Emerging Markets, Copper, Tumble on Quantitative Tightening

by Gary Dorsch, Global Money Trends. January 27, 2010

“A trend in motion, will stay in motion, until some outside force, knocks it off its course.” So far in January, a whirlwind of events have suddenly knocked the global commodity and stock markets off their 10-month upward trajectory. Beijing is clamping down on Chinese bank loans and its M2 money supply, and central banks in Australia and India are expected to tighten their money policies soon. Adding to the jittery tone, US President Barack Obama’s has shocked investors, by moving to sever the White House’s clandestine partnership with the Oligarchic banks on Wall Street, thus removing a key prop for the US-stock market.

Emerging markets including Brazil, China, and India accounted for the bulk of global growth last year, as the developed world struggled with high unemployment, soaring public debt, and badly impaired banks. Private capital flows into emerging markets equaled $435-billion last year, as lenders and traders were once again tempted by riskier assets, and shifted money out of safe-haven assets like government bonds. Capital flows were sustained by better growth prospects and carry traders attracted to higher interest rates in emerging Asia and Latin America.

However, “while the rise in asset prices in emerging markets is not yet in dangerous bubble territory, price pressures have increased significantly in some countries,” the IMF said in an update of its Global Financial Stability Report. “Policymakers cannot afford to be complacent about inflows and asset inflation. As recoveries take hold, the liquidity generated by inflows could fuel an excessive expansion in credit and unsustainable asset price increases. The risk is that a burst bubble could throw the global economy back into recession, the IMF warned on Jan 26th.

The People’s Bank of China, (PBoC), perhaps the most influential in Asia, is sending a strong signal to world markets that it is very disturbed by last year’s upward surge in key industrial commodities for which it is a major buyer, and it’s ready to precipitate a speculative shakeout by tightening its monetary policy. On Jan 12th, the PBoC rattled world markets by increasing the proportion of deposits that banks must set aside as cash reserves by 50-basis points to 16%, its first meaningful move to tighten its monetary policy in eighteen months.

The PBoC has also drained large sums of yuan from money markets over the past several weeks, and started pushing short-term bill rates higher. With less yuan to lend, the growth rate of China’s M2 money supply is expected to slow down towards the government’s target of 17% for this year, which in turn is already sucking the hot air out of the Shanghai red-chip index as speculators abandon the market.

China’s massive stockpiling of industrial commodities last year, helped to push its monthly imports in December to a record $122-billion. It’s demand for base metals surged with copper imports up 40% and nickel 45%, while implied oil demand in 2009 rose 6.3% on the year to 7.7-million bpd. China’s vast steel industry also hit monthly records of volume churned out. That massive surge of steel output, despite a collapse in world markets, has driven Chinese demand for imports of steel-related commodities such as coking coal, nickel, and zinc.

However, China’s voracious appetite for commodities combined with explosive growth of money and credit has also ignited inflationary pressures, fueled asset bubbles, as the economy shows signs of overheating. China’s consumer price index, heavily weighted towards food and energy, was +1.9% higher in December from a year ago and pointing upward, with commodities elevated at 15-month highs.

Thus, Beijing is taking the lead among the Group-of-20 central banks, assuming the role of anti-inflation cop, aiming to bring down the commodities markets and stifle the inflationary pressures that are seeping into world economies. China imported 418,000-tons of copper at very high prices in December. However, since it tightened its monetary policy on Jan 12th, copper prices in London have tumbled by roughly 6% to $7,150 /ton, and crude oil has plunged by $10 /barrel to around $74 /barrel.

On January 11th, Chile’s Mining Minister Santiago Gonzalez warned that copper prices could see an “important" downward correction as metal inventories continue to climb. We are worried that stock levels are climbing higher. We are at 700,000-tons worldwide at the moment, yet prices remain high. This means that at any minute we could see a violent change and prices could fall,” Gonzalez said. The next day, Beijing took aim at the copper market by tightening its money supply.

On January 27th, Beijing took sterner measures by ordering China’s top banks to call back some of the loans that were already extended in January, ratcheting up the pressure on banks to fall in line with official lending targets. Chinese banks extended 1.45-trillion yuan ($212 billion) in new loans during the first 19 days of the year, but on Jan 27th China's largest bank, ICBC, stopped rolling over loans to slow credit growth and knocking copper futures 3.5% lower in New York to $3.28 /pound.

Inflationary pressures are whipping-up in the world’s second fastest growing economy due to last year’s strong rebound in commodity markets. Initial indications for January show that India’s wholesale inflation rate is accelerating at a 7.3% clip compared with 4.8% and 1.3%, respectively, in the previous two months. With food inflation accelerating at a 15% rate, its fastest in 11-years, fears are that money supply pressure would translate into demand-side inflation if not controlled.

“India will take steps to tame rising prices and enable the economy to recover faster,” India’s finance minister Pranab Mukherjee said on Dec 16th. “Prices are a major area of concern and we shall have to address it. Whatever steps are needed, we will take those steps,” he warned. India’s 10-year bond yields were already on the way up, surging about 60-basis points higher to 7.75% as traders anticipated a tighter monetary policy by the Reserve Bank of India (RBI).

The abundant liquidity situation in India, with the M3 money supply running 16% higher than a year ago, poses a threat to an already rising inflation rate that is likely to be addressed by the RBI at the January 29th meeting with a hike in the cash reserve ratio (CRR) by up to 50 basis points. The flood of foreign exchange flowing into the Indian capital markets last year, topping $17-billion, could also add to inflation forcing the RBI to drain liquidity in the form of an increase in CRR.

A half-point hike in cash reserves would drain about 20-billion Indian rupees out of the banking network, and this could be the aim of the RBI’s Quantitative Tightening (QT) - reducing the impact that the excess money supply would have on inflation. But the negative side-effect of QT is to deflate the Bombay stock market, which like other markets has suddenly become a liquidity addict exhibiting severe withdrawals symptoms. Foreign traders have already pulled $676-million from Indian equities in the last four sessions, knocking the 30-share BSE index 8% lower to 16,289.

Aussie /yen carry traders plowed billions into Australian stocks in the fourth quarter, lifting the ASX-200 Index higher from the 4,600-area to the 4,950-level, profiting from both higher equity values and currency gains. The party came to an abrupt end however, when China’s central bank tightened its monetary policy triggering sell-offs in Aussie miners and oil company shares in Sydney. The latest unwinding of the carry trades has since knocked the Aussie dollar by 4.5-yen lower to around 81.50-yen today despite its wide interest rate advantage over the yen.

The Reserve Bank of Australia (RBA) has already lifted its key cash rate 75-basis points since October to 3.75% as the local economy recovered with the rebound in commodity markets, thus lessening the need for an easy monetary policy. The neutral level for RBA’s overnight cash rate - that neither fuels nor hinders growth – is estimated to be 4.5%. In Sydney the futures market is pricing in a series of RBA rates hikes to 4.75% by year-end, which in turn is fueling a mini meltdown in the Australian-200 Index, tumbling 5% over the past five trading sessions.

Gary Dorsch

© 2010 Gary Dorsch

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