Research & Analysis for Business
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The Bank for International Settlements (BIS) is at the epicenter of world markets and international monetary flows. Given this unique view of the world economy, the analyses produced by the BIS provide a macroeconomic glimpse into the near-term financial future for nations and governments.
The Q2 2013 review is an extension of the Q1 2013 review. Markets are still buoyed by widespread central bank easing. To understand the breadth of easing, note that twelve banks eased rates. Banks with accommodative monetary policy include: The United States Federal Reserve, Bank of England, Bank of Japan, European Central Bank, Australia, Denmark, India, Israel, Korea, Mexico, Poland, and Turkey. This global liquidity and accommodative monetary policy fueled risk appetites and the carry trade.
Such accommodative policies have buoyed riskier asset classes (such as equities). However, without signs of growth, intelligent investors are nervous. Although nominal yields are at record lows, fueling growth and investment, market participants expect the Fed to reduce asset purchases. Based on BIS data, the yield on the 10-year is expected to rise to 3% +/- 1% by late 2015.
Weaker purchasing managers’ indices (PMIs) indicate that Europe will continue to contract and economic indicators suggest China’s economic growth is slowing. PMI data combined with China’s recent ratings downgrade contributed to commodity losses averaging 7%. Oil fell below $100 per barrel.
Dominating the financial press, Japan’s accommodative policies were center stage with the Bank of Japan (BOJ) expected to ease monetary policy to hit an inflation target of 2% in the next two years. This policy affirmation weakened the yen and caused Japanese equity prices to jump. The BOJ intends to expand the monetary base by ¥60-70 trillion per year to ¥270 (60% of nominal GDP). BOJ actions and rhetoric caused the yen to depreciate against the dollar by ~10% by late May 2013.
Developed vs. Emerging Market Indices - MSCI
Perhaps, the proverbial ‘canary in the coal-mine’, emerging markets were strongly impacted in the quarter with notable reduction in emerging market index prices relative to the advanced economy index prices. The plot to the right shows the normalized index values plotted for MSCI benchmark indices for advanced and emerging markets (URTH, EEM) The divergence between advanced and emerging indices (currently a 10% spread) suggests that sophisticated investors are reducing exposure to emerging markets and instead seeking lower volatility returns typically observed in ‘advanced economies’. Based on past monetary flow analyses, it is often the case that monetary flows pull back from emerging economies faster than advanced economies because investors have less confidence in emerging market banks, counterparty reliability, corporate solvency, and legal system fidelity.