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The China Syndrome – how volatility is affecting Asean
Capital Markets
<p>The Risks to Asia from China's Financial Volatility</p> <p>The economic slowdown in China and accompanying volatility in its financial markets is wreaking havoc in many parts of the global economy as the country’s demand for commodities and other manufacturing inputs wanes. Many countries in East and Southeast Asia are on the front lines of this shift and were immediately affected by the devaluation of the yuan. In this [email protected] interview, Wharton finance professor Franklin Allen outlines the risks hanging over the region and global economy.  </p> <p>An edited transcript of the conversation appears below.</p> <p>[email protected]: I want to welcome Wharton finance professor, Franklin Allen, who is also a professor of finance and economics at Imperial College in London. He is also executive director of the Brevan Howard Center there.</p> <p>I want to discuss how the situation in China, particularly the devaluation, is affecting East and Southeast Asia. We see the uncertainty in China as having widespread effects. Commodity prices are down, and countries that supply commodities and other goods to China, like Indonesia, are feeling the effects. Many Asian currencies are at multi-year lows against the dollar — the Malaysian ringgit, for example, is down 23% against the dollar this year. Other Asian exporting countries are responding in kind.</p> <p>For some, this brings back bad memories of the late 1990s Asian financial crisis. Now, many of those countries have made important changes to guard against the kind of problems they had back then. More have floating currencies, larger foreign exchange reserves, better banking rules and debt insurance. Still, the pressures seem to be mounting. What are the risks of an intensifying currency war or a financial crisis?</p> <p>Franklin Allen: First of all, the devaluation [in China] itself of course was not very big. It was 3% or so, but it did have a big trigger. There is a sense that we don’t really know what the exchange rate should be. The real issue is what are capital flows going to be like once they start reducing capital controls. That is the big uncertainty.</p> <p>This move — one of the reasons it may have had so much impact is that people realize that [the Chinese] are serious about globalizing, and becoming part of the global financial system. The IMF has been asking them to move towards a freer float and many people have been asking the same thing. This was a sign that they were going to do that and suggests that over the next year or two, or few years, they are going to really change the way they interact with the global economy.There are worries about how that is quite going to play out that helps trigger so much of the turmoil that we saw.</p> <p>It is a very different situation than it was in the mid- to late 1990s, and I don’t know how things are going to go from here going forward. A lot depends on what happens with interest rates in the U.S., and not just in terms of whether it [a rate increase by the Fed] is now, or three months from now, or six months from now, or whenever they start raising rates, but it is about how far is that process going to go, how much money is going to float back from emerging economies in to the U.S. And if the Europeans eventually get through with their quantitative easing, how much will go back to Europe.</p> <p>These are all big uncertainties, and that is why markets are so volatile at t</p>
Should emerging market investors fight the Fed?
Capital Markets
<p>KEY TAKEAWAYS</p> <p>· Fighting the Fed may be a winnable battle for EM.</p> <p>· EM valuations are compelling and, in our view, have priced in a fair amount of risk.</p> <p>· We see sufficient upside potential to maintain modest EM equity allocations despite significant growth challenges.</p> <p>· We expect the Fed to hike rates in December 2015, although it could come earlier — as soon as this week — or potentially slip into early 2016. For our latest thoughts on the Fed, please see our latest Weekly Economic Commentary and Bond Market Perspectives.</p> <p>Emerging market stocks have not won much lately, but the Fed may be a winnable fight. The Federal Reserve, which announces its policy decision on September 17, 2015, is on the verge of starting a rate hike cycle for the first time in more than 10 years. We have previously written that the start of Fed rate hikes has not marked an impending end to bull markets for U.S. stocks (despite the popular Wall Street adage “don’t fight the Fed.”) In reality, the first rate hike has told us we are about halfway through the cycle as discussed in our Weekly Market Commentary of August 25, 2014.</p> <p>But what about emerging markets (EM)? Aren’t these markets more dependent on low interest rates and stimulative monetary policy? Here we look at how EM has performed leading up to and after the start of prior Fed rate hike campaigns. While historical data are limited, we believe this exercise may steer EM investors to consider “fighting the Fed.”</p> <p>WALK DOWN MEMORY LANE</p> <p>Before we take a walk down memory lane to assess how emerging markets equities might handle Fed rate hikes, some context is important. EM has performed poorly for five years now, having underperformed the S&amp;P 500 by more than 50 percentage points during that period [Figure 1]. Tighter expected monetary policy is among the factors that contributed to this weakness. But we would argue that EM’s struggles go much deeper than that and can mostly be explained by other factors as we discuss below.</p> <p>It is evident from looking back at performance during the “Taper Tantrum” during May through July 2013 (annotated in Figure 1) that Fed fears contributed to EM weakness. In May 2013, the Fed announced it would taper bond purchases associated with its quantitative easing program, which caused rate hike fears to intensify sending the 10-year Treasury yield more than 100 basis points (1%) higher in only about eight weeks. This period, during which EM underperformed the S&amp;P 500 by about 12 percentage points, provided a reminder that EM had become somewhat dependent on low interest rates associated with quantitative easing. But as the figure shows, this was just a blip within a prolonged and much more significant period of weakness.</p> <p>International and emerging markets investing involves special risks, such as currency fluctuation and political instability, and may not be suitable for all investors.</p> <p>So should investors sell EM because of the Taper Tantrum? Not necessarily. We have two Fed rate hike cycles to assess (1990s and 2000s) for a more complete picture and EM generally performed well around both of them as shown in Figure 2. (Note that the MSCI Emerging Markets Index only goes back to the late 1980s.)</p>
Weekend Scan: Syriza victorious in Greece; Pope meets Castro; US to accept more refugees
Capital Markets
<p>&nbsp;</p> <p>While you were enjoying the first days of fall, the Pope was touring Cuba and Greeks held elections. Here's what you need to know:</p> <p>U.S. to accept 100,000 refugees annually. Secretary of State John Kerry says the U.S. must do its bit to help Europe with the migration crisis. He was meeting in Berlin to discuss the problem. Wall Street Journal (paywall)</p> <p>The Pope meets Fidel Castro. After addressing tens of thousands in Revolution Square, the Pope had an informal meeting with the ailing Cuban revolutionary. The pair exchanged books. BBC</p> <p>Syriza claims victory. The far left party fell short of a majority but the Independent Greeks said they would help forge a colaition. At last count, Syriza had 35% of the vote and New Democracy 28%. Syriza famously rebuffed a European bailout that it said was too onerous only to turn around and accept an even more austere offer to keep it from falling into economic oblivion. BBC</p> <p>Ben Carson says Muslims should not be president. The GOP candidate says the Muslim faith doesn't vibe with American principles."I would not advocate that we put a Muslim in charge of this nation. I absolutely would not agree with that," Carson told NBC's "Meet the Press." Reuters<br />  More GOP  controversy as Trump bails out of public appearance. The Donald was a no-show at a South Carolina event after he failed refute comments at another event that President Obama is a Muslim and "not even an American." He begged off saying he had to attend to a major business deal. The Hill</p> <p>Died: Romance novelist Jackie Collins at age 77. The legendary chronicler of Hollywood sex and glamour died on Saturday in Los Angeles after a private struggle with breast cancer. Variety</p> <p>Concorde could fly again. A group of British enthusiasts says it has raised enough money to buy a Concorde with the aim of getting it flying again by 2019. Club Concorde, made up of former captains, charterers and aviation fans, says it has £120m in reserve for the "return to flight" plan.<br /> BBC.</p> <p>Photo: Republic of Korea</p>
Daily Scan: Asian markets end mixed; Greek bonds skyrocket on Tsipras win
Capital Markets
<p>Updated throughout the day</p> <p>September 21</p> <p>Good evening everyone. Asian shares ended mixed today amidst a bloodbath in financial and energy stocks. Mainland China was among those which managed to put on some points on the board, Hong Kong and South Korea, not so much:</p> <p> SHCOMP: +1.89%<br /> SZCOMP: +3.55%<br /> Hang Seng Index: -1.10%<br /> Hang Seng China Enterprises Index: +1.74%<br /> Straits Times Index: -0.02%<br /> KOSPI: -1.57%</p> <p>The European markets meanwhile are trading mostly higher at the moment with the FTSE 100 nudging up 0.3%, the CAC climbing 0.4%, while the DAX – perhaps unhappy that Tsipras won the election – is currently down 0.7%. Here’s what else you need to know:</p> <p>Greek bond yields head lower. With Alexis Tsipras victorious – and the Syriza party forced to work alongside the right-wing Independent Greeks – the Greek 10-year bond yield fell a full basis point to 8.22%. Greek banking shares meanwhile have rebounded 76% from its August lows – an awesome showing for a beaten-down sector. It’s still down 81% year on year though. Financial Times (paywall)</p> <p>Malaysian police confirm body of missing DPP. Anthony Kevin Morais, a Deputy Head of the Attorney-General's Chambers Appellate and Trial Division that had worked on the 1MDB task force, has been identified as the man found dead in a drum filled with concrete in Subang Jaya, Selangor. Channel News Asia</p> <p>China, Russia team up to build airliners. Yury Slyusar, president of the Russian state-controlled United Aircraft Corp (UAC), was quoted saying that the UAC and the state-backed Commercial Aircraft Corp of China are on the cusp of working together to build wide-body airliners. Reuters</p> <p>Chinese business sentiment hits market rout lows. The MNI China Business Indicator, one of the most closely-watched business sentiment surveys, fell to 51.3 in September -- a reading 8.4% lower than August's figure and a low unseen since July’s market rout. Much worse however, is the fact that future expectations fell to its lowest level since 2007. Financial Times (paywall)</p> <p>China home sales head for the moon. Existing home sales in China reportedly grew 115% from the year before, but can the nation be able to sustain it? The Telegraph</p> <p>Companies accelerate use of carbon pricing.The number of companies putting a price on their carbon pollution has risen sharply in the past 12 months as governments prepare to agree on tougher action to combat climate change later this year. General Motors, Glencore, and Cathay Pacific are among 437 companies reporting the use of carbon pricing measures to environmental data group CDP. Financial Times</p> <p>Apple’s China apps hacked. Some of the most popular Chinese names in Apple Inc.’s App Store were found to be infected with malicious software in what is being described as a first-of-its-kind security breach, exposing a rare vulnerability in Apple’s mobile platform, according to multiple researchers. </p>
Two behemoths clash for title of biggest bond ETF
Asset Management
<p>On a global basis last year, investors pumped a record $81.9 billion into fixed-income exchange-traded funds. Despite all the talk about the Federal Reserve possibility raising interest rates, investors' enthusiasm for bond ETFs has not waned in 2015, as such funds have attracted over $44 billion in new assets as of the end of July.</p> <p>Momentum for bond ETFs has also significantly increased during the current quarter. On a year-to-date basis, just one fixed income fund, the iShares Barclays 1-3 Year Treasry Bnd Fd (NYSE: SHY) is among the top 10 asset-gathering ETFs. However, in the third quarter, six of the top 10 asset-gathering ETFs, including SHY, are bond funds.<br /> Bond Funds<br /> Another member of that group of six is the ...</p> <p>Full story available on Benzinga.com<br /> Photo: Edward Dalmulder</p>
Robert Sechan, Steven Tananbaum and Anthony Scaramucci On 'Post-Economic Traumatic Stress' – or, the decline of Lehman
Asset Management
<p>&nbsp;</p> <p>&nbsp;</p> <p> Benzinga got a sneak peek of this Sunday’s Wall Street Week show.</p> <p> This week’s guests will be Mary Deatherage, managing director at Morgan Stanley Private Wealth Management; Robert Sechan, managing director at UBS; Steven Tananbaum, managing partner and CIO at GoldenTree Asset Management.<br /> Host Anthony Scaramucci believes “post-economic traumatic stress” is upon the investment world; SEchan and Tananbaum supplement the discussion with their lessons learned from Lehman.</p> <p>&nbsp;</p> <p>“Did Lehman’s bankruptcy throw us into oblivion?” Skybridge Capital’s Scaramucci asked.</p> <p>Sechan responded, “Well, I do not. I think what happened was...Bear Stearns happened. It created a general market assumption that every bank out there was too big to fail. And then, when Lehman was let under, all hell broke loose.”</p> <p>Tananbaum ...</p> <p>Full story available on Benzinga.com</p> <p>Photo: World Economic Forum</p>
Immigrants: Why Merkel opened up the flood gates
Asset Management
<p>The Fed Punts Again<br /> The Demographic Realities of the European Immigration Crisis<br /> A New East-West Rift<br /> Merkel Has a Plan<br /> Newfound Sympathy<br /> Detroit, Toronto, NYC?, and Coconut Grove<br /> “The European Project has very little economic and political capital left to defend it if anything goes wrong now. As Mr Juncker says, the bell tolls.”<br /> – Ambrose Evans-Pritchard<br /> Perhaps I should issue a storm warning for this letter. Maybe it’s because I had major gum surgery on my entire lower jaw this week and am in a bit of discomfort, but as I read the news coming through my inbox, it’s not helping my mood. This week’s letter will focus on the immigration crisis in Europe – after I muse on what I think is the very disturbing aftermath of this week’s Federal Reserve meeting.</p> <p>It wasn’t a shock that the Federal Reserve did not raise rates. Even the most inside of insiders said the odds were at most 50-50. Those Wall Street Journal reporters who have an “inside ear” at the Federal Reserve all indicated there would be no rate increase. The IMF and the World Bank were pounding the table, declaring that it was inappropriate to raise rates now, and although most FOMC members give lip service to the fact that Federal Reserve policy is to be based solely on domestic considerations, global concerns may well have played a role in their decision.</p> <p>What surprised me was the aggressively dovish stance taken by Yellen in her press conference and in the press release. It would have been one thing to come out and say, “We’re not going to raise rates at this meeting, but conditions are getting better, so get ready,” so that the market could have a little certainty. The statement we got instead, combined with early data from the quarter, is making me rethink my entire view on the timing of an interest rate increase.</p> <p>My immediate reaction upon reading the press release was almost perfectly echoed by my good friend Peter Boockvar of the Lindsey Group):<br /> The Fed punts AGAIN on a new set of excuses, and I'm sorry to many<br /> The Fed punted AGAIN and thus are inviting us to the daily obsession of when they eventually will hike for another 6 weeks. While the economic commentary on the US was not much different than the last statement, they added “recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term.” They see the risks to the outlook for economic activity and the labor market as nearly balanced but [are] “monitoring developments abroad.” Jeff Lacker is the only one that stood out fr</p>
Video: ICYMI -- The Janet Yellen press conference post FOMC rate decision
Capital Markets
<p>Chair Janet Yellen read a statement on Thursday, September 17 after the Federal Reserve decided to stand pat on interest rates. She then fielded questions from reporters. Do you agree with the way the press portrayed the Fed decision? Anything in this hour-long video that surprises you?</p>
Fed leaves interest rates unchanged: Four insights from Loomis Sayles
Asset Management
<p>Editor's note:  Loomis Sayles asked members of its staff to explain how they interpret the recent Federal Reserve decision to let interest rates stay near zero percent. Here is what they said:</p> <p>Plans for normalization deferred, not derailed</p> <p>"Today the FOMC signaled that plans for interest rate normalization are deferred but not yet derailed. It's difficult to categorize this outcome as a genuine surprise. While the rate decision and accompanying policy statement were no doubt dovish relative to expectations, the so called "dot plot" reveals that the median Fed member sees that interest rate normalization, once begun, is expected to proceed at the same pace as was expected in June. The expected medium-term path for rates beyond lift-off is little changed. While recent international developments and associated market volatility have increased near-term uncertainty, these developments have not altered the Fed's fundamental outlook."</p> <p>- Michael Gladchun, Fixed Income Trader</p> <p>The Fed is right not to add fuel to the fire</p> <p>"The Fed pointed to "recent global and financial developments" as key reasons for maintaining the status quo. They have been flagging the risks associated with a slowing China and the turmoil in other emerging markets. We believe the Fed is right to not add fuel to that fire, especially since a wait-and-see approach does not present risks to the US economy, which shows no inflationary pressures.</p> <p>China is the main external concern. The good news: the market seems to be pricing in a hard landing for China based upon price actions witnessed in the commodity and emerging markets sectors. Downside from here would require an even worse case economic scenario, which seems less likely. The bad news: we have not yet observed an inflection point in the economic deceleration taking place in China and other emerging markets. Both the financial markets and the Fed will be sifting through the tea leaves in coming months to see if these trouble spots start to show signs of improving. It should show up in trade and credit data first. Until then, expect the markets to be jittery and volatile."</p> <p>- Matt Eagan, Portfolio Manager</p> <p>Stocks poised for further recovery</p> <p>"In my view, whether the Fed raised rates at this meeting or not, stocks are poised for further recovery later this year and have the potential to reach new highs in 2016.</p> <p>S&amp;P 500 earnings have been tamped down by weakness in the energy and commodity sectors. Multinationals could see less adverse currency impact in the first half of next year depending on the extent to which the Fed holds rates steady, leading to less upward pressure on the dollar."</p> <p>- Richard Skaggs, Senior Equity Strategist</p> <p>Company performance will matter most</p> <p>"Equity valuations are much more sensitive to long-term interest rates than to short-term Federal Reserve rate actions. If inflation remains relatively low and long-term rates remain supportive, company performance will matter most to equities.</p> <p>Global equities have been more volatile in recent weeks with emerging markets being one source of heightened concern. The Federal Reserve cited global developments in today's statement; we will continue to watch developments offshore just as intently as developments within the US for direction during the balance of the year."</p> <p>- Craig Burelle, Macro Strategies Research Analyst</p> <p>MALR013940</p> <p>This blog post is provided for informational purposes only and should not be construed as investment advice. Any opinions or forecasts contained herei</p>
Credit risk a bigger problem for emerging markets than higher rates
Capital Markets
<p>The Wall Street Journal recently had a lead article with the headline “Higher Rates A Risk for Emerging Markets.” The implication of the headline—and of much of the article—was that a general rise in interest rates—even a small one such as the Fed soon may generate—poses a danger to EM nations and companies.</p> <p>Frankly, that idea totally misses the point: EM nations and companies have borrowed in dollars and euros that they may not be able to repay in a slower global economy where they will not earn the foreign exchange they will need in order to so. The result is a classic credit risk problem.</p> <p>The Fed may raise short-term rate by a quarter percent—maybe even by a quarter percent a couple of times. Those quarter percents mean nothing when the interest rate on existing borrowings is LIBOR plus 3 and the new credit conditions may require the EM nation or company to pay LIBOR plus 4 or 5—or even more—in order to get credit at all. Brazil, for example, has been downgraded to junk by S&amp;P. That is not interest rates rising; that is the Brazilian economy going in the tank.</p> <p>The WSJ article itself tells us that the issue is credit risk. It has a nice set of graphs at the end (the beginning in the online edition) that it discusses hardly at all. The graphs show that for EM loans in its sample, the margin over LIBOR is 2.5 percentage points, up from 1.2 in 2005. By contrast, six-month LIBOR itself has moved only from .5% in 2013 down to a little over .3% in 2014, back to a little over .5% now. Basically, nothing has happened to general interest rates. It is credit risk that has been changing—and that will continue to change, perhaps at an accelerating pace. The loans were made when EM economies looked strong and the financial world was reaching for yield. Now the EM economies look weaker. Simple story.</p> <p>Real market turmoil comes from credit risk. We might see some of it.<br /> Photo: Global Panorama</p>