The zero interest rate policies being adopted by central banks is causing massive price distortions all over the world – the Fed is now global in scope– its decisions in the coming year will impact the lives of billions and it looks increasingly likely these decisions will be made from the corner which the fed has painted themselves into.
One of the biggest consequences of the Fed’s Quantitative easing program has been a massive injection of capital into emerging markets, resulting in a potentially toxic carry trade of epic proportions. Yield starved investors in the US, Japan and Europe have poured money into high yield sovereign bonds across the world – the yields on many of these bonds tumbled and their corresponding national currencies appreciated significantly during this bull period between 2009–2011.
As domestic yields fell, the banking system in these emerging markets faced a dilemma – the traditional and often conservative investment methods of investing in government bonds and bank time deposits were no longer attractive– in many cases investors were facing negative real rates in as inflation levels remained stubbornly high. Faced with fierce competition from international competitors all scrambling for a piece of the action, incumbent banks were forced into riskier and riskier investments to keep their net interest margins intact. For the man on the street in emerging markets this led to an unprecedented boom in consumer lending – from which a myriad of housing and high end commercial real estate bubbles have emerged.
Increased liquidity within the domestic banking system and negative real rates on traditional deposit investments has also led to unparalleled growth in such countries’ stock markets. 200 – 300% gains in these markets are commonplace since the height of the financial crisis in 2009. An increase in foreign investors in these markets has also brought a new focus on particular performance metrics within the banking sector – loan growth in particular was rewarded heavily by a corresponding increase in bank share prices. As a consequence, consumer and corporate lending within these economies has skyrocketed. Corporates, often with shady corporate governance history, have been granted unrestricted access to financing in both domestic and international markets to yield starved investors – with the proceeds being plowed into trophy commercial real estate projects and commodity related investments.
Halloween Economics: Who’s next at the door?
Emerging market bubbles have been operating well below radar for the time being. The Greek turmoil within the Eurozone and political friction in Russia are taking center stage for financial analysts and commentators. It looks increasingly likely however, that emerging markets will be the next abomination to show yet another guise of the economic malaise which has been changing disguise since the collapse of Lehman all those years ago.
Expectations for a rise in US interest rates have already had dire repercussions for emerging market currencies – however with consumer borrowing and equity markets at all time highs in these regions – it would appear that the full blown affect of fed rate hikes has not been priced in.
Emerging markets are therefore rightfully desperate for deflation trends to continue in the US – a delay in rate hikes will help buy time – but it seems increasingly likely that time is running out before the pidgeons come home to roost and we are faced with yet another weak point in the global financial system to deal with.
Until the price discovery mechanism imposed by market forces instead of central bank policies is able to work again – our economies will continue to operate in a dangerous state of delusion. The relationships between labor, capital and entrepreneurship are the bedrock of all economies, and as long as the cost of capital is distorted, labor and entrepreneurship will continue to be thwarted.
While speculation is promoted, rewarded, and even favored over traditional capital formation – we will continue to increasing polarization within society and dysfunctional economies. The Fed’s next move rightfully has the market on tenterhooks, and emerging markets above all others will be watching with increasing anxiety.
Latest posts by Andrew (see all)
- Yuan Devaluation Spells Trouble Ahead - August 14, 2015
- Bank of England Report Suggests Rates Will Remain on Hold - August 10, 2015
- Fed’s latest minutes keep everyone guessing - July 31, 2015