Monday October 3, 2005 - 10:52:08 GMT
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Black Swan Capital - www.blackswantrading.com
Inflation exposing Asia?
“Selective recall or not, Alan Greenspan was the pied piper of the New Paradigm and the equity bubble it spawned. And up until recently, he took a similar tack with respect to the property bubble -- constantly maintaining that excesses in certain local real estate markets could not morph into a nationwide problem. With 25 states plus the District of Columbia now in double-digit house price appreciation mode over the last year, the Fed chairman suddenly sees the light!”
Stephen Roach, Morgan Stanley
Rising US inflation expectations are the talk of the town. It seems traders are discounting an aggressive Fed that won’t be afraid to push interest rates well into the restrictive zone to deal with inflation fears. But inflation fears are global in nature.
If you are a country that must import key commodities, as most do; rising commodities prices, priced in a rising currency—the US dollar—are a double-hit to costs. These costs are either passed on through final goods into prices or domestic manufacturers must absorb it in the form of lower profits (or governments absorb them through subsidies). Sooner or later it comes out in the wash.
If speculators and investors are somewhat rationale—which they are at times—they may make a simple calculation:
Nominal interest rates – inflation rate = Real return
In countries where the central bank is not staying ahead of the curve, as is the Fed, AND corporate profits are at risk, the relative incentives to remain invested in said country tend to fall. These incentives apply to both domestic and international investors.
And if we had to choose a region most exposed to this kind of dynamic it would be Asia ex-Japan (for now).
1) Central banks are behind the interest rate curve
a. From Andy Xie at Morgan Stanley: “Asia has been associated with low inflation since the Asian Financial Crisis because the region has a high savings rate. However, cost-push and hot money inflows have created an unfavorable inflationary picture for the region. If monetary authorities are not careful, inflation expectations could surge suddenly and force them to tighten excessively.” [our emphasis]
2) Exports are exposed to US consumer demand
a. US consumer demand might ultimately be in the Fed cross hairs now that Mr. Greenspan is coming to terms with the rolling asset bubbles conjured up in the wake of extremely loose monetary policy.
chart: stocks, bonds, housing
Many of the US consumer wealth generators seem exposed if asset bubble deflation becomes an implicit part of the Fed rate policy.
And where does the hot money flow go, if it comes (or is coming) out of Asia? Our guess would be into a rising currency that also provides a decent yield and some depth in capital markets—the US dollar meets those criteria at the moment.
Black Swan Capital
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