The ISIS Praxis Seminar 2011
“Currency War Inflation, Sovereign Debt Crisis & QE2”
Baljeet Kaur Grewal
Managing Director & Vice Chairman
KFH RESEARCH LTD
3 MARCH 2011
Expansionary monetary policy in developed nations
9 Quantitative easing (QE) is an unconventional monetary policy used by central banks to stimulate the
economy
government bonds and other financial assets,, in order
9 The central bank creates moneyy which it uses to buyy g
to increase money supply and the excess reserves of the banking system. This also raises the prices of the
financial assets bought (which lowers their yield)
9 Expansionary monetary policy normally involves a lowering of short-term interest rates by the central bank.
However, when such interest rates are either at or close to zero, normal monetary can no longer function,
and
d QE may be
b used
d by
b the
th monetary
t
authorities
th iti in
i order
d to
t lower
l
i t
interest
t rates
t further
f th outt on the
th yield
i ld
curve and further stimulate the economy
9 QE was used unsuccessfully by the BOJ to fight domestic deflation in early 2000s, whereby BOJ maintains
short-term interest rates close to zero since 1999. With QE, it flooded commercial banks with excess
liquidity to promote private lending,
lending leaving them with large stocks of excess reserves,
reserves and little risk of a
liquidity shortage
9 Similar policies have been used by the US, the US and the Eurozone during the financial crisis 2007-2010
9 According to the IMF, the QE policies undertaken by central banks of major developed nations have
contributed to the reduction in systemic risks following the bankruptcy of Lehman Brothers.
Brothers It has also
contributed to the recent improvements in market confidence, and the bottoming out of the recession in the
G7 economies
9 Risks: (1) higher inflation than desired if it is improperly used, and too much money is created, (2) it can fail
if banks opt simply to sit on the additional cash in order to increase their capital reserves in a climate of
rising defaults in loan portfolios, (3) can effectively ease the process of deleveraging as it lowers yields, and
(4) in the context of a global economy, lower interest rates may contribute to asset bubbles in other
economies
2
Source: IMF, KFHR
US’ quantitative easing
9 During the peak of the financial crisis in 2008, the Fed expanded its balance sheet dramatically by adding
new assets and new liabilities without “sterilizing” these by corresponding subtractions
9 The Fed held between USD700-USD800bln of Treasuryy notes on its balance sheet even before the
recession. In late Nov 2008, the Fed started buying USD600bln MBS
9 By March 2009, it held USD1.75tln of bank debt, MBS and Treasury notes, and reached a peak of
USD2.1tln in June 2010
9 Further p
purchases were halted since the economyy had started to improve.
p
Holdings
g started falling
g naturallyy
as debt matured (projected at USD1.7tln by 2012)
9 However in August 2010, the Fed decided to renew QE, i.e. QE2, because the economy is not growing
robustly as anticipated. Its goal was to keep holdings at USD2.054tln level
9 To maintain that level,, the Fed bought
g USD30bln in 2 to 10-year
y
Treasuryy notes a month
9 In Nov 2010, the Fed announced under QE2, it would be buying USD600bln of Treasury securities by end2Q11. The market currently expects QE2 to continue until end-2011 (USD1.2tln)
US’ 10-year bond yield (2006-Feb 2011)
Fed’s total assets (2007-Feb 2011)
3000000
5.5
4.5
2000000
%
USD mln
2500000
1500000
1000000
3.5
2.5
500000
1.5
0
07:A
08:J
09:J
Total assets
10:J
Securities held outright
06:J
11:J
3
J
07:J
J
08:J
J
09:J
J
10:J
J
11:J
Source: Bloomberg, KFHR
QE2 and its consequences
9 Monetary inflation is one result of QE2. When Fed buys US Treasuries, it injects newly created
money into the financial system, which in turn reduces the value of the USD
9 A lower USD could stimulate US exports,
exports however with unintended consequences,
consequences e.g.
e g excess
liquidity that could lead to asset price bubbles in the US
9 Low interest rates are fuelling a USD carry trade that create asset price bubbles beyond US
g interest rates, but must also debase their currencies to
9 Exporters must control inflation via raising
maintain exports competitiveness
9 QE2 is a doubly destructive policy for exporters i.e. capital inflows are inflationary while exports are
reduced due to currency appreciation
9 Debasing the USD reduces the value of China
China’s
s US Treasury holdings while China relies on exports
to the US, totaling between USD200-USD300bln annually
9 While it stimulate exports and help create conditions for renewed economic growth in the US, QE2
represents a debasement of the USD and suggests that demand for US debt may be weakening
9 Current facts regarding the US economy do not justify the AAA rating of US sovereign debt. In Feb
2010, Moody’s warned that it might have to cut the rating on US government debt. The warning was
reiterated in Dec 2010
9 Confidence in US sovereign debt and in the USD will continue to deteriorate unless the economy
shows
h
stronger
t
growth,
th federal
f d l governmentt gets
t deficit
d fi it under
d control
t l (expected
(
t d att 8.3%
8 3% off GDP for
f
2011)
4
Source: IMF, Bloomberg, KFHR
Global economic outlook 2011
Global GDP Growth (2008-2011F)
Euro Area
2008: 0.6%
2009: -4.1%
%
2010e: 1.8%
2011F: 1.5%
United States
2008: 0
0.4%
4%
2009: -2.6%
2010e: 2.8%
2011F: 3.0%
Middle East
2008: 5.3%
2009: 1.8%
2010e: 3.9%
2011F: 4.6%
Advanced economies
9 Signs are increasing that
private consumption is starting
to gain foothold
9However significant upside to
spending will be capped by high
unemployment
GCC
9 Growth will be supported by
recovery in oil prices and robust
government spending
g
p
g
China
2008: 9.6%
2009: 9.2%
2010e: 10
10.3%
3%
2011F: 9.6%
East Asia & Pacific
2008: 7.9
2009: 7.0%
Emerging economies
2010 9
2010e:
9.3%
3%
9Global growth driver in 2011
2011F: 8.4%
9Activity remains buoyant,
inflation pressures are emerging
9Some signs of overheating in
certain countries
countries, driven in part
by strong capital inflows
9
IMF projects World GDP growth of 4.4% in 2011, up from earlier forecast of 4.2%, mostly due to
QE2 in the US that is expected to boost economic growth by 0.5% to 3.0% for the country
9
Emerging economies will drive global growth in 2011, underpinned by strong private consumption
and infrastructure spending plans
5
Source: IMF, KFHR
US’ economic outlook 2011
US’ GDP growth trend (2000-2010)
10.0
70
80
8.0
65
6.0
60
4.0
55
Points
%
2.0
0.0
50
-2.0
45
-4.0
40
-6.0
35
-8.0
30
00:Q1 01:Q1 02:Q1 03:Q1 04:Q1 05:Q1 06:Q1 07:Q1 08:Q109:Q1 10:Q1
% y-oy
% q-o-q
04
US’ consumer confidence/ sentiment
(2004-Feb 2011)
140
05
06
07
08
09
10
11
9 US’ economy expanded by 2.8% in 2010, the most
in 5 years, after shrinking 2.6% in 2009
9 Household purchases rose 4.1% in 4Q10 (3Q10:
2.4%), boosted by various tax cuts and renewal of
emergency jobless benefits for the unemployed
120
100
Points
US’ non-ISM services index
(2004-Jan 2011)
80
60
9 Consumer confidence increased in February to the
highest level in 3 years supported by a drop in
unemployment
40
20
0
04
05
06
07
Conference board
08
09
10
University of Michigan
9 Risks to growth: rising oil prices and more cutbacks
by state and local governments given rising costs of
food and fuel
11
6
Source: Bloomberg, KFHR
Inflation remains manageable, with spending capped by
the still high unemployment
Inflation: US vs. developed nations
(2000-2013F)
2011-2013
5.0
US’ CPI vs. core CPI (2003-2010)
US: 1.3%
Euro area: 1.5%
1 5%
Japan: 0.1%
4.0
6.0
50
5.0
4.0
3.0
3.0
%
%
2.0
1.0
1.0
00
0.0
0.0
-1.0
-1.0
-2.0
-2.0
-3.0
00
01
02
03
04 05
US
06 07 08
Euro area
09 10 11F 12F 13F
Japan
03
04
05
06
Core CPI
Unemployment: US vs. developed
nations (2003-2010)
07
08
09
10
CPI
9 US’ CPI rose slightly by 1.6% in Jan 2011 (Dec:
1.5%), as higher prices for food and fuel may have
starting to filter through to other goods and services
12.0
10.0
9 Core CPI stood at 1.0% in Jan 2011 (Dec: 0.8%),
the most since Feb 2009
8.0
%
2.0
6.0
9 Even with soaring commodity prices, the Fed
remains concern that inflation is below its long-term
target of 1.6%-2.0%
4.0
2.0
9 Unemployment rate held at or above 9.0% since
May 2009, restraining consumption
0.0
03
04
05
06
US
07
Euro area
08
09
10
Japan
7
Source: Bloomberg, KFHR
US housing market is struggling even as the rest of the
economy recovers
S&P/ case-shiller house price index
(2001-2010)
2500
20
80
15
70
2000
10
5
0
100
-5
-10
50
-15
60
50
1500
mln
150
% yoy
Points
200
40
1000
30
20
500
10
-20
-25
0
10.5
02:J 03:J
Mortgage delinquencies & foreclosures
(1990-2010)
9.5
8.5
7.5
6.5
5.5
4.5
3.5
All deliquencies
0
05:JA J O06:JA J O07:JA J O08:JA J O09:JA J O10:JA J O11:J
Housing starts (annual rate)
5.0
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
NAHB homebuilders index (RHS)
9 US home values fell 2.4% yoy in Dec 2010, the
biggest decline since Dec 2009
9 Mortgage delinquency rate was the highest at
10.1% in 1Q10, easing to 8.22% by end
end-2010
2010
9 Foreclosures expected to increase as banks
resume seizures. The number of homes receiving a
foreclosure notice is expected to climb 20% in 2011
further prompting
9 This may depress home values further,
would-be buyers to hold off on purchases
90:Q1
91:Q1
92:Q1
93:Q1
94:Q1
95:Q1
96:Q1
97:Q1
98:Q1
99:Q1
00:Q1
01:Q1
02:Q1
03:Q1
04:Q1
05:Q1
06:Q1
07:Q1
08:Q1
09:Q1
10:Q1
%
0
04:J 05:J 06:J J 07:J 08:J 09:J J 10:J J
Index reading
% yoy change
%
01:J
Points
250
Housing starts & NAHB homebuilders
index (2005-Feb 2011)
Foreclosures (RHS)
8
Source: Bloomberg, KFHR
US’ fiscal deficit topped 10.6% of GDP in FY2010
US’ fiscal deficit % GDP (1996-2010)
US’ budget deficit, USD bln (1996-2010)
US’ current account deficit % GDP (1996-2010)
9 US’ fiscal deficit official forecast of USD1.267tln or
8.3% of GDP in FY2011 (FY2010: 10.6% of GDP)
9 Stimulus measures: extended unemployment
benefits and healthcare subsidies for the
unemployed, tax and credit incentive for small
businesses to invest and hire workers, extended
payroll tax cuts for the middle class, increased
funding for states, infrastructure and transportation
9 US plans to reduce fiscal deficit in 2012 and brings
it below 4% of GDP by 2014
9
Source: Bloomberg, US Budget FY2011
EU economic outlook 2011
EU GDP growth trend (2002-2010)
EU GDP by sector (2002-2010)
4.0
3.0
5.0
4.0
3.0
2.0
1.0
0.0
-1.0
-2.0
-3
3.0
0
-4.0
-5.0
-6.0
%
%
2.0
-1.0
-2.0
-3.0
30
02:Q1 03:Q1 04:Q1 05:Q1 06:Q1 07:Q1 08:Q1 09:Q1 10:Q1
Q3
10:Q1
Q3
09:Q1
Q3
08:Q1
Q3
07:Q1
Q3
06:Q1
Q3
05:Q1
Q3
04:Q1
Q3
Q3
03:Q1
02:Q1
-4.0
-5.0
Domestic demand
Government expenditure
EU unemployment rate (2002-2010)
Household expenditure
9 Official GDP in the euro region is projected to
increase by 1.6% in 2011, up from an earlier
forecast of 1.5%
12
10
9 Services and manufacturing industries in February
grew at the fastest pace in more than 4 years
8
6
9 Unemployment rate fell to 9.9% in Jan 2011, down
from 10% in Dec 2010
4
2
9 Inflation gathered pace to 2.4%
2 4% in Feb 2011,
2011 and is
expected to average at 2.2% this year, above the
ECB’s ceiling of 2.0%
10:Q1
Q3
09:Q1
Q3
08:Q1
Q3
07:Q1
Q3
06:Q1
Q3
05:Q1
Q3
04:Q1
Q3
03:Q1
Q3
0
02:Q1
%
1.0
0.0
10
Source: Bloomberg, KFHR
ECB is expected to raise interest rates to counter rising
inflation
EU CPI vs. core CPI (2003-Jan 2011)
CPI at 2.4% in Feb, the fastest pace
since Oct 2008 and the third straight
month of exceeding the ECB’s target of
2.0%
%
4.0
35
3.5
3.0
2.5
2.0
1.5
1.0
05
0.5
0.0
-0.5
-1.0
EU 10-year bond yield (2006-2 Mar 2011)
03:J J 04:J J 05:J J 06:J J 07:J J 08:J J 09:J J 10:J J 11:J
CPI
Core CPI
EU fiscal deficit % GDP (1999-2010)
9 Quickened inflation puts pressure on the ECB to
raise rates later in 2011
9 The ECB has toughened its inflation
inflation-fighting
fighting rhetoric
over the past 2 weeks, indicating it is moving closer
to raising rates from a record low even as Europe
grapples with a sovereign debt crisis
9 Market expects the ECB to make its move in Sept
2011
11
Source: ECB, Bloomberg, KFHR
Sovereign debt crisis
Euro
o area
Finla
and
Belg
gium
Austtria
Ireland
Portu
ugal
Gree
ece
Spaiin
Italy
Fran
nce
Euro area fiscal deficit % GDP (2009-2011F)
Germ
many
EU fiscal deficit % of GDP (1996-2010)
0
-5
-10
%
-15
-20
-25
-30
-35
2009
2010e
2011F
Euro countries downgraded by rating agencies
Country
Rating prior to 2009
(M d ’ / S&P/ Fitch)
(Moody’s/
Fit h)
Rating as at Mar 2011
(M d ’ / S&P/ Fitch)
(Moody’s/
Fit h)
Downgraded by (notches)
(M d ’ / S&P/ Fitch)
(Moody’s/
Fit h)
Ireland
Aaa/AAA/AAA
Baa1/A-/BBB+
7/6/7
Greece
A1/A/A
Ba1/BB+/BB+
6/5/5
Portugal
Aa2/AA-/AA
A1/A-/A+
2/3/2
Spain
Aaa/AAA/AAA
Aa1/AA/AA+
1/2/4
12
Source: ECB, Bloomberg, KFHR
Recovery in commodity prices bode well for emerging
and resource-based economies
Crude oil price (2006-2 Mar 2011)
Gold price (2006-2 Mar 2011)
Copper price (2006-2 Mar 2011)
9 Crude oil price surged to a 29-month high at
USD99.63pb amidst political unrest in the MENA
region, gaining 10.9%YTD
9 Commodity prices surged as investors turn to safehaven investments
9 Gold prices gained 2.04%YTD at USD1,433.28/
ounce, aluminium rose 6.4%YTD, platinum surged
76 7%YTD
76.7%YTD
13
Source: Bloomberg
Emerging economies registered strong growth rates
GDP by region (2000-2011F)
Emerging economies GDP (2000-2011F)
10.0
12.0
8.0
10.0
6.0
8.0
%
%
4.0
2.0
40
4.0
0.0
2.0
-2.0
-4.0
0.0
00
01
02
03
04
05
06
World
Advanced
07
08
09
Emerging
10
11F
00
01
02
03
Emerging
Brazil, China & India GDP growth (2000-2011F)
04
05
Asia
06
07
MENA
08
09
10
11F
Asean-5
9 Global economic growth will be driven by emerging
economies this year, namely Asia Pacific (8.4%)
and GCC (4.6%)
16.0
14.0
12.0
10.0
%
6.0
9 Growth
G
th drivers:
di
hi h commodity
high
dit prices,
i
strong
t
private consumption and huge infrastructure
spending plans
8.0
6.0
4.0
2.0
9 2011 GDP growth projections: China at 9.6% in
2011 (2010: 10.3%),
10 3%) India at 8.4%
8 4% (2010: 9.7%),
9 7%)
SEA at 5.5%, Brazil at 4.5%
0.0
-2.0
00
01
02
03
04
Brazil
05
06
China
07
08
India
09
10
11F
14
9 Risks: political unrests in the MENA region, rising
inflationary pressures
Source: IMF, Bloomberg, KFHR
Inflation is accelerating at a 6% pace in emerging
economies vs. 2% in developed nations
2011-2013
China: 2.2%
India: 5.1%
Brazil: 4.6%
MENA: 6.1%
16.0
14.0
12.0
10.0
8.0
China raised 12m lending rate 2 times
by 50bps to 5.81% in 4Q10, lifted
reserve ratio 6 times by 350bps to 19%
in the past 12 months
Sovereign issuers will
8
7
10
8
likely dominate, as well as
those from infrastructure/
construction
6
5
6
4
4
%
6.0
2
3
4.0
4
0
2.0
0
2
0.0
1
-2
-2.0
0
-4
00
01
02 03 04 05 06
China
India
07 08
Brazil
09
03:J
10 11F 12F 13F
MENA
India WPI vs. interest rates (2005-2011)
India raised the reverse repo rate 6 times
by 225bps to 5.5% in the past 12 months
20
18
16
14
12
10
8
6
4
2
0
-2
10
6
8
5
6
4
4
3
2
2
0
1
0
05:A
06:J
07:J
WPI
08:J
09:J
10:J
05:J
06:J
07:J
Interest rate
08:J
09:J
CPI (RHS)
10:J
11:J
GCC planned projects
estimated at USD2.2tln as
at end-2010
%
7
-2
04:J
Brazil inflation trends (2003-2010)
%
12
%
%
China CPI vs. interest rates (2003-2011)
%
Emerging economies inflation (2000-2013F)
11:J
03:J J 04:J J 05:J J 06:J J 07:J J 08:J J 09:J J 10:J J 11:J
CPI
Reverse repo rate
15
Core CPI
Source: IMF, Bloomberg, KFHR
Central banks raise rates to fight inflation
Malaysia’s Overnight Policy Rate
(2006-Feb 2011)
China’s reserve requirement ratio
(2006-Feb 2011)
Australia’s target interest rate (2006-Feb 2011)
9 Australia was the first country in Asia Pacific to raise
interest rates, 4 times since Dec 2009, from 3.0% to
4.75%
9 China raised 12m lending rate 2 times by 50bps to
5.81% in 4Q10, lifted reserve ratio 6 times by
350bps to 19% in the past 12 months
9 India raised the reverse repo rate 6 times by 225bps
to 5.5% in the past 12 months
9 Malaysia raised the OPR 3 times since Feb 2010,
by 75bps to 2.75%
16
Source: Bloomberg
Huge capital inflows into emerging economies post
challenges in monetary policy management
ASX 200 Index (2006-2 Mar 2011)
Shanghai Composite Index (2006-2 Mar 2011)
BSE Sensex Index (2006-2 Mar 2011)
Hang Seng Index (2006-2 Mar 2012)
17
Source: Bloomberg
Currency appreciation for Asia Pacific and emerging and
economies
China’s yuan/ USD (2006-2 Mar 2011)
Australia’s AUD/ USD (2006-2 Mar 2011)
Brazil’s real/ USD (2006-2 Mar 2011)
9 China’s yuan has strengthened 4.23% since mid2008 to 6.5750/USD
9 AUD has reached parity vs. USD
9 South Africa’s rand appreciated by 44% vs. USD in
the past 2 years
9 Ringgit appreciated 10.4% to 3.0350/USD in the
past 12 months
9 South Africa and Indonesia highlighted that stronger
currencies may quell rising prices. Russia favours a
“very flexible” exchange rate
18
Source: Bloomberg
Conclusion
9 Despite the aggressive fiscal stimuli provided by central banks around the world since the beginning
of 2009, private expenditure has not picked up, and economic recovery remains fragile and uneven
in the US and Euro region
9 While bond yields and mortgage rates are at record lows, credit growth in the US remains very
subdued
9 We think further lowering of interest rates (via QE2) would do little to stimulate demand, due to the
still high
g unemployment
p y
and weak housing
g market in the US. Consumers continue to deleverage
g by
y
paying down debt. While QE2 improved sentiments temporarily, it is unlikely to pull the US economy
out of its current lacklustre economic cycle
9 In contrast, QE has caused its own share of side effects which include:
ƒ
Further established USD as a funding currency for carry trades
ƒ
Global markets rallied, as lower bond yields make equities and other risky assets relatively
attractive
ƒ
QE caused a decline in USD, forcing emerging economies policymakers to intervene in the
forex markets
9 Emerging economies are forced to trace the Fed’s decision of monetary easing to prevent unwanted
currency appreciation i.e. an “international currency war” with emerging economies trying to avoid
the appreciation of their currencies in order to support the growth of exports in a challenging global
economic environment
9 The search for yield, growth and inflation protection is likely to continue
19
Source: IMF, KFHR
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