Friday, April 13, 2007

An Open Letter to the IMF



Macro Man

Now, today's open letter was written tongue-in-cheek: but only just. The drumbeat of tit-for-tat protectionist/mercantilist/beggar-thy-neighbour economic policymaking is growing louder by the day. Reserve managers buy unfathomable amounts of dollars and in response, Congressmen rush to join the Smoot-Hawley International Tariffs Help Extend the American Dream Society (see if you can figure out what the abbreviated name is....)

Someone has to be an adult, and as painful as it is for Macro Man to admit it (given his general aversion to "official" intervention in markets), the IMF is the obvious candidate. The alternative- that recent trends accelerate in a parabolic fashion- would almost certainly have unpleasant consequences.

Yesterday, Macro Man had a pop at China, a favourite target in these e-pages. Many others had a similar response to China's enormous reserve growth in Q1. One interesting explanation that's been bandied about is that the parabolic increase in Q1 reserves reflects the maturation of some swaps that were traded a few years ago. Now maybe this is the case and maybe it isn't- we won't really know until we see more data. Regardless, Macro Man isn't sure that it matters. Either PBOC was playing silly buggers last quarter, or they were playing silly buggers a couple of years ago. Either way, it is difficult to avoid the conclusion that they are playing silly buggers.

Moreover, China's reserve growth stands out only because the existing stock is so darned big. On a rate of change basis, China doesn't particularly stand out from its peers. Since the middle of 2006, FX reserves in China, Russia, and India have all grown by more than 20%. So even if the jump in Chinese reserves has a logical explanation...then what the hell are Russia and India playing at?
Intriguingly, today sees the release of US trade data for February. An absolute shocker would provide an interesting backdrop for this weekend's IMG/G7 discussion, to say the least. Macro Man originally thought that there was a reasonable chance of a large widening due to higher oil prices. However, a glance at the the import price data reveals that America's terms of trade actually improved slightly in February. So any blowout would have to come from volumes rather than prices, which would appear rather unlikely given the softness of domestic demand during the month.

Nevertheless, interesting trends are emerging in US trade prices. It looks increasingly like the great goods price deflation trend, which has helped keep core inflation relatively low, has come to an end. The chart below shows the y/y change in the price of imported manufactured goods- the last couple of years certainly look like a change in trend from the late nineties/early noughties! Even import prices from China rose last month! This is one of the reasons why Macro Man loves keeping TIPS in the portfolio.

Elsewhere, M. Trichet performed as expected, signalling in ECB semaphore that a June rate hike remains on the cards. When the euro failed to come off on any 'sell the fact' action, that set the stage for the next leg of the squeeze higher. We're now barely a percent away from the all time high of EUR/USD. If the IMF doesn't do its thing (which would shift the focus away from the € and towards the yen, RMB, etc.), then we could be popping champagne corks on Monday afternoon.

One trade that is not causing Macro Man to sip champagne is the WTI/Brent spread. Continued inventory overhang at Cushing has caused WTI to lag badly in the latest run up in oil, and the Dec 07 contract now trades at a discount to its lower quality counterpart. The trade is singlehandedly responsible for losses in the alpha portfolio this month and has knocked half a percent off of overall performance. Macro Man will want to see an improvement soon, or it might be time for remedial action.



"Cassandra" said...

I recall that the one thing my dour "Macro2" prof, and my always-gleeful Nigerian "Money&Banking" lecturer (I suppose it was his fortuitous 'escape from Lagos c1983 that made him so) always agreed upon was the much vaunted "Crowding Out Effect". Of course, now all the Econ textbooks must be rewritten (courtesy of PBoC and the torch-bearing BoJ who munificently showed us all the way) to insure newly-minted would-be economists (or Macro-WoMen) don't fall into the same trap of believing such demonstrably absurd drivel.

Perhaps the crowding out theory can, be stood on its head, and termed "the Crowding-in Effect"....

Macro Man said...

When the central bank of a 1.2 billion person, 15% nominal growth economy can borrow as much as it likes at 3%, strange things tend to occur...

Anonymous said...

well, the G-7 seems to have concluded that there isn't much of a problem, since the world economy is already moving toward balance (at least so long as you ignore the growing imbalance between the size of the uS current account deficit and the size of the deficit private markets are willing to finance).

nothing much here to my eye -- but it is late ...


Macro Man said...

Well, I'm not sure if anyone really expected much from the G7 statement per se- the key Chinese officials staying home pretty much told you that. There was some noise generated yesterday by will they/won't they concerns over the yen, but even Europe was less vociferous in the run-up to these meetings about EUR/JPY- so no real surprise that nothing was said.

The real key will be if the IMF can deliver the goods- they provide a progress report on FX surveillance this weekend. However, even there, the G7 statement suggests nothing concrete until after this weekend- so as you were, I guess...

Anonymous said...

Darling MM,

You ask "what the hell is Russia and India" playing at.

Doesn't the same china's reason (to preserve export competitiveness) hold good for India atleast ?

INR is already at a 7 year high mate !!! What else can India do ? :-(

Macro Man said...

The comment was intended as a general "WTF?!?!" on reserve growth generally. Like the RMB, the RUB and INR at multiyear highs....against the dollar. Against the euro, sterling, AUD, NZD, and CAD, on the other hand...they aren't.

That reserve growth in the BRICs et al has picked up so very sharply is suggestive that substantial pressures are starting to mount. When the ECB completes its tightening cycle, Euoprean resistance for a stronger euro is likely to rise, perhaps considerably. Who will be left holding the bag then?

Anonymous said...

macro man --

I think lots of CBs are hoping that the US will recover from its growth slump later in the year, and pressures on their currencies, at least those from capital flows will abate as the US becomes a more attractive destination for private capital. The oil exporters can see a way out -- spend more of their surplus. I am not quite sure what China's exit strategy is tho, other than hope jon anderson is right and the recent surge in their current account surplus is more cyclical than structural. I certainly don't see any policy shift on the horizon needed to change a dynamic that looks sure to take cHina's current account surplus above $300b, and total foreign asset growth above $400b (and i am being conservative on both fronts).

I don't think the world's EMs have quite digested a world where their central banks are financing the US to the tune of $800b a year. I haven't quite digested it myself. my guess is that the market have digested it -- and the structure of financial asset prices now assumes such flows will continue; your views on that would be interesting.

Macro Man said...

While it's fair to say that the world's EM CBs probably hope that the US recovers from its growth slump, I'm not sure how much currency-appreciation pressure that would alleviate. After all, a recovery in US domestic demand would probably send the trade deficit widening again, and a growth-happy environment is one that encourages financial market risk taking. I'd think that a US re-acceleration would be more positive for the $ against the euro than it would against Asia, BRL, etc. Regardless, I would concur that real policy shifts in China to emphasize domestic growth at the expense of exports have been negligible.

As for "digesting" the brave new world...I dunno. I'm still coming to grips with it, and I think about it every day!

The currency market clearly realizes there's an issue- see my poll .
What to do about it is something else entirely- performance data suggests that the market hasn't entirely figured it out yet.

Fixed income markets have become accustomed to bonds trading more richly than historical precedent would suggest. Part of that has been the CB bid; but part of it has also been the ALM bid, and the general lack of credible inflation fears. Last May gives us a taste of what the world might look like of inflation really does make a comeback.

Equity folk? They aren't ready for what will hit them if/when the Chinese investment authority, and others like it, move aggressively into equity markets.

The one hallmark of EM CB activity is this: whatever they buy in large volume tends to get pretty expensive.

The most obvious candidate to end all of this is a nasty global recession, which of course no one sees as being in their best interests.

But the issue is something I've been thinking a lot about- how to game the extraordinary (and growing)prominence of EM CBs in the world's financial markets.

Anonymous said...

Hi, can you tell me how do you trade WTI/Brent spread? I should help to find an algorithm for trading this, but am almost clueless where to start. Your help would be appreciated. Thanks