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International Economics, 10/13/22

Updated: Apr 5, 2023

Good morning and welcome back to International Economics, a roundup and analysis of the key stories moving global markets. As always, I would love to hear from you at with news ideas, feedback and anything else you find interesting.

Week’s Intro: Tightening gets tense.

The wave of concern over aggressive global tightening crested into criticism this week. Members of the US administration and FOMC used speaking engagements to address the arguments that the Fed is waging a war that will bring the rest of the world down with inflation. In the absence of any concrete policy changes, international leaders (EU, IMF, World Bank) elevated their criticisms of the emerging dollar-driven crisis. This pressure built to the UNCTAD’s admonishment of global central banks and warning against further rate hikes.

  • Is a US recession the best thing that can happen to emerging economies? (FT)

As the balance of payments, debt servicing, and currency effects of a supercharged dollar make themselves more known, the global financial firefighters are dealing with more demand than ever as private investors pull out historically large amounts of capital from EMs. The cracks in developing economies also coincide with a growing group of central banks that are winding down their tightening cycles with countries shifting from monetary to currency and fiscal support.

It’s Every Nation for Itself as Dollar Batters Global Currencies. (Bloomberg)

It appears that the global risks of coordinated tightening then have set the stage for massive divergence in central banks as some even begin to tighten as the outlook fades while others feel forced to follow the Fed higher. Meanwhile, a small but influential third grouping of the BOE and ECB is testing the neutralization effect of continued QE during tightening. The response to this crisis seems to be sowing the seeds for some interesting medium-term challenges for central banks, something that has begun to materialize into concern over central bank solvency - but we’ll leave that for next week’s newsletter.

Global tightening cycle begins to lose steam across the developing world.

As the concern around global tightening reached a pitch, Australia - traditionally a leading indicator for bond markets - supercharged the debate around peak rates with a dovish 25bp raise. While the monetary policy committee's concern over global fundamentals is far from a return to easing, pockets of central banks have begun to buck the tightening trend. The PBOC has pursued successive small cuts while reducing capital requirements to stimulate China’s battered financial sector and quickly deteriorating growth outlook. Meanwhile, Angola has joined Liberia in lowering rates for the first time in years as inflation slows and the kwanza appreciates.

Beyond these outliers, emerging Europe and Latin America are also facing the end of their tightening cycles as the size and pace of rate hikes decreases. The latest statements from Polish, Romanian, and Czech central bankers indicated that the hiking cycle is over despite rising inflation and increased market volatility. Latin America, meanwhile, has seen relative currency strength following aggressive tightening in 2021. However, the region's central bankers increasingly lack space for additional rate increases despite pro-cyclical spending and persistent inflation.

While currency depreciations and capital outflows still pose a risk, the damage to an economy from excessively high rates can be equally as risky, especially as a global recession looms. The lack of policy space can be seen in Asia, where major economies have resisted large rate hikes despite being forced to tighten. Instead, economies across the region deployed reserves to defend their currencies and additional spending to blunt inflation's effects. These approaches - along with a rising trend of price controls - are a poor substitute for increasing interest rates and are likely to weaken central banks and exacerbate supply-side pressures when neither effect can be afforded.

EMs face record bond outflows amid global turbulence.

Emerging markets have seen a record $70 billion in outflows as rising interest rates and a strong dollar ratchet up pressure on developing economies, the FT’s Jonathan Wheatly reports. The strong outflows, including $4.2 billion from bonds last week alone, come despite an $86 billion wall of dollar-denominated debt maturities EM governments will pay by the end of 2023, according to Dealogic data.

An expedited tightening cycle led by a hawkish Fed has prompted investors to pile into the treasury market, and other developed markets which have been forced to follow US monetary policy. As EM assets have become relatively less attractive, JP Morgan revised its yearly outflow projections from $55 billion to $80 billion. The hit has been broad and deep, with just seven weeks of inflows for the entire year and outflows hitting local and foreign currency bonds alike.

  • Yellen flags need to mind ‘global repercussions’ of tightening. (Bloomberg)

As volatility and illiquidity haunt debt markets globally, the risk of financial stress for EMs, which also have to contend with more expensive imports, has risen substantially. These risks led the UN to urge global central banks to halt increases before a full-fledged debt crisis hits developing economies. While central banks have little choice but continue to raise rates, the long lag in monetary policy’s effects means the UN’s unheeded warning might already be too late.

Brazilian real and Mexican peso beat the dollar on favorable election results and front-loaded tightening. As G20 currencies have collapsed more than 20% against the supercharged dollar, the Brazilian real surged 5% last week to join the Mexican peso as the only two currencies outperforming the dollar this year. Both currencies have benefited from central banks, which preempted the Fed with dozens of consecutive large hikes. Banxico policy has also been boosted by tight fiscal policy and increased demand from the now attractive carry trade. Combined with the benefits of raised FDI from the nearshoring trend, the “super peso” has crushed shorts with room to rise as OPEC looks to keep oil revenues artificially high.

Meanwhile, in Brazil, right-wing incumbent Jair Bolsonaro won a large percentage of voters in the first round, surprising pollsters, who had projected a landslide for left-wing Lula da Silva. Bolsonaro’s allies also performed better than projected in congressional elections, raising the prospect of a fragmented congress that obstructs Lula’s agenda. Markets and businesses alike were optimistic about the prospect that a strong-right wing would force Lula - still expected to win in the runoff - to moderate his policy goals, as seen with left-wing leaders in Chile, Peru, and now Colombia. In response to the results, the benchmark Ibovespa index rose 3.7%, with state-run oil producer Petrobras rallying 8%.

Right-wing policy unorthodoxy alerts markets of turbulence to come.

Across developed markets, right-of-center parties have seen success claiming the role of prudent - albeit sometimes overeager - financial managers. The US Tea Party movement after all was nominally a movement against deficits. However, the right’s credentials are being stripped away by poor policy, populism, and playing politics with their economies, reports Politico’s Paola Tamma. The UK’s saga has been well covered by now and looks far from over as the newly minted PM refuses to back down from tax cuts despite adopting a more conciliatory tone. The continued rise in borrowing costs also reflect how independent central banks cannot necessarily be counted on to save politicians from fiscal mistakes while quantitative tightening is ongoing.

Over in Rome, too, a resurgent right-wing risks upsetting a delicate balance amid low growth and high debt. Moody’s - fresh off of lowering the UK’s outlook - warned of a downgrade to junk status if Meloni backslides on planned economic reforms. Finally, Republicans in the US have again found their concern for the deficit just in time to trigger a showdown over reinstating legal borrowing limits. Such shenanigans have roiled observers but only once led to an actual downgrade in credit ratings. While the three flavors of the right take different approaches, all are adding policy instability just as their need for debt is high and markets are less tolerant of uncertainty.

The lesson from Truss and Number 11’s failure is clear: developed markets cannot take market sensitivity for granted. However the next months will give the right an opportunity to test the waters for themselves. Meloni must send her draft budget for Brussels’s approval in mid-October and has signaled that she plans to reduce taxes and raise spending on pensions despite expecting contraction. Meanwhile the GOP’s likely control of the House after November’s midterms risks an early 2023 government shutdown despite continued volatility in the US bond market and a trillion dollar deficit. The wrong move could risk serious challenges to debt servicing costs in America and a full blown repeat of the Eurozone crisis if Italy managed to scare off bond buyers.

IMF bailouts hit record as global economic outlook worsens.

IMF crisis lendinghas hit a record high as developing economies face compounding crises of rising import bills, higher interest rates and unsustainable debt loads, the FT’s Jonathan Wheatley reports. So far the overlapping crises have forced five countries to default with nearly twenty at risk of following suit.

“The risks are accumulating,” said Pierre-Olivier Gourinchas, the International Monetary Fund’s chief economist, right. Shawn Thew/EPA, via Shutterstock

IMF data shows that disbursement has risen to $140 billion in 44 programs, reaching $268 billion in total lending when including outstanding loans. The Fund is negotiating programs with Zambia, Sri Lanka, Lebanon, Russia and Suriname. Ghana, Egypt and Tunisia are in early talks for similar support.

  • Yellen Calls for World Bank Overhaul Including Scaled-Up Lending. (Bloomberg)

With the prospect of further tightening by global central banks, observers are concerned that rising borrowing costs might stretch the IMF’s lending capacity. A report from Boston University found that 55 developing economies face $436 billion of debt repayments between 2022 and 2028. Meanwhile, the IMF has only around $370 billion in remaining lending capacity, assuming each programme stays below its quota, which does not always happen.

Final Note: An innovative inflation response.

While policy responses to inflation have been predictably beggaring-thy-neighbors, ineffective, and downright counterproductive, economic luminary Alexander Lukashenko has found the solution. The Belarusian president hailed as “Europe’s Last Dictator” has banned all consumer price inflation, making it immediately illegal with no additional details. While the 60 billion dollar economy has already fallen into default - under western sanction since 2021 and highly dependent on Russia - the move stands to further drive the economy into the grips of shortage and stagflation.

In Other News.

Markets Break When Interest Rates Rise Fast: Here Are the Cracks. (WSJ)

Line in the sand: OPEC+ defends $80 oil price floor with output cut. (Nikkei)

Oil shocks versus banking crises. (FT)

WTO Sees Sharp Slowdown in Global Trade, Pointing to Possible Recession. (WSJ)

Fossil-Fuel Financing Poses Growing Risks to Biggest Banks. (Bloomberg)

Global dealmaking plunges as financing market hits rock bottom. (Reuters)

Fed’s Rate Increases Defy All the Rules. (WSJ)

US starts fiscal year with record $31 trillion in debt. (AP)

Muni Borrowing Stays Strong as Local Governments Build More, Refinance Less. (WSJ)

Do Wages Drive Prices, or Vice Versa? The Answer Matters for Interest Rates. (WSJ)

Breaking Down the Dollar's Rise. (Goldman Sachs)

Tories Say Bank of Canada Deserves ‘Ruthless Scrutiny’. (Bloomberg)

A study of lights at night suggests dictators lie about economic growth. (The Economist)

Can Japan avert 'disaster' with interventions to support the yen? (Nikkei)

China Is Rerouting U.S. Liquefied Natural Gas to Europe at a Big Profit. (WSJ)

Depositors storm 4 Lebanese banks, demanding their own money. (AP)

Saudi Sovereign-Wealth Fund Joins 100-Year Bond Club. (WSJ)

Turkey's monetary experiment holds lessons for Asia's central banks. (Nikkei)

Pakistan foreign minister: China debt is price of development. (Nikkei)

OPEC+ production cuts may add additional stress to African oil importers. (The Africa Report)

Zambia’s chance to set the global financial architecture. (FT)

Thai banks' interest rate hikes spark economic concerns. (Nikkei)

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