Many meetings and one major message: Financial risk is real4 min read . Updated: 09 Nov 2020, 09:21 PM IST
Low interest rates, asset purchases, currency debasement and frothy bourses can’t coexist indefinitely
In spite of—or because of—the mainstream media in America announcing mission accomplished, we don’t know for sure who the 46th President of the United States of America will be. Therefore, it might make sense to wait before we analyse the policy implications for financial markets of the next US President. Let us dig out the few important meetings that got lost amid all the election noise last week.
I am not referring to the meeting that Chinese financial regulators had with Jack Ma which resulted in the dramatic last-minute suspension of Ant Financial Group’s initial public offering (IPO). Even though there may have been genuine regulatory concerns about a non-bank financial group becoming so big and influential in China’s financial system, the decision to pull the IPO about 36-48 hours before it was scheduled was a power statement. The party remains the boss and its power had to be demonstrated unmistakably so that no corporate leader, even one who has been a long-standing member of the Communist Party, can entertain even a sliver of a thought that he is just as influential. Not especially after saying that there was no risk of instability in the Chinese financial system because there was no financial ecosystem in China.
That show of power was an important signal that the internationalization of the renminbi is not about to happen anytime soon. American economic policy (monetary and fiscal) has been disastrous in the last two decades; its society is polarized and its politics is dysfunctional. Yet, the moral of the story is that its challengers are no better off. That is the secret shield for the US dollar, although American monetary policy will strive to debase it for a long time. That was the message of US monetary policy meetings that took place during the week.
The Federal Reserve Open Market Committee (FOMC) met on 5 November and decided to leave its interest rate changed. Given the name of the committee, one cannot help wondering if the market is truly open in America. The interesting thing about the FOMC meeting announcement is that the Federal Reserve committed to increasing its holdings of Treasury securities and agency mortgage-backed securities at least at the current pace in the coming months. Coupled with the US political uncertainty, this announcement sufficed to send the US dollar weakening against major currencies—the euro, the Australian dollar and the British pound. The last of these is interesting because the Bank of England made its monetary policy announcement the same day.
The Monetary Policy Committee of the Bank of England (MPC) voted unanimously “to continue with the existing programme of £100 billion of UK government bond purchases" and to increase the target stock of purchased UK government bonds by an additional £150 billion, financed by the issuance of central bank reserves, to take the total stock of government bond purchases to £875 billion." Together with its holding of corporate (investment grade) paper, the Bank of England’s holding of government bonds could easily exceed 50% of gross domestic product (GDP) soon, if it is not a reality already. One can easily discern a serious race underway among the world’s leading central banks to debase their currency. But, the winner of the current lap is the Federal Reserve.
The dollar weakened against the pound, and not the other way around, despite the Bank of England making a more specific commitment to increase asset purchases than the vague promise of the Federal Reserve. Dollar weakness is the default theme for this decade. In theory, all this is good news for capital-starved emerging economies.
The more developed countries keep their interest rates low and expand their monetary base, hungry investors would be willing to send funds—short-term, long-term, portfolio and direct—to developing countries in their quest to earn a decent nominal return on their investments. So, there is a belief that this is all for the good for developing economies and that their assets would generate good returns for investors. Of course, if more people believe this, it can become a self-fulfilling prophecy. A cold shower cannot hurt.
After questioning the mental health of the French President, the President of Turkey fired its central banker for the weakness of its currency. In one sense, he is taking a leaf out of the books of central banks in advanced nations: To solve a problem, create more of it. The short point is that policy risk in emerging markets is not to be dismissed. Second, stocks in America are frothy, to put it mildly. GMO, an experienced asset manager, likened the valuation and conditions in US stock markets to 1999. Celebrations in the “swamp" (bourses) in the week of the election deserves a separate analysis. But, a meaningful correction in US stocks is overdue and a spillover of US market sentiment is a risk for emerging economies. Third, emerging economies are not yet exempt from the virus risk. Indonesia is officially in recession, for example. Four, there are local political risks beyond the American situation. So, conviction is necessary, but luck too is needed for big bets on emerging market assets to come good. Safety first; returns later.
V. Anantha Nageswaran is a member of the Economic Advisory Council to the Prime Minister. These are the author’s personal views.