Topic Tags: International Economy

Initial Results of the ECB’s Targeted Loan Operation Fall Below Expectations

This week’s chart examines the results from the first round of the European Central Bank’s (“ECB”) targeted long-term refinancing operation (“TLTRO”) which occurred on September 18th. The ECB announced this program in June 2014 with the goal of encouraging lending to small and mid-size companies in the region.

This week’s chart examines the results from the first round of the European Central Bank’s (“ECB”) targeted long-term refinancing operation (“TLTRO”) which occurred on September 18th. The ECB announced this program in June 2014 with the goal of encouraging lending to small and mid-size companies in the region. The TLTRO essentially provides a four-year loan to banks at a fixed low rate. This serves as one of several tools the ECB has utilized to address the low inflation and contracting credit conditions in the Eurozone.

With 400 billion euros available, only €82.6B were borrowed by banks, well below the €150B estimated by a Bloomberg survey. Considering the initial outcome, investors are starting to question the potential effectiveness of the program. However, it is important to note that in the month of October the ECB will announce the results of the Asset Quality Review (“AQR”), which is a comprehensive assessment of banks’ balance sheets. The Eurozone’s financial institutions may be more willing to participate in the TLTRO after the stress tests are complete. The second round of TLTRO is slated for December and will provide insight into loan demand in the region as well as essential feedback to the ECB about the effectiveness of its policies. Without stronger demand for loans from this program, strong growth in the Eurozone would seem dubious, and thus participation in later rounds of TLTRO bears watching.

Weak Loan Demand in Euro Area

Due to stagnating growth and marginal inflation in the Euro area, Mario Draghi recently announced that the European Central Bank (“ECB”) would reduce the interest rate on main refinancing operations from 0.15% to 0.05%.

Due to stagnating growth and marginal inflation in the Euro area, Mario Draghi recently announced that the European Central Bank (“ECB”) would reduce the interest rate on main refinancing operations from 0.15% to 0.05%. Reductions would also occur for the rate on the marginal lending facility from 0.40% to 0.30% and the rate on the deposit facility from -0.10% to -0.20%. In addition, the ECB will start purchasing asset backed securities in an attempt to facilitate new credit flows into the economy.

This week’s chart examines the balance sheet of euro area monetary financial institutions (“MFIs”). In particular, the chart illustrates the year-over-year growth of loans in the region. Notably, the growth rate has been negative since the end of 2012. The low lending levels are likely due to poor demand as a result of the subpar economic situation in the euro area, particularly countries on the periphery.

While yields on European government debt have tightened dramatically since Mario Draghi pledged to do whatever it takes to preserve the European Union in mid-2012, the underlying economic environment has remained challenging. The unemployment rate is currently 11.5%, the inflation rate is a paltry 0.3% and projected euro zone growth for 2014 is just 0.9%. The lack of loan demand, slack in labor markets, and overall low growth point toward the likelihood of a protracted period of low inflation.

The potential for deflation has led the ECB to initiate its most recent rate cuts and asset purchases. Similar to the effects of the Fed’s quantitative easing, markets may react favorably to the ECB balance sheet expansion, albeit at the cost of the euro currency. It is important for investors to monitor the ECB monetary policy and structural reforms that have been implemented by many euro zone countries to gauge whether they are effective in stimulating growth, and by extension, promoting positive investment returns from the region.

Emerging Markets Debt a Better Play than Developed Market Debt

Emerging markets debt (“EMD”) represents an outstanding asset class for investors to diversify away from U.S.-centric core bonds, which includes U.S. Treasury, U.S. investment grade corporate and U.S. mortgage-backed bonds, as well as U.S.-centric bank loans and high yield bonds.

Emerging markets debt (“EMD”) represents an outstanding asset class for investors to diversify away from U.S.-centric core bonds, which includes U.S. Treasury, U.S. investment grade corporate and U.S. mortgage-backed bonds, as well as U.S.-centric bank loans and high yield bonds. It gives investors a large and expanding investment opportunity set that has very low correlation with U.S. equities and U.S. bonds.

In addition to stronger yields, where EMD is currently between 6% to 10% versus developed market bond yields between 0% to 6%, emerging markets also exhibit much stronger fundamentals versus their developed markets counterparts. Case in point, GDP growth has been much stronger in the emerging world than the developed world, especially so in the last few years, and is expected to continue for some time. Moreover, demographics are much more favorable for the emerging world, where population growth, especially in the younger, working segment, is expected to outstrip the developed world for quite some time. Lastly, as shown above, emerging market countries have much stronger debt and deficit profiles than developed market countries.

The left axis shows the debt as a percentage of GDP. The greater a country’s debt, the further towards the bottom of the chart it will show. The top axis shows the country’s fiscal deficit as a percentage of its GDP. The greater a country’s fiscal deficit, the further to the right it will show.

Emerging market countries are clustered toward the top left, due to their lower debt-to-GDP ratios and lower fiscal deficits. Developed market countries are clustered towards the bottom right, due to their higher debt-to-GDP ratios and higher fiscal deficits. Greece and Japan are in especially dire straits, and are literally off the charts.

What this chart tells us is that, as a whole, EMD represents a relatively secure asset class as the countries in question have much less debt to service than their developed market counterparts. In addition, they have been more fiscally sound, with lower deficits than their developed market counterparts. All of this adds up to strong support for emerging market countries and corporations to pay both the interest and principal on their bonds. Couple this with their higher yields and low correlations to other asset classes, and it makes it a must-have for most institutional portfolios.

Investors can take advantage of this space through a dedicated emerging markets debt manager that provides a U.S. dollar-denominated “hard currency” sovereign EMD focus, a “local currency” sovereign EMD focus, a corporate EMD focus, or a blended strategy that invests in both hard and local currency EMD bonds as well as sovereign and corporate EMD bonds. Marquette recommends a blended EMD allocation for investors to take advantage of the broadest diversification.

Volatility Index Spikes in August

This week’s chart of the week takes a closer look at the CBOE volatility index (“VIX”) and the German implied volatility index (“VDAX”) in light of recent geopolitical events. Volatility indices are often describes as “fear indices” that tend to increase with market uncertainty.

This week’s chart of the week takes a closer look at the CBOE volatility index (“VIX”) and the German implied volatility index (“VDAX”) in light of recent geopolitical events. Volatility indices are often described as “fear indices” that tend to increase with market uncertainty.  As uncertainty increases, investors typically prefer the safety of U.S. Treasuries, driving up bond prices and pushing yields lower.

• On August, 1st, President Obama announced sanctions on Russia; VIX and VDAX reached their highest levels in more than five months over concern of Russian retaliation.
• On August, 7th, President Obama authorized a targeted strike against Iraq; triggering the VDAX to reach the highest level of the year as concern over global equity markets lead investors to push the 10-Year Treasury yield to 2.43%.
• Finally, August, 15th marked the fall of the 10 Year-U.S. Treasury yield to the lowest in 14 months at 2.34%, due in part to the global tension in Ukraine and conflict in the Middle East.

After spiking in early August on geopolitical worries, the VIX has returned to more normal levels seen throughout most of the year. However, with many of the geopolitical hotspots right on Germany’s doorstep, German market volatility has remained elevated. While U.S. investors may have put the latest crisis behind them, it is worth noting that markets closer to the epicenter of the conflict are not as sanguine.

Commodities Start Positively in 2014

This week’s Chart of the Week examines how the commodities markets have fared since the start of the year. After three years of negative returns driven by relative unattractiveness to equities and fixed income, coupled with declining inflation, commodities began 2014 on a strong foot.

This week’s Chart of the Week examines how the commodities markets have fared since the start of the year. After three years of negative returns driven by relative unattractiveness to equities and fixed income, coupled with declining inflation, commodities began 2014 on a strong foot.

Commodities, as measured by the Dow Jones UBS Total Return Commodity Index, enjoyed four months of consecutive gains and, despite May’s pullback, have advanced by 6.4% so far this year. The strongest growth came from the livestock complex, as the DJ UBS Livestock sub-index benefited from improving supply fundamentals and climbed 12.2% in the first five months of the year. Agriculture has also been strong this year with a gain of 11.9%.

Industrial metals have been the weakest area in 2014. The DJ UBS Industrial Metals sub-index increased by only a modest 0.9% through the end of May. China’s economy, no doubt, has had a negative impact on base metals — concerns over slowing growth in the Chinese economy have weighed on the industrial metals complex. Precious metals have fared slightly better this year with a gain of 1.6%.

Although commodities in aggregate remain below their 2010 levels, their upward momentum thus far provides a positive outlook for investors with commodities exposure.

Playing Politics Helps Emerging Market Investors

After a very disappointing year in 2013 emerging market equities got off to a rough start in 2014, underperforming U.S. stocks by 2.2% during the first quarter. However, emerging markets stocks have recently started to show signs of life, up over 5% since the end of March and outperforming U.S. markets. So why the outperformance?

After a very disappointing year in 2013, emerging market equities got off to a rough start in 2014, underperforming U.S. stocks by 2.2% during the first quarter. However, emerging markets stocks have recently started to show signs of life, up over 5% since the end of March and outperforming U.S. markets. This may come as a surprise to some as the economic data out of China has remained weak and there have been only modest improvements in the current account balances of the “fragile five” (Indonesia, India, Turkey, South Africa, and Brazil). So why the outperformance?

While we mostly focus on economic data and the business cycle to inform our understanding of financial markets, it is important to remember that politics can play a role as well, particularly in emerging markets. This week’s chart looks at the impact of two recent political events on financial markets.

First, the blue line on this chart shows the cumulative price performance, on a quarter-to-date (“QTD”) basis, for the Sensex Index, the main stock market index in India. As the chart shows, improved equity market performance has coincided with the recent Indian election in which Narendra Modi and the BJP party recently won a sweeping victory. Mr. Modi has an impressive record of reform and growth from his days as the Chief Minister of Gujarat and has been elected with a mandate to improve economic growth by cutting red tape and loosening restrictive labor markets.

Second, Gazprom (the largest energy company in Russia) shares have rallied recently ahead of Putin’s much anticipated visit to Beijing. This visit culminated on May 23rd with the announcement that Russia had signed a $400 billion, 30-year pact to supply China with natural gas. Gazprom is the largest natural gas producer in Russia and is likely to be the largest direct beneficiary of the agreement.

India represents 7.08% of the MSCI Emerging Markets index and Gazprom represents 1.27% of the MSCI Emerging Markets index and is the sixth-largest holding in the index. As a result, these recent political developments have had a meaningful effect on the performance of emerging market investors’ portfolios and serve as a reminder that political — as well as economic — developments can drive equity market returns.

Growing Debt in China

This week’s chart of the week examines the difference in private non-financial sector debt levels as a percentage of GDP for the United States and China. Private non-financial sector includes non-financial corporations (both private-owned and public owned), households and non-profit institutions serving households. Rising debt levels are a concern to any economy, as higher debt as a percentage of GDP is a potential drag on growth.

This week’s chart of the week examines the difference in private non-financial sector debt levels as a percentage of GDP for the United States and China. Private non-financial sector includes non-financial corporations (both private-owned and public-owned), households, and non-profit institutions serving households. Rising debt levels are a concern to any economy, as higher debt as a percentage of GDP is a potential drag on growth.

In the chart above, the most striking development is that China’s debt (as a percentage of GDP) is now higher than the U.S. There are a variety of reasons for this, including deleveraging in the U.S. in the wake of the Great Recession, as well as easy credit coupled with massive infrastructure spending in China. Collectively, these trends have driven the relative debt in China higher than the U.S., which is especially worrisome for future growth prospects in China, and by extension, investments in the country. It is not surprising that investor sentiment has cooled regarding China as of late, and investors will closely watch the growing debt level in the coming years.

Lower Debt Costs in Eurozone

This week’s chart examines the improving financial conditions in the Eurozone’s peripheral countries. Italy, Spain, and Portugal have recently seen their borrowing costs reach significant lows as investors’ confidence strengthens.

This week’s chart examines the improving financial conditions in the Eurozone’s peripheral countries. Italy, Spain, and Portugal have recently seen their borrowing costs reach significant lows as investors’ confidence strengthens. Italian and Spanish 10-Year bond yields fell to 3.1% in late April, the lowest since 1999 for Italy and 2005 for Spain. After its first regular debt auction since a 2011 bailout, Portugal saw its yields drop to 3.7% marking a new post-2009 low.

More than two years removed from the European debt crisis, investor sentiment has improved as economic growth (though small) has returned to the region with participation from the peripherals. The Eurozone’s purchasing managers composite index (PMI) has been in expansion territory for nine consecutive months and hit a post-crisis high of 54 in April. While the Eurozone certainly remains in a fragile state with only a tepid level of growth, investors are encouraged by the improving conditions as well as the commitment of additional support from the European Central Bank if needed.

Good News for “Abenomics” and Japanese Wage Growth

In an attempt to revive the long struggling Japanese economy, Prime Minister Shinzo Abe implemented his “Abenomics” strategy which included an unprecedented open-ended asset purchase program. The monetary easing policy was implemented with the goal of spurring domestic spending and increasing exports via a devalued currency.

In an attempt to revive the long struggling Japanese economy, Prime Minister Shinzo Abe implemented his “Abenomics” strategy which included an unprecedented open-ended asset purchase program. The monetary easing policy was implemented with the goal of spurring domestic spending and increasing exports via a devalued currency. Equity investors reacted positively to the plan and the MSCI Japan Index returned 27.4% in 2013. With both corporate profits and business confidence rising, the initial results of “Abenomics” appear promising.

To keep things on course, Japanese companies will need to boost workers’ wages, a phenomenon that has rarely occurred for earners. This week’s chart shows the year-over-year change in wage earnings has been largely negative over the last 24 months. However in recent weeks during the annual wage negotiations (known as “shunto,” which translates to “spring offensive”) between unions and employers, several large companies, including Toyota, Honda, and Toshiba announced significant wage increases for the first time since 2008. Now economists will observe whether medium and small size companies follow suit. A rise in wages will help continue the initial positive momentum created by the monetary easing policies of “Abenomics” and could mean Japanese equities still have some upside left.

Emerging Market Debt

This paper explores EMD as an asset class, focusing on the benefits and risks. Further, EMD characteristics and their impact on portfolio dynamics are discussed. Recommendations as well as guidance toward making an allocation to the asset class are included.

Due to risks, uncertainty, and overall lack of credit quality, institutional investors have not historically included emerging market debt (“EMD”) in their portfolios. However, the investment landscaped has changed over the past few years. Driven by low interest rates and deteriorating fundamentals in the United States and other developed countries, investors’ interest in EMD has skyrocketed in recent years.

This paper explores EMD as an asset class, focusing on the benefits and risks. Further, EMD characteristics and their impact on portfolio dynamics are discussed. Recommendations, as well as guidance toward making an allocation to the asset class, are included.

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