Rex Column 19 April 2017
Emerging risk bonanza
by Cees Bruggemans words 750
It was not quite the expected scenario that has been unfolding with great steadiness, in recent months/years. Instead of being tripped up by an impending Fed policy normalisation (stretching over some years, likely accompanied by market disturbances) and reinforced by a Trump boom driving rates, yields and Dollar higher, or by rising geopolitical tensions threatening to sink anything weak, emerging risk has flourished ever since the great Fed bond tapering of 2013 proved just a scare.
It isn't that the world has become more unpredictable & difficult to understand. If one understands the situation and makes the right assumptions, all of this is very much understandable & predictable.
I can't claim to have been an early convert to this new spectrum of thinking. Far too much conventionality in my bones. But give me time and enough noise, anything becomes questionable and less conventional.
I have written about this in various shades in recent years, but still was unable to connect all the dots down the road for emerging risk where the search for yield (risk), the so-called carry trade, has been stronger and longer-lasting mthan ever.
It started with the Great Financial crisis in the Western World, which also ended most of the growth in China’s great export engine.
Coming out of that dip, after all the financial scandals and unprecedented global fiscal & monetary action to prevent depression, it turned out that business confidence in a general sense had been badly rattled. It caused full recovery expectations to be projected ever deeper into the future. Meanwhile, in the short-term, it inviting ongoing cost-squeezing.
Not on its own, but superimposed on major revolutionary technical progress.
It was as if history had brought together two great capitalistic streams, speculative financial excess and general technological revolution, and both of these fell back on reinforcing cost-curtailment. In the process, they lessened risk-taking and increased recorded stagnation.
Recorded growth potential kept receding until well in the low decimals. The policy prescription was unprecedented easy monetary policy, long after fiscal had bailed out.
Despite the fact that very low growth caused employment levels to return to reasonable balance (starting in the US), it was on minimally measured GDP growth and productivity growth. Part of the explanation is that technical progress drove cost reductions. The other part reflected a lack of a return in confidence and real world risk-taking.
This combination of forces kept advising very low interest rates and yields, despite the old belief that full employment would bring back inflation and underwrite higher rates. The return to higher inflation, too, was held back by the nature of the technical progress.
If this was the reality, what was the imbalance arising anew? It was again in the financial sphere that we see more old-fashioned responses to super easy monetary policies. Low interest rates see financial values pushed up and the search for yield pushed outward, into ever more riskier parts.
Over the past ten years this story line should have died a few times over by now, except for the two great streams of our time (a lack of confidence and technical progress rewriting the fundamentals of growth, inflation and policy support).
When turning away from the world at large, and focusing on its riskier parts, things haven't become more encouraging. Not in Russia with its costly geopolitical adventures, not in China struggling to diversify away from its global export and investment engine, and not in the smaller fry. Overnight Turkey saw its currency firm on the expectation of a more stable Presidency (while some western financial firms lowered their country exposure to it because they see this leading in the wrong direction). Nearer home, the Rand has steadily come back after barely noticing the grotesque Zuma actions promising little good in coming years.
Will we after all soon go back to our old world view logic, penalising emerging markets, or will the new realities keep driving the supportive show for longer? With the Fed in no apparent hurry (despite the dot-scenarios) and the Trump promise fading in recent months, and given the deeper realities described above, it seems unlikely that we will suddenly return to the old normal some of us were brought up on.
Instead, this new normal lingers, and may do so for some while. It could mean the imbalances in the financial sphere could still increase (even spectacularly). It suggests emerging risk is enjoying an enormous windfall, one that presumable will fade one day, but so far gives no sign of doing so.
Bruggemans & Associates, Consulting Economists