A Friday wrap ..... and it's not all about G7 (sorry, G6 +1)

ref :- A run around the Financial Times

There's already saturation coverage of the two-day G7 meeting that starts today in Quebec. Well, that's fair enough ..... by the time it's over we might have a clearer idea whether President Trump's antagonistic, even bullying stance on trade tariffs is a negotiating tactic of the kind he favours, or incontrovertible evidence that he is fully prepared to allow a meltdown in relations with his G7 allies in order to achieve his objectives.

The latter certainly seems the more likely at this stage, which is a bit ominous for a number of reasons above and beyond the obvious commercial and economic implications. The early signs are not encouraging .... Bloomberg are reporting suggestions that Mr Trump has ordered his Air Force One flight out of Canada for Saturday morning so that he has time to prepare in Singapore for his meeting with Kim Jong-Un. In one very particular sense, that's almost reassuring ..... to the consternation of many, the President (almost unbelievably) had previously said that the meeting required very little in the way of preparation. Anyway, that would leave little more than 24hrs for the "G6" to reach an amicable outcome with the  "+1", which would seem a stretch to put it mildly.

It also shortens the odds (already pretty short) that come the middle of next week, we'll be able to say that the President of the USA has had a much friendlier and more constructive meeting with the dictator of North Korea than he did just days before with the leaders of his nation's closest allies. If that's not evidence that the world's a crazy place, we don't know what is. Still, for all the tension that the trade dispute has created nobody really knows how it will all end up. Consequently, from a market point of view, there's a fair bit of "ignoring the issue" going on, at least until the extent and effects of it all become clearer. There's plenty of other stuff to keep an eye on, though ......

ref :- "Lira rallies after Turkey puts up rates ahead of poll" , The Financial Times, International Section

As one of the most dynamic of recent years, Turkey has become something of a bellwether amongst emerging markets. An overheated economy fuelled a huge current account deficit, large dollar-denominated debt and double digit inflation (last at 12.2%). The resultant tumbling value of the currency only exacerbated the problems, and investors took a very dim view of the lack of reaction in monetary policy thought to be the result of political pressure put on the central bank, particularly by President Erdogan who has repeatedly made plain his abhorrence of high rates of interest.

Under pressure or not, on May 23rd the central bank raised rates by 3% in a move that at the time no one was sure was sufficient, tightened further last week and yesterday hiked headline rates by another 1.25% (to 17.75%). It was a bold and unexpected move, and some analysts are saying that for the first time it looks as though policy-makers have got "ahead of the curve". It caused a 2% rally in the Lira, but more importantly, serves to restore credibility in the independence of the central bank and in its determination to tackle inflation.

It also helps to boost the confidence of investors ..... though in the background there's still a suspicion that President Erdogan, who has previously stated both his desire to take a personal grip on monetary policy and his belief that lowering interest rates is the way to lower inflation, will reverse matters if and when he is re-elected on June 24th. That may explain why the Lira is unable to hang on to all its gains this morning.

ref :-  "Brazil Blues  --  Political uncertainty pushes currency to two-year lows" , The Financial Times, Companies and Markets

Turkey may, or may not, have finally adopted the hawkish monetary policy measures to please investors, but another leading emerging market nation looks unlikely to do so anytime soon. Hence the Brazilian Real has climbed to 3.94 versus the dollar, its weakest for two years. Against a background of gradual but continuing rate hikes in the US, the latest sell-off in the Real was sparked by a government climbdown in a row with truckers about the price of diesel.

For investors, it demonstrated a return to the bad old days of price controls and it does not bode well for hopes that the government has any determination to implement the kind of tough fiscal reform required to instil confidence. There's an election in October .... the trouble is that none of the likely winners seems keen to grasp the fiscal nettle, and the leaders in the polls  --  populists, of course  --  definitely wouldn't. The central bank will try to support the currency of course, but on any longer-term basis that is not likely to be enough.

N.B. The next EM target looks like South Africa .... the Rand is off 2% this morning and it has weakened during the week from a low of 12.54 versus the dollar to a high of 13.27 at one point.

ref :- "Watch the Fed's balance sheet, not interest rates" , The Financial Times, Opinion by Gillian Tett

Remember we were talking the other day about Urjit Patel ? The distinguished governor of India's central bank was urging the US Federal Reserve to slow the process of reducing its balance sheet. As it stands, the Fed is unwinding the purchases of US Treasuries that it purchased during its Quantitative Easing programme to the tune of $20bn per month  --  that's due to rise to $50bn next year and will total $1trn by Dec 2019

In advance of this balance sheet reduction, some investors were decidedly anxious about what effects it might have on markets. In the event, it has been going on almost without anyone noticing with most of the focus on how quickly the Fed will tighten interest rates (four times in 2018, or three?). But the calm has yet to take into account the effect of President Trump's unexpected tax cuts, which has suddenly widened projections for the budget deficit, and the Treasury will have to issue more bonds to make up the shortfall. The estimate is that $2.34trn of Treasuries will be issued over the next two years.

Mr Patel pointed out that someone, somewhere, has got to buy all these bonds. As Ms Tett says, that will suck billions upon billions of dollars out of the system and create a liquidity squeeze for global bond investors. That will be very bad news for them, and very bad news indeed once again for those emerging markets having to service dollar-denominated debt when yields are surging (not to mention the value of the dollar).

Poor old EMs .....it's a bit of a theme, isn't it ? Central bankers very rarely directly advise other central banks about policy, and Mr Patel sounding the alarm publicly should give us a fair idea of the depth of his concern.