What’s Good for U.S.-China-Japan Hurts Emerging Markets
What’s good for the global economy’s superpowers risks creating losers in other parts of the world.
Signs that the Federal Reserve is preparing to curtail its stimulus are boosting interest rates abroad as well as in the U.S. The strictest credit squeeze in China in at least a decade threatens to erode a pillar of international growth. Japan’s reflation push is lifting the exchange rates of trade rivals and luring capital.
While the transitions could mean slower growth in the U.S. and China, they ultimately prime the three biggest economies for less volatile and longer-lasting expansions. Losers for now include the emerging markets and commodity producers previously buoyed by easy U.S. monetary policy and Chinese demand. Economies that still need cheap cash or weaker currencies, including the euro area, also could suffer. Policy makers already are responding.
“Pieces of the world are moving, and when that happens you have frictions,” said Stephen Jen, co-founder of hedge fund SLJ Macro Partners LLP in London. “There’s more divergence, and financial markets will see more volatility.”
The shifts are reflected in today’s new International Monetary Fund forecasts, which show the gap between developed-and emerging-market growth rates will remain close to the narrowest in a decade, at 3.8 percentage points in 2013. Further undermining the trend set in the wake of the 2008 global financial crisis, the Washington-based lender cited a slowdown for emerging markets in cutting its prediction for worldwide expansion this year to 3.1 percent from 3.3 percent in April.
The new environment is leaving some emerging countries -- especially Brazil, Mexico, South Africa, Turkey and Ukraine -- vulnerable to a sudden stop in which capital flows are thrown into reverse, say economists at Morgan Stanley, who used 12 metrics including debt issuance and current accounts to measure the risk.
For all the shake-up, international policy makers have long sought such changes because of concerns about easy U.S. money, China’s outsized demand and Japan’s malaise. Group of 20 finance ministers and central bankers will assess the outlook when they gather next week for talks in Moscow.
“We are seeing significant progress in the global economy now, so people shouldn’t be worrying,” said Holger Schmieding, chief economist at Berenberg Bank in London. “The gradual return to a more balanced pattern of global growth should be good rather than bad for almost everyone in the medium term.”
The biggest source of market turmoil was the June 19 announcement by Chairman Ben S. Bernanke of a possible time frame for the Fed to begin paring its $85 billion in monthly asset purchases, starting as soon as later this year.
Since Bernanke first raised the possibility of 2013 tapering in May 22 congressional testimony, the yield on 10-year Treasury notes has risen to 2.62 percent at 10:30 a.m. in New York today from 2.04 percent, according to Bloomberg Bond Trader prices. Treasuries lost the most since 2009 in the first half of the year and posted their longest run of quarterly declines since 1999.
Jim Paulsen, chief investment strategist at Wells Capital Management, calls the gains in long-term borrowing costs a “good yield rise” because they reflect mounting confidence at the Fed and among investors in the U.S. economy. He finds that since 1967, whenever the 10-year bond yield has been below 6 percent, any increase typically has been associated with improving sentiment.
U.S. payrolls rose by 195,000 workers in June, beating analysts’ forecasts, and revisions added 70,000 jobs to the employment counts for April and May, according to Labor Department data released July 5. The jobless rate remained at 7.6 percent, near a four-year low.
If the faith continues to solidify, “higher interest rates should not materially impact economic activity, and the stock market may continue to provide favorable results,” said Paulsen, who helps manage more than $340 billion in Minneapolis. The Standard & Poor’s 500 Index has risen 15 percent this year.
Tapering “is actually healthy,” given that an expansion in the Fed’s balance sheet beyond $3 trillion has failed to spur much growth in credit or the economy, according to a June 27 report by BlackRock Inc., the world’s largest asset manager. Gross domestic product grew at a 1.8 percent annualized rate in the first quarter, revised from a previous estimate of 2.4 percent, according to Commerce Department data.
There is less room for celebration elsewhere as investors push yields up even in economies less able than the U.S. to cope with tighter credit. The decoupling is reflected in the 0.6 percent decline since May 22 in the S&P 500 Index (SPX) compared with a 3.7 percent fall in the MSCI World Index.
Countries that may suffer from unwanted yield increases include the U.K., Russia and those in the euro area’s crisis-hit periphery, said Stephen King, chief global economist at HSBC Holdings Plc in London.
The yield on Spain’s 10-year note has risen to 4.71 percent from 4.18 percent on May 22, even with the economy contracting for seven straight quarters. Portugal’s yield last week jumped above 8 percent for the first time since November as the government struggled to address crisis-fighting austerity fatigue. Ten-year U.K. government bond yields climbed to 2.59 percent on June 24, the highest since 2011.
Such gains will make it costlier for governments to finance their debt and for consumers and companies to access credit, extending the countries’ woes.
“Rather than being a sign of incipient recovery, a sudden spike in bond yields might be enough to send some economies off the rails altogether,” said King, adding that the U.S. may suffer a backlash if trade dries up as a result.
Policy makers are pushing back in the hope of persuading markets to refocus on the weakness of their economies. Mark Carney, who became governor of the Bank of England on July 1, and European Central Bank President Mario Draghi both signaled last week that they will keep interest rates low for longer than investors anticipated.
The prospect of less U.S.-led stimulus also is rocking emerging markets. Particularly prone are economies that took advantage of easy money to run up current-account deficits and borrowing imbalances, according to Michael Saunders, a Citigroup Inc. economist in London. Outside of China and the Middle East, emerging economies have aggregate current-account shortfalls of about 2 percent of GDP, the highest since the late 1990s.
Thailand (EHCATH) and China (EHCACNY) are among nations whose surpluses have shrunk, while Indonesia (EHCAIDY) and India (EHCAIN) face mounting deficit challenges. Gaps in Chile (EHCACLY) and Brazil (EHCABRY) also have grown. Meantime, average private-sector debt in South Korea, Thailand, Singapore and Indonesia has risen by 25 percentage points of GDP in the last four years, according to Citigroup.
China, Hong Kong (EHCAHK) and India are in a “high-risk danger zone” if a pullback by the Fed prompts investors to punish Asian countries that have weak economic fundamentals and are too slow to reform, according to a June 28 report from Nomura Holdings Inc.
In Europe, Hungary and Poland are at risk because foreign investors have large holdings of local-currency debt, according to Oxford Analytica, based in Oxford, England. Turkey is especially vulnerable because of its reliance on foreign cash to finance its large current-account gap at a time when political tensions are rising, the consulting company said in a report last week.
“Many emerging-market countries now face the long-absent challenge of rising capital needs with worsening fundamentals at a time when global-liquidity conditions may not be easing further,” said Citigroup’s Saunders.
That already is forcing a response as authorities from Brazil and Thailand to India and Indonesia raise interest rates, intervene in currency markets or unwind capital controls to stanch the exit of cash or limit its fallout. In doing so, they’re reversing some of the measures introduced to cope with the hot money sent their way by the loose monetary policies of recent years.
China is also in transition as its policy makers seek to rein in financial speculation and real-estate prices, signaling tolerance of a weaker expansion. Interbank borrowing costs reached records on June 20 before easing.
HSBC and Goldman Sachs Group Inc. are among those now predicting expansion of 7.4 percent this year in the world’s second-largest economy, compared with Premier Li Keqiang’s 7.5 percent forecast. This would be the first miss for a government growth prediction in 15 years. Manufacturing expanded at the slowest pace in four months in June, and the economy probably eased for a second straight quarter, according to the median estimate in a Bloomberg News survey.
Chinese authorities may be trying to make economic performance more consistent after a credit surge helped propel expansion above 9 percent in recent years, said Shane Oliver, Sydney-based head of investment strategy at AMP Capital Investors Ltd. By addressing the imbalances, China also may avoid the mistake the U.S. and Europe made in not tackling excesses before they sparked crises.
“The new leadership quite clearly seems to be taking a much longer-term view on China and are prepared to take some risks that growth in the short term will disappoint in order to encourage a more balanced and sustainable economy,” he said.
Again there are likely losers, among them Australia, South Korea and Taiwan, each of which dispatches more than a quarter of its exports to China. New Australian Prime Minister Kevin Rudd is warning that the end of a China-led mining boom possibly portends recession, noting trade with China represents 10 percent of GDP.
China accounts for one-sixth of global output, estimates Julian Callow, chief international economist at Barclays Plc in London.
“But the consequences of a domestically driven Chinese slowdown would be much more significant than this implies, given China’s role as a major importer of commodities and capital goods, and in particular its role in supporting business confidence across Asia,” said Callow, who calculates China accounted for 43 percent of worldwide growth from 2007 to 2012.
While he said cheaper commodity prices would be good for advanced nations, they would hurt producers. Deutsche Bank AG analysts estimate the Chinese have accounted for about a quarter of worldwide demand for major raw materials in recent years. Chinese purchases of copper, coal, iron ore and oil are all “closely connected” to loan-growth conditions and so are at risk if the credit crunch continues, according to Bank of America Merrill Lynch analysts.
Companies and countries that produce materials for transportation, power and property development will be particularly hit, said Larry Hatheway, chief economist at UBS AG in London. More than 80 percent of the exports to China from Russia, Brazil, Australia, Canada and Indonesia are for domestic use, UBS calculates.
“If China slows, this will have a disproportionate impact on commodity producers and chunks of emerging markets,” said Hatheway. “Property and infrastructure are big uses of nickel and copper, etc, so a slowdown in China will obviously mean a pretty generalized effect on the commodity universe.”
Japan, the world’s third-largest economy, is trying to end 15 years of deflation-fighting by easing monetary and fiscal policies and pursuing deregulation. The effort overseen by Prime Minister Shinzo Abe is starting to pay off. Factory output rose the most in May since December 2011, retail sales climbed and consumer prices ended a six-month slide.
“Abenomics is aimed at ending deflation and rebuilding the nation’s fiscal health by spurring longer-term growth,” said Takuji Okubo, chief economist at Japan Macro Advisors in Tokyo. “It’s essential and seems to be on the right track.”
A byproduct is nevertheless a falling yen. The currency weakened the most in the first half of this year versus the dollar since 1982. It also dropped 12 percent against the euro and about 7 percent versus the sterling, threatening to undercut European trade.
“Japan is exporting deflation risk to Europe, increasing competitive pressures when much of Europe is suffering chronic growth deficiency,” said Lena Komileva, managing director at G+ Economics Ltd. in London.
Emerging markets again may suffer, BlackRock’s Peter Fisher said June 27 on Bloomberg Television’s “Surveillance.” While hurting exports, the weaker yen is drawing investment away from these countries and toward Japanese equities -- the Nikkei 225 (NKY) Stock Average has gained 39 percent so far this year.
“That’s a whole lot of pressure” on these nations, said Fisher, a former U.S. Treasury and Fed official.
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