The long wait is over

So, finally, the Federal funds rate in the United States is not at zero. Instead of targeting a range of 0.0% to 0.25% for the Federal Funds rate, the Federal Reserve would target now a range of 0.25% to 0.50%. This is the first rate hike made by the Federal Reserve Board in the US in over nine years. The press release is here.

What are my take-aways from the press release?

(1) The word ‘only’ before ‘gradually’ was significant. That emphasis must have been the principal trigger behind the positive stock market reaction in the US after the rate decision.

(2) The Federal Reserve made a pointed reference to inflation undershoot as one of the factors that they would watch. If inflation stayed below 2%, they would probably go even slower on future rate hikes (“In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal”). Of course, it is not impossible that they would look through the effect of falling oil price on the rate of inflation.

(3) The Federal Reserve also mentioned that they would track financial and international developments in determining the timing and size of future rate increases. Clearly, financial market volatility and international turbulence would hold them back, even if domestic economy was resilient

(4) They continue to reinvest their maturing Agency bonds and Treasury bonds and hence the Fed balance sheet is not shrinking. That is the key. The Fed balance sheet is not shrinking.

So, in the short-term, the equity market was correct to judge that the overall tone was dovish. But, the action in EURUSD is interesting this morning. That exchange rate moved lower.

Stocks are, of course, setting them up for a big fall in 2016. No change in that view, as far as I am concerned. Of course, this is not a investment recommendation!

This is a very useful Bloomberg article showing the dispersion of Fed governors’ interest rate forecasts and the state of the health of the US economy now compared to the previous two Fed tightening cycles on various parameters.


China does an encore

On December 7, Zerohedge had tweeted:

China has 9 days to unleash another EM market crisis and delay the Fed hike.

That was a good one. In August, China made a seemingly innocuous adjustment to its exchange rate fixing and unleashed a month of volatility in financial markets around the world. The Federal Reserve blinked and postponed a planned and telegraphed rate hike in September.

The Federal Reserve had already made the next rate hike in its meeting to be held on Dec. 16-17, a fait accompli.

China may not have much of a chance to stop it. But, that has not stopped it from trying. On Friday, the People’s Bank of China quietly announced a change in the way it fixes the daily value of the yuan. According to the FT,

China has paved the way for a further weakening of its currency by announcing changes in how it measures the renminbi’s value.

The move, announced on Friday, has raised investors’ alarm at the prospect of a new currency war — just as the US prepares to raise interest rates.

As markets gear up for next week’s Federal Reserve meeting, the People’s Bank of China signalled it would measure the level of the renminbi (or yuan) against a basket of currencies rather than just the US dollar. [Link]

The FT is absolutely right to begin the story with the aim and purpose of this move by China. While it might not derail the first rate hike in nine years by the Federal Reserve, it might help to keep the Federal Reserve wary of the next move.

Many unsuspecting analysts and China-apologists were willing to overlook the August action by China as an innocuous decision that had unexpectedly large and global consequences. It will be too hard to explain away the encore as such. But, well, have I spoken too soon? Eswar Prasad has another academic/innocuous explanation for the Chinese announcement on Friday. Check out the FT link again.

Bullets on the bullet train

Some people feel excited and some people feel frustrated. I am not excited and I am not frustrated. But, I see it as a good thing. I refer to the announcement of a Bullet Train project between Mumbai and Ahmedabad by the Indian and Japanese governments.

Typical reaction is whether the money could have been spent on more immediate priorities. In life, there are urgent things to do and there are important things to do. Both need to be done. Some fall in between. This need not be deemed important but the mileage and the benefits that one reaps from this project are more than those that can be quantified. The optics and the pride that come with it are not insignificant.

The confidence booster and its trickle-down to other areas plus the usual development of many ancillary activities around the construction of the high speed line and the manufacture of the coaches in India are likely to be substantial. If a trophy project can be executed within time and cost estimates, then it gives us confidence and self-belief about executing other projects.

Second, the transfer of know-how and management techniques in project management should also be counted. Considerable scope for public Sector and private sector skills acquisition in these projects exists.

Probably, similar objections were raised – ‘needless expenditure’ – when India embarked on space research. Now, India is launching satellites for the UK, for France and for Singapore. The information that is being gathered from the Indian remote-sensing satellites is immense.

Similarly, with respect to Pokhran nuclear tests in the Seventies and the Nineties, many well-intentioned but naive do-gooders criticised them. The reality is that a country with a hostile and difficult neighbourhood with one billion people of which a substantial portion is flirting with the poverty line has to pursue multiple goals and objectives simultaneously. Time and tide wait for no man. If it is the case for men, certainly, not for countries.

In the Tamil film, ‘Nayakan’, Kamal Hassan does social work for his people but also has to engage in ‘Dadagiri’. To his daughter, in a scene of famous confrontation, he tells her to tell the other side to stop and then he would stop too. India is in a similar position on many of these things. In an idyllic and ideal world, the bulk of the government spending would be on essential infrastructure and social needs.

India awarding the project to Japan, while China was also bidding for it, is significant. Indonesia appeared to have decided on a similar high-speed rail project to Japan. Then, wanted to abandon it. Then, turned around and  went ahead with the project. Then, it awarded it to China! Now, Indonesia wants to take China to international court for disputes over islands in the South China Sea. Is there any chance that China would take Indonesia’s objections seriously, after it has awarded the project to them?

The common fallacy that people make is about the opportunity cost of the resources deployed in the project. It is tempting and, prima facie, correct to argue that resources have competing ends. But, in these instances, the resource won’t be available if it is not for this project. The Japanese government is not giving a general purpose loan to India at concessional rates of interest for a 50-year period and giving the choice to the Government of India to spend it on any project and then, the Government of India has chosen to ‘waste’ it on a high-speed rail project. It does not work that way.

If the Government of India did not spend on this project, the funds from Japan would not be available for other projects. You can check out the terms of the financial concessions offered on this project in this news link. It is rather generous and, Suresh Prabhu, the Minister for Railways said, 85% of the trains are being made in India. Know-how will be accumulated in India.

I had also overlooked the fact that a High Speed Rail Corporation of India has been incorporated. The website is here.

The Indian Prime Minister’s media statement welcoming the Japanese Prime Minister is available here.

Having written all of the above, I might have overlooked more positives to the story and also some negatives. I would appreciate comments that provide more substance to the above observations.

Two and counting, already

A gloomy bookend to a gloomy day for the credit markets, news that the hedge fund group Stone Lion Capital Partners is barring redemptions from a $400m credit fund….

The message from Stone Lion to its investors is that they will be better off if it does not have to dump positions on to the market quickly, after months of weakening prices and growing concerns about illiquidity in the credit markets.

New York-based Stone Lion is run by former Bear Stearns high-yield bond traders Gregory Hanley and Alan Mintz…. [Link]

The news that former Bear Stearns bond traders are shutting redemptions on their fund would be Déjà vu for many.

If it is not Stone Lion, it is LionEye. They are not barring redemptions. They are shutting shop.

LionEye Capital Management, the investment firm led by Stephen Raneri and Arthur Rosen, is shutting its main hedge fund after losses, according to a person with knowledge of the matter.

The firm managed $1.7 billion of regulatory assets, a measure that can include leverage, at the end of last year, according to a filing. Rosalia Scampoli, a spokeswoman for the New York-based firm, declined to comment on its plans.

LionEye’s fund is shutting amid the worst year since 2011 for strategies that make wagers on corporate events like mergers, spinoffs and restructurings. [Link]

This is a big one and it seems to have been announced late on Thursday, after markets closed in New York (my guess).

New York-based Third Avenue Management is blocking investors from withdrawing their money from a near $1 billion junk bond fund as it tries to liquidate the fund in the biggest failure in the U.S. mutual fund industry since the Primary Reserve Fund “broke the buck” during the 2008 financial crisis….

Heavy redemptions and losses since the end of July cut the size of the Third Avenue Focused Credit Fund by more than half, with assets falling below $1 billion from $2.1 billion, according to Lipper. The latest data from Morningstar Inc showed the fund with just $789 million in assets, as of Thursday…..

About a year ago, the Focused Credit Fund had $2.75 billion in assets, but 18 percent of that amount included exposure to securities deemed illiquid. These so-called Level 3 assets typically carry valuations pegged to assumptions made by the investment managers themselves…

The fund’s year-to-date total loss of 26.98 percent is nearly nine times worse than the 3.0 percent average loss in the junk bond sector, according to Lipper. [Link]

Now, they (some commentators – see my post here, for example) will already blame the Federal Reserve for this. Actually, it is not the impending rate hike but the long period of rate inaction that is behind this.

Post-crisis repair and recovery – because they simply became ‘extend and pretend’ by other means – had resulted in a relapse into behaviours that brought about the crisis of 2008 in the first place. The Fed must now go through with its rate hike. Otherwise, its credibility would be badly damaged. If it did, it would be blamed for events which have their roots in the zero interest rate policy and not in the 0.25% rate hike.

Central banks’ hubris and their QE policies are again to be blamed much more intensely for the next crisis that is coming, just as they were responsible for the previous one. The difference was that the weights between hubris and incompetence tilted slightly more towards the latter pre-2008 and now, the weights on both factors are equal.

Weekend links – 12.12.2015

Disappointing remarks by Shashi Tharoor on cows being safer than Muslims cleverly attributed to an unnamed Bangladeshi.

Minhaz Merchant has a thoughtful piece. I think what he alludes to on the attitudes of the leadership may be happening already.

A lady recounts her experience with Chennai rains and floods. Anil Padmanabhan has another good column on India’s urban planning or the lack of it. Zeroing in on the failure on the ‘Disaster Management’ front in Chennai.

Journalist cum auditor cum Hindu scholar Gurumurthy explains the ‘National Herald’ case in a series of tweets.

Good to know that India’s BPO policy for small towns attracts a lot of interest.

Good to read the former Foreign Secretary explain the dangerous games being played by the Nepali ruling elite.

ISRO to launch six Singapore satellites on 16th December.

Hong Kong may have a message for the beef bhakts in India.

The Sports Bubble is about to pop. 2016 will truly be the year of discontinuity.

This line caught my eye:

For more than 30 years prior, ESPN enjoyed an unbroken stream of growth and innovation on its way to becoming the immovable Gibraltar of the cable bundle. [Link]

Apparently, UBS did not feel energized by a visit to China. The economy is still struggling. Torrent of Commodities exports from China. Protectionism will be catching up soon.

We can keep writing about the imperative of reforms and restructuring in China. But, China is not interested except to pay lip service. China’s room for fiscal manoeuvre is limited. I agree. The China horror story from shipping industry woes

In China, the plot always continues to thicken. An ally of the deposed former princeling Bo Xilai died mysteriously in a heart attack in prison. He was only 44. The FT story has more meat in it. He had testified against Bo Xilai’s wife. The prosecutor who had helped put Bo Xilai’s wife had died under mysterious circumstances too earlier in the year.

The US is to deploy P-8 Poseidon surveillance aircraft to Singapore for the first time in the latest response to China and its growing military presence in the South China Sea. China is paying close attention.

Knife attack in London Tube Station on Saturday evening. Police treating the case as an act of terror.

Edward Luce writes that America more polarized than before after San Bernardino massacre when a Muslim couple casually shot 14 people dead, after leaving their baby with their mother. The husband was earning $70K in his job.

LA Times story on the San Bernardino shooters.

Short on answer but long on diagnosis. Interesting, important and useful read, nonetheless: “there are no quick fixes to the problems of urban disenchantment”. If so, are there no quick fixes to reversing the appeal of violent jihad?

French regional elections go into the second and final round over the weekend. It could signal tectonics shift in country’s politics. To that extent that it polarised the country’s politics, it will be a victory for ISIL.

In Germany, the number of registered asylum seekers rose to about 965,000 by the end of November, exceeding the government’s full-year forecast from August of 800,000.

Petition in the UK gathers more than 200,000 signatures for banning Donald Trump from entering the UK for his call to ban Muslims from entering the US for a year. The choice of the picture of Trump accompanying the article is revealing.

Two very good reads on Donald Trump and what he means for the broader discourse.

Turkey PM says Russia doing ethnic cleansing.

Did not know that Finland is debating a motion on staying in the Eurozone. Wolfgang Muenchau thinks that Europe may have to disintegrate before reintegrating.

Turkey angered by a Russian solider displaying a rocket launcher on shoulder as Russian ship passed through Istanbul.

According to this FT report, BIS still wants Western Central banks to normalize monetary policy without being swayed by financial market volatility (December BIS Quarterly Review).

One among many reasons why ECB did not offer as much stimulus as the market expected:

A pending U.S. Federal Reserve rate hike also factored into the decision, though to a lesser extent, as policymakers were concerned that a big move by the ECB would weaken the euro further and possibly force the Fed to delay its own action on rates to prevent a too rapid divergence of policy between the world’s top two central banks. [Link]

ECB Governing Council member Ewald Nowotny called market expectations of a big ECB move absurd. He was probably addressing ECB President stoking the market expectations as well.

SEC to crack down on derivatives. About time too.

Larry Summers endorses India’s stance at COP21. India’s rich have a smaller carbon footprint than rich countries’ poor. Very interesting.

Scientists link UK weekend storm to man-made global warming

Sanjeev Sanyal explains why Delhi’s road-rationing policy (odd and even numbered plates) might be difficult to implement.

China issues red alert for pollution in Beijing. What about Delhi? Further, the Public unhappy with China government for failing to issue pollution red alert in Beijing.

Saudi Arabia is getting isolated in many ways, it seems. Its stance in the Global Climate Negotiations comes under critical scrutiny.

Gideon Rachman in FT: Perhaps it is time to give the Saudis a choice: agree to allow churches, Hindu temples and synagogues to open in Saudi Arabia, or face the end of Saudi funding for mosques in the west.

Iranian leader Ayatollah Khomeini’s grandson to enter politics. He is considered a moderate.

It is not clear what exactly are hedge funds hedging. They have had a rough year. The real shakeout in the industry is still in the future.

FT thinks that South Africa removing its Finance Minister from his job was a bad idea.

FT has a long story on America’s shrinking middle class. If a distribution of any phenomenon is shrinking in the middle and fattening in the tails, it is no longer a normal distribution but a skewed one.

Capital flowing out of Turkey too and not just out of China. Well deserved, I must add.

Sovereign wealth funds pulling money out of asset managers.

Moody’s puts Brazil credit rating for a review for possible downgrade to junk status. Must be in the price already. Currency hardly reacted.

The shrinking Gross Planetary GDP – fascinating.

South Korea to issue a ‘panda’ bond (bonds denominated in RMB)

The head of the Croatian Human Rights Group sees his pants drop while posing for a picture with Croatian woman President!

On genetics and fitness. Looks like it does not make sense to exercise outside at all, in places like Delhi.

Andrew Batson’s list of best books he has read for 2015

The certitude of Martin Sandbu

Mr. Martin Sandbu who writes for FT under the moniker ‘Free Lunch’ has been running an unceasing campaign for more ‘drug supply’ to financial markets. Be it QE or zero or negative interest rates or helicopter drop of money, he would be the first cheerleader.

On Dec. 8, he had voiced strong exception to the likely first Federal Reserve rate hike after nearly a decade. This is a slightly modified (fixed some awkward phrasing) version of the comment I posted below his article:

Mr. Martin Sandbu’s certitude is rather impressive. If only economists and economic commentators accept the wide arc of uncertainty and imperfect knowledge with which they operate, the world would not have accumulated so many risks as it did between 2002 and 2008 and again, after 2009. That important lesson seems to have eluded many and continues to elude many, including Mr. Sandbu.

He cites Mr. Tim Duy approvingly:

“You need to go back to the mid-80s to find another time the Fed hiked with a sub-50 manufacturing ISM.”

Equally, one needs to go back (to when and where?) to find another time when the policy rate remained at zero as the unemployment rate came down to around 5.0% (in November 2015) from 10% (in October 2009).

When the US financial markets – stocks and bonds – tumble as they must and as they would – these folks would be ready to tell the Fed that they warned of it before. That will be the ultimate tragedy.

What is going to come in 2016 has been set in motion over the last six years. The train had left the station. It is already too late. This rate hike will do nothing to prevent the financial instability that is coming next year. The camel’s back was broken once by debt accumulation and it has been broken again by policies that have fostered even more excessive risk-taking and allowed more debt burden to be placed on its back.

Commentary and analysis such as these are doing considerable harm to the cause of sound public policy, sustainable economic growth and financial stability.

One lesson the rest of us should remember is that some of us never learn.

Talk, talk, talk

Those in the Know will know why India and Pakistani National Security Advisors met and who made them meet, regardless of the fact that it would yield precisely nothing. Praveen Swami in IE on why Pakistan and India are talking. Ms. Sushma Swaraj, India’s External Affairs Minister visited Pakistan too. An endless charade.

This is the cycle: Escalation by Pakistan – India threatens but does nothing – international pressure – de-escalation – Talks – Re-group and hatch new plans – Escalation. Rinse – Lather – Repeat.

I am glad to note that this MINT Edit endorses my stance.

China in the SDR

This comment is probably a week overdue. Let us hear what Ben Bernanke wrote on this:

If SDR inclusion is only symbolic, then what’s the big deal about the IMF’s decision? Well, the Chinese authorities, who very much want their country to be recognized as a global economic power, care a lot about symbolism. And SDR inclusion does recognize both the increasing economic power of China and the important steps the Chinese have taken over the years to open up their capital markets, to meet international norms in financial regulation, and to increase the extent to which market forces help determine the renminbi’s value. Recognizing China’s progress in these areas, and encouraging more progress, are reasonable steps for the IMF and the global community to take. [Link]

He is right that it is about symbolism. I do not know about the recognition part because I am not sure of what is being recognised. More on that a bit later.

It is true that currencies that are not part of SDR are being held by the global central banks as part of their Reserves – Canadian dollar, Australian dollar and the Swiss franc. That is why Bernanke is right when he says the following:

the dollar’s global status is a market outcome, not the result of a decision by any international body or of an international agreement. Private investors and governments freely choose to hold dollars because the markets for dollar-denominated assets are, by far, the deepest and most liquid of any currency; because the United States imposes no restrictions on capital flows in or out of the country; because of the quality of U.S. financial regulation; because the Federal Reserve has kept inflation low and stable for the past thirty years; and because the United States is large, prosperous, and politically stable.

We will grant Bernanke most of it. We do have big quibbles on his observation about the Federal Reserve keeping inflation low and stable. That is at best debatable and at worst, vastly overblown. But, the rest of his comments is, more or less, okay.

At the same time, one cannot rule out the possibility that China hopes for some purchases of the yuan by global reserve managers to help stabilise the yuan and clear the way for some more currency depreciation or devaluation. That is what I wrote here. I think yuan devaluation is still coming in 2016.

We will have to contest this statement of Bernanke below:

The underappreciated fact is that the direct benefits to the United States of issuing the dominant international currency are probably quite modest. It’s often argued, for example, that the dollar’s status allows the United States to borrow abroad more cheaply; but, in inflation-adjusted terms, the U.S. government does not enjoy meaningfully lower borrowing costs than other advanced industrial countries. We do benefit from the fact that much U.S. currency is held abroad, since these holdings amount to interest-free loans to our government; but other currencies, like the euro, are also widely held, and in any case the interest savings from foreign currency holdings are tiny compared to the overall U.S. government budget or the size of our economy.

Well, it is difficult for Bernanke to substantiate what he wrote there simply because the counterfactual is hard to establish. Would the United States have had to pay a much higher rate of interest for borrowing from international lenders, but for its global and dominant reserve currency status? In my view, quite likely or even most likely.

Given its post-Bretton Woods track record of steady depreciation, investors would have demanded a much higher risk premium to lend to America in US dollars but for its dominant status. It has helped and I wonder why he is underplaying it.

This article in Wall Street Journal Real-Time Economics argues that the IMF had cut corners for China. The article mostly cites those who were critical of the IMF decision to include the yuan in the SDR basket.

Professor Victor Shih of the University of California at San Diego thinks that non-transparency has been rewarded. He points out several unresolved questions about PBoC balance sheet.

The folks at ‘’ contacted two China experts to comment on this matter. One of them was Arthur Kroeber. He is a China bull. Yet, he was restrained. You have to read between the lines of a bull to know how much of a bear he/she is inside.

The other was Professor Zhiwu Chen, Professor of Finance at Yale School of Management. This is what he wrote:

We can see why fundamental reforms are out of the question if we follow the quick logic chain: maintaining the Party’s absolute control of economy/society is priority #1, far above and beyond everything else, for the current president —> SOEs must dominate economy —> banks and financial institutions must be controlled to serve the party and SOEs —> market principles must be restricted and capital in/out-flows cannot be free —> fundamental reforms continue to be talked about but not implemented, and structural imbalances cannot be corrected.

If the SDR inclusion had happened three or four years ago, more real reforms would have been possible. But, right now, too many burning challenges and downturn pressures are at hand (e.g., overcapacity, capital outflow pressure, difficulty to achieve growth target even after many policy interventions, pollution and environment, all financing tools/channels exhausted to the limit and beyond). So, short-term goals are far more dominating, making the SDR story more of a transitory news event. Reality will be back soon. [Link – emphasis mine]

Finally, according to this blog post, Bank of America-Merrill Lynch thinks that the yuan would depreciate by 3% to 4% in the second week of December, after the SDR basket inclusion. Perhaps, I think that it is appropriate that they have the last word in this blog post.

China FX Reserves leaking again

Stories here, here and here on China FX Reserves dropping by more than USD87.0bn in November. In August, they declined by around USD94.0bn. The FT article has a mitigating quote, attributed to a China-based analyst, in the end. Reserves are the lowest in more than two years now. Should not be surprised. Second and third quarter saw back-to-back capital outflows out of China. October was a partial reversal, it seems. It has resumed in November.

The Bloomberg story is important for it says that the amount of Reserves People’s Bank of China (PBoC) is expending could be more than what is gleaned from the reduction in Reserves. It is accumulating contingent foreign currency liabilities through Forward Contracts – something that Thailand did in 1997-98 and was caught out. It is not clear if China’s FX Reserves disclosure includes disclosure on forward currency positions.

According to this Yahoo! Finance story, Julian Evans-Pritchard of Capital Economics in Singapore estimates that capital outflows in November out of China were USD113.0bn.

It is raining canaries

Sinkholes are popping up in the credit market. Specific junk bonds are simply plummeting in value on little trading. For example, nothing all that obvious triggered a plunge in Syniverse Holdings, whose bonds fell to 39 cents on the dollar Monday, from 84.25 cents less than a month earlier. Debt of Intelsat, United States Steel, SandRidge Energy and Ultra Petroleum all lost about 30% last month. Yet looking broadly, there isn’t a financial crisis in developed markets. U.S. stocks are still eking out gains. Companies are still issuing bonds. So why the precipitous drops without warning? The explanation is that asset managers are being forced to exit their riskiest positions, either because of withdrawals or to placate increasingly nervous investors, and they’re finding no buyers on the other side. When these fund managers finally get an offer to shed their unwanted holdings, they’re just taking it, even if it means taking a huge loss.” [Link via Credit Bubble Bulletin – Link]

More than $1tn in US corporate debt has been downgraded this year as defaults climb to post-crisis highs, underlining investor fears that the credit cycle has entered its final innings. The figures, which will be lifted by downgrades on Wednesday evening that stripped four of the largest US banks of coveted A level ratings, have unnerved credit investors already skittish from a pop in volatility and sharp swings in bond prices. Analysts with Standard & Poor’s, Moody’s and Fitch expect default rates to increase over the next 12 months, an inopportune time for Federal Reserve policymakers, who are expected to begin to tighten monetary policy in the coming weeks. S&P has cut its ratings on US bonds worth $1.04tn in the first 11 months of the year, a 72% jump from the entirety of 2014. In contrast, upgrades have fallen to less than $500bn, more than a third below last year’s total. The …rating agency has more than 300 US companies on review for downgrade, twice the number of groups its analysts have identified for potential upgrade.  [Link  via Credit Bubble Bulletin – Link]