repeat of the last boom, which peaked in 2011 when they rose above $1,900 a troy ounce. Encouraged by bankers, miners splurged cash on ambitious deals and projects that ultimately destroyed value for investors when gold crashed in 2012.

“The big thing we’d like to see is for companies to grab the margin expansion from higher gold prices and return that to shareholders as dividends,” said Mark Burridge, managing partner and fund manager. “We don’t want to see a massive shift to growth.”

Investors also want gold producers to keep a lid on costs and take a more conservative approach to executive remuneration.

Shareholders’ Gold Council, a group backed by 19 investors including New York hedge fund Paulson & Co and Egyptian billionaire Naguib Sawiris, has found gold miners spend much more on salaries and general administrative costs than their peers in copper and iron ore.

If listed gold miners brought their spending in line with the rest of the mining industry, $13bn could be unlocked for shareholders, the group says.

“SGC believes that it is imperative for management teams and boards to immediately explore ways to reduce excessive spending levels,” it said.

That message appears to have been taken on board, at least by the largest companies in the sector. Gary Goldberg, head of Newmont Mining, the world’s biggest gold producer, will not be distracted by the high gold price.

“If I was an investor I’d be making sure people aren’t getting starry eyed with the gold price,” he told the Financial Times. “Making sure they are staying focused on the basics going forward.”

Mr Foster expects that sentiment to be shared by some miners at Denver. “Companies are no longer afraid to say they have a flat production profile,” he said. “If a company can sustain production for the foreseeable future and maybe grow margins by becoming more efficient — you’ll see that type of talk.”

While investors are justifiably wary of deals, many believe there needs to be a round of consolidation among the small and mid-cap producers.

According to bankers these companies should merge to improve returns, but in many cases entrenched senior management — who do not want to give up pay packages that stretch into the millions — are standing in the way.

“There are clearly some companies that should be paying more dividends but in other cases it makes sense for them to consolidate,” said George Cheveley, portfolio manager at Investec Asset Management.

Emerging market central banks most dovish since financial crisis

Monetary authorities are reacting to faltering growth

Steve Johnson

Emerging market central banks have turned more dovish than at any point since at least the global financial crisis, according to analysis of the language in 4,000 monetary policy publications.

The extreme pro-easing bias is remarkable given that banks, including those of Brazil, Russia, India, China, South Africa and Turkey, have already cut rates this year, suggesting the scope for further policy loosening should be narrowing.

Bank of America Merrill Lynch’s Emerging Monetary Mood Indicator, based on robotic scanning of keywords used in the publications of 11 big EM central banks, is at its more dovish extreme since the height of the crisis in 2009, based on a six-month moving average.

Based on single-month figures, the August reading — the latest available — was the most extreme since the depths of the dotcom crash in 2000.

“There are quite a few emerging markets where we are comfortable saying we think [central banks] will cut more than the market is expecting,” said David Hauner, head of EM cross-asset strategy and economics at BofA, who cited Russia, Brazil, China and the Czech Republic as examples.

“We don’t think the market is aggressively pricing in rate cuts. There is plenty of firepower out there. Real rates in emerging markets are still quite high,” he added.

Turkey has led the way among big EM central banks this year, slashing base rates by 750 basis points to 16.5 per cent, while India has cut by 110bp to 5.4 per cent. Since the start of 2017, Brazil has eased by 775bp to 6 per cent and Russia by 300bp to 7 per cent.

Monetary authorities are reacting to faltering growth, with the IMF forecasting that EM-wide growth will slow to a post-global financial crisis low of 4.1 per cent this year.

Tame inflation (outside of Turkey and Argentina) has given central banks headroom to ease. Mr Hauner said many countries “have got rid of the current account deficits that have constrained policy in the past, so they have more room to cut without their currencies exploding”. He argued the extreme dovishness should be supportive for EM equities and bonds, but be a potential drag on currencies.