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Volatility will rise toward its long-term average and that means an increase in risk premiums, said Philip Moffitt, head of fixed income in Sydney for Asia and the Pacific at Goldman Sachs Asset Management, which had $991 billion of assets under supervision worldwide as of September. The risks for different emerging economies will become more idiosyncratic and Mexico presents a buying opportunity following the rout, he said.
Markets from Turkey to South Africa and Argentina were roiled during the past month as investors sold off emerging-economy currencies, stocks and bonds, prompting emergency measures from governments and central banks. The bout of risk aversion follows the Fed’s decision to scale back asset purchases and China’s pledge to rein in leverage and give market forces a more decisive role in allocating resources.
“The selloff in emerging markets has much more to do with China than with Fed tapering,” Moffitt said yesterday in an interview in Sydney. “China’s such a big source of global demand, in particular for other emerging markets, uncertainty’s going to stay high and risk premiums should be expanding.”
The worst isn’t over for emerging markets, Mark Mobius, who oversees more than $50 billion in developing nations as an executive chairman at Templeton Emerging Markets Group, said in an interview. Prices can decline further or take time to stabilize, he said.
China’s policy makers have attempted to rein in the unprecedented credit boom they unleashed in 2008-2009 amid the global financial crisis. Money market rates in China have surged, the cost of insuring against credit default by banks has increased and payment difficulties are emerging in the country’s $6 trillion shadow-banking industry.
“They’re looking to create a market that prices credit risk, rather than having prices imposed,” Moffitt said. “In the absence of a strong mechanism for pricing credit risk, there’s likely to be a lot of uncertainty and volatility.”
The world’s second-largest economy is predicted to expand by 7.4 percent this year, the slowest pace since 1990, according to the median estimate in a Bloomberg News survey.
The slowdown in China comes as the U.S. economy is showing signs of a pickup, allowing the Fed to trim its monthly bond purchases to $65 billion from $85 billion. U.S. growth is expected to accelerate to 2.8 percent in 2014 from 1.9 percent last year, according to a another Bloomberg poll.
Moffitt said investing in Mexico would be his top trade at the moment because the country’s fundamental outlook is strong even though it has been affected by the global selloff.
“There’s been outflow from emerging-market assets and when you get that kind of flow people sell what they can sell, often high-quality assets,” he said. “It will benefit from the strong U.S. growth we’re expecting and there’s the prospect for rate cuts, so Mexico stands out to us on both value and fundamentals.”
As reported yesterday, following a surge in various short-term and money market rates in the aftermath of the Fed’s taper announcement, the PBOC admitted after the close that it used Short-term Liquidity Obligations (SLO) to add funding to the market, and in doing so, bailing out money markets – the same product that nearly collapsed the financial system in the aftermath of Lehman.
The bank didn’t specify when it added the funds but, in another direct echo of the June panic, the PBOC said it is prepared to add more. However, it seems the market was less the convinced, and despite an early plunge in the seven day repo rate by over 2%, it suddenly and rapidly reversed direction and instead blew out hitting a whopping 9%, the highest since the June near-crash of the Chinese banking sector.
The outcome: China said it injected another $50 billion to bailout and stabilize its money markets in what is increasingly looking like a replay of this summer’s liquidity lock up. Perhaps the PBOC hinting at tapering at a time when the Fed is actually doing so is not the smart choice…
China’s central bank said it had injected over 300 billion yuan ($49.2 billion) into the nation’s money markets over a three-day period as interbank interest rates surged to their highest levels since June.
The People’s Bank of China said on its official Twitter-like weibo account that the banking system had current excess reserves of over CNY1.5 trillion and it called that level “relatively high.”
The central bank said that it had injected the funds through its “short-term liquidity operations” and this was in response to the year-end market factors.
The interest rates banks charge each other for short-term loans jumped to 8.2%, the highest level since the June cash squeeze.
The stress in the banking system is starting to spread elsewhere, with stocks in Shanghai falling for a ninth straight day to the weakest level in four months while government bonds dropped, pushing the 10-yield up to near the highest in eight years.
The turmoil has been sparked by a scramble for funds by banks as they near the end of the year when they typically need extra cash to meet regulatory requirements as well as the demand for funds from companies.
The central bank also said reminded banks that they need to manage liquidity better.
As to what drove the rapid mood reversal, the Chinese market was hit early on with talk of a missed payment at a local Chinese bank. For now it has not been confirmed, and even if it was the PBOC is expected to never allow any government-backstopped bank to fail. Still, a few more days like the last two and the world may just find out how prepared for a bank failure a credit-stretched China really is.