Uncertainty is not a bug, it’s a feature, indeed it’s the whole point of policy and the old political adage: “If it ain’t hurting, it ain’t working” has some resonance here too.
The hand behind the Fed
If the bond markets praise the central bank, it’s precisely because the Fed has effectively told them what is happening and thus underwritten the huge leverage trades they like to put on. Thus, if traders are unhappy, risk managers should be comfortable there are no hidden leverage carry trades going on somewhere.
Two things look to have stayed the Fed’s hand in the past couple of weeks, neither to do with the unemployment rate. First, there was some general concern about the impact the rising dollar was having on several emerging markets.
Second, Ben Bernanke was clearly troubled by the thought of a re-run of the debt ceiling debacle of a year ago. Indeed, debt ceiling has taken over from tapering as the over-used word of the week and the S&P has accordingly had a soggy end to the month and quarter. We saw a sharp spike in the put/call ratio following triple-witching last week which is probably being reflected by the delta hedging desks over the past few days creating some downward pressure on the S&P which is spilling over into other markets.
At the CLSA investors’ forum in Hong Kong earlier this week, I heard perma-bear Russell Napier, an economic historian, speak with who I, surprisingly, have rather more to agree with than might be expected from his reputation.
Eighteen months or so ago, he was, quite rightly, bearish on the emerging market debt bubble, particularly the notion whereby bond markets appeared to be willing to lend to countries in local currency. As we always used to say, fine to lend someone money, but not in a currency where they can pay you back simply by printing more of it!
Currency chaos
Equally, lending in your own currency might on the one hand seem more prudent, but then you face a quite different problem: as Napier put it, if their currency devalues, then everybody goes bust. One doesn’t need too long a memory to recall the citizens of Hungary borrowing billions in Swiss franc mortgages.
In 2008, your Swiss Franc mortgage of CHF 100,000 would have cost you 1.4m forints. Three years later it would have cost you 2.7m forints. Not surprisingly bad debts on Hungarian sourced Swiss Franc mortgages went up. A lot. The problem now is that Turkey, Poland and Hungary have borrowed an awful lot in euros from European banks and that a rush to cover may be leading to further currency weakness/euro strength. Far from Asia repeating 1997/8, the risk is that emerging Europe will.
The risk of contagion is always there, not least because in a liquidity crisis people sell what they can, not necessarily what they want to.
There would also be a risk of other collateral damage from policy response. If things get too bad there is a very real threat of exchange controls being put on, paralyzing activity, something that Napier believes nobody is even considering.
One of his great advantages is that he is a historian rather than an econometrician. As such he was early in discussing financial repression, the system whereby governments push rules and regulations that effectively force savers to buy overpriced government debt.
He derives his analysis from history rather than inferring economics from daily market moves, which is a welcome change.
