Why S&P 500 can reach the 3,000 level by 2020

We are working through a curious period in financial history during which neither capital nor labour has pricing power. Neither can generate much income. Average earnings in nominal and real terms have barely grown, while capital sits idly in cash deposits or in government bonds yielding next to nothing. Whether you are working or investing, income is hard to come by.

We know the reasons why. The power of labour to command a greater share of the economic pie has been undone around the world by policy initiatives focused on labour mobility. In most developed countries, labour’s share of GDP has been falling. Even in the US economy, which added a record 3m jobs last year, labour’s share sits at 50-year lows. Employment growth has been offset by weak wage growth. Productivity gains have passed to the owners of capital, allowing operating margins to rise.

Concurrently, the propensity of developed nations to accumulate savings faster than income growth compresses yields everywhere. Wealthy nations with excess savings and little growth, such as Japan, Germany and Italy, can only export capital, lowering yields. Central banks’ quantitative easing programmes exaggerate the yield compression. Their bond-buying further crowds these countries out of their own domestic sovereign and credit markets compounding the effects abroad.

If we are to believe economist Thomas Piketty, income will become even more prized. He argues the capital/income ratio is set to rise for the rest of this century. Private capital stands at 450 per cent of income today and is set to approach 700 per cent by 2100. Net savings (after capital appreciation) are currently rising approximately twice as fast as income. An ageing population will constrain income growth, and further exaggerate the problem, even as rates of return decline. Mr Piketty describes a world in which too much capital chases too little income.

So in this financial climate how would we value an asset class that offered a current real yield and that had consistently increased its income in double digits each year? Highly, one might think.

And yet this is precisely what the S&P 500 has offered. At the close of the third quarter of 2014, the S&P 500 notched up its 15th consecutive quarter of double-digit dividend growth. Dividend per share growth over 12 months to the third quarter of 2014 was 11.3 per cent. Over the 15-quarter period, dividends per share have averaged 14.2 per cent growth. It is little wonder the US equity market has been one of the most rewarding asset classes in recent years.

"We can find no other asset class that offers this level of income growth in dollar terms. Emerging markets offer little dividend growth in US dollar terms. Currency headwinds and falling returns on equity are the obstacles"

Is this set to continue? We think so. We can find no other asset class that offers this level of income growth in dollar terms. Emerging markets offer little dividend growth in US dollar terms. Currency headwinds and falling returns on equity are the obstacles.

In Europe we may hopefully see single-digits, but a lot will depend on the euro/dollar level. Japan, as always, is a wild card and depends largely on corporate governance reform, and the capacity of investors to convince companies to distribute excess cash.

In contrast, dividend per share growth for the S&P 500 is likely to stay at double-digit levels. This is above earnings growth but the payout ratio is 32 per cent. We need to anticipate a fall in dividends from energy companies, but this will be more than offset by dividend growth from the financial sector, which is still low.

S&P 500 dividends benefit from a high level of diversification, unlike other benchmarks where dividends are concentrated in one or two sectors, or even a handful of stocks. More than 400 stocks in the S&P 500 pay a dividend. Nine out of 10 sectors increased dividends in the past 12 months. Six of these increased dividends by 10 per cent or more. Consumer discretionary, IT and industrials were among these, emphasising that the regulatory risk to dividends is lower than elsewhere.

In the age of income investing, the income growth properties of the S&P 500 will continue to be highly valued. According to our estimates, S&P 500 dividends could exceed $48 by 2016 and $60 is not beyond reach by the end of the decade. If we assume a 2 per cent dividend yield, its 10-year median, the S&P 500 could exceed 2,400 before the next president is inaugurated. A level of 3,000 is within reach before the decade is out.

Source: http://www.ft.com/intl/cms/s/0/ff1c88f6-a588-11e4-8636-00144feab7de.html#axzz3RSBoBmRj

QE and ultra-low interest rates: Distributional effects and risks

There is widespread consensus that the conventional and unconventional monetary policies that world’s major central banks implemented in response to the global financial crisis prevented a deeper recession and higher unemployment than there otherwise would have been. These measures, along with a lack of demand for credit as a result of the recession, contributed to a decline in real and nominal interest rates to ultra-low levels that have been sustained over the past five years.

 

MGI’s Richard Dobbs and Susan Lund discuss the economic impact of QE and ultra-low interest rates and the problems that may arise, depending on future conditions.

A new report from the McKinsey Global Institute examines the distributional effects of these ultra-low rates. It finds that there have been significant effects on different sectors in the economy in terms of income interest and expense. From 2007 to 2012, governments in the eurozone, the United Kingdom, and the United States collectively benefited by $1.6 trillion both through reduced debt-service costs and increased profits remitted from central banks (exhibit). Nonfinancial corporations—large borrowers such as governments—benefited by $710 billion as the interest rates on debt fell. Although ultra-low interest rates boosted corporate profits in the United Kingdom and the United States by 5 percent in 2012, this has not translated into higher investment, possibly as a result of uncertainty about the strength of the economic recovery, as well as tighter lending standards. Meanwhile, households in these countries together lost $630 billion in net interest income, although the impact varies across groups. Younger households that are net borrowers have benefited, while older households with significant interest-bearing assets have lost income.

 

Ultra-low interest rates have had distributional effects on interest income and expenses.

 

The impact that ultra-low interest rates have had on banks has been mixed. They have eroded the profitability of eurozone banks, resulting in a cumulative loss of net interest income of $230 billion between 2007 and 2012. But banks in the United States experienced an increase in effective net interest margins and a cumulative increase in net interest income of $150 billion. The experience of UK banks falls between these two extremes.

Life-insurance companies, particularly in several European countries, are being squeezed by ultra-low interest rates, so much so that if this environment were to continue many of these insurers would find their survival threatened.

Theoretically, ultra-low interest rates may have resulted in higher asset prices, and this effect may have offset lost interest income for households and other investors. But we find a mixed picture.
Rising bond prices are the flip side of declining yields, and the value of sovereign and corporate bonds in the eurozone, the United Kingdom, and the United States increased by $16 trillion between 2007 and 2012. Investors that mark the value of their assets to market have therefore seen a significant gain on their fixed income investments, at least on paper.

Ultra-low interest rates are likely to have bolstered housing prices by lowering the cost of mortgage credit. This effect is most clearly seen in the United Kingdom, where the majority of mortgages have variable interest rates that have automatically adjusted downward. The impact is less clear in the United States, where the recovery in housing prices has been dampened by an oversupply of housing, high levels of foreclosures, a predominance of fixed-rate mortgages, tightened credit standards, and the prevalence of homes with negative equity whose mortgages cannot be refinanced.

We found little evidence that ultra-low interest rates have boosted equity markets. We cannot discern a large-scale shift into equities as part of a search for yield by investors, and price-earnings ratios and price-book ratios in stock markets are no higher than long-term averages. Although stock prices do react to announcements by central banks, these are transitory effects that do not persist.

If one accepts that housing prices and bond prices are higher today than they otherwise would have been as a result of ultra-low interest rates, then the increase in household wealth and the possible additional consumption it has enabled would far outweigh the income lost to households. But we are skeptical about whether increases in wealth have translated into higher consumption in today’s environment, given that housing prices in the United States remain far below their peak. Moreover, it is more difficult for today’s households to borrow against any increase in wealth because of tighter credit standards.

Ultra-low interest rates do appear to have prompted additional capital flows to emerging markets, particularly into their bond markets. Purchases of emerging-market bonds by foreign investors totaled just $92 billion in 2007 but had jumped to $264 billion in 2012. Emerging markets that have a high share of foreign ownership of their bonds and large current account deficits will be most vulnerable to capital outflows if and when central banks begin tapering current policies.

There are likely to be risks ahead whether asset purchases are tapered and interest rates rise or, alternatively, if current monetary policies continue and interest rates remain low. In the first scenario, the benefits gained or losses incurred could be reversed. Government interest payments on debt, for instance, could rise up to 20 percent. Amid anecdotal evidence that some investors have increased their leverage to amplify returns in some markets, rising interest rates could lead to a collapse in leveraged trades and could pose a threat to some financial institutions. Capital flows to emerging markets could reverse. Investors in bond markets forced by accounting rules to mark to market could face large write-downs. Eurozone countries could be caught in a crosswind if rates increase in the United States before they do in Europe, leading to a shift in foreign capital from Europe to the United States. In the second scenario, life insurers and banks in Europe would experience continued erosion in their profitability. A continuation in ultra-low interest rates could also prompt higher leverage and the return of asset-price bubbles in some sectors, especially real estate.

Source: http://www.mckinsey.com/insights/economic_studies/qe_and_ultra_low_interest_rates_distributional_effects_and_risks

End of QE will test diversification faith

Diversification, the great free lunch of investing, is often taken for granted by investors. Bonds and equities have acted as effective portfolio diversifiers for much of the new millennium because of their different return and volatility patterns. Two of the three main assets in a typical portfolio, cash being the third, moved in opposite directions during financial crises such as 2001 and 2008.

Indeed, portfolio management has become accustomed to this trend and now treats it as an article of faith. But does this faith represent a dangerous cocktail of overconfidence and extrapolation?

The mantra that monetary policy is driving market returns is well rehearsed. Less obvious is the idea that policy is driving the relationship between bond and equity returns.

This year gave a flavour of things to come: a period of high turbulence in May and June as markets took on board the possibility the global liquidity flood was about to abate. Bonds fell sharply and equities stumbled as investors fretted about an end to the Federal Reserve’s emergency asset-buying. Price volatility rose in both mainstream asset classes. Using US equities and 10-year bonds as proxies, the correlation was negative from 2009 to the middle of this year and positive thereafter.

Shock absorbers

Next year could mark a turning point as policy makers exiting the triage phase of recovery from the Great Financial Crisis move away from a material reliance on monetary activism into the potentially more volatile territory of forward guidance.

What does this mean for fixed income? Suppose there is one dominant, price-insensitive buyer (the Fed). Now suppose this buyer has a progressively smaller wallet. All other things being equal, the volatility of prices rises as buyer and seller strive to match each other. Add in another group of (reasonably) price-insensitive buyers (China and the like) downsizing their spending due to slowing growth in foreign exchange reserves, and this risk expands.

Of course, there are shock absorbers. First, the developed world’s ageing populations and their agents (think insurers) have a structural bid for yield. Second, the Bank of Japan is expanding its monetary easing . Some of governor Haruhiko Kuroda’s largesse eventually will pass through Narita Airport as growing shortages of domestic bonds force local institutions to shake off some of their home bias. The conclusion? Do not expect a fixed income bloodbath in 2014 – but brace for more volatile returns.

How about equities? 2013 will probably be known as the Year of Equity. The problem: the numerator of the price to earnings ratio (price) has been driving returns in most markets this year, rather than the denominator (earnings). Higher pricing of the final claim on corporate cash flows – equity – has been aided by the tightest debt spreads on record, insatiable demand from yield-hungry investors, and the ability to refinance and extend fixed obligations at low cost. This works well for a while, but at some point earnings need to come through.

Theory has it the discount rate partially connects bonds (fixed coupons discounted by an interest rate) and equities (fluctuating cash flows discounted by this interest rate plus some variable risk premia). Here is the rub: arithmetically, the lower the real interest rate, the greater the volatility triggered by small changes. If the major driver of returns (policy) becomes more volatile, so do the assets that have benefited from that support.

QE tide turns

Clearly the unprecedented monetary stimulus tide will not last forever. When it dwindles, what will become an effective diversifier of portfolio risk? Bonds or equities? Not entirely; see the drawbacks described above. Cash? Perhaps, but if rates rise for longer-dated bonds and remain anchored by policy for short-dated issues, the diversification benefit of a near zero return is limited.

Challenging the assumptions of the past at a time of regime change is vital in financial markets. This means rethinking fixed income to seek out relative value between bonds, capitalising on rises in volatility and harvesting risk premia. In other words, taking an unconstrained approach. It means a focus on alternative strategies that do not start with the discount rate. Examples are infrastructure and real estate debt, opportunistic acquisition of long duration assets chased off bank balance sheets by regulation and market neutral long-short strategies.

Any reversal in the policy tide involves uncharted territory. A reversal in the 30-year downward trend of rates must, however, involve some different results. 2014 may very well become known as the year in which unwary investors ask: “Who stole my diversifier?”

Source: http://www.ft.com/intl/cms/s/0/0687562c-5e7f-11e3-8621-00144feabdc0.html#axzz2nwa2gnpW

Currencies: The weak shall inherit the earth

OVER most of history, most countries have wanted a strong currency—or at least a stable one. In the days of the gold standard and the Bretton Woods system, governments made great efforts to maintain exchange-rate pegs, even if the interest rates needed to do so prompted economic downturns. Only in exceptional economic circumstances, such as those of the 1930s and the 1970s, were those efforts deemed too painful and the pegs abandoned.

In the wake of the global financial crisis, though, strong and stable are out of fashion. Many countries seem content for their currencies to depreciate. It helps their exporters gain market share and loosens monetary conditions. Rather than taking pleasure from a rise in their currency as a sign of market confidence in their economic policies, countries now react with alarm. A strong currency can not only drive exporters bankrupt—a bourn from which the subsequent lowering of rates can offer no return—it can also, by forcing down import prices, create deflation at home. Falling incomes are bad news in a debt crisis.

Thus when traders piled into the Swiss franc in the early years of the financial crisis, seeing it as a sound alternative to the euro’s travails and America’s money-printing, the Swiss got worried. In the late 1970s a similar episode prompted the Swiss to adopt negative interest rates, charging a fee to those who wanted to open a bank account. This time, the Swiss National Bank has gone even further. It has pledged to cap the value of the currency at SFr1.20 to the euro by creating new francs as and when necessary. Shackling a currency this way is a different sort of endeavour from supporting one. Propping a currency up requires a central bank to use up finite foreign exchange reserves; keeping one down just requires the willingness to issue more of it.

When one country cuts off the scope for currency appreciation, traders inevitably look for a new target. Thus policies in one country create ripples that in turn affect other countries and their policies.

The Bank of Japan’s latest programme of quantitative easing (QE) has, like most of the unconventional monetary policy being tried around the world, a number of different objectives. But one is to counteract an unwelcome new appetite for the yen among traders responding to policies which have made other currencies less appealing. Other things being equal, the increase in money supply that a bout of quantitative easing brings should make that currency worth less to other people, and thus lower the exchange rate.

Ripple gets a raspberry

Other things, though, are not always or even often equal, as the history of currencies and unconventional monetary policy over the past few years makes clear. In Japan’s case, a drop in the value of the yen in response to the new round of QE would be against the run of play. Japan has conducted QE programmes at various times since 2001 and the yen is much stronger now than when it started.

Nor has QE’s effect on other currencies been what traders might at first have expected. The first American round was in late 2008; at the time the dollar was rising sharply (see chart). The dollar is regarded as the “safe haven” currency; investors flock to it when they are worried about the outlook for the global economy. Fears were at their greatest in late 2008 and early 2009 after the collapse of Lehman Brothers, an investment bank, in September 2008. The dollar then fell again once the worst of the crisis had passed.

The second round of QE had more straightforward effects. It was launched in November 2010 and the dollar had fallen by the time the programme finished in June 2011. But this fall might have been down to investor confidence that the central bank’s actions would revive the economy and that it was safe to buy riskier assets; over the same period, the Dow Jones Industrial Average rose while Treasury bond prices fell.

After all this, though, the dollar remains higher against both the euro and the pound than it was when Lehman collapsed. This does not mean that the QE was pointless; it achieved the goal of loosening monetary conditions at a time when rate cuts were no longer possible. The fact that it didn’t also lower exchange rates simply shows that no policies act in a vacuum. Any exchange rate is a relative valuation of two currencies. Traders had their doubts about the dollar, but the euro was affected by the fiscal crisis and by doubts over the currency’s very survival. Meanwhile, Britain had also been pursuing QE and was slipping back into recession. David Bloom, a currency strategist at HSBC, a bank, draws a clear lesson from all this. “The implications of QE on currency are not uniform and are based on market perceptions rather than some mechanistic link.”

In part because of the advent of all this unconventional monetary policy, foreign-exchange markets have been changing the way they think and operate. In economic textbooks currency movements counter the differences in nominal interest rates between countries so that investors get the same returns on similarly safe assets whatever the currency. But experience over the past 30 years has shown that this is not reliably the case. Instead short-term nominal interest-rate differentials have persistently reinforced currency movements; traders would borrow money in a currency with low interest rates, and invest the proceeds in a currency with high rates, earning a spread (the carry) in the process. Between 1979 and 2009 this “carry trade” delivered a positive return in every year bar three.

Now that nominal interest rates in most developed markets are close to zero, there is less scope for the carry trade. Even the Australian dollar, one of the more reliable sources of higher income, is losing its appeal. The Reserve Bank of Australia cut rates to 3.25% on October 2nd, in response to weaker growth, and the Aussie dollar’s strength is now subsiding.

So instead of looking at short-term interest rates that are almost identical, investors are paying more attention to yield differentials in the bond markets. David Woo, a currency strategist at Bank of America Merrill Lynch, says that markets are now moving on real (after inflation) interest rate differentials rather than the nominal gaps they used to heed. While real rates in America and Britain are negative, deflation in Japan and Switzerland means their real rates are positive—hence the recurring enthusiasm for their currencies.

The existence of the euro has also made a difference to the way markets operate. Europe was dogged by currency instability from the introduction of floating rates in the early 1970s to the creation of the euro in 1999. Various attempts to fix one European currency against each other, such as the Exchange Rate Mechanism, crumbled in the face of divergent economic performances in the countries concerned.

European leaders thought they had outsmarted the markets by creating the single currency. But the divergent economic performances continued, and were eventually made manifest in the bond markets. At the moment, if you want to predict future movements in the euro/dollar rate, the level of Spanish and Italian bond yields is a pretty good indicator; rising yields tend to lead to a falling euro.

The reverse is also true. Unconventional interventions by the European Central Bank (ECB) over the past few years might have been expected to weaken the currency, because the bank was seen as departing from its customary hardline stance. They haven’t because they have normally occurred when the markets were most worried about a break-up of the currency, and thus when the euro was already at its weakest. The launch of the Securities Market Programme in May 2010 (when the ECB started to buy Spanish and Italian bonds), and Mario Draghi’s pledge to “do whatever it takes”, including unlimited bond purchases, in July 2012 were followed by periods of euro strength because they reduced fears that the currency was about to collapse.

Currency war, what is it good for?

Currency trading is, by its nature, a zero-sum game. For some to fall, others must rise. The various unorthodox policies of developed nations have not caused their currencies to fall relative to one another in the way people might have expected. This could be because all rich-country governments have adopted such policies, at least to some extent. But it would not be surprising if rich-world currencies were to fall against those of developing countries.

In September 2010 Guido Mantega, the Brazilian finance minister, claimed that this was not just happening, but that it was deliberate and unwelcome: a currency war had begun between the North and the South. The implication was that the use of QE was a form of protectionism, aimed at stealing market share from the developing world. The Brazilians followed up his statement with taxes on currency inflows (see Free Exchange).

But the evidence for Mr Mantega’s case is pretty shaky. The Brazilian real is lower than it was when he made his remarks (see chart). The Chinese yuan has been gaining value against the dollar since 2010 while the Korean won rallied once risk appetites recovered in early 2009. But on a trade-weighted basis (which includes many developing currencies in the calculation), the dollar is almost exactly where it was when Lehman Brothers collapsed.

Many developing countries have export-based economic policies. So that their currencies do not rise too quickly against the dollar, thus pricing their exports out of the market, these countries manage their dollar exchange rates, formally or informally. The result is that loose monetary policy in America ends up being transmitted to the developing world, often in the form of lower interest rates. By boosting demand, the effect shows up in higher commodity prices. Gold has more than doubled in price since Lehman collapsed and has recently reached a record high against the euro. Some investors fear that QE is part of a general tendency towards the debasement of rich-world currencies that will eventually stoke inflation.

The odd thing, however, is that the old rule that high inflation leads to weak exchange rates is much less reliable than it used to be. It holds true in extreme cases, such as Zimbabwe during its hyperinflationary period. But a general assumption that countries with high inflation need a lower exchange rate to keep their exports competitive is not well supported by the evidence—indeed the reverse appears to be the case. Elsa Lignos of RBC Capital Markets has found that, over the past 20 years, investing in high-inflation currencies and shorting low-inflation currencies has been a consistently profitable strategy.

The main reason seems to be a version of the carry trade. Countries with higher-than-average inflation rates tend to have higher-than-average nominal interest rates. Another factor is that trade imbalances do not seem to be the influence that once they were. America’s persistent deficit does not seem to have had much of an impact on exchange rates in recent years: nor does Japan’s steadily shrinking surplus, or the euro zone’s generally positive aggregate trade position.

 

In short, foreign-exchange markets no longer punish things that used to be regarded as bad economic behaviour, like high inflation and poor trade performance. That may help explain why governments are now focusing on other priorities than pleasing the currency markets, such as stabilising their financial sectors and reducing unemployment. Currencies only matter if they get in the way of those goals.

Source: http://www.economist.com/node/21564210

Buttonwood: Pausing for breath

IT IS known as the “reflation trade”. The theory is that rich-world central banks will do whatever it takes to revive their economies, even if that means tolerating a period of above-target inflation. As a result, investors feel an incentive to buy “real assets”, those linked to nominal economic growth (notably equities) or to rising prices (commodities).

From October 4th to March 1st, the MSCI World equity index rose by 21.4% and the S&P GSCI commodity index rose by 23.8%, vigorous rallies by any standard. Bullish sentiment was driven by a sense that quantitative easing (QE), the creation of money to buy assets like government bonds, had become a competitive sport.

America and Britain had been in the vanguard but in September the Swiss central bank pledged to create sufficient money to peg the franc against the euro; and in February the Bank of Japan added {Yen}10 trillion ($128 billion) to its asset-purchase programme and unveiled a target inflation rate of 1%. For its part the European Central Bank has lent more than €1 trillion ($1.3 trillion) in three–year loans to banks, in what is widely seen as a case of QE by the back door.

But the reflation trade took a bit of a dent on February 29th when Ben Bernanke, the Federal Reserve’s chairman, gave no hint of a third round of QE in testimony to Congress. Admittedly, there was a bullish underpinning to Mr Bernanke’s speech: a better performance by the American economy means there is less need for further action. Nevertheless, the Fed is seen as “pump-primer in chief” by many in the markets. Gold fell by $100 an ounce after Mr Bernanke’s statement.

A setback was probably inevitable after such a strong rally. A bigger question, however, is whether the rationale behind the reflation trade makes any sense.

Central banks have undoubtedly expanded their balance-sheets during the crisis. Back in 2008 the monetary base of the euro zone (in effect notes and coins plus reserves held at the region’s central banks) was around 10% of GDP; the equivalent figures for the Federal Reserve and the Bank of England were in the 4-6% range. Now the monetary base in all three places is between 16% and 18% of GDP.

However, expansion of the monetary base does not necessarily lead to growth in broad money, which measures the supply of credit to businesses and consumers and which ultimately drives inflation. Money-supply growth still looks sluggish in Britain, Japan and the euro zone (see chart). Only in America does it look robust.

The problem is that many banks remain unwilling to extend credit given the need, among other things, to shore up their capital. Figures show that total euro-zone lending to households and non-financial firms has declined in recent months, despite the ECB’s actions. Dhaval Joshi of BCA Research says that “banks have destroyed money just as fast as the ECB has created it.” Jennifer McKeown of Capital Economics concludes from the data that “bank lending remains extremely weak, suggesting that a lack of credit will continue to hold back economic activity.”

In short, the reflation trade may be based on a false premise. The rally may well have been driven by a lifting of the intense economic gloom that enveloped the markets in the autumn of 2011 and a sense that the European authorities had removed the immediate threat of a banking collapse, while simultaneously halting the rapid rise in Italian and Spanish government-bond yields. But now that investors have paused for breath, they can see that the economic outlook is still pretty murky. On March 5th, for example, China lowered its growth target to 7.5% (see later story); survey data on activity in the euro area’s services sector were also weaker than expected.

Furthermore, the markets are starting to lose a key source of support. As the global economy emerged from recession in 2009, profit margins surged thanks to falls in borrowing costs and weak wage growth. But European profits are down by 7% compared with the previous year, according to HSBC. Even in America, which is doing rather better, Bank of America Merrill Lynch is expecting corporate profits for S&P 500 companies to grow by just 6.4% in 2012, down from 14.8% last year.

It all looks remarkably like 2011, when an early-year rally also ran out of steam. So long as the yields on other assets like bonds and cash are so low, it is hard for stockmarkets to collapse. But those yields are so low because central banks are frightened about the economic outlook. That makes it very hard for a bull run to be sustained.

Source: http://www.economist.com/node/21549966

Sovereign bonds: Oat cuisine

FIFTEEN years ago Western government bonds were regarded as being like porridge: stodgy but easily digestible. Investors knew returns would be modest but perceived the asset class as risk-free, an important concept in both financial theory and portfolio construction. And bond markets were seen as all-powerful, capable of imposing discipline on governments by pushing up borrowing costs in the face of irresponsible policies. James Carville, an adviser to President Bill Clinton, spoke with awe of their intimidatory power.

Things are different now. The bond vigilantes seem less frightening. They were asleep at the wheel as debts mounted in the euro zone, waking up in time to provoke the latest crisis but not avoid it. Private-sector bond investors in Greek sovereign debt face losses of around 70%, making the idea that government bonds are risk-free laughable.

The most powerful investors in many government-bond markets are not profit-maximising fund managers but central and commercial banks, which are buying bonds for all sorts of reasons. Other investors need to be like Kremlinologists, guessing what central banks will do next.

The market is also much bigger than it was. According to Bank of America Merrill Lynch, there were some $11 trillion-worth of government bonds in issue at the end of 2001; by the end of 2011, that figure had risen to more than $31 trillion (see chart 1). And although some euro-zone countries have been cut off from the markets, the story is very different in other places. The British and American governments are enjoying the lowest borrowing costs they have seen for decades, despite big deficits.

The implications of all these changes are still being worked through. The risk-free rate has historically been the rock around which a financial system is built. Other borrowers, such as banks and corporations, pay a premium over their domestic government’s cost of debt. This is still true for companies that are tied to a local economy, such as utilities. But multinational firms can, in theory, move to economies where growth prospects are better and taxes lower. Some, such as Johnson & Johnson or Exxon Mobil, may thus now be seen as better bets than their governments.

Thanks to the European Central Bank’s lending activities, banks in several European countries can also now borrow more cheaply than their governments—a heavy irony given that it was the banking sector’s problems that ushered in the current sovereign-debt crisis. Indeed, investors have learned that simply studying the ratio of government debt to GDP is not enough. Both Ireland and Iceland entered the crisis with very low ratios. But the collapse of their banking sectors meant that private-sector debt was assumed by the government, causing the ratio to balloon.

Modern bond investors have to worry about other contingent liabilities, too—the pensions promised to public-sector workers, say, or the rising costs of Medicare as America’s baby-boomers retire. Governments might easily decide that such promises have a better claim on tax revenues than the rights of foreign creditors. The negotiations in Greece have shown that official creditors deem themselves to have a greater claim on a government’s revenues than private-sector creditors. The more official aid a country receives, the bigger the eventual write-off private bondholders may suffer.

The rise of official creditors is not new. It was first noticed in the 2000s when Asian central banks began to plough their massive foreign-exchange reserves into Treasury bonds. Alan Greenspan, the then chairman of the Federal Reserve, talked of the “conundrum” that bond yields were falling even as the Fed was pushing up short rates, a shift from the usual pattern.

The reason was that central banks were pretty indifferent to low yields, being content to park their reserves in the relative safety and liquidity of Treasury bonds as a way to manage their currencies’ level versus the dollar. More recently, central banks have been buying up their own government’s debt through quantitative easing (QE). It is debatable whether yields are set by economic fundamentals or by the anticipated buying patterns of central banks.

Of course, central-bank policy has always had an effect on the bond markets. One way of viewing long-term bond yields is as a forecast of future short-term rates (sometimes there is an additional premium for tying up your money). On that basis, says Eric Lonergan, a fund manager at M&G, the current level of Treasury-bond yields is quite rational. The average of American short rates over the past ten years is around 2%, almost exactly the level of the ten-year Treasury-bond yield now.

Rates are likely to remain low for some time. The Fed recently indicated that it expected rates to stay near zero until late 2014. Add in the effect of QE and the Fed may be the dominant influence on yields all the way out to bonds with maturities of five years. There is talk of a third round of QE from the Fed, and the Bank of England was set to add to its £275 billion ($437 billion) pile of gilts at a February 9th meeting, held after The Economist went to press.

Rates low, bond mountains high

Analysts argue about the precise impact of QE on yields but the presence of an ever-willing buyer must have some effect. In particular, it must make private-sector investors cautious about betting on higher yields. “Bond crashes become very unlikely, unless they are accepted by central banks,” says Patrick Artus of Natixis, a French bank. “Long-term interest rates could remain very low for a long time.”

Less clear is how central banks will ever dispose of these bond mountains. In practice, it makes no difference whether central banks try to sell their holdings or simply let the bonds mature (since maturing bonds have to be refinanced). Either way the private sector will have to absorb the extra supply on top of the new bonds being issued that year. If central banks are correct in arguing that QE has driven bond yields down, then logically a reversal of QE might drive yields up, in effect tightening monetary policy. It may be a long while before the economy is sufficiently robust to absorb the impact. Large central-bank holdings of government bonds may be a semi-permanent feature of the landscape.

Central banks are not the only distorting presence in the market. In Britain pension funds have been eager buyers of long-dated securities as a way of matching their liabilities (a promise to make pension payments for 25-30 years is equivalent to a debt). Since many pension benefits are linked to inflation, this has sparked a particular enthusiasm for inflation-linked debt. Insurance companies are also heavy buyers of government debt, in large part because of solvency requirements that push them into owning “safe” assets.

And then there are the banks. One feature of the early days of the euro was convergence. Short-term interest rates are the same across the zone. Since government-bond yields are related to expectations for future levels of short rates, bond yields equalised across the region. This was immensely beneficial for countries like Italy and Greece, which saw their borrowing costs fall. It also meant that banks happily owned regional, rather than merely national, government-bond portfolios.

Now that trend is reversing. Banks are suddenly conscious of the credit risk involved in holding another country’s bonds. When the crisis broke French banks were “encouraged” to hold on to their Greek bonds by their government and suffered losses as a result. Now it seems they are willing to buy only their own government’s bonds, and those of Germany; they are far less keen on holding Italian or Spanish debt. “It is almost if the euro zone has already broken up,” says Andrew Balls of PIMCO, a fund-management group.

Domestic banks, however, may well figure that holding the debt of their own sovereign is a “double or quits” bet. If their government defaults the banking system will collapse anyway, so they might as well own its bonds. That incentive has been reinforced by the ECB’s provision of virtually unlimited three-year loans. As President Nicolas Sarkozy of France has hinted, banks can borrow cheaply from the ECB and invest the proceeds in government debt, earning a higher yield in the process.

This is an approach to boosting bank profitability that has been tried before. In the early 1990s the Federal Reserve held rates very low (by prevailing standards) to help the banks recover from the savings-and-loan crisis. Banks were able to earn a “carry” by borrowing at 3% and buying ten-year Treasuries yielding almost 7%.

The carry trade is not the only reason why banks might buy government bonds. In the wake of the 2007-08 crisis, when banks were suddenly cut off from the wholesale markets, regulators have been urging banks to own a “liquidity cushion” of safe assets. Banks can use government bonds as collateral for loans with each other, and with central banks.

The result has been a big expansion in banks’ sovereign-bond purchases, very handy when governments have lots of bonds to sell. In Britain, data from the Debt Management Office show that banks and building societies owned just £26 billion-worth of gilts in the last quarter of 2008; by the end of 2011 they owned £131 billion, or around 10% of the total (see chart 2).

How would you like your loss?

The role that credit risk is now playing in the euro area highlights another great change in the government-bond markets: the influence of exchange-rate regimes. For decades countries struggled to cope with the constraints of fixed exchange-rate systems, whether the gold standard or Bretton Woods, in part because this approach would reassure foreign creditors. “Who would be prepared to lend with the fear of being paid in depreciated currencies always before his eyes?” asked Georges Bonnet, a French finance minister of the 1920s.

But the euro crisis has shown the perils for international investors of a fixed-rate regime. Denied the option of devaluation, Greece is being forced, in effect, to default on its debts. In contrast America and Britain, with their floating exchange rates, have the freedom to expand their money supplies and depreciate their currencies. Although this may still result in losses for foreign investors, they are likely to be far smaller than the Greek write-offs. As Mr Balls puts it, countries with floating rates are the “least dirty shirt” in the markets.

Emerging markets have also changed their role. Historically, developing countries defaulted often and had high inflation. They had to borrow in dollars and to pay high yields. But now the finances of many developing countries are better than those of the rich world (see chart 3). Brazil and Mexico pay yields of less than 2% on five-year dollar-denominated debt.

It all adds up to a completely changed investment landscape. For the 25 years from 1982 to 2007, owning rich-world government bonds was almost a no-brainer. Yields fell steadily in line with inflation and there was no question of default. Now the market is much more complex. The players are more diverse and their motives more varied. The balance between risk and reward has also shifted against investors. In the past bondholders have not made money buying Treasury bonds on yields as low as 2%. At current levels of inflation, bond investors are getting negative real yields.

That may be the idea. Carmen Reinhart, Jacob Kirkegaard and Belen Sbrancia, three academics, have suggested that governments may use “financial repression”—forcing debts down the throats of captive buyers and keeping real rates negative so that inflation eliminates their debts. This trick worked after the second world war. The presence of “forced buyers” in the market such as central banks and commercial banks may enable it to be repeated.

But could governments really pull it off? Or are rich-world bond markets signalling that Japan is the more likely template? Ten-year yields there have been around 1% for much of the past decade, thanks to persistent deflation and slow growth.

This is a vital issue since a sudden surge in bond yields might wreck government finances, economic prospects and the outlook for other asset markets. “The unknown question is how much inflation central banks are willing to tolerate. Until that is settled, one cannot be sure about the outlook for bonds or other asset markets like equities,” says Manoj Pradhan at Morgan Stanley. For a supposedly risk-free asset it all adds up to a lot of risks.

Source: http://www.economist.com/node/21547245

Low rates: the drug we can all do without

Low interest rates and novel forms of monetary accommodation, such as quantitative easing, have become seen as a panacea for economic ills. The US Federal Reserve has committed to holding rates around zero for the foreseeable future. Faced with deep-seated economic problems, other central banks are likely to follow.

Financial markets have generally reacted positively to low rates, pushing up asset prices. However, low rates point to a worrying lack of economic growth and the increasing risk of deflation. Indeed, the relationship between rates and economic activity is tenuous. The cost of funds is only one factor among several complex drivers of demand.

In the housing market, demand depends on many things – the level of deposit required, existing home equity (the price of a house less outstanding debt), the ability to sell a current property, income levels and employment security.

And businesses, in the absence of growing demand for their products, are unlikely to borrow to invest in new capacity based purely on the low cost of debt.

In reality, low interest rates create economic distortions, especially where real interest rates (nominal rates adjusted for inflation) are low or negative.

Low cost of debt encourages substitution of labour with capital in the production process. Given that 60-70 per cent of activity in developed economies is driven by consumption, this shift reduces aggregate demand as employment and income levels decrease.

Low rates favour borrowing, encouraging substitution of debt for equity in financing structures and increasing financial risk. Where companies and nations are overextended, incentives to reduce debt decrease. In fact, low rates, which lower coupon payments, are economically identical to a disguised reduction of the principal amount of the loan.

Low rates discourage savings, creating a disincentive for the capital accumulation that would reduce overall debt levels. Lower earnings on savings should encourage spending, stimulating economic activity, but may perversely encourage greater saving to provide for future needs, reducing consumption and demand. For an individual saving for retirement, a drop in interest rates from 5 per cent to 4 per cent requires an 18 per cent increase in savings each year to reach the same target sum over 30 years.

Low rates also increase the funding gap for defined benefit pension funds. In the US, for every 1 per cent fall in rates, pension fund liabilities increase by about $180bn.

Low rates also feed asset price inflation. Low costs of borrowing encourage investors to seek investments with income, feeding demand for shares that pay high dividends and for low-grade debt. A resurgence of structured products, where investors take on additional risk, which they have not fully understood, to generate higher income, is driven by low rates. In previous cycles, this has led to large losses and costly disputes between investors and dealers. In this way, low rates encourage mispricing of risk, creating asset bubbles.

Minimal opportunity costs allow investors to hold assets that pay no income in the hope of price increases, evidenced in demand for commodities and alternative investments such as art works. Money tied up in non-productive investments reduces the flow of capital and economic activity.

Low interest rates also provide an artificial subsidy to financial institutions, allowing them to borrow cheaply and then invest in higher yielding safe assets such as government bonds. Assuming bank deposits of $6tn and a difference between borrowing costs and government bond rates of 2 percentage points, this equates to a transfer to the US banking sector of about $120bn.

Low rates do not necessarily increase the supply of credit. Risk aversion and higher returns on capital encourage banks to invest in government securities, eschewing loans. In the US, bank holdings of cash and government securities currently exceed the outstanding volume of commercial and industrial loans.

Internationally, low interest rates distort currency values, and encourage volatile and destabilising short-term capital flows as investors search for higher yields.

A sustained period of low rates, such as the one the world is experiencing, makes it difficult to increase the cost of borrowing. Levels of debt encouraged by low rates rapidly become unsustainable when they increase, as is evident in Europe. This reinforces the financial distortions implicit in the policy.

For the moment, policymakers are relying on the advice of actress Tallulah Bankhead: “Cocaine isn’t habit forming. I should know – I’ve been using it for years.” But reliance on low interest rates, like all addictions, is dangerous. It is also ineffective in addressing the real economic issues.

Source: http://www.ft.com/intl/cms/s/0/372a405c-480e-11e1-b1b4-00144feabdc0.html#axzz1l0bJLxBP

Central banks Crazy aunt on the loose

THERE was a time when the Federal Reserve wouldn’t say whether it had changed interest rates. Soon it will say where it thinks rates will be years from now. Beginning with its policy meeting on January 24th-25th, Fed officials will disclose when they expect to start raising their short-term interest-rate target, which is at near-zero now, and what they expect its path to be over the coming years. Behind such radical transparency is a grim fact: at the start of a fourth successive year of extraordinarily low short-term rates and a still-moribund economy, the Fed is desperate for new ways to stimulate demand.

It is not alone. Of the rich world’s four major central banks, Britain’s and Japan’s already have their policy rates stuck near zero and the fourth, the European Central Bank (ECB), is likely to get there this year. Meanwhile, the balance-sheets of all four institutions have ballooned as they expand the volume and range of assets and loans they hold (see charts).

Central banks have never been comfortable with unconventional monetary policies such as verbal interest-rate commitments and quantitative easing (QE), the purchase of assets by printing money. Alan Blinder, a Princeton economist and former Fed official, has likened them to a family that lets its crazy aunt out of the closet only on special occasions. QE is “best kept in the locker marked ‘For Emergency Use Only’”, is how Charlie Bean, the Bank of England’s deputy governor, put it in 2010.

The unconventional, however, is now conventional. In a presentation to this year’s annual meeting of the American Economic Association, Mr Blinder will argue that the circumstances—low inflation and low nominal interest rates, persistent excess capacity, and fiscal policy paralysed by large debts—that have forced central banks to operate through unconventional policy will be a recurring feature of the economic landscape. “We can’t stuff the crazy aunt back in the closet,” he says.

How long could she stay out? In Japan, interest rates have been near zero almost continuously since 1999. Since then the Bank of Japan has bought government and corporate bonds, commercial paper, exchange-traded funds and real-estate investment trusts. Last year it offered targeted loans to spur long-term investment and rebuild areas damaged by the earthquake and tsunami. Such measures have prevented a deeper recession but not deflation or stagnant employment.

That outcome is not yet likely in Western countries. But 2012 will nonetheless require more unconventional policy. The Fed’s decision to include interest rates in its quarterly projections of key economic indicators, announced this week, emulates central banks in New Zealand, Norway and Sweden. But whereas this trio sought transparency for its own sake, the Fed’s main motivation is practical. It has been saying since August that it would hold rates near zero at least until mid-2013. Its new projections should persuade investors to expect no tightening before 2014, thereby nudging down long-term rates.

Whether the stimulative impact will be sufficient is another matter. In November Fed officials thought the economy would grow between 2.5% and 2.9% in 2012. The private sector projects growth of just 2%. The Fed may yet be proven right, given the upbeat tone of recent data. But if it is not, it will probably launch another round of QE, on top of its two previous rounds and “Operation Twist,” under which it swapped short-term for long-term bonds.

A similar sort of dynamic is at work in Britain, where the Bank of England’s most recent forecast was for growth of 1.2% in 2012. As in America, private-sector forecasts are gloomier as recession in Europe and austerity at home bite. The bank is likely soon to resume QE.

Most eyes are on the ECB. It has bought government bonds reluctantly and lent to banks enthusiastically, and portrayed both actions as ways of restoring liquidity to the financial system so that monetary policy can work, not as monetary policy itself. Yet now that it is lending huge sums to euro-zone banks for up to three years, this distinction is becoming meaningless. The idea is for banks to use this money to buy peripheral government debt; to lend more to households and business; or to reduce the amount of debt that they must refinance. In all instances that would raise the price and lower the yields on government or private debt, which is how QE is supposed to work. Asked recently if the ECB was conducting QE, Mario Draghi, the bank’s president, sidestepped the question: “Each jurisdiction has not only its own rules, but also its own vocabulary.”

The ECB could yet explicitly embrace QE if it saw inflation falling short of its goal of just below 2%. Elga Bartsch of Morgan Stanley thinks that could happen this year. The ECB already expects inflation of only 1.5% in 2013 and that number could drop as the bank brings its growth projections into line with the gloomier private consensus. Ms Bartsch thinks the ECB will cut its policy rate to 0.5% from 1% now in the first half of the year, about as low as it can go for technical reasons. Asset purchases would be the next logical step.

The question is: which assets? Mr Blinder notes QE can work by narrowing the spread between long-term and short-term rates or between private and government rates. The first is best conducted by purchasing government debt, the second by purchasing private debt. The Bank of England has stuck firmly to the first route, leaving it to the Treasury to extend credit to the private sector. The Fed has done a bit of both by purchasing federally-backed mortgage bonds as well as Treasuries, but avoided purchases of private assets because of legal and political constraints.

The ECB is in the opposite position to the Fed: circumscribed in its ability to fund governments but at liberty to buy private debt. Although expanded purchases of peripheral government bonds would be more effective, Ms Bartsch therefore reckons the bank is likely first to conduct QE through expanded purchases of private debt such as bank and corporate bonds (assuming its three-year loans to banks prove ineffective at expanding credit). It could also purchase bonds of all euro-zone governments, in the process relieving pressure on struggling peripheral sovereigns.

Whatever central bankers do, they cannot repair problems best fixed by politicians, such as America’s incoherent fiscal policy or Europe’s fractured institutions. Asked about the ECB’s aggressive new lending to banks, Masaaki Shirakawa, the governor of the Bank of Japan, said it could “buy time”. But he warned it could backfire if politicians fritter away whatever time the central bank has bought. Unfortunately, that risk is never low.

Source: http://www.economist.com/node/21542416

Bond Bulls May Yet Have Reason for Cheer

The bond-market limbo act goes on. At the start of 2011, bond-fund giant Pimco bet against U.S. Treasurys when the 10-year note was yielding about 3.3%. But Treasury yields ended the year under 2%, along with yields on German and U.K. government bonds, extending further a 30-year bull market for bonds. There might be further to go yet.

Central-bank bond purchases, known as quantitative easing, will play a part. While earlier rounds of QE pushed up yields on hopes that this would support recovery, repeat operations may have diminishing effects. In the U.K., yields have continued to fall despite a new £75 billion purchase operation. The Bank of England is widely expected to increase that program early this year, and many speculate that the U.S. Federal Reserve may engage in a third round of QE. Former European Central Bank board member Lorenzo Bini Smaghi has suggested that even the ECB could make use of the policy if monetary conditions demand it.

Such central-bank purchases may coincide with a reduction in the stock of securities still regarded as "safe" due to potential ratings downgrades in the euro zone. That could have a dual effect. Yields could be kept down as investors question the effectiveness of QE in generating economic growth. But buyers who have little choice about investing in bonds due to regulation may be forced to compete with central banks for paper.

Banks are being required to hold greater liquidity buffers. Central-bank reserve managers, particularly from Asia, are likely to remain core buyers of government debt. And despite deep concerns about the euro, many investors within the currency bloc have no choice but to invest in euro-denominated bonds. Even those struggling with the effects of low yields, such as pension funds, need to match assets with liabilities. Rather than shunning low-yielding bonds in countries like the U.K and Germany, funds that expected yields to rise may be forced to accelerate purchases to reduce the mismatch in their portfolios.

Many advanced economies are entering a multiyear period of paying down debt. That will likely weigh on growth and on domestic inflation, as it has in Japan, boosting the allure of government bonds over risk assets. This process may cause periodic outbreaks of panic about banking systems, as in 2011, driving yields lower. As the panic fades, yields may rise—but so far, they have risen to a lower peak each time.

This environment also creates a challenge for governments. Germany in November saw investors balk at buying new 10-year bonds at yields below 2%. But with two-year bond yields anchored at 0.3% or below by zero interest-rate policies, investors will have to buy longer-dated bonds to generate any return.

That means long-dated yields could go lower and for longer than many thought possible. Just look at Japan, where 10-year yields ended 2011 at 1%.

Source: http://online.wsj.com/article/SB10001424052970203550304577138101578099224.html?mod=WSJ_Heard_LEFTTopNews

Bond Buying Proves Poisonous for Pensions

Today's economic medicine carries harmful side effects.

Bond buying, known as quantitative easing, or QE, may have boosted growth and lowered corporate borrowing costs, according to a Bank of England analysis. But it is playing havoc with pension funds. Deficits have ballooned by £74 billion ($116 billion) as a direct result of the BOE's bond-buying program, estimates Pension Corp., an insurer.

The problem for pension funds is QE's design, not its rationale. The BOE's gilt purchases drive up prices and push yields down, a particular problem now that the scale of the BOE's bond buying is forcing it to buy longer-dated gilts of over 25 years in maturity, popular with pension funds. While quantitative easing boosts the value of pension assets, it lowers investment returns and increases estimates of future liabilities. Because typical defined-benefit plans are only 70% funded and face liabilities several years longer than their assets, that leads to wider deficits.

The BOE had hoped the bond-buying program would encourage pension funds to sell gilts and buy stocks and corporate bonds. Instead, many pension plans are doing the opposite: derisking and buying more gilts in the hope of closing shortfalls sooner. That isn't only exacerbating deficits but accelerating a move out of stocks, reducing a major source of long-term risk capital.

Some cash-strapped firms facing demands to plug QE-related deficits are petitioning the U.K. regulator to allow them more than 10 years to make up shortfalls. Another approach might be to discount liabilities at a higher rate than government or double-A corporate-bond yields. The Treasury uses a rate of 3% above consumer inflation for public-sector pensions.

But many trustees say the best response would be for the BOE to stop buying long-dated gilts and buy bank bonds instead. Not only would this ease bank funding difficulties, and thereby improve the supply of business loans, it would allow gilt yields to rise.

So far, the BOE has ruled this out, fearing credit risk and accusations it is subsidizing banks. But given the scale of the crisis, it may be time to take a less doctrinaire approach.

Source: http://online.wsj.com/article/SB10001424052970203686204577116573609854972.html?mod=WSJ_Heard_LEFTSecondNews

Tokyo will not shift to a contentious currency policy

The yen has once again made a new postwar high against the dollar, rising to Y75.69 on Wednesday as Japanese exporters continue to repatriate their foreign currency earnings. The strong yen has prompted finance minister Jun Azumi to warn that the authorities are ready to take “decisive action” in the currency markets and that he has instructed the finance ministry to be prepared to act.

Investors should heed these warnings about intervention and not chase the yen higher. Yet Japanese policymakers are unlikely to follow Switzerland’s example and announce an explicit exchange rate target for the yen as some are predicting.

Since the credit crunch began in 2007, Japanese and Swiss officials have faced similar challenges in the currency markets. As central banks around the world started cutting interest rates, foreign exchange investors unwound carry trades funded in low-yielding, safe-haven yen and Swiss francs.

The global financial crisis of 2008, the Federal Reserve’s two rounds of quantitative easing since 2009 and the eurozone debt crisis from 2010 led to both currencies appreciating substantially further. As a result the Swiss franc rose from SFr1.68 against the euro in 2007 to a record high of SFr1.00 earlier this year, while the yen strengthened from Y125 against the dollar four years ago to Wednesday’s new high.

In order to counter surging exchange rates, the Swiss National Bank and the Bank of Japan both cut interest rates to zero and engaged in unilateral intervention in the currency markets. SNB sales of francs pushed Switzerland’s foreign exchange reserves up from $43bn in March 2009 to $220bn by the summer of 2010 while the BoJ sold yen in September 2010, in March this year after Japan’s earthquake, and again in August.

But with the Swiss franc continuing to surge, the SNB went a major step further last month and announced it would pursue an explicit exchange rate target for the franc, committing itself to selling unlimited amounts of domestic currency to prevent the euro from falling below SFr1.20.

So far the Swiss authorities have been successful in setting a floor for the euro/Swiss franc exchange rate. The SNB intervened in the currency markets to push the exchange rate up to SFr1.20 on September 6 when it made its announcement to shift to a formal exchange rate target. Since then the Swiss franc has remained weaker than its target level, allowing the central bank to avoid re-entering the currency markets. In contrast the yen has continued to strengthen, raising expectations that authorities in Tokyo will follow Switzerland and announce a minimum floor against the dollar, perhaps at 80.

Exchange rate policy in Japan is set by the Ministry of Finance with the Bank of Japan acting as the government’s agent in the currency markets. Officials in Tokyo are increasingly concerned that the strength of the yen will result in local companies relocating factories and jobs from Japan to more competitive destinations like the US. Thus foreign exchange investors should expect renewed intervention in the currency markets if the dollar keeps falling from its weak historic levels against the yen. But Japan is not Switzerland. Despite Tokyo’s desire to prevent yen strength, policymakers are unlikely to follow the Swiss and pursue an explicit exchange rate target for the yen.

First, the authorities in Switzerland only acted after the franc had reached record levels against both the euro and the dollar. In contrast the yen is not trading at extreme levels in real, trade-weighted terms.

Second, Switzerland represents a small economy of 8m people. Japan, on the other hand, has the third-largest economy in the world and is a member of the G7. Any move to target its exchange rate explicitly would attract intense criticism from North America and Europe, particularly as it would make it harder to press China to appreciate the renminbi at a faster pace.

Third, Japan has more policy options. Switzerland’s government and corporate bond markets are limited in size. Thus when the SNB pursues quantitative easing, it has little choice but to print money and buy foreign bonds, making the franc weaken. In contrast, Japan’s authorities can undertake quantitative easing by printing money and buying local government bonds as the Japanese government bond market totals a huge $7,000bn. They do not need to use the exchange rate to loosen monetary policy.

Japan’s greater policy scope suggests Tokyo will not shift to a politically contentious exchange rate target for the yen. Instead, Japanese policymakers are likely to continue to intervene periodically in the currency markets while undertaking further quantitative easing measures at home to curb the strength of the yen. Switzerland’s shift to announcing an explicit ceiling for its domestic currency seems a step too far for Japan.

Source: http://www.ft.com/intl/cms/s/0/ace44c10-fe31-11e0-bac4-00144feabdc0.html#axzz1cUcP5WLp

Clearing the usual suspects

Clearing the usual suspects

NO ONE likes paying more to fuel their car. The fluctuations in the oil price caused by political turmoil in the Middle East are hard enough to bear. But the idea that speculators are driving commodity prices beyond their “true” level seems particularly galling.

To many, that oil went from $65 a barrel in June 2007 to $145 in July 2008, and back down to $31 in December of the same year, is proof the price was not being set by supply and demand. Academics who have proclaimed on the issue come down on both sides of the argument. A recent report* from the OECD analyses the literature, applies its own statistical tests and finds investors not guilty.

Technically speaking, the report does not deal with the influence of speculators on commodity markets but with the role of index-tracking funds. But the spectacular growth of these funds (from $90 billion at the start of 2006 to almost $200 billion at the end of 2007) coincided with the boom in raw-materials prices, so it is hardly surprising they have been fingered as suspects.

The big buyers were pension funds and endowments. They became convinced, after the bear market of 2000-02, that they were overcommitted to shares. So they started to diversify into “alternative” asset classes that were not correlated with equities yet offered the prospect of hefty returns. Commodities fitted the bill.

Surely this lumbering herd must have had an effect on prices? There are some sound theoretical reasons why they might not. For a start the index funds buy futures—a contract to buy or sell an asset at a future date—not the physical good. They are not cornering the commodity, as the Hunt brothers from Texas attempted to do with silver in the late 1970s.

Higher futures prices could have sent a signal to commodity producers, who then decided to hoard their stocks rather than sell them in the cash market. The shortage might then have pushed spot prices higher. The evidence, however, is that inventories were falling, not rising.

An even more telling argument is that commodities without futures markets (apples, edible beans) or futures markets where index funds did not get involved (milk, rice) also saw price rises during 2006-08. Nor was there any correlation between the size of index funds in particular commodities and the price rise for those raw materials.

After analysing data on both prices and individual holdings from America’s Commodity Futures Trading Commission, the OECD study found that there was “no convincing evidence that positions held by index traders…impact market returns”; indeed, the OECD reckons that larger positions led to lower market volatility (although data issues mean the finding is more convincing for agricultural products than for energy markets).

So if the funds are innocent, who was guilty? The report does not give an answer but some economists have made the attempt, variously citing demand from China and other developing nations, the diversion of crop use from food to fuel oil, and production constraints.

These explanations may seem to strain plausibility, given that the oil price fell by 79% within five months. The Chinese did not suddenly cut their oil consumption by four-fifths. But if supply and demand are in close balance (as they were in the oil market), even very small changes in either component can lead to large price shifts.

In his book, “The Logic of Life: Uncovering the New Economics of Everything”, Tim Harford postulates a “marriage supermarket” in which men and women who agree to wed can present themselves at the checkout and share $100. Given equal numbers of men and women, say 20 apiece, one would expect couples to split the $100 down the middle. But assume there are 20 women and just 19 men. If the women are determined to get married, this shortage of males will cause a bidding war. None will want to be left in the aisles so they will agree to cut their share of the pot. In theory, the lack of just one male will mean the men get to keep $99.99 of the proceeds, leaving the women with one cent.

Similarly, in boom conditions commodity consumers will be so desperate to get their hands on raw materials that they will drive prices up to absurd levels, at least for a short time. When demand falters, or new supply shows up, the price bubble can evaporate as quickly as it arose, without a speculator in sight.

Source: http://www.economist.com/node/16432870

Giá lương thực thế giới và lạm phát ở Việt Nam

(TBKTSG) - Nhiều người cho rằng chính sách kích cầu của Mỹ là nguyên nhân của sự tăng giá đột biến hàng hóa trong thời gian qua. Chính điều này tạo nên áp lực lạm phát ở các nước mới nổi, trong đó có Việt Nam. Giả thuyết này mặc dù dễ thuyết phục tuy nhiên lại vấp phải khá nhiều vấn đề trong suy luận và số liệu thực tiễn.

Tại sao giá lương thực thế giới tăng?

Cần chú ý là gói kích cầu “nới lỏng định lượng 1” được thực hiện từ tháng 1-2009 đến tháng 3-2010. Việc tăng giá các mặt hàng lương thực xảy ra muộn hơn rất nhiều so với các mặt hàng công nghiệp khác. Theo chỉ số giá của IMF, có thể thấy giá cả hàng hóa công nghiệp tăng nhanh ngay sau khi sản lượng công nghiệp của thế giới chạm đáy vào tháng 2-2009. Còn giá lương thực trong cả năm 2009 gần như không có biến động mạnh (hình 1). Tuy nhiên, giá lương thực bắt đầu tăng nhanh vào tháng 8-2010 ngay sau khi thời tiết xấu ảnh hưởng lớn đến các vụ mùa ở Nga, Ukraine, Kazakhstan, và một số nước khác.

Điểm thứ hai là tổng cung so với tổng cầu của thế giới về lương thực. Giá lương thực thế giới đạt đỉnh vào tháng 4-2011. Theo số liệu thống kê và dự báo vào tháng 4 của USDA (Bộ Nông nghiệp Mỹ) về tổng sản lượng ngũ cốc của thế giới, điều thấy rõ nhất là thế giới đã bị một năm mất mùa khá trầm trọng. Tổng sản lượng ngũ cốc giảm gần 3%, nếu tính luôn cả lượng tăng dân số thế giới thì sản lượng ngũ cốc trên đầu người giảm gần 5%.

Vấn đề là tại sao sản lượng giảm chỉ có 5% mà giá cả của một số lương thực lại tăng gần 100%? Một phần có thể được giải thích do nhu cầu về lương thực tăng nhanh hơn tốc độ tăng của dân số. Ví dụ, Trung Quốc đã trở thành một nước nhập siêu rất lớn về ngũ cốc để thỏa mãn nhu cầu về thức ăn gia súc. Nhưng điểm quan trọng là độ co giãn của cầu ở các mặt hàng ngũ cốc rất thấp (demand inelasticity). Có nghĩa là, giá phải tăng rất mạnh thì nhu cầu mới giảm được. Theo USDA, hệ số co giãn cầu của các mặt hàng ngũ cốc tại Mỹ là 0,04. Điều này có nghĩa giá cần phải tăng 25% (1/0,04) để nhu cầu giảm 1%.

Ở một khía cạnh nào đó, các gói kích cầu có thể làm trầm trọng thêm việc tăng giá của các mặt hàng lương thực. Nhưng nguyên nhân chính của việc tăng giá lương thực thế giới trong thời gian qua là sự mất mùa trong năm 2010.

Một vài dự báo về giá lương thực thế giới

Dự báo về thu hoạch vụ mùa 2011-2012 tốt hơn rất nhiều so với vụ mùa 2010-2011. Theo báo cáo của FAO (Tổ chức Lương nông thế giới) và USDA vào tháng 7, tổng sản lượng ngũ cốc trong vụ mùa 2011-2012 sẽ tăng khoảng 2,5-2,9% so với vụ mùa 2010-2011. Chính điều này đã làm cho giá ngũ cốc giảm trong ba tháng vừa qua. Giá bắp và lúa mì đã giảm nhẹ từ 6-10% kể từ tháng 4 sau một giai đoạn tăng nóng gần 100%.

Lượng hàng dự trữ của các loại ngũ cốc đã không còn giảm mạnh và có khả năng tăng trở lại. Đặc biệt là dự trữ gạo vẫn tiếp tục tăng trong vụ mùa 2011-2012 sau khi sản lượng đạt kỷ lục vào vụ mùa 2010-2011.

Nếu không có vấn đề lớn về biến động thời tiết trong thời gian tới, bất chấp gói kích cầu lần 3, sẽ không có sự tăng giá đột biến ở các mặt hàng ngũ cốc như năm 2010 và đầu năm 2011.

Lạm phát do cơ cấu thị trường?

Một câu hỏi được đặt ra là, tại sao các nước lân cận có một số điểm tương đồng với kinh tế Việt Nam như Thái Lan, Ấn Độ, Trung Quốc, giá thực phẩm cũng tăng cao nhưng với tỷ lệ thấp hơn so với Việt Nam? Mặc dù Việt Nam là nước xuất siêu lương thực nhưng chỉ số giá lương thực tăng cao hơn gấp 2-3 lần các nước lân cận. Điều này cho thấy ảnh hưởng của giá thế giới chỉ tác động phần nhỏ đến giá cả Việt Nam.

Giá lương thực thực phẩm có thể biến động mạnh do ảnh hưởng của thời tiết và dịch bệnh, chứ không chỉ do ảnh hưởng từ chính sách tiền tệ và tài khóa. Điều này cũng lý giải việc ở hầu hết các nước, nhất là những nước có nhóm giá lương thực thực phẩm chiếm quyền số cao trong rổ hàng hóa tính CPI, khi tính lạm phát cơ bản thì chỉ số giá lương thực thực phẩm được loại ra. Vì vậy có thể nói, yếu tố tiền tệ và tài khóa ở Việt Nam không phải là nguyên nhân làm cho giá lương thực thực phẩm của Việt Nam tăng cao hơn các nước trên.

Chúng ta phân chia các nước ra làm hai loại: các nước phải nhập khẩu gạo và các nước xuất gạo. Việt Nam là một trong những nước xuất khẩu gạo lớn nhất thế giới và cũng là nước xuất khẩu gạo duy nhất có giá gạo tăng gần 37%, hơn gấp đôi tỷ lệ tăng giá thế giới trong cùng giai đoạn (hình 2). Việc tiền đồng mất giá khoảng 7,2% vào tháng 2 có thể giải thích được một phần sự chênh lệch trên. Nhưng độ chênh lệch vẫn quá lớn trong bối cảnh lạm phát vào cuối năm 2010 đã lên rất cao.

Tuy nhiên, lạm phát của Việt Nam có thể bắt nguồn từ một nguyên nhân sâu xa hơn, từ khâu phân phối khi chênh lệch giữa giá thu mua và giá bán lẻ ngày càng lớn. Một ví dụ có thể thấy rõ là thị trường thịt. Tính đến tuần đầu của tháng 7, giá thịt heo thăn bán lẻ tại Hà Nội đã tăng khoảng 82% so với đầu năm, trong khi giá mua heo hơi ở Hà Nội chỉ tăng khoảng 51%. Điều này cho thấy lạm phát một phần rất lớn đến từ cơ cấu thị trường. Giá bán lẻ tăng liên tục từ đầu năm bất chấp giá thu mua có nhiều giai đoạn chững lại hay giảm, cho thấy cơ cấu thị trường kém hiệu quả.

Một vấn đề quan trọng nhưng lại rất ít được chú ý là cơ cấu thị trường, đặc biệt của thị trường lương thực thực phẩm, ảnh hưởng rất lớn đến lạm phát. Cơ cấu thị trường ở đây bao gồm cơ chế giám sát điều hành, cơ cấu về quy mô chăn nuôi, hệ thống thu mua phân phối, hệ thống hàng tồn kho cũng như vận chuyển, các tầng lớp trung gian… Sự yếu kém của cấu trúc thị trường thường chỉ biểu hiện mạnh khi kỳ vọng lạm phát cao. Có thể nói kỳ vọng lạm phát cao cùng với sự yếu kém của cấu trúc thị trường là nguyên nhân chính dẫn đến mức tăng bất thường của giá lương thực thực phẩm ở nước ta.

Chính điều này luôn làm cho lạm phát của chúng ta một khi đã lên thì lên rất mạnh và nhanh. Rõ ràng bài toán lạm phát đã không được quan tâm và hiểu một cách đúng mức.

Có lẽ chúng ta đã đặt kỳ vọng quá lớn và không đúng vào khả năng kiểm soát lạm phát của chính sách tiền tệ. Việc kiểm soát lạm phát ở Việt Nam đòi hỏi sự phối hợp đồng bộ các chính sách và một chiến lược dài hơi để kiểm soát lạm phát trong trung và dài hạn, không nên chỉ tập trung nguồn lực vào kiểm soát lạm phát ngắn hạn. Một trong những việc cần làm để kiểm soát lạm phát trong trung và dài hạn là một chiến lược đầu tư vừa nguồn vốn vừa tri thức vào lĩnh vực nông nghiệp.

Source: http://www.thesaigontimes.vn/Home/diendan/sotay/59504/