Global Markets at a Glance
You could just read the last 10 posts on Economics here at Alpha.Sources but the recent edition of The Economist gives a very good descriptive round-up of the global economy and markets right now. The key concepts are ...
- Joint rate hikes by the major central banks (The Fed, ECB and BOJ) in order to scoop up excess liquidity and quell inflationary pressures. See more about the excess liquidity argument here and here. I have argued that the ECB and BOJ will face difficulties and boundaries towards a any substantial raising but the broad picture still points to a tightening cycle.
- Market wobbles in emerging markets as investors become more risk averse towards the riskier parts of the market because the carry-trade premium declines as the major central banks close the gap. See also this Economist article about the increasing differentiation in emerming market assets (walled for non-suscribers). Obviously (yen) carry-trade is one to watch here as well.
- The risk averse investor and whether she is risk averse enough ... expectations although difficult to gauge are a key concept here.
Let us look at the article then ... (bold parts signify my version of the important points)
So rates are definitely going up, or at least that is what the expecations point to.
'Central bankers in the world's big, rich economies have played a frustrating guessing game with financial markets this year. But if there is one thing about which investors can be more or less sure, it is that for the first time in years, official interest rates in America, Europe and Japan are heading in the same direction.'
The end of Japanese ultra loose monetary policy and a new Fed chairman ... not a good cocktail for global markets as it were in the past months. And the ECB? Well, Trichet and his lot have their gaze firmly attached to their inflation target of 2.5%. Note also the relative shift away from emerging market assets.
'Yet the prospect of an end to a long era of easy money has put financial markets into a lather. After the BoJ turned off the monetary printing presses in March and began to drain ¥20 trillion ($175 billion) of excess liquidity—the equivalent of 4% of GDP—from the banking system, the Japanese stockmarket dropped violently. And global investors reconsidered their appetite for risky investments, retreating from overheated economies such as New Zealand, Saudi Arabia and Iceland.
In May concerns about how the Fed, under a new chairman, would handle the live wires of slowing growth and rising inflation caused a month-long drop in global equity and commodity markets. Uncertainty, especially about global interest rates, made financial markets of all sorts turbulent in May and June.'
The dynamics of an excess liquidity global economy; enter the carry trade and its unwinding?
'The jumpy reaction was understandable. For years, loose money has lubricated markets and encouraged consumers, companies and speculators to borrow handsomely. Recently Japan, with interest rates at nil, has provided much of the liquidity. Japanese investors have bought high-yielding assets abroad to beat the miserable returns at home. Meanwhile, global hedge funds have borrowed in yen and invested profitably in anything from emerging markets to high-yield debt.
A few years ago, they did the same with the dollar. When American interest rates were as low as 1%, there was money to be made by borrowing greenbacks and buying higher-yielding currencies such as the Australian and New Zealand dollars. But as interest rates rose, the dollar lost its lure as a funding currency, and speculators switched to yen. With Japanese interest rates now heading up as well, such investors may have to think of a new game.'
So not quite the end of excess liquidity ...
'What of rising interest rates elsewhere? Will these prick the liquidity bubble? Probably not for the time being, says Barclays Capital, an investment bank. It notes that global interest rates are still well below nominal GDP growth (see chart), whereas throughout the inflation-busting 1980s and 1990s they were mostly higher. That suggests monetary policy is still pretty loose. Barclays Capital believes that interest rates will have to rise further to quell inflation. It thinks America's fed funds rate will end the year at 6%.'
Would the investors be wise to be a bit more risk averse after all?
'Michael Metcalfe of State Street Global Markets, a big asset-management company, notes that investors are buying cross-border assets again this month after abandoning them in June. Provided they do so selectively, that is fine. But if the tightening continues, bravery may soon look like folly.'
I have kept my usual arguments and normative assesment in moderate check on this one because I think the article is very good on the descriptive and explanatory level. And as we know ... before we can rant we must understand so there you have it.