Yes, the pendulum of market prices is a cruel mistress. Two years ago, Brazilian Finance Minister Guido Mantega was voicing concerns about the developed economies declaring a currency war on the emerging markets through the use of its quantitative easing programs. The Brazilians reacted by imposing various forms of exchange controls to slow the inflow of “hot money,” as well as cutting Brazilian interest rates. Now that the Brazilian Real has depreciated by 50% since August 2011, the Brazilians believe that they have had enough and want to stem the depreciation because of the inflationary effects of a rapid depreciation. The Brazilian Central Bank (BCB) raised interest rates again last night by 0.5% to 9% in an act to help end the REAL‘s recent downward move. Last week, the BCB announced a large currency intervention package of $60 billion involving swaps and loans to the markets. This program ensures that the Brazilian financial markets will have a steady stream of dollars and will prevent a fear among investors that Brazil will not be able to meet investor demands for currency redemptions.
The Brazilians have the foreign reserves to enable this program to succeed but in the end is it another piece of financial collateral damage from the FED‘s massive QE program. Yes, the Brazilians are certainly not innocent as they wished a weaker currency and also partied as the “hot money” flowed in. But as we saw in Jackson Hole last week, certain Fed officials were taking a view that everybody in the world is responsible for their own policy. It seems only a short while ago (2004 to be exact) that Fed Chairman Bernanke was blaming the ultra LOW bond yields on too much saving by Asian investors and policy makers. So it seems the Chinese consume too little–resulting in the U.S. importing too much capital–but the U.S. central bank creating $3.5 trillion in reserves has no bearing on global financial stability. I will wait for next week’s G-20 meeting in Russia to see the world’s reaction to the Fed’s recent attitude of “every man for himself.”
In the “every man for himself” theme that echoed from Jackson Hole, even the previous Fed Vice Chairman weighed in on the discussion. In response to the huge growth in global imbalances, Donald Kohn was quoted in the FT: “One of the ways that monetary policy from the U.S. was transmitted to the rest of the world was by resistance to exchange rate appreciation in many other countries.” Many of the emerging market policy makers responded that “how much currency appreciation was enough?” So the Bernanke group blames Chinese savers for the housing bubble but the appreciation of the emerging markets currencies and the imbalances in the global economy is the fault of the individual countries. In support of the emerging markets position, IMF Director Christine Lagarde maintained the IMF would increase its lines of defense against any type of emerging market crisis. Wow, now we can all sleep easier tonight.
***Last Friday’s FT had a wonderful op-ed piece by Gillian Tett. Titled, “Central Bank Chiefs Need to Master the Art of Storytelling,” it’s a strong reassurance for gold investors and cites the primary role for central bankers: “… the key point is this: WHAT IS UNDERPINNING THE FINANCIAL SYSTEM THESE DAYS IS NOT SO MUCH A TANGIBLE BENCHMARK [SUCH AS A GOLD STANDARD] BUT AN INTANGIBLE ISSUE OF ‘PUBLIC TRUST”. This is the outcome of the continued reliance on the phrase “FORWARD GUIDANCE.” We are not going to raise rates for the forseeable future and the bond market seems to be questioning the credibility of all those bankers bearing the gift of “forward guidance.” As Tett concludes, the next Fed Chair needs to be “somebody … who can cast spells with both their spreadsheets and words. In short, what is needed is nothing less than a monetary shaman.” The FED‘s long-respected CREDIBILITY is being tested by domestic and global voices. The FED‘s tapering may be the least of the problems going forward.
***Two-year yields in Portugal have been on the rise recently, causing the 2/10 Portuguese curve to flatten again. It has narrowed from a recent high of 310 basis points to a close today of 175 basis points positive slopped. When the two-year yield rises in the peripherals it has been indicative of possible funding problems. Readers of NOTES FROM UNDERGROUND know that I believe that the European crisis is far from over and post-German elections will bring previously suppressed issues to the forefront. Bundesbank President Jens Weidmann raised some of the troubling issues in a speech today in Hamburg, Germany. President Weidmann raised the issue of the need to strengthen the framework of monetary union. Much of what Weidmann proposes involves a transfer of sovereignty of fiscal issues to a central authority. It admits it won’t be easy as many states are opposed to relinquishing their taxing authority.
The German monetary authority maintains that if a fiscal union is unattainable then the individual states are going to have to be held to the strict standards of the Maastricht Treaty. He does acknowledge that Germany has previously been lax in meeting the fiscal rules established in the euro treaty. In my opinion the President Weidmann was subtly pointing his finger at France for it is the French and Spanish who continue to push for a EUROBOND but do not want to surrender fiscal authority to a central governing body. As the German election nears, Weidmann found his way into the fray.