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International Economics - 7/27/22

Good morning and welcome back to International Economics, a weekly roundup and review of the key stories moving global markets. We would love to hear any feedback, news ideas, or thoughts for improvement as we start out.

Hooked on public funds, economies around the world face ‘subsidy dominance.’

The release of the ECB’s new Transmission Protection Instrument, or unlimited bond buying authorization to compress peripheral country's borrowing costs, has prompted new warnings of fiscal dominance. At this point, though, the BOJ and to a lesser extent ECB look like the only central banks truly beholden to non-monetary ends. However, a new old pressure is being applied to governments as central banks withdraw the liquidity that has trickled into pockets across the developed and developing worlds alike.

Anti-inflation protests in countries like traditionally stable Panama are demanding large reductions in fuel prices, cheaper goods, and more public spending, despite a rising debt load. These 'solutions' are increasingly unaffordable on post-covid fiscal space but are still all too common across an increasing number of states. Meanwhile a growing list of influence groups, from elderly homes to small business owners are pressuring congress for shelter from the imminent looking recession. Central bank independence might have done its job, but it's looking like the rest of the economy is not ready to accept a conventional pull back in public money. Has three years of free flowing state aid created a type of ‘subsidy dominance’ where political pressure locks in bad and inflationary fiscal policy? Email me at

Default Risks Rise and the Rupee Falls as Pakistan's IMF Deal Fails to Impress.

International investors fled the Pakistani rupee last week, with the currency falling 7.6% on fears that the country will default on its external debt, reports the FT. In recent weeks Pakistan’s reserves have sunk to cover less than two months of imports, while the rupee fall against an increasingly strong dollar has pushed up Islamabad's trade deficit and cost of debt service. The inflation-driven balance of payments crisis has compounded, making Pakistan’s bonds the worst EM performer despite last week’s IMF agreement that came with a $1.2bn loan disbursement. Fitch Ratings downgraded its country outlook to negative from stable, noting what it called a “significant deterioration in Pakistan’s external liquidity position and financing conditions” this year.

Source: Bloomberg

A 125 basis point rate rise in early July has failed to stem demand for foreign currency, while inflation has remained over 20%. The rating agency said the central bank’s forex reserves had declined to about $10bn by June 2022, down from $16bn a year previously and equivalent to just over one month’s worth of current external payments. Pakistan’s financial woes risk a political crisis, like in Sri Lanka, as the IMF deal has forced reductions in fuel and energy subsidies. The subsidy withdrawals have added to the impact of world market price increases caused by the war in Ukraine. Moody’s, which downgraded Pakistan's outlook to negative last month, said the country’s ability to complete its current IMF program “remains highly uncertain.”

ECB’s surprise 50bp rise heralds the death of forward guidance.

The European Central Bank’s shock 50 basis point rate hike has signaled an end to forward guidance; a tool central bankers have long used to provide monetary policy signals to financial markets, reports Reuters’ Sujata Rao and Dhara Ranasinghe. While markets had priced a 25 bp hike based on comments by Lagarde, revised inflation figures and the Euro's precipitous fall prompted the governing council to disregard their previous messaging. In abandoning its forward guidance, the ECB joined the Fed, which raised its overnight benchmark interest rate by 75 bp in June, less than a month after Chair Powell ruled out such a move.

If the U.S. Federal Reserve eroded the efficacy of forward guidance in June, the European Central Bank and Bank of Canada's surprise rate hikes might have killed the tool for the foreseeable future. This absence of clear monetary policy trajectories will make investment strategy formulation more difficult as interest rate conditions are liable to change rapidly and undermine longer-term positions.

The combination of average inflation targeting and a reduction in the usefulness of forward guidance also highlights how central banks are increasingly caught in their own mistakes with a quickly dwindling toolbox. It remains an open question whether disregarding their own guidance will reassure markets of their commitment to end inflation or whether it will contribute to policy uncertainty and ultimately undermine confidence in central banks.

Angolan and Gabonese debt distress highlights how even commodity exporters are not spared balance of payments pain.

Sub-Saharan oil producers Angola and Gabon have joined the ranks of distressed emerging markets such as Nigeria, Kenya, and Egypt as investors increasingly expect defaults, Bloomberg’s Selcuk Gokoluk and Henrique Almeida report. Both country’s bonds were trading over 1,000 basis point spread with US Treasuries. This psychological threshold suggests investors are pricing in a high probability of default for each as higher import costs than crude exports deteriorate the balance of payments and international liquidity decreases. With the inclusion of Luanda and Libreville, the number of distressed sovereigns has risen to 21 this year.

The entrance of oil producers such as Angola, Ghana, and Nigeria into distressed territory highlights how even major commodity exporters are not insulated from the ill effects of inflation and rising rates. Net crude exporters have tended to fare better against a strong dollar because they have access to U.S. currency and are less reliant on imports with rising prices. However, rising commodity prices have eased in Q2 as refined oil is up to $15 more expensive, leading to deteriorating balance of payments for EM exporters according to Goldman Sachs. The International Energy Agency also found dollar strength plus record prices for refined fuels, has begun weighing on oil demand across EMs.

Global Housing Markets Fall In Tandem Weakening Case for Soft Landing.

The global housing boom is ending as prices fall against rising interest rates from Europe to Latin America, the Wall Street Journal reports. Home sales are down 40% and 50% from the US and UK’s respective pre-pandemic highs. In some markets, home prices are decelerating while they have declined as much as 8% in Australia, Canada, and New Zealand. Despite falling prices, mortgage rates have soared at the fastest rate since 1995, undermining any increased. With housing making up over 10% of GDP in developed economies, the shrinking real-estate sector further undermines hope for a “soft landing.”

Reduced housing demand harms the real economy through lay offs and weaker hard commodity demand. Additionally, falling home prices also undermine consumer sentiment and erode bank balance sheets which tend to weigh on spending and lending, respectively. With global housing markets falling in tandem, observers have begun to worry about the potential for impacts on the highly exposed financial sectors in China, Australia, and Canada. While a full-fledged financial crisis remains unlikely, the pullback in housing bolsters recession fears and complicates the job of key central banks in the process.

China faces the potential for a full fledged, albeit very domestic, financial crisis.

Continued challenges in the Chinese property market have further raised credit risk in the property, threatening to send shocks into the financial and banking systems just as growth slows. Bond defaults have already more than doubled as the domestic debt crisis accelerates in the country’s $2.7 trillion property sector. Three-quarters of China’s most indebted developers have missed completion deadlines, which has led to a backlash from home buyers who have boycotted as much as $296 billion in mortgage payments. These boycotts come as developers face a faster pace of defaults than last year, already exceeding 2021 figures by $11bn, with over $30.1bn in bond payments still due through the end of 2022, according to Bloomberg.

Turbulence in the Chinese housing appears to be spilling into a highly leveraged financial sector that has underpinned the scale of real estate development over the last decade and a half. Confidence in Chinese banks has been undermined by the April failure of several small banks in Henan Province. The implosion of these poorly supervised rural financial institutions is not surprising given endemic corruption, weak supervision, poor risk management.

Normally, the country’s local banks would play a large role in any government response. However, the country’s roughly 4,000 local banks with nearly $14tn in assets have already suffered a run on deposits and face an estimated $6.8tn in outstanding real-estate loans. In response, Beijing is doing what it does best: buying itself time and numbing the pain with more spending. China’s bank regulator instructed lenders to provide credit to developers to complete unfinished homes for the first time since an August 2021 loan cap while ramping up hard infrastructure spending.

Despite such efforts, dollar bonds of Chinese developers fell sharply last week, while rising mortgage boycotts could unleash a vicious cycle, curbing developers' cash flows and causing them to default on loans and bonds. Facing its lowest rate in two years, economists are increasingly debating whether China is facing a "balance sheet recession" and the prospect of its first modern financial crisis.

US Sanctions and Slow IMF Talks Prompt Warnings that El Salvador May Be Next Debt Crisis.

As El Salvador's bitcoin experiment dramatically backfired and default risk spiked, the country's democratic backsliding is making financial relief more difficult. Bukele’s government faces an $800 million bond payment in January 2023. The cash-strapped government lacks the funds for payment, with Bloomberg projections finding El Salvador the most likely defaulter in Latin America.

To make up for its funding shortfalls, San Salvador has been trying to obtain a $1.3bn loan from the IMF. However, the slow-moving talks reflect mutual antagonism with the Fund repeatedly calling for a reversal on Bitcoin and Finance minister Zelaya stating that the IMF would have the "least impact on the country". Complicating talks, the administration's increased authoritarianism has led the US to sanction “corrupt and undemocratic actors,” including a key Bukele’s advisors, congressional allies, and cabinet officials - until recently including the finance minister. If the badly needed IMF deal does not materialize, the Bukele administration is considering nationalizing pension funds, issuing new taxes, and going to other institutions like the World Bank and Central American Bank for Economic Integration, El Faro reported.

While being sanctioned by the US makes dealing with the IMF more difficult, not all investors are as pessimistic about the country's future. In a recent research note, Morgan Stanley argued that El Salvador’s $7.7 billion in Eurobonds have been “overly punished” by the market, reported Bloomberg’s Maria Elena Vizcaino. The bank argues that the 2027 bonds, currently trading at 28 cents on the dollar, should trade at an average of 43 cents given the country's primary surplus and smaller maturities relative to distressed peers like Argentina, Egypt, and Pakistan.

In Other News

Ukraine Seeks to Delay Debt Payments. (WSJ)

U.S. Initiates Trade Fight With Mexico Over Energy Policy. (WSJ)

Kenya: New Financial centre bets on tax incentives to attract foreign investors (The Africa Report)

IMF calls for rethink of German debt-cutting plan if Russia halts gas flows. (FT)

Italy Is Haunted by the Pain of Past Economic Crises. (NYT)

China cut US debt holding amid ‘risk of possible conflict’. (South China Morning Post)

South-east Asian currencies weather market storm better than international peers. (FT)

Buharinomics: Evaluating the impact of Buhari’s key policies. (The Africa Report)

China struggles to launch digital yuan after 8 years of trials. (Nikkei)

Interest-Rate Pain From Higher Inflation Has Barely Begun. (WSJ)

Derby’s Take: Fed’s Bullard Says Yield-Curve Signal Might Not Be So Ominous. (WSJ)

The dollar sits atop a global monetary order shaken by sanctions. (FT)

HSBC installs Communist party committee in Chinese investment bank. (FT)

Central banks across Southeast Asia diverge in their approaches to monetary policy. (FrontierView)

The investment drought of the past two decades is catching up with us. (FT)

Why American wages haven’t grown despite increases in productivity. (CNBC)

Stablecoins would get federal rules under emerging House deal (Washington Post)

Peter Spiller: Look at the 1960s, not 1970s, for economic lessons. (FT)

Microsoft president sees 'new era' of stagnating labor pool. (Reuters)

The One Place You Can Still Get a 3% Home Loan: Your Family. (WSJ)

Loans Could Burn Start-Up Workers in Downturn. (NYT)

Pensions — a Roman legacy needing reform. (FT)

Stagflation, Recession, or a Reprieve? (FrontierView)

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