Tag Archives: FED

Emerging Markets in Emergency Mode

Despite how much we prayed for a peaceful and prosperous year, 2014 has started off with a crisis; this time in the Emerging Markets. In a previous Economy in Digits post, I had discussed how India and Turkey had responded to large losses in the value of their currencies by raising interest rates. In the following days, the sell-off in stocks and currencies extended to other Emerging Markets. If you’d like to get a better understanding of Emerging Markets, feel free to check out one of my earlier posts regarding upcoming Emerging Market elections, which I will touch on shortly. As you can see from the following graph provided by Bloomberg, the MSCI has been performing very poorly. Lets take a look at what is causing all this mess in the countries that not so long ago were deemed to lead the world out of the global economic crisis.

emerging markets index

The first reason for the rapid sell off of Emerging Market stocks is a topic that my regular readers might be getting sick of hearing, but its tapering. The main reason why most Emerging Markets fared so well after the economic crisis of 2008 was that central banks in developed nations pushed interest rates to almost 0%. Seeing as how they would make almost no money on investing in developed countries, investors sent their money to do its magic in Emerging Markets where interest rates are higher. Combined with an increase in price of global commodities, which is an important source of income for many Emerging Markets, the inflow of foreign funds caused Emerging Market economies to skyrocket. However, in the last week of January, the FED decided to continue tapering by reducing its bond purchase program by another $10 billion. This is causing interest rates to rise in developed markets, especially in the United States. Thus, investors are now doing the opposite of what they did in 2008 and are now pulling their money away from Emerging Markets and are putting their cash back in developed markets such as the US and the UK.

Another reason why Emerging Markets are in trouble is because of China. China had been the poster child of Emerging Market success in the past several years. However, as the country reaches a limit on urbanization and its population transitions from rural to middle class, the government has had to enact reforms that inevitably slow down the Chinese economy. Combined with the fact that the Chinese government has also tried to reduce credit in the Chinese economy due to fears of a credit bubble, some investors now fear of a “hard landing” for the Chinese economy. These fears were strengthened in the final week of January as Chinese officials announced that the country’s Purchasing Mangers Index (PMI), a monthly manufacturing report that surveys private manufacturers, contracted for the first time since 2008.The reason why China is so crucial to other Emerging Market nations is that China is one of the world’s largest importer of commodities. On the other hand, most Emerging Markets are net exporters of commodities. Thus a slowdown in China would mean less demand for commodities from other Emerging Markets, causing a chained slow down across all Emerging Market nations. Here is a video that further breaks down whats going on in China.

Finally, we have the isolated incidents across individual Emerging Markets. In an earlier post, I discussed the political crisis created from a corruption probe in Turkey and rampant inflation in India. However, other Emerging Markets have also had their own troubles. Thailand has been in social and political turmoil since November of last year. Protesters have taken to the streets across Thailand to force Prime Minister Yingluck Shinawatra to resign and postpone the elections that was supposed to occur in the beginning of this month. Protesters see Mrs. Yingluck’s regime as corrupt and wishes her to reform the Thai political structure before elections are held again. In fact protesters managed to postpone the elections which were planned on February 2nd. To learn more about the events in Thailand, feel free to read more about it on the BBC.

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To make matters a tad bit worse, as if it wasn’t bad enough already, the Argentinian economy is rapidly deteriorating. On February 13, Argentinian inflation was announced to be at 44%. That is at levels where one would call it hyperinflation. Argentina had once been a prosperous nation. But a crisis in 2001 has left it with naively populist governments that have slowly shut itself out of global capital markets. The gradual downfall of the Argentinian economy is an issue I will cover in another post but for now check out this post by the Economist to get a better understanding.

So what happens now? Are Emerging Markets doomed for eternal decline? First of all, even though most people like to lump all Emerging Markets together, not all countries are the same and not all have suffered greatly over the past couple of months. In fact, in January, shares in the MSCI Indonesia rose by 4.6% while the market in the Philippines gained 2.4%. These countries have done well to turn the money that was invested in their economies into long term growth opportunities that improve their trade balances over the long run and increase the education and productivity of their population. However, many of the Emerging Markets  that experienced rapid economic growth in 2010 and 2010 were fueled by short term foreign investments and increasing consumer demand which required constant to satisfy. As foreign investors pull out and domestic demand cools, these economies will start looking back to 2010 and 2011 as the glory years of the past. Countries such as Turkey, India and Brazil, which were on the verge of double digit growth back in those years will now find it difficult to reach 4% let alone 5% growth. Even though Emerging Markets may not collapse and fall out of favor with all investors, I think the markets in these nations will revert to a new normal which is slower growth.

“So much of what happened to India late last year and early into 2011 is the same story we’ve seen with other big emerging markets, and that is that investors started to realize that the growth trajectory in India would have to get moderated by tightening policy.”
-Jerrry A. Webman

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Video of the Week – Taper Continues

This video does a great job to explain what I wanted to talk about from the previous week. However, I know you’d be devastated if you didn’t get a taste of my elegant writing. Have no fear.

As he passed the torch to Janet Yellen, Ben Bernanke announced in his last FOMC meeting that the FED would continue tapering QE by decreasing the bond buying program by another $10 billion. This brings the total of the program down to $65 billion of treasury bonds and mortgage-backed securities. FED officials decided that the American economy is strong enough for a second round of tapering, despite recent mediocre data including a weak jobs report.

Once again, this second step of tapering will end up lowering US stock markets, raising interest rates in the United States and appreciating the US Dollar in value against other currencies. This is having a profound on effect on Emerging Markets such as Turkey and South Africa where a devaluing currency and a rise in American interest rates is causing investors to flee those markets. In response, Emerging Markets have resorted to raising interest rates but so far they have not been able to regain the losses to the value of their currencies. In response to the effects that tapering is having on foreign countries, FED officials have stated that their priority is to maintain the strength of the American economy and tthat if they succeed, then Emerging Markets would fare better off as well.

“Most projects start out slowly – and then sort of taper off.”
-Norman Ralph Augustine

The Economy in Digits – 12/28/2013

Welcome to this week’s edition of the Economy in Digits. Without further adieu, here are the economic highlights from the week ending December 28th.

United States

Pending home sales, which measures contracts to purchase previously owned sales, rose less than forecast in the month of November. Pending home sales rose only 0.2% whereas economists had predicted a rise of 1%. This indicates that rising borrowing costs due to the FED tapering its asset purchases is resulting in a slowdown in the residential real estate market. When compared with the previous year, pending home sales have fallen 4%. The graph below displays an aggregate of 30 year mortgage rates in the United States. As you can see, mortgage rates dropped after 2008 but have recently been picking up.

fredgraph (3)

Since the start of the financial crisis, the US government and the FED had been artificially supporting the housing market. For example, the FED’s Quantitative Easing program had been purchasing $40 billion of mortgage backed securities since last year, leading to an artificial decrease in mortgage rates. The recent indicators displaying a slowdown in the housing sector points to the fact that the housing market is returning to its fundamental levels instead of being inflated by external factors.

Japan

In response to Prime Minister Shinzo Abe’s expansionary monetary and fiscal policy, Japanese inflation (measured by the Consumer Price Index) increased by 1.2% over the previous year, which is the largest increase over the last 5 years. In an effort to bring Japan out of a two decade long era of slow growth and deflation, Shinzo Abe promised to stimulate the Japanese economy and increase inflation with massive fiscal and monetary easing. The recent inflation figure indicates that Abenomics, as some have labeled this policy, seems to be working. The graph below depicts Japanese CPI since 2010.

japan-consumer-price-index-cpi

But as I had stated in the previous Economy in Digits post, not everything is clear sailing for the land of the rising sun yet. Monetary and fiscal stimulus devalues a nation’s currency. This usually has the effect of increasing exports. But because Japan imports a majority of its energy, devaluing its currency has the effect of increasing the value of its imports too. Additionally, the Japanese government is expected to implement a tax hike later this year which could weaken demand and bring inflation back down again.

China

Ever since the Chinese Communist Party first started opening up China’s economy to the world and adopting free market principles under the leadership of Deng Xiapoing in the 1908s, China had been experiencing extremely rapid growth,  As you can see from the graph below GDP growth had been almost 10% on average over the last decade. But over the past few years, as China enters the final stages of its transformation from a rural to an urban economy and implements the reforms to become a middle class nation, its economy has started to slow down. With that in mind, the Chinese government announced last Tuesday that their target GDP growth for 2014 would be 7.5%. As you can see from the graph below, if you exclude the crisis of 2008, 7.5% is lower than the growth numbers that China used to produce in the past. However, Chinese President Xi Jinping has promised to continue to reform the Chinese economy and the Chinese society. In line with that promise, Chinese officials have stated that they are confident that maintaining a 7.5% growth rate will help keep creating more jobs, while providing room to deepen reforms as well.

china-gdp-growth-annual

That is all for this week ladies and gentlemen. I was late in posting this week’s Economy in Digits due to an exam I had to take on Sunday. But I can assure you that it won’t happen again. So tune in next Saturday for the upcoming week’s economic indicators.

“The economy isn’t some vengeful being that takes things away from us. The economy is just made up of people, and people have just lost their faith in it. What people really should be doing is spending more. Spending is fine. People should just go outside. People should just go outside. They should buy the things they need for their friends and family”
Kyle Broflowski

Video of the Week – Fed Tapers

On December 18th, following the final FED Open Market Committee meeting of the year, Ben Bernanke announced that the FED will finally begin ‘tapering’ its asset purchase program. Under the title of Quantitative Easing (QE), the FED had been purchasing $85 billion of treasury bonds and mortgage backed securities each month. However, after multiple indications that the US economy is hastening its recovery, the FED has decided to reduce that purchase by $10 billion to $75 billion per month.

Because this decision wasn’t unexpected and because it was only a modest reduction in asset purchases, stocks responded positively to the announcement. The Dow Jones Industrial Index rallied by 293 points to an all time high of 16,167.97.

As long as unemployment and GDP numbers keep improving, the FED is expected to keep gradually reducing its asset purchases in order to continue shrinking its balance sheet. Nevertheless, Bernanke states that the FED will still keep interest rates at near zero levels as long as unemployment exceeds 6.5%, which should be till sometime in late 2014 or early 2015.

On a final note, this was Ben Bernanke’s last FOMC meeting and press conference as FED Chairman. Janet Yellen will be taking over from Bernanke on January 31st of 2014. When asked about how he views his performance over the last 8 years, Bernanke said, “I hope I live long enough to read the textbooks.”

“Monetary policy cannot do much about long-run growth, all we can try to do is to try to smooth out periods where the economy is depressed because of lack of demand.”
-Ben Bernanke

Video of the Week – Janet Yellen Nominated as FED Chair

Ladies and gentlemen, its official.

As many, including myself, had predicted, Janet Yellen has been nominated by President Obama to be next chairman of the Federal Reserve. Her nomination was almost a done deal when Larry Summers withdrew himself from the race. Since investors predict that Yellen will continue Ben Bernanke’s accommodative monetary policies, stocks rallied across America and emerging markets when the nomination was officially announced.

Video of the Week – FED Does Not Taper

Unfortunately, I’m two days late in posting the Video of the Week. I was out of town and did not have access to the internet. But better late than never.

When I was first writing this post, I went into great detail to explain Quantitative Easing (QE) for those of you that might not be familiar with it. QE is basically a bond buying program first enacted by the Federal Reserve in 2008 in order to help the US economy recover. If you have no clue what QE is, instead of me rambling on and on, I think it would be better if you watch this short and simple explanatory video by Marketplace. Its actually quite entertaining.

Bernanke stated in May of this year that because of the positive trend in US economic performance, the FED was contemplating reducing, or as Bernanke put it “tapering” the level of QE later this year. There are key indicators that the FED takes into account.

1) The Unemployment Rate
When the latest  version of QE was announced in September of 2012, the FED stated that they would end the program when the unemployment rate fell to 6.5%. Since the start of the financial crisis, unemployment has fallen from a peak of 10% in 2009 to 7.6% as of last month.

2) Inflation
Many critics of QE thought the excess money in the economy would cause inflation to rocket. However, since 2008, inflation has remained low. The FED also stated that they would maintain QE as long as inflation remained below 2%.

3) Manufacturing, Housing, Stock Markets
Manufacturing indices, housing starts and prices, and the stock markets have all experienced an upward trend since 2008. The indicators to observe here are the ISM Manufacturing Index, the S%P/Case Shiller House Price Index, and the S%P 500 stock market index

Thus, markets were expecting a taper announcement after the FED’s Open Market Committee meeting last week. However, as the Video of the Week shows, Bernanke decided to carry on full speed and not taper QE. Well why did Captain Picard with an awesome beard do this? As he says in his speech, despite the positive outlook, the US economy. still faces some issues.

Firstly, even though the unemployment rate has been dropping steadily, the labor force participation rate has actually declined. This means that one of the reasons that the unemployment rate is falling is because more and more people are giving up on looking for a job. Thus they are dropping out of the labor force. Due to the way the unemployment rate is calculated, these people are taken out of the unemployment rate.

Secondly, inflation is still well below the FED’s 2% objective. If FED reduces QE, inflation might drop even further and this might eventually lead to deflation, which is a lot worse.

Finally, there is still ongoing debates in Congress regarding the debt ceiling which provides an onset of risk on the US economy.

“But why does this all matter?” you might ask. “I want the 4 minutes back I spent to read this post so I can watch Youtube videos of cats” you might say. Well,  Bernanke’s speech caused the US Dollar to lose value in the currency markets, the stock market to rise, and bond yields to drop. How do I know this? Well the S&P 500 index rocketed, not to mention stock markets around the world. Additionally, the US dollar gained in value versus other currencies, and the interest rate on Treasury bonds fell. However, make no mistake. This is only temporary. The taper is inevitable. The US economy is slowly and steadily improving. The FED will taper and sooner or later end QE. This will have the opposite effect of what happened this week. The US Dollar will gain in value, stock markets will face a downward risk, and interest rates will rise.

“Whatever the Federal Open Market Committee may say now about its plans for 2014 or 2015, it can always do something different when the future turns into the present.”
-Paul Krugman

Larry Summers Throws in the Towel

Down goes Summers! Down goes Summers!

Several days ago, I had written a post about the candidates that were in consideration to become the new FED chairman after Ben Bernanke. The two leading candidates were Federal Reserve Vice Chairwoman Janet Yelen and renowned economist Larry Summers. But on Sunday, Larry Summers stated to President Obama that he would be dropping out of the race.

"I was too sleepy to be FED Chairman anyway"
“I was too sleepy to be FED Chairman anyway”

 “I have reluctantly concluded that any possible confirmation process for me would be acrimonious and would not serve the interest of the Federal Reserve, the Administration or, ultimately, the interests of the nation’s ongoing economic recovery,” stated Larry Summers in his letter to President Obama

That sounds so noble but let me translate that for all of you.

“There is no chance of me becoming the next FED chairman so I’m throwing in the towel” is what Larry Summers really meant to say. If you think I’m being too cruel, allow me to explain.

The process for electing the chairman of the Federal Reserve is as follows: the President elects a nominee which is then voted on by the Senate Banking Committee. On Friday, senator Jon Tester of Montana became the fourth Democratic senator on the Senate Banking Committee that stated that they would not support Larry Summers. The other three dissenting Democratic senators are Elizabeth Warren from Massachusetts, Sherrod Brown from Ohio, and Jeff Merkley from Oregon. The reason why so many liberal Democratic senators dislike Larry Summers is because they believe that his policies of deregulating the financial markets in the 1990s (as President Clinton’s Treasury Secretary) caused the economic crisis of 2008. In order for the Senate Banking Committee to vote in favor of Summers, Obama would have to lobby votes from Republican senators and that is something he doesn’t have the time or leverage to do right now.

Thus, with Summers out of the picture, Janet Yelen appears to become an even greater favorite to become the next and first FED chairwoman. Her resume checks many boxes. She has experience with working in the FED, she would be the first woman FED chairman, and her support of quantitative easing is supported by Wall Street investors. Now recall that quantitative easing is the FED policy of pumping money into financial markets. Summers had at times spoken against this policy. Therefore it wasn’t a big surprise that the stock market increased following the news that Summers had dropped out of the race. It must be a horrible day for any person if you decided to give up on your dream and the financial markets rejoice.

A final candidate for the job is Fed Vice Chair Donald Kohn. Additionally, Timothy Geithner, the former Treasury Secretary under Obama’s first term, was also listed as a possible candidate. However, Geithner had turned the job down. Thus, Janet Yelen appears to likely be the next FED chairman.

 In honor of Larry Summers, we remember him one last time by taking a look at his most memorable moments courtesy of Bloomberg.

“There are children who are working in textile businesses in Asia who would be prostitutes on the streets if they did not have those jobs.”
-Larry Summers