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Tuesday, August 23, 2016

Bloomberg: Emerging Markets Flash Warning Signs, and Other Research to Read This Week

Emerging Markets Flash Warning Signs, and Other Research to Read This Week

Here's a summary of important economic research released Aug. 16-22

A pedestrian walks through a neighborhood slated for redevelopment as the Shanghai Tower stands in the distance in Shanghai, China, on Aug. 15.

Federal Reserve Chair Janet Yellen will speak at the Kansas City Fed's Jackson Hole symposium Friday morning, so it's an easy week to get economic tunnel vision.

If you're too short on time to read anything that doesn't relate to "Designing Resilient Monetary Policy Frameworks for the Future" — the conference's oh-so-sexy theme — we've got you covered. 

This week's research roundup, the latest installment of a new weekly column, starts with a look at vulnerabilities in emerging markets. From there, we go to euro area aging, the still-glum outlook for big-time fiscal spending, and the cost of Democratic presidential nominee Hillary Clinton's carbon emissions goal. If there's an unifying theme here, it's that central bankers aren't the only ones with troubles at hand — though if you read to the end you'll get an overview of their challenges too.

International Capital Flows and Vulnerabilities in EMEs: Analysis and Data Gaps

Authors:  Nikola Tarashev, Stefan Avdjiev and Ben Cohen

Available: Bank for International Settlements website, published Aug. 18

Indebted corporations in several emerging markets – including China and Brazil – could face trouble in the near future, which may send shocks reverberating through their national banking sectors, this BIS paper finds.

The accumulation of debt since the global financial crisis has left emerging-market economies especially vulnerable to capital outflows, according to the authors. 

Points of particular concern: Offshore borrowing by non-financial corporates has "grown at a fast clip" in some countries, helping to shape national financial conditions and increasing vulnerabilities. And because data on international capital flows are lacking, the scope of any weakness in emerging-market banking systems might be misunderstood.

The authors look at warning signals of financial overheating, and find heightened risk of financial distress in the medium-term in China, Brazil and Turkey in particular. 

The Euro Area Workforce is Aging, Costing Growth

Authors: Shekhar Aiyar, Christian Ebeke and Xiaobo Shao

Available: IMFdirect blog from the International Monetary Fund, published Aug. 17

Over the next two decades, the share of euro area workers who are 55 to 64 years old will rise by a third, according to the paper – more than in the U.S. or United Kingdom. "We find that workforce aging significantly reduces productivity," the authors write, holding that a 5 percentage-point increase in the older age group is associated with a 3 percent labor productivity decline. "Worryingly, some of the largest adverse effects on productivity will fall on countries that can least afford it, such as Greece, Spain, Portugal, and Italy."

Policies can help to ease the productivity effects of aging, the authors say. Improved health conditions could particularly help, along with worker training or re-training.

It's important to note that the effects of population aging on productivity are controversial. For another take, check out this recent paper, which focuses instead on aging in the U.S. and suggests that the loss of productivity from aging may come partly from lost opportunities for older and younger workers to complement one another.  

Fiscal Drug for Addicted Markets

Author: Athanasios Vamvakidis

Available: to Bank of America Merrill Lynch clients, published Aug. 19

Vamvakidis, a foreign exchange strategist at Bank of America, has a warning: don't get too excited about fiscal policy.

Markets long addicted to monetary stimulus have begun to look to fiscal policy for their next hit, but "we see limits to the extent to which advanced economies have room for substantial fiscal expansion," so markets could find themselves let down, he writes.

Basically, the argument is that major economies have historically high debt levels, especially Japan and, to a lesser extent, the U.S. and eurozone. The only countries that Vamvakidis and his colleagues see having much fiscal space – Australia, New Zealand, Norway, Sweden and Switzerland – are too small to have much effect on the global economy.

Despite that lack of room, Bank of America notes that more fiscal stimulus is in the pipeline in Japan, but they warn that markets may get too excited about the prospect of helicopter money. They also see a possibility of short-term stimulus in the U.K., but expect little chance of additional fiscal injections beyond what's happening in the eurozone. 

What Would It Take to Reduce U.S. Greenhouse Gas Emissions 80% by 2050?

Author: Geoffrey Heal

Available: National Bureau of Economic Research website, included in Aug. 22 digest

The U.S. is trying to stay on track to reduce carbon emissions by 80 percent or more from 2005 levels by 2050, and Hillary Clinton has made that ambition a campaign goal. But how much would that achievement cost? 

The bill would total anywhere from $42 billion to $176 billion per year, according to Columbia Business School's Heal. "My conclusion is that the U.S. economy could reduce carbon emissions by 80% from 2005 levels within three decades," he writes, but it would take a $3.3 trillion to $7.3 trillion capital investment in new energy generation, transmission and storage capacity.  "I see decarbonizing electricity production as the key step in decarbonizing the whole economy," Heal writes, because that electricity could be extended to cars and heating – other carbon generators. 

The paper discusses various options for the mix of future energy sources and storage methods and alternatives, and the breakdown of the best and worst scenarios are above. "Whichever case we focus on, these are large numbers," Heal writes, noting that in 2015 U.S. capital expenditures on new electric generation was about $42 billion. "In the best case we are on track: in the worst, we are scaling up the U.S.'s level of expenditure on new generating capacity by a factor of about four."

Gauging the Ability of the FOMC to Respond to Future Recessions

Author: David Reifschneider

Available: Fed's website, published Aug. 19

We couldn't leave you without something Jackson Hole-relevant. Reifschneider is among Yellen's most-cited economists, and his new paper highlights that the Federal Reserve will be able to juice the economy using unconventional measures in the next recession, even if it has less room to cut rates. "Even in the event of a fairly severe recession, asset purchases and forward guidance should be able to compensate for the FOMC's likely limited scope to cut short-term interest rates in the future." He does note that there are situations in which the Fed's capabilities could be strained.


Bloomberg: Citi: Here Are Six Ways Central Banks Have Distorted Markets

Citi: Here Are Six Ways Central Banks Have Distorted Markets

Dysfunction rules the roost in developed-world credit markets, contend Citigroup Inc. analysts.

"Remorse or Sphinx Embedded in the Sand" by Salvador Dali, a 1931 oil on canvas painting from the collection of the Kresge Art Museum at Michigan State University. The work, an East Lansing Gift of John F. Wolfram, will be on view as part of the exhibition "Dali: Painting and Film" at New York's Museum of Modern Art through Sept. 15. Source: Fundacio Gala-Salvador Dali/ARS/MoMA via Bloomberg News

Once upon a time, credit and economic fundamentals drove returns, investors preached the virtues of asset diversification, and market volatility spiked when macro risk rose.

Then central banks turned up.

Their post-crisis stimulus polices and verbal interventions have conspired to upend the normal functioning of credit markets. Market prices are increasingly driven by cheap liquidity, the Federal Reserve's near-term policy stance, and domestic real rates, rather than market and macro fundamentals, analysts contend.

In a research report last week, Citigroup Inc. credit analysts lamented this brave new world of "deeply dysfunctional" fixed-income and equity markets, citing, among other factors, the broken relationships between corporate profits and credit spreads, and the structural reduction of volatility despite a slew of macro headwinds.

Here are six ways central banks have bred market dysfunction, according to the Citigroup analysts led by Matt King.

1. Macro factors rather than fundamentals are increasingly important in driving returns in developed-world equity markets, a development the analysts say is leading to herding behavior among U.S. mutual funds.


2. With year-to-date defaults now equaling 2015's full-year total, according to S&P Global Inc., high-yield credit spreads in Europe and the U.S. haven't materially adjusted. "With macro this dominant, credit no longer seems bothered by defaults," Citigroup says. 

credit spreads

3. The correlation between U.S. corporate spreads and corporate leverage has broken down since 2011,  while equity markets echo the fixed-income market's relative nonchalance with respect to bad corporate news. Since 2012, for example, downward revisions to consensus earnings expectations in developed markets haven't been accompanied by equity market sell-offs.


4. In Europe, an uptick in bad news in recent years, as tracked by the Baker, Bloom & Davis economic policy uncertainty indexes, has had little discernible correlation with credit spreads.

5. Long-held relationships between rate and credit markets have broken down. Typically, when the economy is buoyant, government bonds sell-off and corporate spreads tighten as investors reckon good growth prospects justify risk-taking — and vice versa. However, this negative correlation has broken down in recent years, Citigroup notes, citing the relationship between Bund yields and euro investment-grade spreads, as well as U.S. Treasury yields and U.S. corporate spreads. "While it's never completely clear-cut, these days what's good for rates is good for credit (and equities) too. Either it all rallies, in a gigantic reach for yield – or it all sells off. The benefits of diversification just went completely out of the window."

6. Volatility is low, despite a rise in cross-asset correlations, and the upcoming U.S. elections, negative news in Japan and political risks in Europe. 

As they survey the broken credit-market landscape, the Citigroup analysts seek to explain how central banks have numbed investor allocation strategies based on fundamentals. "Portfolio managers are buying not because their analysts tell them assets are cheap; they're buying because they have inflows. And when the central bank liquidity taps are turned on, they figure there are still more inflows to come."

They conclude: "And yet the more stretched all these relationships become, and the more extreme the central banks' policies, the greater is the tail risk."

Still, there are opportunities for credit differentiation in Europe, and strategies to juice returns in a low-rate environment. But as the Bank of England and European Central Bank expand their balance sheets and up their purchases of corporate debt some analysts say yet-more market dysfunction is en route.