Even though India left interest rates unchanged this morning, as broadly expected, there were hints of rate cuts to come from the central bank governor, leaving scope for rates to come down from the current 8.50% level. The pattern we have seen in the BRICs recently (Brazil, Russia, India and China) has been concerning to varying degrees.
The Brazilian economy ground to a halt in the third quarter, whilst China is suffering a growing over-hang in the property market (see below) which risks causing some significant ripples in the banking sector. On this front, it’s interesting to note the jump in the yuan overnight, to a record high vs. the dollar at 6.3294.
This follows several days of modest yuan depreciation and suggests that the Chinese authorities are not yet in a position to be comfortable with a sustained reversal of the currency, some of which has been down to investors fleeing the currency in the face of real economy and credit concerns.
In the wider picture, it’s clear that the sovereign crisis, which the IMF leader overnight suggested could lead to a 1930s style recession, is largely contained in the developing world (with the US unable to sit back and relax by any means). In contrast, the IMF predicts falling sovereign debt in the emerging world, but in the near-term, there are significant headwinds to be overcome.
Guest post by FxPro
China – just as scary as Europe. Recent surveys of manufacturing suggest that growth in the sector is contracting, money supply growth last month was the slowest for more than a decade and export growth has slowed markedly, especially to Europe. Property prices are declining and quite quickly in some major cities. Developers, squeezed by lending restrictions and higher rates, have invariably been forced into a fire-sale of new developments at a time of huge oversupply. In many cities, property valuations had become completely unsustainable in terms of price/income ratios. As is so often the case, excess leverage is amplifying China’s slide. According to the IMF, the value of loans as a percentage of GDP has doubled in the country since 2006. Justifiably, there is growing concern that bad debts at financial institutions could grow quite swiftly next year. China will soon discover just how difficult it is to manage the combination of widespread deleveraging and a large debt mountain. At the same time, it must be said that China has a fair degree of policy flexibility available. Bank reserve ratios must be lowered as a matter of urgency, and by a significant percentage; fiscal policy needs to be loosened and the currency needs to be allowed to depreciate, especially with dollar demand so strong. The latter may be controversial, and would certainly attract enormous ire in Washington (especially during an election year), but would be defensible, especially if China slipped back into recording trade deficits. Offshore investors have been fleeing China over recent months in any event – witness the 30% decline in the Shanghai Composite over the past six months, the recent pressure on the yuan and the decline in China’s massive foreign exchange reserves in recent months. This year, Europe has completely dominated the headspace of investors and traders. Next year, China will absorb much of the focus.
China/US trade wars. It is starting to get ugly between China and America on the trade front. In retaliation for US dumping practices and subsidies, China’s Commerce Ministry has announced a duty of 2-21.5% for two years on imported cars and SUVs with an engine capacity greater than 2.5 litres. It will hit some of America’s largest car-makers hard, such as GM, Ford and Chrysler, not to mention BMW and Mercedes who both have a large manufacturing presence in the United States. Unfortunately, these tit-for-tat trade measures are becoming much more common these days between the world’s two large superpowers. For instance, last week the US announced it was taking China to the WTO to challenge its use of anti-dumping measures against US poultry exports. China has been actively utilising anti-dumping provisions since the 2008 global financial crisis. If it does allow its currency to decline in coming months, at a time when offshore investors are keen to get money out of the country, we can expect this trade tiff to develop into something more substantial. Tensions between the two countries are on the rise again.
Finally, UK inflation starts to decline. At least UK consumers can finally see some benefit from this incredibly prolonged period of austerity. Inflation, so high for so long, is headed lower according to the latest retail sales figures from the ONS. The implied deflator for all retailing (ex auto fuel) rose by 2.6% in the year ended November, down from August’s peak of 3.8%. Household goods are already experiencing deflation and non-store retailing (i.e. online shopping) is also seeing virtually no growth in prices. For their part, consumers remain extremely cagey, with the volume of sales ex auto fuel falling 0.7% last month, worse than expected. In the year ended November, the volume of sales is only barely positive. To put this into perspective, the level of retail sales (in volume terms) has not changed since mid-2008. Interestingly, after such extraordinary restraint, the support of the British public for continuing austerity shows no signs of diminishing. According to one poll this week, three-quarters of the public want the deficit paid off as soon as possible.
SNB forecasts suggest more work to do. The SNB kept the floor on EUR/CHF at 1.20, but its forecasts suggest there is likely more to do on the currency front if deflation is to be avoided on a sustained basis. For next year, the SNB expects the economy to grow a mere 0.5% and expects inflation of -0.3%, rising to 0.4% for 2013. The SNB bases these forecasts on maintaining zero rates and a depreciating CHF. The question naturally arises as to how likely the latter assumption is and whether it comes about from market developments or whether the SNB has to move the EUR/CHF floor higher so as to push the CHF lower. Given the continued tortuous global environment we are seeing, it still appears that the latter route is more likely. The SNB was fairly vocal in viewing this 1.20 level as being overvalued when it was introduced back in September. It could well be a tough haul though. The outlook for the eurozone has deteriorated and the political backdrop has also weighed on the single currency into the year-end. This will likely mean that the SNB could be doing more work to defend the 1.20 level on EUR/CHF, let alone thinking about moving it to 1.25 or beyond. But this will have to happen next year if Switzerland is to avoid a more entrenched period of deflation.Get the 5 most predictable currency pairs