PrefBlog

The blame game has begun:

India central bank Governor Raghuram Rajan warned of a breakdown in global policy coordination after the Federal Reserve further cut stimulus, weakening emerging-market currencies from the rupee to the Turkish lira.

Rajan, a former chief economist at the International Monetary Fund, called for greater cooperation among policy makers weeks before finance chiefs from the world’s top developed and emerging markets gather in Sydney.
…
The Fed shouldn’t be blamed for turmoil in emerging markets, former Fed Governor Randall Kroszner, a professor at the University of Chicago where Rajan once lectured, said on Bloomberg Radio’s “The Hays Advantage.”

“Countries that are being hit tend to be ones that have high current-account deficits, high fiscal deficits and relatively high inflation, and the challenge is brought on by their own domestic policies,” Kroszner said. “It’s unfair to say it’s all the Fed’s fault.”
…
In 2011, Rajan co-authored a report that called for the creation of an International Monetary Policy Committee composed of representatives from major central banks that would regularly report on the aggregate consequences of individual central bank policies. Central banks from bigger countries should be encouraged to internalize the spillover effects of their policies, it said.

Rajan said yesterday developed countries might not like adjustments emerging markets take to cope with the outflows, without elaborating on specific measures. His surprise Jan. 28 move to raise the benchmark repurchase rate by a quarter point – – adding to increases of 50 basis points since he took over the Reserve Bank of India in September — was to stem consumer-price inflation running at close to 10 percent, he said.

Some economists are taking a stab at quantifying the effects of quantitative easing:

The economists, Jing Cynthia Wu and Fan Dora Xia, used a concept known as the “shadow rate” to gauge the impact of quantitative easing and the Fed’s forward guidance on the likely path of interest rates.

Their findings: as of December, Fed policy was the equivalent of cutting the benchmark interest rate to minus 1.98 percent, according to Wu at the University of Chicago Booth School of Business and Xia at the University of California at San Diego.

Fan Dora Xia’s web page also shows his estimates for the ECB (-0.24% as of 2013-05-31) and the UK (-3.06% as of 2013-10-31).

Meanwhile, Argentinian bonds are doing what Argentinian bonds do best:

Argentine dollar bonds tumbled the most in emerging markets on concern government measures from devaluation to rate increases aren’t enough to improve the country’s deteriorating debt payment capacity.

Argentine government dollar bonds due 2015 fell 3.88 cents on the dollar to 85.75 cents, driving yields up to 19.12 percent, the highest since June 2012.
…
Argentina is losing foreign currency reserves at the fastest pace in more than a decade as estimated 28 percent inflation and currency controls spur capital flight. The funds, which the country relies on to pay debt and finance energy imports, dropped to a seven-year low of $28.3 billion. The government devalued the peso 15 percent last week and raised benchmark interest rates as much as 6 percentage points. The moves, coupled with less risk appetite for emerging market assets, haven’t settled investor concerns.

The Canadian preferred share market closed the month on a happy note, with PerpetualDiscounts winning 20bp, FixedResets gaining 5bp and DeemedRetractibles up 8bp. BAM Floating Rate issues were notable on the downside of a relatively lengthy Performance Highlights table. Volume was above average.

I’m all in favour of ETFs (most of them, anyway. Not the silly ones). By reducing friction, they make it easier for small investors to construct a well diversified portfolio. Trouble ensues when all these small investors collectively become a tidal wave of dumb money:

Investors are pulling money from exchange-traded funds that track emerging markets at the fastest rate on record, as China’s slowing growth and cuts to central-bank stimulus sink currencies from Turkey to Brazil.

More than $7 billion flowed from ETFs investing in developing-nation assets in January, the most since the securities were created, data compiled by Bloomberg show. The iShares MSCI Emerging Markets ETF has seen its assets shrink by 11 percent, while the Vanguard FTSE Emerging Markets ETF is poised for the biggest monthly redemption since the fund was started in 2005. The WisdomTree Emerging Markets Local Debt Fund is on track for an eighth straight month of withdrawals.
…
Withdrawals from the iShares fund and the Vanguard ETF, the largest such products by assets for emerging markets, totaled $1.9 billion on Jan. 27, the biggest one-day redemption since 2005, data compiled by Bloomberg show. About $58 million has been withdrawn from the WisdomTree debt fund this month, bringing the total redemption since June to $752 million.

It will be most interesting to see if any smaller, derivative-based ETFs get into trouble as a result of all this.

Assiduous Readers will remember that I am most interested in good statistics regarding actual default rates of AAA US RMBS, as opposed to downgrades. The politicians are always whimpering about downgrades and seek to make them sound like defaults in their speeches. Today I found – free! – S&P’s Global Structured Finance Default Study, 1978-2012: A Defining Moment For Credit Performance Stability. Yep, downgrades are awful! No less than 70.68% of US RMBS were downgraded in 2009, as shown in the table on page 19. More seriously, 57.3% of investment-grade global structured finance instruments issued in 2006 have defaulted (page 24) and, even more seriously the Global Structured Finance Five-Year Default Rate for AAA issues for the five years ending 2012-12-31 was 12.91% (page 35). Regrettably, it’s not clear to me whether the US agencies’ default is included in these figures, or what the recovery on default was. Still, it’s a fascinating topic and I continue to keep my eyes peeled for solid analysis.

David Parkinson of the Globe writes a good piece about wage inflation:

Average weekly earnings, including overtime, were up 2.5 per cent in November compared with a year earlier – the fastest pace in six months. In November alone, average weekly wages jumped 0.9 per cent.
…
Statscan data show that average hourly earnings excluding overtime have barely moved in the past six months, but average earnings including overtime are up 1.2 per cent.

Curiously, though, the November wage growth came despite a drop in average weekly hours worked (to 33.1 from 32.8 a year earlier). This would seem to contradict the notion that overtime has been ramped up. However, given that most of the job growth in the past year has been in part-time positions, this could be a function of overtime shifts being spread among part-time workers.

It was a mildly negative day for the Canadian preferred share market, with both PerpetualDiscounts and FixedResets off 6bp and DeemedRetractibles flat. Volatility was very low. Volume was average.

The Fed is forging ahead with tapering:

The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate. The Committee sees the risks to the outlook for the economy and the labor market as having become more nearly balanced. The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term.

Taking into account the extent of federal fiscal retrenchment since the inception of its current asset purchase program, the Committee continues to see the improvement in economic activity and labor market conditions over that period as consistent with growing underlying strength in the broader economy. In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in February, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $30 billion per month rather than $35 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $35 billion per month rather than $40 billion per month.

And when the Fed speaks, Emerging Markets listen:

India’s central bank got the ball rolling with its surprise decision Tuesday to raise its main interest rate by a quarter of a percentage point to 8 per cent. Though it justified the move in terms of keeping a lid on inflation pressures, protecting the rupee is widely considered to have been a key motive.

Those considerations were clearly behind the decisions in Turkey and South Africa. The Central Bank of Turkey said it was raising its main overnight lending rate to 12 per cent from 7.75 per cent and more than doubling its one-week rate to 10 per cent from 4.5 per cent.
…
South Africa’s central bank was clear that the falling rand had a key role in its decision to raise its main interest rate by a half percentage point to 5.50 per cent despite concerns over growth.
…
“The history of using interest rates to defend a currency usually ends in tears,” said Neil MacKinnon, global macro strategist at VTB Capital.

MacKinnon pointed to the experience of Europe before the launch of the euro in 1999. Many currencies had been pegged to each other in the so-called Exchange Rate Mechanism and when markets became volatile in the early 1990s, central banks raised their interest rates to support their currencies.

However, that came at a cost, most notably in Britain. The government there left the currency pact after the Bank of England splashed out billions of pounds and raised its main interest rate a massive 5 per cent in one day in a last-ditch — and ultimately futile — effort to defeat the speculators.

The ERM example is not, I think, the best; there you had interest rate policy essentially being set in isolation with little regard for other problems:

Britain entered under conditions of high inflation, huge balance of payments deficits, a growing PSBR [Public Sector Borrowing Requirement, the government’s cash deficit], and political uncertainty.

Still, Black Wednesday remains vivid in my memory as one of the most fun days I’ve ever had in the market. The Canadian yield curve flattened like hell ‘n’ gone and I was trading all day in big size.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts gaining 1bp, FixedResets down 15bp and DeemedRetractibles off 3bp. A surprisingly lengthy Performance Highlights table is dominated by losers. Volume was at the high end of average.

PerpetualDiscounts now yield 5.63%, equivalent to 7.32% interest at the standard equivalency factor of 1.3x. Long Corporates now yield about 4.55% (maybe a little bit more?) so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 275bp, the same as in the January 22 report.

I always take heart from evidence that governments don’t really control economies:

When Argentina decided last week to ease limits on dollar purchases, it became the latest emerging-market nation to acknowledge that capital controls usually fail in masking an economy’s flaws.

Argentina allowed the peso to plunge 15 percent after the central bank began scaling back interventions in the foreign-exchange market on Jan. 22, spurring price increases of as much as 30 percent on consumer goods as international reserves fell to a seven-year low. The black-market price in Argentina rose last week to a record 12.75 pesos per dollar, compared with the official rate of about 8, according to Buenos Aires newspaper Ambito.
…
Restrictions on capital flows, ranging from Argentina’s tax on vacations abroad to Malaysia’s stabilizing the ringgit after the 1997 Asian crisis, have had mixed results in boosting investor confidence in a country’s economy. Capital outflow restrictions can be effective “if they are sufficiently comprehensive to slow a sudden ‘rush to the exit,’” according to a report by four International Monetary Fund researchers released this month.
…
In Venezuela, a decade of currency controls is fueling the world’s fastest inflation among the 114 economies tracked by Bloomberg and shortages of basic goods.

The official rate of 6.3 bolivars per dollar compares with the 75-bolivar rate on the black market. Official dollars therefore are the most profitable assets in the country, allowing people who have access to them enjoy a lifestyle far beyond the reach of an average Venezuelan.

The referenced paper by Christian Saborowski, Sarah Sanya, Hans Weisfeld and Juan Yepez has the abstract:

This paper examines the effectiveness of capital outflow restrictions in a sample of 37 emerging market economies during the period 1995-2010, using a panel vector autoregression approach with interaction terms. Specifically, it examines whether a tightening of outflow restrictions helps reduce net capital outflows. We find that such tightening is effective if it is supported by strong macroeconomic fundamentals or good institutions, or if existing restrictions are already fairly comprehensive. When none of these three conditions is fulfilled, a tightening of restrictions fails to reduce net outflows as it provokes a sizeable decline in gross inflows, mainly driven by foreign investors.

Turkey’s done a lot of catching up!

Turkey’s central bank more than doubled its main interest rate at an emergency meeting, reversing years of policy after the lira slid to a record low.

The bank in Ankara raised the benchmark repo rate to 10 percent from 4.5 percent, according to a statement posted on its website at midnight. It also raised the overnight lending rate to 12 percent from 7.75 percent, and the overnight borrowing rate to 8 percent from 3.5 percent.
…
While most investors advocate higher rates to bolster the lira, Prime Minister Recep Tayyip Erdogan has repeatedly railed against an “interest-rate lobby,” blaming it for a series of blows to his government, including last year’s wave of protests and the graft probe implicating his ministers.

Ignoring reality only makes it hit harder. But politicians never learn.

Sheila Bair has achieved the regulatory end-game:

Sheila Bair, the Federal Deposit Insurance Corp.’s chairman from 2006 to 2011, has been hired for a new gig as a board member at the Spanish lender Banco Santander SA. This seems to have gotten some people upset, even riled.
…
The general rule in banking is that it’s OK to become a regulator, put in a few years playing nice with the industry, then take a cushy board seat. Bair didn’t follow that path exactly. Now and then she made some remarks criticizing the way huge banks were run. But she never said anything so piercing or harsh that it distracted them from blowing up the financial system while she was FDIC chairman. She didn’t interfere with anybody’s bailout checks. She kept the FDIC’s bank-financed insurance fund woefully undercapitalized for years. It’s hard to see why “many in the banking world” are upset with her.

It was an unevenly good day for the Canadian preferred share market, with PerpetualDiscounts up 28bp, FixedResets flat and DeemedRetractibles gaining 9bp. Volatility was minimal. Volume was above average.

This is interesting … the demand for physical gold is (currently) uncorrelated with demand for gold certificates:

Austria’s Muenze Oesterreich AG mint hired extra employees and added a third eight-hour shift to the day in a bid to keep up with demand. Purchases of bullion coins at Australia’s Perth Mint rose 20 percent this year through Jan. 20 from a year earlier. Sales by the U.S. Mint are set for the best month since April, when the metal plunged into a bear market.

Global mints are manufacturing as fast as they can after a 28 percent drop in gold prices last year, the biggest slump since 1981, attracted buyers of physical metal. The demand gains helped bullion rally for five straight weeks, the longest streak since September 2012. That won’t be enough to stem the metal’s slump according to Morgan Stanley, while Goldman Sachs Group Inc. predicts bullion will “grind lower” over 2014.

“The long-term physical buyers see these price drops as opportunities to accumulate more assets,” said Michael Haynes, the chief executive officer of American Precious Metals Exchange, an online bullion dealer. “We have witnessed some top selling days in the past few weeks.”

Gold ETFs have always struck me as being something of an internal contradiction. If the world dissolves in hyperinflation followed by chaos, do you really want to own an electronic record that gives you ownership of part of a company that holds title to some gold three thousand miles away? Although mind you, if I did want to stockpile something as chaos insurance, I’d prefer something of more practical value … books, spices, a smithy, ammunition.

We have another entry for the ‘Unintended Consequences’ competition:

Ten years ago, Congress passed a law intended to penalize chief executive officers whose companies shift their legal addresses to tax havens.

It hasn’t worked out as planned. Companies have found ways around the law that create new rewards for executives. When Actavis Inc. (ACT) changed its incorporation to Ireland in October, the New Jersey-based drugmaker helped CEO Paul Bisaro avoid the law’s bite by handing him more than $40 million of stock as much as three years ahead of its schedule, then promising him an additional $5 million to remain with the company.

The payouts to executives highlight the ineffectiveness of the 2004 law, which contained a series of provisions aimed at reducing the tax benefits of reincorporating overseas. In the past two years, a fresh wave of companies has fled the U.S. system to avoid hundreds of millions of dollars in taxes.

The 2004 law has “clearly been a failure” in halting the tax exodus, said Edward Kleinbard, a professor at University of Southern California’s Gould School of Law. “And it now has the perverse result of putting money into executives’ pockets sooner.”

The law imposes a special tax of 15 percent on restricted stock and options held by the most senior executives when a company reincorporates outside the U.S. Since the measure took effect, at least seven large companies have disclosed in securities filings that they risked triggering the tax. All took steps to shield their executives from having to pay.

The consequences of the regulators’ assault on public markets is also becoming more clear:

Facebook Inc. (FB)’s 2012 stock market debut helped spark a boom in U.S. initial public offerings, sucking the life out of a Wall Street fad that the social network had helped popularize: private share exchanges.
…
[NASDAQ honcho Robert] Greifeld’s proposed Nasdaq Private Market would help companies large and small let employees trade while avoiding the disclosure requirements and compliance standards that publicly traded firms face. A barrier was reduced in 2012 with the Jumpstart Our Business Startups Act, which quadrupled to 2,000 the number of shareholders a company could have before it needed to disclose financials.
…
To succeed, Nasdaq Private Market must persuade more companies to forgo the rewards of being public, such as the lure of greater riches and the brand recognition that comes with a ticker symbol. And only accredited investors — such as large institutions and wealthy individuals — will be eligible to buy stakes, limiting the pool of potential shareholders.

And, in the latest inflation chatter:

One of Janet Yellen’s first challenges as Federal Reserve chairman is generating enough inflation to meet the central bank’s target of 2 percent.

Policy makers have failed to attain their goal for almost two years and now are paring the pace of their bond buying. Inflation rose at a 0.9 percent rate for the 12 months ending in November, according to the central bank’s preferred measure. The last time prices were climbing at or above 2 percent was in April 2012.
…
Eric Rosengren, president of the Federal Reserve Bank of Boston, said in a Jan. 7 speech that too-low inflation can be “a cause for real concern” because it increases the possibility a “negative shock” to the economy may lead to deflation. That could cause households to delay purchases in anticipation of even lower prices and companies to postpone investment and hiring as demand for their products dries up. Too-low inflation also means higher inflation-adjusted interest rates, making it harder to achieve a sufficient pace of growth.

“Furthermore, persistently low inflation can theoretically undermine the credibility of the central bank,” said Rosengren, who dissented against the December decision to cut monthly bond buying by $10 billion. If the Fed announces a goal “but is unable to achieve that target in a reasonable time frame, some may call into question its ability to do so in the medium- or long-term as well.”

It was a quiet day for the Canadian preferred share market, with PerpetualDiscounts gaining 4bp, FixedResets flat and DeemedRetractibles up 8bp. Volatility was more than might be expected given these figures, but with no clear pattern. Volume was low; but such as there was was dominated by the RY FixedResets with the February Exchange Date.