Bernanke Recouples With World Offering Bond Yield Relief Abroad
Federal Reserve Chairman Ben S. Bernanke is granting his international counterparts some relief from the tighter borrowing costs he forced on them this year.
Four months of rising bond yields around the world and reduced capital flows into emerging markets were thrown into reverse by the Fed’s surprise decision yesterday not to pare its $85 billion in monthly asset buying. Yields on the bonds of Spain, France, Thailand and Turkey were among those to fall in response, and currencies including those of India and Malaysia dropped against the dollar.
Such shifts should prove welcome news for global policy makers such as Mario Draghi and India’s Raghuram Rajan after summer-time signs the Fed was set to curb monetary stimulus led investors to whip capital out of emerging markets or enforce higher interest rates on still-sluggish economies. A falling dollar and the knowledge that so-called tapering is merely postponed could check any renewal of confidence.
“It helps those central banks concerned about rising interest rates, as just maybe it will break the upward trend in bond yields,” said Peter Dixon, an economist at Commerzbank AG in London. “It will also take pressure off emerging markets although we still know tapering is coming so it may just be a short-term relief.”
Spanish and Italian bonds rose along with government debt across Europe, while yields on Thailand’s 10-year bonds fell the most since June and the rate on Turkey’s two-year note reached a two-month low. Emerging-market stocks surged, led by the biggest gain in Turkey’s shares since 2010. The currencies of Malaysia, Thailand and India all rose more than 2 percent versus the dollar.
That marked a change from recent performances when investors fretted that five years of liquidity provisions were about to start drying up. Bond prices slumped internationally and emerging-market stocks plunged after May 22 when Bernanke said for the first time the Fed could withdraw stimulus “in the next few meetings” so long as the economic outlook showed “sustainable” improvement. The declines continued even as economists pared forecasts to show Bernanke and colleagues removing $5 billion of Treasuries buying from their program ahead of yesterday’s meeting.
The decision to do nothing means emerging market policy makers should now “send flowers to Washington,” said Benoit Anne, head of emerging markets strategy at Societe Generale SA in London.
The prospect of reduced U.S. stimulus had forced central banks including those of Brazil, India, Indonesia or Turkey to raise interest rates or intervene in markets as their currencies plunged. Investors began to anticipate an eventual shift to higher U.S. interest rates or refocused on economies with large current-account deficits.
A group of the 20 most-traded emerging market currencies lost 7.4 percent between May and August, the most in two years and EPFR Global data showed more than $50 billion leaving global funds investing in emerging market debt and stocks since May. The strains led to calls from Mexico to China for the Fed to better communicate its intentions, only for U.S. officials to respond that their sole focus was their own economy’s needs.
The delay in tapering “gives emerging markets more policy room and reduces the market stress,” said Anne. “They now don’t have to intervene to defend their currencies and going forward they can anticipate a sharp deceleration in capital outflows.”
In Asia, Nomura Holdings Inc. economists said those nations with current-account gaps such as India, Indonesia and Thailand stood to benefit most from the Fed’s pause and that the diminished need to intervene should stabilize currency reserves.
“Any lift in asset prices could also create positive feedback loops on domestic consumption and investment through financial wealth, collateral and confidence channels,” said the economists including Singapore-based Rob Subbaraman in a report to clients today. “In the near term, it does seem like the stars have become more aligned for Asia’s economies.”
The region’s policy makers also now have extra time to address domestic economic fragilities. India faces the challenge of opening more industries to foreign investment; Indonesia needs to tackle domestic infrastructure weaknesses; Malaysia is running a persistent budget deficit; and Philippines has still to complete its anti-corruption campaign.
“The fact that the money train will continue for a while means the risk of a hard landing or a balance-of-payments crisis has been greatly reduced, if not averted,” Frederic Neumann, co-head of Asian economic research at HSBC Holdings Plc in Hong Kong, wrote in a note today. “Policy makers in Asia will need to use this brief window to implement structural reforms to put Asian growth on a more sustainable path.”
Still, Erik Nielsen, chief economist at UniCredit SpA, told Bloomberg Television that emerging markets should still be alert to an eventual curtailing of U.S. support, especially those with trade imbalances greater than 3 percent of gross domestic product such as India and Indonesia.
“It’s just a delay, it’s not a cancellation,” he told Bloomberg Television’s The Pulse with Guy Johnson and Anna Edwards.
Fellow Group of Seven central banks may also have reason to thank the Fed after the tapering signals led them to adopt new forms of “forward guidance” to stress they would maintain stimulus in the hope investors would differentiate their weaker economies from the U.S.
The Bank of England first said in July that recent market rate increases were “not warranted” before announcing the next month it doesn’t intend to raise its 0.5 percent benchmark rate before unemployment drops to 7 percent, something it doesn’t expect for three years.
European Central Bank President Draghi said in July gains in euro-area borrowing costs were “unwarranted” and pledged to keep the region’s key rate at 0.5 percent for an “extended period.” At Sweden’s Riksbank, there is a bias for a potential rate cut by the first half of next year.
The trouble was that with the world’s largest economy showing signs of strength and the Fed poised to act, investors questioned such commitments and pushed up bond yields, threatening to make it costlier for consumers and companies to borrow. In the U.K., for example, 10-year gilt yields climbed above 3 percent this month for the first time since July 2011. They fell to 2.85 percent today.
“It’s good news because if you think forward guidance was to stop contagion from the U.S., then this reduces the pressure,” said Gilles Moec, co-chief European economist at Deutsche Bank AG in London.
In the case of the ECB, there may be some concern that the euro’s rise to the highest since February could hamper its expansion, said Howard Archer, an economist at IHS Global Insight in London. “Improving exports is important to Europe’s recovery prospects, so a strengthening euro could hinder exports and make recovery harder.”
Today’s reverberations still show the influence of the Fed on foreign economies and markets. A report by Citigroup Inc. economists this month showed the American economy’s size means its monetary policy often sets the tone for foreign policy makers, with a 100 basis-point tightening in the U.S. translating into a rise of as much as 25 basis points over two quarters in the U.K. and the euro area.
The delay in tapering “helps, although the signal for the bond market on the way up as well as the way down continues to be from the U.S.,” said Moec, a former Bank of France official.
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