SEPTEMBER 2013 - A Mother of a Macro Month

Mapping The 7 "Risk" Horsemen Of The Sept-ocalypse 09-04-13 Deutsche Bank via ZH

Ahead of September, historically the worst month for stocks, Deutsche Bank notes that volatility has picked up and corporate bond issuance has slowed. There are several possible risks over the next few weeks that could trigger a further escalation in market volatility...

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Via Deutsche Bank,

1. Emerging markets could become more vulnerable as the Fed tapers QE and capital outflows from EM intensify

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2. Central banks forward guidance may fail to keep rates low for an extended period

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3. US consumers could come under pressure from higher energy costs and rising mortgage rates

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4. Political deadlock amid US budget talks and the mid-October debt ceiling could rattle markets

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5. The next Fed chair will soon be nominated and the main candidates differ in style and policy. The markets may take note

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6. While Chancellor Merkel is on track for re-election on September 22, the governing coalition may change

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7. The crisis in the Middle East may escalate, impacting oil prices, inflation and growth

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But Deutsche's Base Case is that none of these risks pose a systemic threat...

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and yields will 'normalize' higher gradually...

Or so they hope...

Source: Deutsche Bank

SEPTEMBER 2013 - A Mother Month

"Explosive" September Straight Ahead 09-02-13 Zero Hedge

If you thought August had more than enough events to crush the best laid vacation plans of Wall Streeters and men, you ain't seen nothing yet. Presenting "explosive" September.

Here is a compendium recap, courtesy of Bloomberg, of the key events that may shake global markets in the next 30 days:

Global event risks this month including

1. Fed tapering,
2. Berlusconi debate and German elections may favor turning neutral on core govt bonds from short positions, analysts say. UBS says turn underweight govt bonds as Fed taper will lead to higher rates.
3. Other events to keep an eye on are the unresolved Syrian situation,
4. a potential announcement of Bernanke's successor,
5. the budget/debt ceiling impasse which likely will remain a non-issue until the last minute in October,
6. ongoing emerging market tremors.

• Sept. 5: BoE, ECB announce monetary policy decisions
• Sept. 6: U.S. Aug. change in nonfarm payrolls
• Sept. 9: Italy Senate committee to start debate on Berlusconi’s expulsion after his tax-fraud conviction
• Sept. 13: Euro-area finance ministers meet
• Sept. 16: Portugal EU/IMF aid review mission starts
• Sept. 18: FOMC meeting with rate decision and economic projections being released
• Sept. 22: Germany holds federal elections
• Sept. 29: Portugal holds municipal elections

Natixis

• “Explosive” agenda in coming weeks favors core debt * Focus trades on 4/5Y sector of curves; German 5/10 steepener at 104bps attractive
• See value in Belgian and Finnish 2/5 flatteners
• Political risks and upward revision of issuance in Italy will continue to weigh on BTPs
• Spanish debt may outperform Italy especially at short-end
• Hold positive bias on Ireland in Sept. as may see positive Troika review and GDP figure

Goldman Sachs

• Sept. risks back duration-neutral pose; favor Europe spreads
• Stay long 10Y BTPs vs OATs into Italian senate hearings on Berlusconi; looks to reassess trade after Italy budget plans in late Sept.
• Doesn’t expect outcome of German elections to lead to significant change in govt’s response to euro crisis

Credit Suisse

• Selloff in 10Y bunds has been aggressive; September event risks favor neutral Euro duration positioning from short initiated at start of August
• Sept. risks include Italy vote on Berlusconi, FOMC meeting and German elections
• Look to sell bunds if rally seen toward 1.7% yield level; expect yield range of 1.7%/2% to be sustained until year-end

Societe Generale

• Neutral duration for now; stay bearish into year-end as geopolitical tensions battle with U.S. data and Fed tapering
• Rising oil prices, falling equities and further U.S. fiscal talks may hurt sentiment
• Nascent euro-area recovery favors 1Y/1Y vs 1Y Eonia flatteners; scale back country spread compression trades

Barclays

• Heavy issuance and packed political agenda may result in widening of EGB spreads
• Look to go long Spain vs Italy using SPGB supply concession this week as entry opportunity
• Lift bund yield forecasts to 2.1% for 10Y sector at end 2013
• Higher German yield environment may still see rise in peripheral yields, with spreads narrowing
• Higher German yield environment may still see rise in peripheral yields, with spreads narrowing

UBS

• Turn underweight govt bonds from neutral position held over summer, as tapering will push rates higher
• Negative on Treasuries, bunds, gilts and JGBs; overweight high yield and underweight investment-grade

A summary calendar via RanSquawk:

And as a reminder, from Bespoke...

CANARIES - Mauldin a Cassandra

How Do I Hate Thee? Let Me Count the Ways…

The market is down about 3½% since early August, with trading rooms short-staffed the last few weeks. Will the senior traders come back from vacation rested and looking for value? Or will they survey the gains they have banked so far this year and decide to lock them in to assure their year-end bonuses? Finding value these days is tough. It won’t be hard for them to find reasons to head for the sidelines.

1. There is a reason tapering is on everybody’s radar screen. When the Fed ended its last two rounds of quantitative easing, the resulting sell-off was not pretty. Some think that happened because the Fed was not really providing “juice” to the market. There is an element of truth to that analysis, but I think a more fundamental reason has to do with sentiment. Fighting the Fed is very difficult. Or it might be more apt to say, fighting the narrative of the Fed that produces positive sentiment is very difficult. I remember more than a few commentators coming on CNBC in January of 2001, when Greenspan lowered interest rates by 1% in the span of 30 days, and telling us “Don’t fight the Fed! You have to go long the stock market today!”

I was writing at the time that there was a recession coming, so I was saying pretty much the opposite. Perhaps the more appropriate lesson is to not fight the Fed unless there is a recession coming.

Here is a graph from a webinar (see below) that I will be doing in a few days. The last two times the Fed has ended a period of quantitative easing, the air has come out of the market balloon. Has this coming move been so telegraphed that the reaction will be different than in the past, or will we see the same result? Want to bet your bonus on it? Or your retirement?

2. Global growth is in a funk (that’s a technical economic term), and this market just doesn’t seem to care. One of the first market aphorisms I learned was that copper is the metal with a PhD in economics. While you can get into a great deal of trouble regarding that as a short-term trading axiom, it is definitely a longer-term truth. Copper is a metal that is closely associated with construction, industrial development and production, and consumer spending. One can argue that the price of copper is falling today because of a fundamental increase in supply, but for those of us of a certain age, the following chart is nervous-making. Unless the long-term correlation has disappeared, the data would indicate that either the price of copper needs to rise or the market is likely to fall.

3. There is a full-blown crisis developing in the emerging markets that has more than one serious commentator thinking of 1998. On Thursday, the lead article in the business section of USA Today asked “Are we poised for a repeat of 1998 — or worse?” Yet as I highlighted in last week’s Outside the Box, the US Federal Reserve has very clearly said that problems in the emerging markets are not the concern of US policy. One of my favorite thinkers, Ambrose Evans-Pritchard over at the London Telegraph, wrote this on Wednesday:

This has the makings of a grave policy error: a repeat of the dramatic events in the autumn of 1998 at best; a full-blown debacle and a slide into a second leg of the Long Slump at worst.

Emerging markets are now big enough to drag down the global economy. As Indonesia, India, Ukraine, Brazil, Turkey, Venezuela, South Africa, Russia, Thailand and Kazakhstan try to shore up their currencies, the effect is ricocheting back into the advanced world in higher borrowing costs. Even China felt compelled to sell $20bn of US Treasuries in July.

Back in 1998 the developed world was twice as big as the developing world. Today that ratio is about even. We all know what a crisis for the markets 1998 was. And now, more than a few emerging markets have clear debt problems denominated in currencies other than their own.

Evans-Pritchard goes on to say:

Yet all we heard from Jackson Hole this time were dismissive comments that the emerging market rout is not the Fed’s problem. “Other countries simply have to take that as a reality and adjust to us,” said Dennis Lockhart, the Atlanta Fed chief. Terrence Checki from the New York Fed said “there is no master stroke that will insulate countries from financial spillovers”.

The price of oil in Indian rupees has gone from 1100 to 7800 in the space of 10 years. Think about what a move like that would do to the US economy. (Chart courtesy of Dennis Gartman)

The next chart shows the recent price spike in the Chinese SHIBOR (their short-term interbank rate, more or less equivalent to LIBOR). It is difficult to trust any of the economic data (positive or negative) coming out of China, so we really do not know whether China’s growth story is simply moderating or whether we are seeing a hard landing in progress; but the sudden shock in interbank lending rates is an important sign that all is not well in the Middle Kingdom. The big question: is the recent SHIBOR spike a harbinger of a banking crisis, or does it presage an RMB devaluation? Interbank rates do not spike from 3% to 13% (in about 2.5 weeks) in a healthy economy, and a big event along these lines in China would have enormous implications for global growth.

And while we are on the subject of emerging markets, I have to give you the lead paragraph of the latest note from my good friend and uber-bear Albert Edwards of Societe Generale. It is just too delicious.

The emerging markets “story” has once again been exposed as a pyramid of piffle. The EM edifice has come crashing down as their underlying balance of payments weaknesses have been exposed first by the yen’s slide and then by the threat of Fed tightening. China has flip-flopped from berating Bernanke for too much QE in 2010 to warning about the negative impact of tapering on emerging markets! It is a mystery to me why anyone, apart from the activists that seem to inhabit Western central banks, thinks QE could be the solution to the problems of the global economy. But in temporarily papering over the cracks, they have allowed those cracks to become immeasurably deep crevasses. At the risk of being called a crackpot again, I repeat my forecast of

• 450 for the S&P,
• sub-1% US 10 year yields and
• gold above 10,000.

4. I have highlighted at length in recent letters (here and here), the significant rise in valuations in this latest stock market rally, which explains a significant portion of the run-up. Here is another chart, which shows that the rise in prices is not being accompanied by a rise in corporate earnings. This situation just screams for a correction. Either corporate earnings have to rise above their already rather significant margins (at least in terms of overall profits to GDP), or the market needs to reflect the lack of earnings growth. That can happen by the market’s either going sideways for a long period of time or dropping in price. Choose your frustration wisely.

5. The Fed is telling us they’re going to begin to reduce their purchases of bonds and mortgages. Three academic papers at Jackson Hole, plus the paper that I showed you a couple weeks ago from the San Francisco Federal Reserve, all suggest that QE has not been as helpful as was originally hoped. However, many other respected academics and the market itself disagree. If you are in the latter camp (and believe that QE has given a significant boost to the economy and not just the stock market), you should be very nervous.

The table below shows the revision of second-quarter GDP released Thursday. We should all be happy that growth was revised upward by 85 basis points — 2.5% annualized growth is about as good as we could expect. In fact, this result would argue that tapering should begin sooner rather than later and should proceed faster than most market observers expect. If the economy has recovered that much, it is time to take the foot off the gas pedal.

The problem I want to point out is highlighted in bold, and that is the implicit inflation deflator used by the Fed. Notice that it did not move at all with the revision, even though the economy was seen to grow almost 50% faster. That’s a tad unusual though certainly within the realm of possibility. But if after the massive quantitative easing we have seen, all you can get is 0.7% inflation, that simply illustrates one of my main contentions: we are in an overall deflationary environment. What happens if you then suck the juice from the markets? Will we see a further fall in inflation?

Q2  Advance (7/31)             Q2 Revision (8/29)

Real GDP                   1.67%                          2.52%

Nominal GDP             2.39%                          3.25%

Deflator                      0.71%                         0.71%

Just for fun, the next table gives us the numbers on CPI inflation for the last eight years. Notice that the number moves around a lot.

The Fed prefers to use Personal Consumer Expenditures (PCE) as its measure of inflation. For the last 12 months, inflation has been only 1.2% as measured by PCE. Even if you use core CPI, inflation is still rather tame.

Couple tame inflation with the velocity of money’s continuing to fall and you get a deflationary environment. What will happen when the Fed removes QE?

6. Given the rise in interest rates of 30-year bonds, real interest rates (interest rates minus inflation) have increased to 2.6% if we use CPE. The long-term average for real interest rates is 2%, which suggests that rates need to come back down, or inflation should rise. You make the call as to which will happen when the Fed begins to reduce QE. This development suggests a rotation back into bonds, which is again another reason not to be thrilled with the equity markets.

7. And this is not something I can talk about in specifics, but I follow a number of money managers who use various systems to manage risk. The number of managers who have raised the cash portion of their portfolios to very high levels is significant. These are managers with long-term systematic models designed to keep their emotions out of investment decision-making. Talking with them, they all wish they could raise even more cash.

The Silver Lining

Yesterday after the markets closed I was invited to a local watering hole here in Dallas to meet with some younger but generally successful hedge fund managers (although younger for me is becoming a relative term). They were all interested in the macro environment, and they were all nervous. What interested me most, though, was not what they wanted to sell; it was what they wanted to buy. They were starting to find value in Saudi Arabia and Turkey and India and Indonesia — stocks of serious companies in those countries had fallen to very low levels. Some were getting on planes to go check things out. And here and there some of the longer-term investors were teasing out opportunities in the US market. For these young Turks, market corrections were not a problem but simply an opportunity to find value.

And I picked up one other key thought from them. You would think, given their view of the world (which I generally share), that they were short a great deal of their book. That is not the case. Today’s environment is a very, very difficult short, because the carry costs are so high. (Definition: Costs incurred as a result of an investment position. These costs can include financial costs, such as the interest costs on bonds, interest expenses on margin accounts, interest on loans used to purchase a security, and economic costs, such as the opportunity costs associated with taking the initial position.)

The Fed has distorted the interest-rate environments both in the US and internationally, and it is simply too costly to put on a short position for very long and be wrong. If you short something, you need to be right fairly quickly, or you will watch your portfolio begin to bleed. For young managers, their track record is critical, so they become quite sensitive to making longer-term macro calls that can go against them for a period of time. They have even more ways to hate the market than I do.

Investing in a Market to Hate

In my August 3rd newsletter (“Can It Get Any Better Than This?“) I shared research supporting our forward-looking prospects for the markets. There was no way to sugar-coat our conclusions:  if history is any indication, we are looking at the potential for a significant peak-to-trough drawdown and negative annual returns in equity markets for an extended period of time. We pointed out that where there is danger, there is also opportunity. Investors have a lot to gain from diversifying as broadly as possible and reducing their

ASIAN CRISIS II - "TAPER" Shock Waves Across Asia

Are Emerging Markets Submerging? 09-02-13 Prof Kenneth Rogoff, Project Syndicate

• “echo crisis” in emerging markets already upon us
• the combined effect of decelerating long-term growth in China and a potential end to ultra-easy monetary policies in advanced countries is exposing significant fragilities.
• Has the eurozone crisis finally taught the IMF that public and private debt overhangs are significant impediments to growth, and that it should place much greater emphasis on debt write-downs and restructuring than it has in the past?
• The market has been particularly brutal to countries that need to finance significant ongoing current-account deficits, such as Brazil, India, South Africa, and Indonesia.
• Fortunately, a combination of:
  • flexible exchange rates,
  • strong international reserves,
  • better monetary regimes, and
  • a shift away from foreign-currency debt provides some measure of protection.
• years of political paralysis and postponed structural reforms have created vulnerabilities
• Equity and bond markets in the developing world remain relatively illiquid, even after the long boom. Thus, even modest portfolio shifts can still lead to big price swings
• a narrowing of growth differentials has made emerging markets a bit less of a no-brainer for investors, and this is naturally producing sizable effects on these countries’ asset prices.

A Bumpy Ride for Emerging Markets 08-31-13 Lauara Tyson, Project Syndicate

• Are we witnessing the collapse of yet another economic bubble, as many analysts are claiming?

CAPITAL FLOW DETERMINANTS: According to economic theory, the major determinants of capital flows to emerging-market economies are:

1. real growth-rate differentials,
2. interest-rate differentials, and
3. global risk aversion.

 

• REAL GROWTH-RATE DIFFERENTIALS: India’s growth rate has plunged as a result of faltering economic reforms and unsustainable budgetary choices: it now has record-high fiscal and current-account deficits. And political unrest has marred growth prospects in Turkey, Brazil, and South Africa.
• GLOBAL RISK AVERSION: global risk aversion has spiked in response to Fed Chairman Ben Bernanke’s announcement of plans to “taper” QE. As the 2008 and 2011 experiences demonstrate, heightened risk aversion among global investors reduces capital flows to emerging markets, even when they are not the source of risk.
• INTEREST RATE DIFFERENTIALS:Finally, the interest-rate environment has changed. Despite repeated assertions by Fed officials that they are committed to near-zero short-term interest rates for the foreseeable future, hints of QE tapering have caused yields on ten-year US Treasury bonds to rise by 100 basis points from this year’s lows. Higher long-term interest rates in the US (and expectations of further hikes) are eating into the interest-rate differentials that attracted yield-hungry investors to emerging markets from 2009 to 2012.

BETTER PREPARED: Many emerging economies are better prepared to weather the storm now than they were then:

• Their exchange rates are now flexible,
• They have built large foreign-currency reserves, and
• They have limited their foreign-currency debt.
• Moreover, their macroeconomic fundamentals are sound, and
• They have used macro- and micro-prudential tools to contain surges in capital inflows and minimize their destabilizing effects on asset prices and credit conditions.

AT RISK: Some countries are at risk, especially those with

• large current-account deficits,
• large foreign capital inflows relative to the size of their financial markets, and
• low foreign-exchange reserves.

FRAGILE FIVE: Among the most vulnerable are Turkey, South Africa, Brazil, India, and Indonesia – a group that Morgan Stanley researchers have dubbed the “Fragile Five.”

• Over the long term, owing to increasing populations, expanding middle classes, and rapid productivity gains, emerging-market economies that pursue sound policies will continue to grow much faster than developed economies.

Emerging-Market Party 08-30-13 Ricardo Hausmann, Project Syndicate

• Between 2003 and 2011, GDP in current prices grew by a cumulative 35% in the United States, and by 32%, 36%, and 49% in Great Britain, Japan, and Germany, respectively, all measured in US dollars. In the same period, nominal GDP soared by 348% in Brazil, 346% in China, 331% in Russia, and 203% in India, also in US dollars.
• And it was not just these so-called BRIC countries that boomed. Kazakhstan’s output expanded by more than 500%, while Indonesia, Nigeria, Ethiopia, Rwanda, Ukraine, Chile, Colombia, Romania, and Vietnam grew by more than 200% each. This means that average sales, measured in US dollars, by supermarkets, beverage companies, department stores, telecoms, computer shops, and Chinese motorcycle vendors grew at comparable rates in these countries. It makes sense for companies to move to where dollar sales are booming, and for asset managers to put money where GDP growth measured in dollars is fastest.
• One might be inclined to interpret this amazing emerging-market performance as a consequence of the growth in the amount of real stuff that these economies produced. But that would be mostly wrong. Consider Brazil. Only 11% of its China-beating nominal GDP growth between 2003 and 2011 was due to growth in real (inflation-adjusted) output. The other 89% resulted from 222% growth in dollar prices in that period, as local-currency prices rose faster than prices in the US and the exchange rate appreciated.
• Some of the prices that increased were those of commodities that Brazil exports. This was reflected in a 40% gain in the country’s terms of trade (the price of exports relative to imports), which meant that the same export volumes translated into more dollars.
• Russia went through a somewhat similar experience. Real output growth explains only 12.5% of the increase in the US dollar value of nominal GDP in 2003-2011, with the rest attributable to the rise in oil prices, which improved Russia’s terms of trade by 125%, and to a 56% real appreciation of the ruble against the dollar.
• By contrast, China’s real growth was three times that of Brazil and Russia, but its terms of trade actually deteriorated by 26%, because its manufactured exports became cheaper while its commodity imports became more expensive. The share of real growth in the main emerging countries’ nominal US dollar GDP growth was 20%.

The three phenomena that boost nominal GDP – increases in real output, a rise in the relative price of exports, and real exchange-rate appreciation – do not operate independently of one another.

Countries that grow faster tend to experience real exchange-rate appreciation, a phenomenon known as the Balassa-Samuelson effect. Countries whose terms of trade improve also tend to grow faster and undergo real exchange-rate appreciation as domestic spending of their increased export earnings expands the economy and makes dollars relatively more abundant (and thus cheaper).

Real exchange rates may also appreciate because of increases in capital inflows, which reflect foreign investors’ enthusiasm for the prospects of the country in question. For example, from 2003 to 2011, Turkey’s inflows increased by almost 8% of GDP, which partly explains the 70% increase in prices measured in dollars. Real appreciation could also be caused by inconsistent macroeconomic policies that put the country in a perilous position, as in Argentina and Venezuela.

Distinguishing between these disparate and inter-related phenomena is important, because some are clearly unsustainable. In general, terms-of-trade improvements and capital inflows do not continue permanently: they either stabilize or eventually reverse direction.

Indeed, terms of trade do not have much of a long-term trend and show very pronounced reversion to the mean. While prices of oil, metals, and food rose very significantly after 2003, reaching historic highs sometime between 2008 and 2011, nobody expects similar price increases in the future. The debate is whether prices will remain more or less where they are or decline, as food, metals, and coal prices have already done.

The same can be said of capital inflows and the upward pressure that they place on the real exchange rate. After all, foreign investors are putting their money in the country because they expect to be able to take even more money out in the future; when this occurs, growth tends to slow, if not collapse, as happened in Spain, Portugal, Greece, and Ireland.

In some countries, such as China, Thailand, South Korea, and Vietnam, nominal GDP growth was driven to a large extent by real growth. Moreover, according to the soon-to-be-published Atlas of Economic Complexity, these economies began producing more complex products, a harbinger of sustainable growth. Angola, Ethiopia, Ghana, and Nigeria also had very significant real growth, but nominal GDP was boosted by very large terms-of-trade effects and real appreciation.

For most emerging-market countries, however, nominal GDP growth in the 2003-2011 period was caused by terms-of-trade improvements, capital inflows, and real appreciation. These mean-reverting processes are, well, reverting, implying that the buoyant performance of the recent past is unlikely to return any time soon.

In most countries, the US dollar value of GDP growth handsomely exceeded what would be expected from real growth and a reasonable allowance for the accompanying Balassa-Samuelson effect. The same dynamics that inflated the dollar value of GDP growth in the good years for these countries will now work in the opposite direction: stable or lower export prices will reduce real growth and cause their currencies to stop appreciating or even weaken in real terms. No wonder the party is over.

During the last few years, a lot of hype has been heaped on the BRICS (Brazil, Russia, India, China, and South Africa). With their large populations and rapid growth, these countries, so the argument goes, will soon become some of the largest economies in the world – and, in the case of China, the largest of all by as early as 2020. But the BRICS, as well as many other emerging-market economies – have recently experienced a sharp economic slowdown. So, is the honeymoon over?

Trouble in Emerging-Market Paradise 07-22-13 Nouriel Roubini, Project Syndicate

Brazil’s GDP grew by only 1% last year, and may not grow by more than 2% this year, with its potential growth barely above 3%. Russia’s economy may grow by barely 2% this year, with potential growth also at around 3%, despite oil prices being around $100 a barrel. India had a couple of years of strong growth recently (11.2% in 2010 and 7.7% in 2011) but slowed to 4% in 2012. China’s economy grew by 10% per year for the last three decades, but slowed to 7.8% last year and risks a hard landing. And South Africa grew by only 2.5% last year and may not grow faster than 2% this year.

Many other previously fast-growing emerging-market economies – for example, Turkey, Argentina, Poland, Hungary, and many in Central and Eastern Europe – are experiencing a similar slowdown. So, what is ailing the BRICS and other emerging markets?

OVERHEATING: First, most emerging-market economies were overheating in 2010-2011, with growth above potential and inflation rising and exceeding targets. Many of them thus tightened monetary policy in 2011, with consequences for growth in 2012 that have carried over into this year.

COUPLED ECONOMIES : Second, the idea that emerging-market economies could fully decouple from economic weakness in advanced economies was far-fetched: recession in the eurozone, near-recession in the United Kingdom and Japan in 2011-2012, and slow economic growth in the United States were always likely to affect emerging-market performance negatively – via trade, financial links, and investor confidence. For example, the ongoing eurozone downturn has hurt Turkey and emerging-market economies in Central and Eastern Europe, owing to trade links.

STATE CAPITALISM: Third, most BRICS and a few other emerging markets have moved toward a variant of state capitalism. This implies a slowdown in reforms that increase the private sector’s productivity and economic share, together with a greater economic role for state-owned enterprises (and for state-owned banks in the allocation of credit and savings), as well as resource nationalism, trade protectionism, import-substitution industrialization policies, and imposition of capital controls.

This approach may have worked at earlier stages of development and when the global financial crisis caused private spending to fall; but it is now distorting economic activity and depressing potential growth. Indeed, China’s slowdown reflects an economic model that is, as former Premier Wen Jiabao put it, “unstable, unbalanced, uncoordinated, and unsustainable,” and that now is adversely affecting growth in emerging Asia and in commodity-exporting emerging markets from Asia to Latin America and Africa. The risk that China will experience a hard landing in the next two years may further hurt many emerging economies.

COMMODITY SUPER-CYCLE: Fourth, the commodity super-cycle that helped Brazil, Russia, South Africa, and many other commodity-exporting emerging markets may be over. Indeed, a boom would be difficult to sustain, given China’s slowdown, higher investment in energy-saving technologies, less emphasis on capital- and resource-oriented growth models around the world, and the delayed increase in supply that high prices induced.

"TAPER":The fifth, and most recent, factor is the US Federal Reserve’s signals that it might end its policy of quantitative easing earlier than expected, and its hints of an eventual exit from zero interest rates, both of which have caused turbulence in emerging economies’ financial markets. Even before the Fed’s signals, emerging-market equities and commodities had underperformed this year, owing to China’s slowdown. Since then, emerging-market currencies and fixed-income securities (government and corporate bonds) have taken a hit. The era of cheap or zero-interest money that led to a wall of liquidity chasing high yields and assets – equities, bonds, currencies, and commodities – in emerging markets is drawing to a close.

CURRENT ACCOUNTS: Finally, while many emerging-market economies tend to run current-account surpluses, a growing number of them – including Turkey, South Africa, Brazil, and India – are running deficits. And these deficits are now being financed in riskier ways: more debt than equity; more short-term debt than long-term debt; more foreign-currency debt than local-currency debt; and more financing from fickle cross-border interbank flows.

These countries share other weaknesses as well: excessive fiscal deficits, above-target inflation, and stability risk (reflected not only in the recent political turmoil in Brazil and Turkey, but also in South Africa’s labor strife and India’s political and electoral uncertainties). The need to finance the external deficit and to avoid excessive depreciation (and even higher inflation) calls for raising policy rates or keeping them on hold at high levels. But monetary tightening would weaken already-slow growth. Thus, emerging economies with large twin deficits and other macroeconomic fragilities may experience further downward pressure on their financial markets and growth rates.

These factors explain why growth in most BRICS and many other emerging markets has slowed sharply. Some factors are cyclical, but others – state capitalism, the risk of a hard landing in China, the end of the commodity super-cycle – are more structural. Thus, many emerging markets’ growth rates in the next decade may be lower than in the last – as may the outsize returns that investors realized from these economies’ financial assets (currencies, equities, bonds, and commodities).

Of course, some of the better-managed emerging-market economies will continue to experience rapid growth and asset outperformance. But many of the BRICS, along with some other emerging economies, may hit a thick wall, with growth and financial markets taking a serious beating

The Global Implications of Falling Commodity Prices José Antonio Ocampo, former United Nations Under-Secretary-General, Project Syndicate

The decade-long commodity-price boom has come to an end, with serious implications for global GDP growth. And, although economic patterns do not reproduce themselves exactly, the end of the upward phase of the commodity super-cycle that the world has experienced since the early 2000’s dims developing countries’ prospects for continued rapid catch-up to advanced-country income levels.

Over the year ending in July, The Economist’s commodity-price index fell by 16.5% in dollar terms (22.4% in euros) with metal prices falling for more than two years since peaking in early 2011. While food prices initially showed greater resilience, they have fallen more sharply than those of other commodities over the past year. Only oil prices remain high (though volatile), no doubt influenced by the complex political events in the Middle East.

In historical terms, this is not surprising, as our research into commodity super-cycles shows. Since the late nineteenth century, commodity prices have undergone three long-term cycles and the upward phase of a fourth, driven primarily by changes in global demand. The first two cycles were relatively long (almost four decades), but the third was shorter (28 years).

The upward phases of all four super-cycles were led by major increases in demand, each from a different source. During the current cycle, China’s rapid economic growth provided this impetus, exemplified by the country’s rising share of global metals consumption.

While these cycles reached similar peaks, the downswings’ intensity has varied according to global economic growth. The downswings following World War I and in the 1980’s and 1990’s were strong; in contrast, the dip after the Korean War, when the world economy was booming, was relatively weak. After World War II, the super-cycles of different commodity groups became more closely synchronized (including oil, which had previously shown a different pattern).

Just as China’s economic boom drove commodity-price growth in the current cycle, so the recent weakening of prices has largely been a result of its decelerating GDP growth, from double-digit annual rates in 2003-2007, and again in 2010, to roughly 7.5% this year. While projections of China’s future growth vary, all predict weaker economic performance in the short term – and even lower growth rates in the long term.

The fundamental short-term issue is the limited policy space to repeat the massive economic stimulus adopted after the collapse of Lehman Brothers in 2008. China’s investment-led strategy to counter the crisis left a legacy of debt, and the continued deterioration of the demand structure – now characterized by an extremely high share of investment (close to half of GDP) and a low share of private consumption (about 35%) – further constrains policymakers’ options.

There is a consensus that these abnormal demand patterns must change in the long term, as China moves to a consumption-led growth model. But, to accomplish this transition, China’s leaders must implement deep and comprehensive structural reforms that reverse a policy approach that continues to encourage investment and exports while explicitly and implicitly taxing consumption.

The uncertainty surrounding China’s impending economic transformation muddies the growth outlook somewhat. Some forecasters predict a soft landing, but differ on the growth rate. Official estimates put annual GDP growth at 6.5% in 2018-2022, while Peking University’s Michael Pettis, for example, regards 3-4% growth as consistent with continuous rapid consumption growth and the targeted increase in consumption’s share of GDP.

While hard-landing scenarios, associated with a potential debt crisis, are also possible, the authorities have enough policy space to manage them. In any case, downside risks are high, and room on the upside is essentially non-existent.

The main engine of the post-crisis global economy is therefore slowing, which has serious implications for one of the last decade’s most positive economic trends: the convergence of developed and developing countries’ per capita income levels. Just as China’s economic boom benefited commodity-dependent economies, primarily in the developing world, its slowdown is reflected in these economies’ declining growth rates. (In fact, while several South American countries have been among the hardest hit, even developed countries like Australia have not been immune.)

If weak global demand causes the current commodity super-cycle’s downswing to be as sharp as those of the post-1918 period and the late twentieth century, the world should be prepared for sluggish economic growth and a significant slowdown – or even the end – of income convergence worldwide