A Fine (Im)Balance: Global macro (dis)equilibrium…
Dresdner Kleinwort Emerging Markets Research
Arnab Das
+44 (0) 20 7475 3875
Arnab.das@dkib.com
March 2007
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The big picture: Getting to grips with risks
Global macro imbalances at risk: Coyote Ugly aka ‘The Coyote Moment’?
► Will the world experience a ‘Coyote Moment’ in the
unwinding of Global Macro Imbalances?
► In the Roadrunner cartoons, the Coyote would often
chase the Roadrunner off a precipice.
► For a short while, the Coyote would fly, but soon
enough, he would look down into the abyss below and
coming crashing back to earth...
► So, are the markets in for a ‘Coyote Moment’ – an
ugly time when reality will collide with unrealistic
expectations and everything changes all at once … as
some major thinkers have suggested
► Could we be at a turning point?
► The US cycle peaks and the economy heads for a
slowdown, even as G7 monetary policies diverge.
Source: Concept from Krugman, Portes. Cartoon from Hanna-Barbera Cartoons
Goldilocks encounters three bears, in the driver’s seat of Global Macro and Emerging Markets
►
De-Synchronizing G7 monetary policies and business cycles.
►
The JPY carry trade – source of risk appetite, or of risk aversion?
►
FX reserve accumulation – the flip side of global macro imbalances.
Is the world becoming riskier, safer, or staying about the same? The fine balance between risk appetite and risk aversion
hinges on the market’s joint assessment of issues.
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The big picture: Getting to grips with risks
Synchronicity/De-Synchronicity…aka Monetary policy normalisation, divergence
►
G10 monetary policies underwent synchronised, emergency
easing in response to many shocks in the late 90’s and early
2000’s
►
Fast forward a few years: G7 policy is more or less
normalised…
Synchronicity to de-synchronicity:
Diverging monetary policy in the G7
►
Recovery has run a long way and still seems to have legs of
its own in the major economies.
►
The Fed is on hold, with the US economy at risk of
slowdown. And, rebalancing is occurring.
►
The UK is growing robustly; monetary policy is in fine tuning
mode.
►
The Eurozone continues to recover, amid patches of
concern, further tightening is likely.
►
Japan is posting growth even though doubts persist about
consumption.
Source: National authorities, Bloomberg, Dresdner Kleinwort Emerging Markets Research
►
Most EM economies are growing smartly, especially those
exporting natural resources or labour intensive services or goods.
►
2
Monetary policy is generally tightening or on hold throughout
EM, with the notable exception of Brazil.
The big picture: Getting to grips with risks
Japan’s BoP saga: A long term trend of capital outflows
The very long run: USD/JPY not driven by interest rate differentials alone
Source: Us Federal Reserve; Bank of Japan, Bloomberg, Dresdner Kleinwort Emerging Markets Research
► Japan’s BoP is a saga of capital outflows, led by outward investment, portfolio and direct, mainly to the United States (not the carry trade in
EM countries!) and current account surplus, led by the trade account, underpinned by a long running appreciation of the JPY.
► The nominal yen had been on an upward march since Japan’s re-emergence as a modern industrial giant, with dollar-yen rising from
350ish some 40 years ago, to a 20th Century high of 80ish in March of 1995, at the nadir of the Mexican Tequila Crisis.
► But asset prices were rising sharply amid directed credit and a state-driven, export-led industrial development strategy. Sustained yen
appreciation helped drive down inflation in both the data and expectations. Eventually bank asset quality deteriorated. Disinflation turned
into deflation when asset bubbles burst, and all after the JPY rally engineered by the 1985 Plaza Accord.
► Japan is still recovering…
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The big picture: Getting to grips with risks
Would carry trade unwinding imply a turnaround in Japan’s BoP?
► Carry trades of speculators and hedge funds are one thing…the accumulation of household mortgage debt in CHF and JPY is another,
also arising from low interest rates.
► But Japan’s underlying story is of sustained resident investment abroad, driven by considerations of portfolio balance and low rates of
return on investment in Japan, reflected in low nominal rates, quantitative easing, and current account surpluses.
► It’s well worth noting in this context that the BoJ largely stopped intervening directly in the FX market in Q1-04.
► During 2006, the monetary story was about quantitative easing, which contributed via money creation and low nominal rates to capital
outflows, and thereby to a weak yen.
► And for at least the last two years, outward foreign investment and non-residents’ JPY-funded carry trades have combined to help keep
the JPY weak.
► Clearly the carry trade is becoming riskier, with the yen hovering around fresh lows. Further bouts of volatility in dollar-yen, euro-yen and in
risky asset prices with underlying yen carry funding can hardly be ruled out.
► This is partly what happened when the end of quantitative easing and faster than expected absorption of excess reserves – liquidity –
in the Japanese banking system paved the way for early normalisation of monetary policy, precipitating widespread market volatility
including in EM in Q1-06.
► History could well repeat itself if/when the BoJ tightens monetary policy further or faster than expected.
► However, there is an underlying fundamental question – will the rate of return in Japan be high enough to induce a sustained rally
in the JPY? Does anyone really expect the BoJ to take policy rates up to a level where Japan can compete not as a funding currency
but as a destination of capital?
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The big picture: Getting to grips with risks
Global imbalances or balances?
EM reserve accumulation: dominated by EM Asia, led by China
(US$bn)
3000
2500
2000
1500
1000
500
0
2000
2001
2002
EU Candidates/Members
2003
EM ASIA
2004
LATAM
2005
2006
FSU incl. Russia
Source: National Authorities , Dresdner Kleinworth Debt Research
►
Some highly regarded people dispute even that there really are imbalances, for a few key reasons:
►
First, deficits anywhere are offset by surplus elsewhere.
►
Second, many countries have opted into a de facto dollar bloc by (in-)formally pegging to the USD for reasons of selfinsurance and/or to maintain export-led growth.
►
Third, reserve accumulation may be a natural consequence of globalisation/financial integration, even at this pace/rate.
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The big picture: Getting to grips with risks
The aggregate EM Balance of Payments: Surpluses nearly everywhere
► EM current accounts are in surplus nearly everywhere
(upper chart).
► Deficits are an issue in the EU Periphery and
South Africa, and a few energy importers in EM
Asia.
► EM capital accounts are also in surplus in most
regions (lower chart).
► EM economies as a group should therefore be able to
weather a global macro shock.
► High reserves and BoP surpluses should provide
plenty of cushion
► We stick with a mixture of sore surplus and
tactical deficit country positions.
Source: IIF , Dresdner Kleinworth Debt Research
6
The big picture: Bridging past and future
EM Fiscal Accounts: Significant turnaround – excluding the EU Periphery
A. Fiscal balances have improved significantly across EM…
B. Led by rising primary fiscal balances in general…
(% GDP)
2
1
0
-1
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
-2
-3
-4
-5
EMEEA
EM ASIA
LATAM
►
C. But New EU-10/CE4 run sizeable primary deficits
►
(% GDP)
7
6
5
4
3
2
1
0
-1
-2
-3
-4
Considerable fiscal adjustment – cyclical and policy-led
►
Primary surpluses in commodity-exporters, high debt countries:
►
►
1995
1996
1997
1998
CE4
1999
Turkey
2000
2001
South Africa
2002
2003
2004
2005
2006
2007
Non EU members/Candidates
Fiscal deficits cut where financing constraints were binding.
LatAm; Russia/CIS; Turkey; South Africa
Sizeable primary fiscal deficits persist in CE-4; EM Asia.
►
EM Asia enjoys high domestic savings;
►
CE-4, New EU-10, enjoy access to foreign savings.
►
Source: National Authorities, IIF, Dresdner Kleinwort Debt research.
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(Convergence Funds; ‘EU Umbrella’).
The big picture: Bridging past and future
EM BoP Accounts: Significant strengthening, surpluses – excluding EU Periphery
C. Basic balances are strong or improving – in general…
A. EM countries have swung from capital importers to exporters
(US$bn)
300
(US$bn)
700
250
600
200
500
400
150
300
200
100
100
50
0
-100
0
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
1995
2007
-300
-50
-100
EMEEA
ASIA
4
2
0
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
-4
-6
-8
CE4
Turkey
South Africa
1998
1999
2000
2001
2002
2003
2004
2005
EMEEA
ASIA
LATAM
D. Except in CE-4, compared to other deficit countries
(% GDP)
1995
1997
LATAM
B. But the EU Periphery and South Africa run large C/A deficits
-2
1996
-200
Non EU members/Candidates
Source: Bloomberg, Datastream, national authorities, Dresdner Kleinwort Debt Research calculations and 2006, 2007 forecasts
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2006
2007
The big picture: Bridging past and future
Taking stock of EM liabilities… Declining and better diversified by region, sector.
Gross nominal EM external debt issuance declining again, led by sovereign debt
(US$bn)
165
115
65
15
-35
2003
2004
Sovereign
EM gross issuance is well
diversified by country…
Poland
0.3
0%
Russia
18.9
27%
India
2.4
3%
Hungary
5.5
China
8%
1.2
2%
1Units:
South Africa
2.2
South Korea
3%
10.3
14%
Turkey
14.1
19%
Brazil
16.2
22%
Argentina
1.6
2%
US$bn % total
Source: Bloomberg; national authorities,
Dresdner Kleinwort Debt research
2005
As are EM corporate
issues
Poland
0.3
India1%
Russia
18.9
36%
2.4
5%
Hungary
3.6
7%
China
1.2
2%
1Units:
Brazil
13.7
27%
Argentina
1.6
3%
2006
Corporate
Though gross sovereign
issuance is concentrated
South Africa
0.9
2%
South Korea
8.1
16%
Turkey
0.5
1%
South
Africa
1.3
6%
1Units:
US$bn % total
Source: Bloomberg; national authorities,
Dresdner Kleinwort Debt research
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Turkey
13.7
63%
South
Korea
2.2
10%
Hungary
1.9
9%
Brazil
2.5
12%
US$bn % total
Source: Bloomberg; national authorities,
Dresdner Kleinwort Debt research
Disclosure appendix
Disclosures
The relevant research analyst(s), as named on the front cover of this presentation, certify that (a) all of the views expressed in this research presentation accurately reflect their personal views about the securities
and companies mentioned in this presentation; and (b) no part of their compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or views expressed by them contained in this
presentation.
Any forecasts or price targets shown for companies and/or securities discussed in this presentation may not be achieved due to multiple risk factors including without limitation market volatility, sector volatility,
corporate actions, the unavailability of complete and accurate information and/or the subsequent transpiration that underlying assumptions made by Dresdner Kleinwort or by other sources relied upon in the
presentation were inapposite.
Recommendation history tables
Past performance is not an indicator of future performance.
Please refer to our website www.dresdnerkleinwort.com/research/disclosures for our tables of previous fundamental credit opinions
Dresdner Kleinwort Research - Explanation of fundamental credit opinions (Euro and Sterling)
Issuer
Definition
Overweight
The recommendation is based upon Dresdner Kleinwort's assessment of the fundamental credit quality of an issuer together with the expected market performance of the issuer's bonds relative to the iBoxx/iTraxx indices.
This approach applies at the borrower level, where the benchmark index for allocation is, unless otherwise specified, the relevant sector iBoxx index for cash instruments or iTraxx index for CDS. The weightings are not
indications of particular degrees of expected spread movement relative to the index. An overweight recommendation implies expected outperformance to the relevant index over a three months time horizon. For issuers that
are not included in the relevant iBoxx/iTraxx indices, we express expected performance compared to the appropriate sector indices.
The recommendation is based upon Dresdner Kleinwort's assessment of the fundamental credit quality of an issuer together with the expected market performance of the issuer's bonds relative to the iBoxx/iTraxx index.
This approach applies at the borrower level, where the benchmark index for allocation is, unless otherwise specified, the relevant sector iBoxx index for cash instruments and iTraxx index for CDS. The weightings are not
indications of particular degrees of expected spread movement relative to the index. A marketweight recommendation implies expected in-line performance to the relevant index over a three months time horizon. For
issuers that are not included in the relevant iBoxx/iTraxx indices, we express expected performance compared to the appropriate sector indices.
The recommendation is based upon Dresdner Kleinwort's assessment of the fundamental credit quality of an issuer together with the expected market performance of the issuer's bonds relative to the iBoxx/iTraxx index.
This approach applies at the borrower level, where the benchmark index for allocation is, unless otherwise specified, the relevant sector iBoxx index for cash instruments and iTraxx index for CDS. The weightings are not
indications of particular degrees of expected spread movement relative to the index. An underweight recommendation implies expected underperformance to the relevant index over a three months time horizon. For issuers
that are not included in the relevant iBoxx/iTraxx indices, we express expected performance compared to the appropriate sector indices.
Marketweight
Underweight
Dresdner Kleinwort Research - Explanation of fundamental High Yield opinions
Issuer
Definition
Buy
Hold
Sell
The company has an improving credit profile that will likely benefit further from positive credit developments and events/news with a corresponding expected positive effect on bond prices.
The company has an improving or stable credit profile with little headline risk either positive or negative. Bond price movements are likely to be consistent with shifts in the market in general.
The company has a declining credit profile and there is likelihood of negative credit events/news with a corresponding expected negative effect on bond prices.
(Our recommendations for issuers, unless otherwise specified, are for a minimum of a 3-months horizon, but more often for 6 to 12 months)
We started tracking our trading recommendation history in compliance with the requirements of the Market Abuse Directive on 8 April 2005.
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Distribution of Dresdner Kleinwort credit research recommendations as at 30 Sep 2006
All covered companies
Companies where a Dresdner Kleinwort company
has provided investment banking services
Investment grade Euro Recommendations
Overweight (€)
26
14%
7
27%
Marketweight (€)
94
52%
31
33%
Underweight (€)
61
34%
18
30%
Total Euro
181
56
Investment grade Sterling Recommendations
Overweight (£)
4
11%
1
25%
Marketweight (£)
22
59%
6
27%
Underweight (£)
11
30%
4
36%
Total Sterling
37
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High Yield Recommendations
Buy/Add
0
0%
0
NM
Hold
5
100%
1
20%
Sell/Reduce
0
0%
0
NM
Total High Yield
5
1
Source: Dresdner Kleinwort Debt research
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