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8/3/2019 [Beta] News Rem
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Agenda
European Sovereign Crisis
The Chinese Landing Hard or Soft?
Relative outperformance of Asian economies
Operation Twist US Subprime Crisis
Currency Markets Yen & CHF Appreciation
Commodities
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European Sovereign Crisis
Reaction to Sovereign risk gained credencewith Dubai World- An investment companymanaging the portfolio for the Dubai Govt
Efforts to tide over the crisis has beenreactionary at best Markets havehistorically lead in pre-determining the
culprits before the ECB
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European Sovereign Crisis
Currency union enabled low borrowing rates acrosscountries
Maastricht treaty Countries pledged to keep
spending in check Greece & other countries through derivatives were
able to mask their deficits
A squeeze in credit, coupled with a fall in asset prices
accelerated the recession in these countries Market focus on PIIGS France too has entered the
fray
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European Sovereign Crisis
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European Sovereign Crisis -Greece
Main economic drivers: Tourism& Shipping
Highly cyclical both declinedduring recession (18%unemployment)
High level of public spending
External Debt/GDP : 182%
GDP ~ $320bn
Political turmoil has increaseduncertainty New unity govtpost referendum drama
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European Sovereign Crisis -Spain
Economic drivers: Real Estate(20% of GDP), Tourism (12%)
Low industrial production growth& high levels of leverage
Unemployment rate ~ 20%
Lack of labor reforms such ascollective bargaining by unions,high severance pay etc
External Debt ~ 180%, GDP: $1.37trillion
Political uncertainty due to harshausterity measures
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European Sovereign Crisis
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European Sovereign Crisis
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Issues
Single Monetary Union vs Different Fiscal Unions
Y = C + I + G + NX
In the euro zone, Governments find it hard to increase NX(depreciating currency) or G (austerity measures!), I
(dependent on interest rate set by the ECB), C (dependent oninterest rates as well)
Labor Mobility
One will not see the unemployed from Spain making a run for
Germany Transfer mechanisms
Bailout Mechanisms restricted to a block of power outside yournation
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EFSF (European FinancialStability Facility)
A fund created by 17 Euro member states in 2010
EFSF essentially raises debts in the capital markets to help distressedcountries
Member states guarantee up to EUR 780 billion of this debt; EuropeanCommission funds another EUR 60 bn; IMF another EUR 250 bn
EFSF mandated to lend to countries in financial difficulties
EFSF can also finance recapitalization of banks through loans to govts.
Recent capital raises
Issued EUR 3 billion bonds yesterday to help Ireland
Issued EUR 3 bn bonds in June to aid Portugal
ESM (European Stability Mechanism)
This is a permanent funding program to succeed the temporary EFSF
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European Sovereign Crisis
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Chinese Economy Growth VsInflation
Inflation 6.1%, mainly due to food inflation of 13.4%
Chinas central bank has raised interest rates fives times since October, 2010; reserve
requirement have been increased 9 times (currently at 21.5%)
A devalued currency has typically a role to play in inflation
PBOC is allowing Yuan to appreciate with respect to dollar
Inflation data of China should be taken with a pinch of salt
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Chinese Economy RealEstate
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Activities linked to Real Estate account for ~25% ofthe total GDP of China
Government is determined to control the priceincrease in Real Estate price
Steps such as high interest on mortgage payments,other credit controls has been taken
S&P has turned its outlook on Chinese Economy ondownturn
Banks in China & Hong Kong have huge exposuresto the Real Estate in China
Question is whether it will be soft or hard landing ?
Real Estate prices in China are finally stabilizing or is the cycleabout to turn ?
Real Estate Price Index in China
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Chinese Economy Issues?
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Any economy has to make a trade-off between inflation and growth
Phillips curve Unemployment Vs Inflation
Chinas growth is export oriented low cost base
Increasing inflation has an impact on the cost structure
Increasing cost structure hurts export competitiveness
Currency devaluation helps in increasing competitiveness in globalmarkets
Currency devaluation has implications for inflation
Countries such as US are coming harder on currency controls
Proposed currency Bill in US
Maintaining Competitive Edge while stimulating growth
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China Other points to notice
Pushing for Yuan as an internationalcurrency
Role in Euro zone
Interested in buying debt
Looking for a market
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Relative outperformance ofAsian economies
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Reasons for Asias outperformance:
Reducing public debt levels
Strengthening currency reserves
Applying discipline to fiscal deficits
Government packages for strengthening infrastructure etc.
Future outlook:
Greater uncertainty implies that Asian central banks are likely to pause
monetary tightening
Capital flows could re-emerge as a policy challenge for some Asian central
banks, especially if they are reluctant to allow their currencies to appreciateon a trade-weighted basis
Continuing search for yield by global investors will attract them to invest in
Asian markets
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Relative outperformance ofAsian economies
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Relative outperformance ofAsian economies
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What is Operation Twist?
US Fed targets inflation as well as unemployment
Ten year Treasuries as low as 1.95% but Unemployment 9%, Inflation 2% (but inflationary pressures rising - CPI)
Sell medium term bonds ($400B) due in the next fewyears and buy 6-10y chiefly10y Treasuries (long term)
Major interest rates (e.g. Mortgage rates, corporate bonds,long term bank loans) tied to the 10y Treasury rate
Tried once before in 60s pushed down rates by 0.15%and mortgage rates by even less so it really effective?
Also, treasury issuing long term securities at an evenfaster rate. So supply matching demand.
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Monetary easing (QE) withtreasury curve steepening
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10y @1.95%
Source US Treasury website
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Effects of Operation Twist
BUT - 30 yr yields fell by 17bp on announcement and2s/10s curve flattened sharply, correcting to10bp flatter
May have been caused due to other effects weakeningEuropean economy, cut in IMF world growth forecast
from 4.5%-4% (risk off sentiment)
Support in favor of above equities/commodities fell(should have risen on announcement of a new stimulus)
Fed is not printing money to fuel the risk appetite to buy
risky assets and fund carry trades so no fall in dollar
Dollar rose against major currencies (risk off sentiment,higher short term yields attracting short term investors)
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Risk off sentiment takes hold
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Risk off sentiment takes hole
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Effects of Operation Twist
Fed running out of options liquidity trap. Fiscal policy outof Feds control high deficits, no stimulus
Flatter yield curve reduces incentives for banks to lend fall in Net Interest Margins Bank stocks tanked
Argument in support of Operation Twist MonetaryDisequilibrium theory easing demand for money
But yield rise on T-bills is capped by banks arbitragingbetween excess reserves and T-bills
Expectations - Should Fed commit to a nominal income andprice level target?
Investment alternatives Treasuries? Gold? Stock?
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Where to invest?
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The Subprime Credit Crisis
The business of banking
Anatomy of a bank run Panic: People think bank assets are falling in
value; they panic and start withdrawing money In other words the short term financing is notrenewed
Fire sales: Bank sells assets to repay depositors
Assets fall in value because of massive sales
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Short Term Liabilities
(Deposits) BankLong Term Assets
(Loans, mortgages)
Vicious cycle
appears A bank run: From the movie Its a wonderful life
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The Subprime Credit Crisis
In response, U.S. govt. introduced deposit insurance in 1934 which finallyended such bank runs
A new form of depository banking emerged the repo market
And this market is not insured!
So who are these new depositors? Institutional investors like pension funds and non-financial companies like Coke also
need to have some accounts where they can park money
But deposit insurance is limited and does not cover these huge amounts
So they go to the Repo market!
Example: Fidelity has $ 500 million which it wants to keep in a safe placefor a short duration say overnight
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Fidelity Bear Stearns$ 500 mm
$ 500 mm collateral
Next morning, Bear repays $ 500
mm in exchange for collateral
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The Subprime Credit Crisis
How does Bear Stearns earn income? The asset which it gives as collateral earns a higher interest than the interest it gives to
Fidelity on the $ 500 mm loan
So what happened in the crisis?
Investors like Fidelity want safe collateral, but Treasuries and AAA corporate bonds
were not sufficient for this collateral demand in comes Asset Backed Securities
The 21stcentury bank run
Around Aug 2007, when subprime bonds started deteriorating, the new depositorspanicked
Bear Stearns starts selling assets asset prices fall across all categories
Such prices are due to forced sales (called fire sales) and do not reflect fundamentals
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The Subprime Credit Crisis
AAA corporate bond spreads wentabove those of AA corporate bonds!!
Most relevant points
Subprime by itself was $ 1.2 trillion (whichis not large enough compared to size of the
shadow banking system which is $ 20 tn) All asset classes (e.g. student loans, auto
loans) were not fundamentally bad it isforced sales which led to all assets tanking
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Currency Markets YenAppreciation
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Swiss bank intervention
Earthquake
BoJ Intervenes
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Currency Markets - YenAppreciation
Yen recently recorded post World War-II highof 75.31 against US$ (83 at start of 2011)
This is hurting Japans exporters as
appreciating Yen makes their goods expensiveto foreign buyers
What is driving the Yen up? Two theories to
explain this.
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Currency Markets - YenAppreciation
First theory: Repatriation of foreign assets
March earthquake caused destruction of life andproperty and therefore insurance claims
Insurance companies sold assets held abroad tobring proceeds to Japan for repaying claims
People who were devastated sold their foreignassets as well
Did these inflows caused the Yen to rise?
Market doesnt think so inflows were notsignificant & secondly
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Currency Markets - YenAppreciation
Second theory: Negative real yields in U.S.
The real interest rates in the U.S. have gonenegative!
The Japanese real rates though low are still positiveWith Yen & US $ being the safe haven currencies
investors flock to them at the sight of distresssignals in global economy
With Yen now offering higher real yields, it is thepreferred choice
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Yen Appreciation
View Short-term: Likely to strengthen given the positive real rates
Risk in short-term posed by the Bank of Japan intervening toget the Yen to depreciate
Medium term: Likely to weaken as the U.S. economy recoversand the real interest rates rise
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Currency Markets CHFAppreciation
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Swiss bank intervention
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Commodity Market Overview
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Types of commodities Oil and Energy
Agri-Based
Metals
Usage Metals
Precious Metals
Gold!!!
What are the commodity based economies
Australia China
Canada/New Zealand
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Commodity Market Linkages
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Commodity Market drivers Real world Demand Supply
Inflation and Price rises in other commodities
Currency Linked moves: Especially Oil and Gold Behavior common to all commodities
Tendency to high volatility
Highest Cyclicity among other commodities
Peculiarities of recent moves Extremely high volatility
Gold as single global currency
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Commodity Markets:Gold
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The history: Traditional measure of value
Gold Valuation: Demand supply for use is small percent of total trade
Links to tulips story: Is there anything intrinsic?
Foreign Exchange reserves Asian economy demands very high
Inflation Hedge Tendency to high volatility
Trends: Rise and recent correction
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Exchange reserves and Goldreserves
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Gold's share
Rank Country Gold of national
tonnes forex reserves(%)
1 USA 8,133.50 74.70%
2 Germany 3,401.00 71.70%
3 Italy 2,451.80 71.40%
4 France 2,435.40 66.10%
5 China 1,054.10 1.70%
6 Switzerland 1,040.10 16.40%
7 Qatar 950.3 7.10%
8 Russia 775.2 6.70%
9 Japan 765.2 3.00%
10 Netherlands 615.5 59.40%
11 India 614.8 8.10%
Rank Country Reserves
1 People's Republic of China 31,97,000
2 Japan 11,37,809
2 Eurosystem 8,86,355
4 Russia 5,16,800
5 Saudi Arabia 4,56,200
6 Republic of China (Taiwan) 4,00,770
7 Brazil 3,50,000
8 India 3,11,516
9 Republic of Korea 3,05,084
10 Switzerland 2,88,590
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Gold as currency backing
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Gold Price trends
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Thanks & All The Best!