FOMC Recap: Ready Steady Go
February 01, 2007
By David Greenlaw | New York
The outcome of the FOMC meeting was pretty much as expected. The Fed left the funds rate target at 5.25% and retained a tightening bias. The language in the official statement was tweaked to reference the recent signs of firmer economic growth along with some “tentative” signs of stabilization in housing and an improvement in core inflation. There were no dissents (Richmond’s Lacker is no longer a voting member). Bond and stock markets rallied on the news.
From our standpoint, the changes in the wording of the statement merely reinforce the stable outlook for Fed policy. The recent improvement in the near-term growth outlook has taken a Fed ease anytime in the foreseeable future completely off the table. However, at the same time, it’s hard to see how the Fed could move into tightening mode as long as core inflation is drifting lower. At this point, we see the Fed on hold for quite a while and believe that the direction of the next change in monetary policy is very close to a toss-up. What factors will determine the future course of Fed policy? If core inflation continues to drift lower, it is conceivable that the Fed could ease — even if the economy is growing near trend. A further deceleration in core inflation is possible, given the recent indications of some cooling in the pace of increase in shelter costs. Shelter accounts for more than 40% of core inflation and, with some of the inventory of unsold new homes making its way onto the rental market, vacancy rates for rental properties have started to rise. There is a reasonably strong correlation between rental vacancies and shelter costs, reflecting the heavy influence of the rental market on the so-called owners’ equivalent rent measure that is included in the core inflation gauges. However, it could take a year or more for core inflation to come down enough to allow the Fed to ease. At the same time, labor markets are tight and cost pressures continue to build. If this trend continues, we could ultimately see a pick-up in core inflation. However, it’s unclear if the elevation in labor costs will be powerful enough to offset the potential downside tied to the shelter category. Most importantly, it’s likely to take a considerable amount of time before it becomes clear if either of these factors will meaningfully outweigh the other. So, absent an unforeseen shock to the economy, it appears that the Fed will be on hold for at least the next few quarters. Finally, we know that the FOMC had planned to discuss possible changes to its communication strategy at this meeting. Apparently, one item on the table involved more frequent release of the Fed’s own economic forecast. However, there was no official announcement of any changes along these lines in the statement that was released today. If a decision regarding any new communication policy was reached, we may hear about it at the upcoming Humphrey-Hawkins testimony.
Important Disclosure Information at the end of this Forum
The Downside of Being Attractive
February 01, 2007
By Serhan Cevik | London
Economic normalization is a secular trend, but being a carry-trade magnet is still risky. Conventional valuation models suggest that the Turkish lira has been overvalued in recent years, but these metrics fail to capture structural turning points and the appreciation of the equilibrium exchange rate. In our view, fundamental improvements in economic performance justify the so-called ‘misalignment’ of the lira. Productivity-driven growth — surging to an annual rate of 7.5% in the past five years — and disinflation from an average of 77.5% in the 1990s to the single-digit territory are enough to bring appreciation. But that is just a part of the story and does not fully reflect the extent of the continuing correction. Since the mother of all problems in the Turkish economy had been fiscal imbalances, fiscal consolidation is the key factor in removing distortions and revaluing asset prices. The latest figures show that the budget deficit already narrowed from 16.5% of GDP in 2001 to 0.7% last year. Moreover, the public sector borrowing requirement — a better measure of fiscal stance — moved from 17.5% of GDP to a surplus of 3.2% in the same period, making the Treasury a net debt payer for the first time. As a result, Turkey’s net public sector debt/GDP ratio declined from the peak of 90.5% in 2001 to 46.5% by the end of 2006, driving the real interest rate from an average of 28.5% in 2002 to 9.2% in 2005 and 7.9% last April. And this is exactly where managing normalization gets tricky. The real interest rate may have come down to the lowest level, but the structural shift of the yield curve and interest rate differentials vis-à-vis other countries keep attracting more capital flows, especially in a low yield-low volatility environment. The unprecedented wave of capital inflows may lead to exaggerated currency movements. In the last five years, Turkey received US$110.5 billion in net capital inflows and the central bank increased its currency reserves from US$18.8 billion to US$60.9 billion. Even though the composition of external financing has improved, with the share of foreign direct investment and long-term loans covering more than 70% of the current account deficit, the absolute size of liquidity-driven portfolio flows remain huge. Foreign investors now hold 69% of free float in the equity market and 32.5% of non-bank holdings of domestic government securities. Turkey’s improving economic prospects certainly set the stage for this unprecedented wave of capital inflows, but the behavior of international investors has also been shaped by ‘push’ factors — global liquidity, financial innovation and low volatility. With record-low funding costs and easier access to capital, a growing number of investors have started pursuing speculative strategies to generate ‘excess’ return in a world of ‘excess’ liquidity (see Carried Away, September 27, 2006). Of course, coupled with de-dollarization of residents’ financial portfolios, these leveraged carry trades exploiting interest rate differentials have altered the supply/demand balance for currencies and become the most important determinant of short-run exchange rate movements. The unwinding of carry trades can increase volatility in financial markets. Official statistics do not reveal the true magnitude of carry trades in Turkey’s financial system, but we can still come up with a rough estimate based on non-residents’ holdings of domestic government debt instruments and foreign exchange-funded interest rate swaps. Foreign investors increased their exposure to domestic government debt from US$6.1 billion (or 11.5% of non-bank holdings) at the end of 2003 to US$22.5 billion (or 26.2%) last March. In the meantime, the issuance of foreign exchange-funded swaps soared from nothing to about US$10 billion. But the sudden re-pricing of risk last spring lowered the value of non-resident holdings of domestic government bonds to US$14.5 billion (or 20.7%), weakening the lira and pushing interest rates higher, even though there was no decline in the amount of outstanding swaps. Since then, however, thanks to higher risk appetite, foreign investors have accumulated more lira-denominated bonds, and now account for 32.5% of non-bank holdings. The Turkish economy may still be facing the risk of volatility bursts — triggered by occasional shifts in global portfolio allocations — but it has become far more resilient, and the current liquidity structure of domestic money markets should limit the potential for weakness in the lira, in our view.
Important Disclosure Information at the end of this Forum
Brilliant, Mr. Abe, Brilliant!
February 01, 2007
By Robert Alan Feldman | Tokyo
Introduction Political commentary on PM Abe has been unrelentingly negative. Indeed, there seems to be a bandwagon effect, as more and more pundits jump in to criticize. Unseen by these pundits, however, is a revolutionary change in the process of government. Policy competition within the government is emerging and seems to be a permanent feature of governance. Prior to PM Koizumi’s tenure, policy areas were typically monopolies. One ministry had control of the agenda for a given area. By gentlemen’s’ agreement, other ministries did not move beyond their jurisdictions. With PM Koizumi, cross-ministry cooperation because essential to implement reforms. By clever use of the Council of Economic and Fiscal Policy (CEFP), PM Koizumi was able to knock heads and force change. The decision to slash the size of the government financial institutions was a good example. At a meeting of the CEFP, two ministers opposed the plan, and PM Koizumi literally pounded the table to demand cooperation. However, the scope of top-down competition between the PM’s ideas and the ministries was narrow, and implementation was ad hoc. PM Koizumi focused the use of the method to a few key issues (e.g., financial system revival, road reform, Postal Reform). Under PM Abe, competition between the PM’s Office and the bureaucracies has become the standard. Now, from the very start, PM Abe has formed special committees of non-government experts to deal with a broad range of issues. Examples areas include labor policy, agricultural policy, education policy, innovation policy, and — most interestingly — financial sector reform policy.[1] Action in the latter area has accelerated sharply over the last few days, and points to what we can expect in other areas. Abe makes the first move In the debate on financial regulatory reform, PM Abe made the first move. As the issue of Japan’s competitiveness emerged, he formed the ‘Experts Committee on Globalization Reforms’ under the CEFP, and headed by Prof. Takatoshi Ito, a member of the CEFP. The committee has eight members, a very manageable size. At the first meeting (on December 28, when most of the country was already on vacation for the new year’s holiday), the committee decided to focus discussions on two topics — agricultural reform and financial sector competitiveness. The minutes of the first meeting show aggressive reform statements in both areas by committee members.[2] On the financial system, members mentioned a large number of areas of concern, including the regulatory system, access to talented personnel, inadequate English language ability, lack of global accounting standards, tax problems, risk control system, poor incentives for risk taking, etc. The FSA fights back The financial regulatory authority could not let this challenge go unanswered, for two reasons. First, its jurisdiction is being challenged. Second, it risked losing control of the financial reform agenda if it ceded the initiative to the CEFP. The FSA decided to form its own experts committee, which had its first meeting this week. This committee is led by Prof. Kazuhito Ikeo of Keio University, a highly regarded expert on the financial system, and includes 25 others from academia, financial institutions, industrial corporations, the legal profession, thinks tanks, auditors and even hedge funds. The minutes of the first meeting have yet to be published, but the materials presented at the meeting show sufficient reason for action. For example, latest data show that there were 53 firms from Asia-Pacific listed on the NYSE, and 41 listed on the LSE. On the TSE, there are three. The public debate heats up Now that both committees exist, they will have to compete in the public eye. Both will release materials and minutes, so that investors and the public can follow the debate closely. Moreover, since PM Abe’s committee has been formed under the CEFP, the matter will have to be discussed in that committee, under his own chairmanship. Naturally, both committees take the debate seriously. The next phase of the debate is gathering opinions from the public. Both committees are eagerly seeking advice from around the world. Indeed, a friendly competition has emerged to see which committee can come up with the best plan. Expert witnesses will be called by both committees, and the press will notice. Debate is good for markets A healthy debate over financial market quality is long overdue. Investors have seen far too many scandals over the last few years, and far too many failures of regulatory oversight.[3] The mere fact that problems are aired is a step forward. Moreover, no party can monopolize the debate. Indeed, at the moment, the press itself is under fire, due to recent cases of faked stories (although in areas far removed from finance). As the debate progresses, the likelihood of a more intelligent solution to the problems in Japan’s financial system will rise. As a result, investor confidence in financial regulation — which is still suffering from the destructive results of the consumer finance law revisions last year — may begin to revive. If so, the risk premium on financial stocks may begin to decline, as the likelihood of arbitrary regulatory decisions recedes. Even more important could be the effect on confidence in the Abe government itself. The government has already scored major wins in foreign policy, but a clear victory on reform has yet to emerge. The financial system debate is a major opportunity. The conclusion will not be far off. The PM’s own subcommittee on the issue is reportedly scheduled to submit its ideas by the end of March. The FSA committee cannot lag far behind, for fear of losing the battle.
[1]For a summary of the debate on financial regulatory reform, see Financial Regulation Rethink, by Robert Feldman, Morgan Stanley, January 11, 2007. [2]The minutes are available in Japanese at, http://www.keizai-shimon.go.jp/special/global/global/01/global-s.pdf [3]In the most recent case, there were several major issues. First, a financial institution was involved in lending to an organized crime syndicate. This is a violation of standard ‘know your customer’ rules. Second, the authorities have been inspecting the institution (and its pre-merger predecessors) for many years, and have never taken action. Third, the reported sanctions on the bank will stop it lending to legitimate customers, and thus punish the innocent. Fourth, the press egregiously leaked the news about impeding sanctions. An investigation is needed, to see where the leak occurred. If it came from within the government, there will have been a clear violation of the Civil Service Law, which compels civil servants to maintain confidentiality of such information.
Important Disclosure Information at the end of this Forum
Tightening Mode Maintained
February 01, 2007
By Chetan Ahya | Mumbai
Reverse repo rate unchanged, repo rate hiked by 25bp: In the third quarter review of its monetary policy, the Reserve Bank of India (RBI) left the reverse repo rate (the rate at which the RBI absorbs excess liquidity) unchanged at 6% and announced a 25bp hike in the repo rate (the rate at which the RBI infuses liquidity) to 7.50%. This was in line with our expectation. Additional measures to address higher credit growth: The current credit cycle continues to be one of the longest that India has witnessed in the past 35 years. Despite the measures taken by the RBI over the last two years, credit growth remains buoyant. In its latest monetary policy review, the RBI announced an increase in the provisioning requirement for standard assets (real estate sector, outstanding credit card receivables, loans and advances qualifying as capital market exposure and personal loans) to 2% from 1%. In addition, the provisioning requirement for bank exposure in the standard assets category to the non-deposit-taking systemically important non-banking financial companies (NBFCs) rose to 2% (from 0.4%) and simultaneously the risk weight for banks’ exposure to such NBFCs was raised to 125% (from 100%). We believe that this step was warranted in view of the fact that associated institutions have been mispricing credit, thus exposing themselves to significant risks in coming months. RBI stays concerned on stability factors: In its earlier monetary policy statement, the RBI had indicated “the need to reckon with the dangers of possible overheating even though there was no conclusive evidence thereof”. In its latest statement, the RBI highlighted that “in the subsequent period, the relevant signs, especially in terms of aggregate demand, have firmed up”. We believe that concerns about demand-side pressures — as reflected in rising inflation, strong money and credit growth, high asset prices, the widening trade deficit and potential wage pressures — appear to have weighed on the RBI’s decision to hike the policy rate. Bottom line: We think that domestic macro trends warrant the RBI maintaining a tightening stance in coming months.
Important Disclosure Information at the end of this Forum
Current Account Narrows on Trade Balance
February 01, 2007
By Deyi Tan | Singapore
Current account remains in surplus in December: The current account came in at US$1.2 billion (versus +US$1.5 billion in November). Despite the seasonally higher net services and transfers balance (+US$483 million versus +US$242 million in November), the current account surplus narrowed on the back of trade balance (+US$732 million versus +US$1.3 billion). For the full year, the current account balance reached US$3.2 billion. Exports in US$ terms still healthy, but currency appreciation likely reducing exporters’ baht revenue: We are seeing a disconnect in export data measured in US$ terms and Bht terms. On a BOP basis (US$ terms), exports rose at a healthy 16.4% YoY (versus +21.7% YoY in November). However, the baht appreciation has likely reduced exporters’ revenue in local currency terms. Exports on a custom basis (Bht terms) have continued to register a slowdown to 3.4% YoY (versus +10.1% YoY in November). On the custom basis (Bht terms), segments such as machinery, manufactured goods and food decelerated to 4.5% YoY, 4.7% and 8.7% YoY, respectively (versus +9.7% YoY, +13.1% YoY and +11.2% YoY in November). Imports continued to point to weak domestic demand: The import front remained lackluster. Imports on a balance of payments (USD terms) rose 6.5% YoY (versus +6.3% YoY in November) while imports (custom basis, Bht terms) have fallen to -6.6% YoY (versus -5.5% YoY in November). Specifically, consumer goods imports registered -1.9% YoY (versus -3.1% YoY in November). Capital goods imports registered -20.2% YoY (versus -6.8%) and raw materials were at -4.6% YoY (versus -1.8% YoY).
Important Disclosure Information at the end of this Forum
January Inflation Decelerates
February 01, 2007
By Deyi Tan | Singapore
Inflation rises below expectations: January inflation rose 3.0% YoY, following an increase of 3.5% YoY in December. This was below our and market expectations. Even on a sequential basis, prices declined by 0.3% MoM (versus -0.1% YoY in December). However, core inflation rebounded to 1.6% YoY (versus +1.5% YoY in December). Non-food inflation accounted for the bulk of the deceleration: Inflation in the non-food category decelerated to 1.1% YoY and 0.7 ppt (versus 1.9% YoY and 1.2 ppt in December). Specifically, prices in the transportation segment (accounting for around 22% of the overall index) decelerated sharply to 0.8% YoY and 0.2 ppt (versus 3.3% YoY and 0.8 ppt last month). In addition, the other components — housing and clothing & footwear — decelerated slightly to 1.4% YoY and 0.0% YoY, respectively (versus 1.5% YoY and 0.1% YoY in December). January food inflation highest in 13 months: Food prices accelerated to 6.3% compared with 6.0% YoY last month, thus contributing 2.3 ppt to headline inflation. Prices in the vegetables and fruits (+27.8% YoY versus +24% YoY in December) and seasonings & condiments (+4.4% YoY versus +4.0% YoY in December) segments accelerated in January. However, prices contracted/decelerated in the meat, poultry & fish (-1.4% YoY versus 1.1% YoY) and rice & cereal segments (+8.8% YoY versus +8.9% YoY). Domestic growth and inflation environment warrants rate cuts:In the current scenario, both growth and inflation numbers are coming below our expectations. We believe that this might provide the Bank of Thailand (BoT) with room to cut rates faster than we had previously expected.
Important Disclosure Information at the end of this Forum
January Inflation Eased Slightly
February 01, 2007
By Deyi Tan | Singapore
January inflation down slightly: Prices rose 6.3% YoY in January. This is down from the 6.6% we saw in December. On a sequential basis, prices rose 1.0% MoM, which is roughly in line with the average MoM% trend for January. Core inflation, which is a better measure of demand-side price pressures, was fairly stable at 6.1% YoY (versus +6.0% in December). Inflation pressures concentrated in food: January data continue to show inflation pressures in food, albeit at a decelerated pace. Food prices rose 11.2% YoY (versus +12.9% YoY in December). On a MoM basis, this is 2.7% higher than December (versus +3.1% MoM in December). The food segment contributed 2.6%-pt to headline inflation. Inflationary pressures in other segments rose marginally but remained at relatively more subdued levels. Housing prices rose 4.9% YoY (versus +4.8% YoY in December), adding 1.3%-pt to inflation. Transport prices rose 1.2% YoY (versus +1.0%), adding 0.2%-pt to inflation. Inflation and monetary policy outlook: El Niño conditions could persist until 1Q-2Q07 and pose some upside risks to inflation, despite the government’s measure to stabilize prices by importing rice. However, we believe that stable core inflation supports our view that El Niño-induced inflation is unlikely to cause the central bank to deviate from a 25bp-cut-per-meeting path. We expect policy rate to reach 8.75% by year-end.
Important Disclosure Information at the end of this Forum
Disclosure Statement
The information and opinions in this report were prepared or are disseminated by Morgan Stanley & Co. Incorporated and/or Morgan Stanley & Co. International Limited and/or Morgan Stanley Japan Securities Co., Ltd. and/or Morgan Stanley Dean Witter Asia Limited and/or Morgan Stanley Dean Witter Asia (Singapore) Pte. (Registration number 199206298Z) and/or Morgan Stanley Asia (Singapore) Securities Pte Ltd (Registration number 200008434H) and/or Morgan Stanley & Co. International Limited, Taipei Branch and/or Morgan Stanley & Co International Limited, Seoul Branch, and/or Morgan Stanley Dean Witter Australia Limited (A.B.N. 67 003 734 576, holder of Australian financial services licence No. 233742, which accepts responsibility for its contents), and/or JM Morgan Stanley Securities Private Limited and their affiliates (collectively, "Morgan Stanley").
Global Research
Conflict Management Policy
This research observes our conflict management policy, available at www.morganstanley.com/institutional/research/management_policies.html
Important Disclosures
This report does not provide individually tailored investment advice. It has been prepared without regard to the circumstances and objectives of those who receive it. Morgan Stanley recommends that investors independently evaluate particular investments and strategies, and encourages them to seek a financial adviser's advice. The appropriateness of an investment or strategy will depend on an investor's circumstances and objectives. This report is not an offer to buy or sell any security or to participate in any trading strategy. The value of and income from your investments may vary because of changes in interest rates or foreign exchange rates, securities prices or market indexes, operational or financial conditions of companies or other factors. Past performance is not necessarily a guide to future performance. Estimates of future performance are based on assumptions that may not be realized.
With the exception of information regarding Morgan Stanley, reports prepared by Morgan Stanley research personnel are based on public information. Morgan Stanley makes every effort to use reliable, comprehensive information, but we do not represent that it is accurate or complete. We have no obligation to tell you when opinions or information in this report change apart from when we intend to discontinue research coverage of a company. Facts and views in this report have not been reviewed by, and may not reflect information known to, professionals in other Morgan Stanley business areas, including investment banking personnel.
To our readers in Taiwan: This publication is distributed by Morgan Stanley & Co. International Limited, Taipei Branch; it may not be distributed to or quoted or used by the public media without the express written consent of Morgan Stanley. To our readers in Hong Kong: Information is distributed in Hong Kong by and on behalf of, and is attributable to, Morgan Stanley Dean Witter Asia Limited as part of its regulated activities in Hong Kong; if you have any queries concerning it, contact our Hong Kong sales representatives.
This publication is disseminated in Japan by Morgan Stanley Japan Securities Co., Ltd.; in Canada by Morgan Stanley Canada Limited, which has approved of, and has agreed to take responsibility for, the contents of this publication in Canada; in Germany by Morgan Stanley Bank AG, Frankfurt am Main, regulated by Bundesanstalt fuer Finanzdienstleistungsaufsicht (BaFin); in Spain by Morgan Stanley, S.V., S.A., a Morgan Stanley group company, which is supervised by the Spanish Securities Markets Commission (CNMV) and states that this document has been written and distributed in accordance with the rules of conduct applicable to financial research as established under Spanish regulations; in the United States by Morgan Stanley & Co. Incorporated and Morgan Stanley DW Inc., which accept responsibility for its contents. Morgan Stanley & Co. International Limited, authorized and regulated by Financial Services Authority, disseminates in the UK research that it has prepared, and approves solely for the purposes of section 21 of the Financial Services and Markets Act 2000, research which has been prepared by any of its affiliates. Private U.K. investors should obtain the advice of their Morgan Stanley & Co. International Limited representative about the investments concerned. In Australia, this report, and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act.
Trademarks and service marks herein are their owners' property. Third-party data providers make no warranties or representations of the accuracy, completeness, or timeliness of their data and shall not have liability for any damages relating to such data. The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of MSCI and S&P. Morgan Stanley bases projections, opinions, forecasts and trading strategies regarding the MSCI Country Index Series solely on public information. MSCI has not reviewed, approved or endorsed these projections, opinions, forecasts and trading strategies. Morgan Stanley has no influence on or control over MSCI's index compilation decisions. This report or portions of it may not be reprinted, sold or redistributed without the written consent of Morgan Stanley. Morgan Stanley research is disseminated and available primarily electronically, and, in some cases, in printed form. Additional information on recommended securities is available on request.
|
