Random Shots - High Expectations

If investors were hoping that the strength of commodities was sign that decoupling, led by Asia and Latam, were running on course to help the global economy expanding, events last week must surely have extinquished such hopes. Indeed, it was always a question of commodities and emerging markets catching up to the ongoing slaugther in Europe. 

Indeed, what seems to be main question now is whether the US economy will avoid a recession and, as a consequence, just how bad it has to get before the Fed starts another round of shock and awe QE. In this sense, I also always thought that expectations of emerging market foreign exchange reserves bailing out Europe and/or central banks easing aggressively to support the global economy were pinned on expectations that after all were too high. 

(Quote Bloomberg)

The world’s largest emerging economies will not act as a bloc to ease Europe’s financial crisis, Russian Deputy Finance Minister Sergei Storchak said.“It’s impossible, I’m certain of that,” Storchak told reporters today in Washington. “If the BRICS are going to act to overcome the euro zone’s financial problems, then it will be based on the possibilities presented by working through the International Monetary Fund.”Finance ministry and central bank officials from Brazil, Russia, India, China and South Africa met before this week’s IMF annual meeting to discuss coordinating policy as Europe reels from a sovereign debt crisis and growth slows in the U.S. There is a “high” danger that Greece will not fulfill all of its debt obligations, Storchak said.

As for the EM tightening cycle I think that while we may certainly see an easing of pace or perhaps even a full stop of tightening measures I think a reversal is out of the question. This is the case even if the recent strong correction in commodities and the global slowdown is likely to make inflation a non issue going forward. The point is that inflation lags the cycle and if the central banks are fixed on this measure it will take some time before the data allows decisive action unless of course the future is suddenly discounted in a radically different way due to rising downside risks. 

In India, the tightening cycle is surely near its end with the yield curve already flat as a pancake, but with sticky inflation and fiscal policy continuingly loose, there is limited scope to the central banks' ability to manoeuvre.

(Quote Bloomberg

India’s central bank is close to the end of its record series of interest-rate increases as inflation will probably slow next year, Deputy Governor Subir Gokarn said.“You could say that the cycle is nearing its end,” he said, “given the projection that inflation will start coming down and will continue to move down from December onwards.” He declined to specify when the Reserve Bank of India may stop raising rates.

Worryingly, recent news out of China appears that the country may be turning Indian or at least that easing may not come quite as expected. Especially, it is bad news for the global economy in the near term (but perhaps good in the long run?) that Chinese authorities seem to be engineering a crack down on property developers which will not only lead to an acceptance of lower growth in order to effectively quell off balance sheet lending. 

It seems that investors hoping for emerging markets to drive forward the global economy may, for the moment, be guilty of too high expectations.