Month: November 2013

Back in March 2011, author Carmen
Reinhart wrote a comment in Bloomberg describing the terms “financial
repression.”  He wrote:

“As they have before in the
aftermath of financial crises or wars, governments and central banks are
increasingly resorting to a form of “taxation” that helps liquidate the huge
overhang of public and private debt and eases the burden of servicing that
debt.

Such policies, known as financial
repression, usually involve a strong connection between the government, the
central bank and the financial sector. In the U.S., as in Europe, at present,
this means consistent negative real interest rates (yielding less than the rate
of inflation) that are equivalent to a tax on bondholders and, more generally,
savers.”

http://www.bloomberg.com/news/2012-03-11/financial-repression-has-come-back-to-stay-carmen-m-reinhart.html

In
the FDIC data released this week, the financial repression imposed by Ben
Bernanke, Janet Yellen and the rest of the Federal Open Market Committee over
the past five years is very apparent.  Chief
among the data points to be noted is that net interest expense, which is the
money paid to depositors at banks, continues to fall.  While all banks earned about $118 billion in
interest income last quarter, they paid just $13 billion to depositors, a
graphic example of the “financial repression” used by the Fed to subsidize the
US banking industry.

http://www2.fdic.gov/qbp/qbpSelect.asp?menuItem=QBP

Notice
that while the Fed has maintained the net interest income to banks, the
earnings of depositors have fallen more than 90% since 2008.  Via QE, the Fed is subsidizing all banks to
the tune of over $100 billion per quarter in artificially depressed interest
cost and income to depositors of all stripes. By robbing consumers and all
savers of income, the FOMC is in fact feeding deflation and hurting growth and
employment.  The chart below using data
from the FDIC shows the interest earnings, expenses and net interest income through
the end of September 2013 for all US banks.

Prior to the 2007 financial
crisis, total interest expense for all US banks was over $100 billion every
three months and interest income was almost $200 billion.  In order to maintain the net interest margin
for banks at +/- $100 billion per quarter, the Fed is confiscating income of US
savers, including companies, investors and the elderly, of almost the same
amount each quarter in badly needed income. 
This data graphically illustrates the deflationary nature of current Fed
interest rate policies and why Janet Yellen and the Federal Open Market
Committee need to raise interest rates soon.

In a paper published this month
by Carmen Reinhart and Ken Rogoff, the authors argue that financial repression
is a necessary part of the adjustment process for heavily indebted nations,
even the advanced nations.  The Guardian
reports: “They say that if history is any guide countries will not be able to
return to more sustainable levels of public debt through a combination of
austerity and growth. They cite Europe, where the assumption is that normality
can be restored by a combination of belt-tightening, forbearance and rising
output, as an example of Panglossian thinking.”

http://www.theguardian.com/business/economics-blog/2013/nov/20/reinhart-rogoff-latest-paper-harvard-financial-repression

Say Reinhart and Rogoff:   “The
claim is that advanced countries do not need to apply the standard toolkit used
by emerging markets, including debt restructurings, higher inflation, capital
controls and significant financial repression. Advanced countries do not resort
to such gimmicks, policy makers say.”

The Guardian:  “Historically, this is poppycock according to
Reinhart and Rogoff. Rich countries, when faced with high levels of debt in the
past have been more than happy to default, inflate away their debts or indulge
in financial repression (capping interest rates or putting pressure on savers
to lend to the government).”

The current policy mix in the US
certainly shows this tendency to resort to financial repression, but the real
question is whether current Fed policy has not resulted in a deflationary trap,
with falling income driving consumption, jobs and economic activity lower.  Taking $100 billion in income away from
savers each quarter does not seem to be a recipe for economic growth. 

But as Reinhart and Rogoff
document well, there is no easy solution available for the US, EU, Japan and
other heavily indebted developed nations. 
Once interest rates start to rise, the necessity of debt restructuring
in Europe, Japan and even the US will become more apparent.  There is no free lunch.  Either we kill growth via financial
repression of savers or we embrace the painful process of debt restructuring
for the major industrial nations.

www.rcwhalen.com

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/BPhAOa4tWOo/story01.htm rcwhalen

Submitted by James E Miller of The Ludwig von Mises Institute of Canada,

This past weekend I caught The Hunger Games: Catching Fire at my local theater. The movie is based on the second part of a dystopian trilogy written by Suzanne Collins. In Collins’s fictional world known as Panem, a despotic government rules over all with a violent iron fist. There is a strict separation between the political class and the rest of the populace, with the latter working in slave-like conditions to support the former. The story focuses on protagonist Katniss Everdeen and her struggle to protect her loved ones while surviving the tyranny of her brutal overlords.

Throughout Catching Fire, the subject of revolution is paramount. Since the first instalment of the series when Katniss bested her oppressive dictators in the highly-publicized, annual fight-to-the-death tournament, she has become a symbol of agitation to the people. They look to her as a chink in the government’s armor – a sign that tyranny is not immortal but can be damaged. The plebs and their desire for freedom results in riots in the streets with vicious crackdowns from Orwellian-named “peacekeepers” who maintain tranquility with the bloodied end of truncheons. At one point during Katniss’s victory tour, an older gentleman raises his hand in defiance of the regime and whistles the popularized tune of revolution. He is summarily executed on the spot while the crowd that attempts to protect him is beaten handily.

The act of violence drew a startled and winced response from the movie audience. It was a demonstration of the horribly destructive nature of tyranny. There was no question as to the evilness of Panem’s dictatorial government. The line between enemy and hero was straight and untainted.

Stories such as the Hunger Games are wonderful things because they spark what conservative statesman Edmund Burke called the “moral imagination.” In his famed Reflections on the Revolution in France, Burke chided the Jacobin revolutionaries for endeavoring to paint “the decent drapery of life” and the “moral imagination” as “ridiculous, absurd, and antiquated.” Russell Kirk expanded on this phrase and defined it as the “power of ethical perception which strides beyond the barriers of private experience and momentary events.”

Whether viewers know it or not, the basic plot of the Hunger Games series is an appeal to the moral imagination that men should be free from working as servants to others. It’s not exactly a new theme when compared to other modern movies. There are a multitude of storylines where a strong-willed protagonist finds the courage within themselves to fight off an authoritarian power, not alone, but with the help of others. The narrative follows a familiar pattern: while outgunned and outmanned, good ultimately triumphs over evil not so much because of one person but rather the hope for a better life embodied within a symbol.

The engrossing message of liberty over tyranny in the Hunger Games is thought to be why the franchise is so popular. In some ways, that is correct. People tend to have the urge of rooting for the underdog. When the abuser receives his just deserts, it’s seen as a representation of justice fulfilled.

But as great as the moral imagination is, it ultimately means nothing if it does not translate into real-life behavior modification. It’s one thing to cheer on a character on screen who is risking their life for a freer world. It’s another to embody that risk yourself in a reality that is slipping towards despotism.

Anyone who claims the post-apocalyptic setting in Hunger Games bears an uncanny resemblance to state control in our time is liable to be marked as a black helicopter-type. The ridicule is the same that was aimed, and still is aimed, at Friedrich Hayek after his great work The Road to Serfdom was released. “No,” the critics say, “the existence of the large welfare-warfare state has not translated itself to one world authoritarianism.” That is certainly true for now. Still, the general public finds it fun to mock the government as an over-bearing and inefficient behemoth while relying on the beast for a bi-weekly allotment of tax subsidies.

We may not be living hand-to-mouth while being forced to labor for thuggish overlords but the modern trend is clear: the political class is consuming more and more wealth-generating capital for themselves. It can be seen in highly-unionized European countries and within the bubble of richness known as the District of Columbia. The police state is ratcheting up its already untamed authority. Economic regulation is becoming more varied and intrusive. In the West, the state as an institution has been growing by leaps and bounds for over a century. Only an imbecile would deny this mass centralization in government power.

Yet most viewers of the Hunger Games will not let that message sink into their consciousness. They will not make the connection between a story and their own lives. It’s far too discomforting. At the same time, they will revere characters in a tale who come off as heroes. These fictional thought constructs are viewed as perfectly noble persons who sacrifice for the greater good. One would think the same reverence would be shown to those individuals who engage in the same art of defiance against what is generally deemed an unjust situation. If characters in fiction can be seen as courageous, why not real-life persons who display the same type of behavior?

Edward Snowden, the now-infamous whistleblower of the National Security Agency, is still seen as a dirty, rotten traitor by much of the public. It’s a strange cognitive dissonance that while a majority are irate over their government’s spying, they see the man who clued them in as some type of mendacious plotter who hates Uncle Sam. It’s equally as strange that the same folks who hardly bat an eye when calling Snowden a scumbag will just as quickly latch on to the fighter of injustice in a movie.

Stories provide valuable insight into the limits of mankind and what constitutes good. But they are not reality in the end. There is little risk in admiring a character in fiction who stands up for the right thing. Doing so in real-life is apt to bring ridicule, and thus has a social stigma attached to it.

It takes no spine to be a warrior on paper. It also requires little brain power to bend your will with that of an author’s. The science of critical thinking demands a logical and coherent approach to viewing issues. Criticizing someone for doing the very same action that you praise in make-believe land is inconsistent and a sign of poor judgment. The borderline between the real and the imagination does not render ethics and morality capricious. A proper way to live is to be transcendent of observable examination alone.

Hunger Games contains a pertinent message to those living under big government. The heroes and villains of the story should not be unfamiliar to current events. Edward Snowden is a real life Katniss Everdeen. He defied the powers-that-be in order to do what he believed was right. But instead of receiving praise, he got condemnation from voices normal
ly wary of statism. The irony remains that the same men and women who call Snowden a traitor should be cheering for the tyrannical government of Panem to squash the rebellion and restore its oppressive hold on society. Of course, that suggestion sounds crazy, but then so does the person who pays lip-service to freedom while cheering for the death of someone who risks their life for greater liberty. Their moral imagination is in great need of fine-tuning.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/0hreCSvJ_UM/story01.htm Tyler Durden

When the US government said the sequester would cripple its ability to single-handedly rule over the world, it wasn’t kidding. Either that, or Joe Biden’s Joint Strategic Plan to “curb” copyright infringement was just a case of very confused humor by the vice president gone badly wrong, and he meant to “encourage.” Whatever the reason, the fact that the Obama administration was just busted with a $50 million case of software piracy involving none other than the US Army, is indicative that while the Bureau of Labor Statistics was adopting all the best features of the Chinese Department of Truth, the US government was busy copycatting China’s respectful approach toward intellectual property. Yet what is even worse, is that the software that was pirated managed the US army’s troop and supply movements: in other words, the US government relied on pirated software to prepare for and engage in eventual war.

Specifically, the army “used Apptricity’s integrated transportation logistics and asset management software across the Middle East and other theaters of operation. The Army has also used the software to coordinate emergency management initiatives, including efforts following the January 2010 earthquake in Haiti.”

Here’s what happened, as reported by RT: in 2004, Apptricity agreed with the US Army to license the troop-movement software, allowing the government to use it on five servers and 150 standalone devices. What happened instead is that the Army proceeded to use the softward around the world.  “The improper installation of thousands of unlicensed copies of software was discovered incidentally, when the US Army Program Director said during Strategic Capabilities Planning 2009 that thousands of devices had Apptricity software.”

Ultimately, 93 servers and over 9,000 standalone devices of the Army had the unlicensed software. Apptricity figured it was owed US$224 million based on usual fees of US$1.35 million per server and US$5,000 per device.

Upon discovering just how vast the US government piracy stretched Apptricity sued the government, accusing the US military of willful copyright infringement. It won, and the government went on to admit the illegal use and entered into lengthy negotiations with Apptricity to settle. The cost to the Obama administration from being caught in the act: $50 million in damages.

RT does a great summary of yet another instance of remarkable hypocrisy by the “most transparent administration ever.”

While the Obama administration’s has launched efforts against intellectual property theft – including the Joint Strategic Plan run by Vice President Joe Biden that aims to curb copyright infringement – the US Army was concurrently using pirated Apptricity enterprise software that manages troop and supply movements.

 The Administration has yet to comment on the settlement. But Biden’s words upon announcing the federal anti-copyright-infringement plan ring clear.

“Piracy is theft, clean and simple.”

Even when it was your subordinates that engaged in theft? Surely someone’s hand will be slapped, right? But one can be absolutely certain: neither Biden nor Obama “had any idea”…

What was not mentioned anywhere, however, is just how the US government spent the hundreds of millions in appropriated funds, because it is guaranteed that the Army was allotted the full mandated amount by Congress to purchase every single piece of Apptricity software it would ever need. And still somehow $200 million disappeared. Of course in any non-banana republic, a legal system might inquire in whose pockets this excess cash ended up. Which of course means that in the US nobody will even consider this eventuality, especially since Ben Bernanke prints that amount in roughly 5 minutes every day.

Finally, one wonders: what would happen if in the middle of a Syrian (or any other) war suddenly the US army was halted dead in its tracks when HQ got a flashing red “Your 30 Day trial period has expired. Please insert activation code now” notification. We can only hope US drone command didn’t get its copy of “Blow Up Innocent Women And Children From 10,000 Miles Away Ver 1.0” on the Moscow black market.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/PknTGNUkVXw/story01.htm Tyler Durden

While moderate recovery in growth and inflation is BofAML’s rates team’s base case, there are numerous risks to that forecast. The risk of tapering is already quite well known and they suspect it may not result in the significant market-moving event many expect when it actually happens; however, the following downside and upside risks threaten BofAML’s central scenarios for 2014 as well.

 

Via BofAML,

1. Downside risk from US inflation

This is probably the most important risk the market is underpricing, in our view. We forecast US real GDP growth will accelerate to 2.6% in 2014 while inflation will continue to hover at current levels. With weaker fiscal headwinds, and the potential for the Fed to taper very gradually, we see a risk that the data may surprise to the upside. This could benefit EM via the trade channel. However, if the output gap narrows by more than commonly estimated due to lower potential growth or higher structural unemployment, US inflation could increase faster than we forecast. This would primarily impact the belly of the US and EM curves.

To watch: Growth improvements without a corresponding healing of the labor market could be a sign of a structural rise in unemployment. We would also watch long-run inflation expectations in the University of Michigan Consumer Sentiment Survey, core inflation readings, and wage growth data.

2. Upside risk from European inflation

Continued disinflation is a worrisome risk to the European economy in the coming quarters. In our Global Economics Year Ahead, our EU economists argue that the biggest risk to debt dynamics is persistently weak inflation. Worsening debt dynamics or fiscal slip-ups combined with uncertainty surrounding the banking exercise could reignite negative sentiment. CEE FX and yields would move lower. However, this may prove a trading opportunity. The ECB would likely respond with an LTRO to combat such weakness. Also, the ECB could turn aggressive with the LTRO, or even embark on weakening the EUR. Given these risks, we maintain a bullish HUF bias versus the EUR, and prefer to fund long BRL and MXN positions against the EUR.

To watch: CPI readings and fiscal performance in the periphery, particularly in Spain given the relatively large primary deficit, should be a focus. Also look for shifts in the ECB’s stance on extraordinary measures; we are already seeing some of this with the discussion of negative deposit rates.

3. Downside risk from China hard-landing

We expect growth to pick up slightly in 1H14 before moderating in 2H14 and then again in 2015. This will require fine-tuning from the authorities, balancing still ambitious growth targets with the planned shift in the composition of domestic demand towards consumption. Doing so, while reining in the property sector, may be no easy task. A sharper deceleration of growth would impact commodity prices negatively. Exporters like Brazil, Argentina, Peru, South Africa, Indonesia and Colombia would be hurt. ZAR could be most at risk given the continued current account concerns.

To watch: Pay attention to sharper rhetoric from authorities regarding the property sector, especially after the raising of minimum down payments in Shenzhen and Shanghai. Also, our ChinaLEAP indicator (MECILEAP Index <GO>) and credit data should provide leading information on activity.

4. Mixed risks from the BRIC election season

There will be important elections in two of the BRICS in 2014: Brazil and India. Both are in great need of fresh thinking to enact much-needed structural reforms after growing evidence of slowing potential growth (see GEMs in Focus: On surfers and workers). In Brazil, the polls suggest the risk of an opposition victory is very low, certainly lower than what we believe it is on the basis of the country’s relatively poor economic performance. An opposition victory would likely result in improved policy management and faster implementation of structural reforms.

In India, there is some risk of a hung Parliament, where neither national party is able to form a government. If this materialized, it would likely exacerbate pressures on the INR due to the continued threat of political instability and a lower chance of structural changes, especially in the infrastructure sector. Alternatively, a strong and decisive outcome with a stable coalition government led by either national party could benefit the INR, one of the most undervalued currencies according to Compass (down 13%).

To watch: Watch out for the evolution of polls in both countries. On 8 December, state poll results in India will be released. Then, national elections will take place around April/May 2014; Brazil’s presidential elections will be in October 2014.

5. Russian bear comes out of its cave

We see some chance that President Vladimir Putin will decide to reshuffle the government and/or push much-needed reforms in order to spur the stagnating economy, despite possible high political and social costs. An ambitious privatization agenda and improvements in the investment climate would fuel capital inflows, supporting EXD and LDM. Less positively, “reforms” could also take the form of tighter supervision of businesses and even greater state control of the economy.

To watch: Any government reshuffle could be a sign of impending changes, with personalities of new government officials most likely setting the direction of the change. The likelihood of changes will most likely increase after the politically important Winter Olympics in February.

6. Brazil gets ratings downgrade

S&P already has a negative outlook for Brazil and we believe a ratings downgrade could be coming next year. It is still unclear whether government efforts to curb public lending will be sufficient to contain fiscal risks. As we pointed out in a recent Brazil Viewpoint, the structural fiscal dynamics are still expansionary, and this may force the central bank to hike rates more than what we currently forecast. In other words, the current fiscal policy may prove inconsistent with Bacen’s objective of lowering inflation. Although Selic futures price in more hikes than we forecast, it is for these reasons why we view the riskreward as unattractive and prefer to stay square.

To watch: Pay attention to the evolution of the primary fiscal surplus and whether this converges on the target of 2.3% of GDP from 1.6%, and whether authorities actually follow through with their intentions to slow public lending in the face of weak growth

7. Tail risks to the Mexican reform tiger

Everybody loves Mexico, but there is a risk that the disappointment with the fiscal reform extends to the restructuring of the energy sector, which we expect to be enacted in 2013-14. Our base case is for the reform to constitute a productivity-enhancing game changer for the country. We see both upside and downside risks. The reform could allow production contracts for the riskier projects as well.

On the negative side, the reform could prove insufficient to entice foreign oil companies and open up the sector, which would have a large negative market impact. An upside surprise is more likely than a negative one, in our view, but the latter would have a more significant market impact. Prospects of lower foreign direct investment flows would weigh on the MXN, which is one of our top FX picks next year (vs EUR).

To watch: We expect constitutional changes to be approved by 15 December while secondary laws may not be approved until 1Q14. The devil will be in the details of implementation with respect to private sector participation through profit-sharing contracts, the lowering of Pemex’s fiscal burden and private electricity generation.

8. Geopolitics rears its ugly head

Saudi Arabia and Israel may become increasingly worried about Iran in the next six months, possibly even resorting to tactics that would shake the region’s stability. Beyond the interim period, the deal may not live up to expectations given what appears to be little commitment at the top level in Iran. Therefore, medium-term risks to oil prices will remain.

Countries with relatively higher shares of energy in their CPI baskets could have upward pressures on their local curves if prices tend to adjust rapidly (e.g., Chile, CEE, Turkey or India), or to their CDS curves if governments tend to take the brunt of the adjustment (e.g., Indonesia).

To watch: It will be important to see how domestic politics in Iran change over the next six months with respect to the deal, as well as the stance of the other regional powers, Israel and Saudi Arabia. Actions by the US Congress could also derail the process.

Global sentiment could sour if tensions escalate between China and Japan over islands in the East China Sea. Japan and the US have yet to comply with the Chinese introduction of an air zone around the islands, which leaves room for tensions to escalate. The latest developments increase the risks for error and misjudgment, but the market is unlikely to increase the risk premium for now. There are risks that this may spill over into retaliatory economic policies (trade, investment, tourism).

To watch: The US recently tested China’s air defense zone and further US involvement could prevent some escalation by reducing the boldness of some hawks in China.

9. FX mortgages lawsuits in Eastern Europe

Lawsuits against banks on FX mortgages have appeared in several Eastern European countries, introducing new uncertainty on potential future compensation costs for banks but also providing the opportunity to reach a final resolution to the legacy stock of FX loans. In Hungary, the Kuria, which is the highest court, is due to give guidance on FX loans validity (outstanding stock US$17bn) and whether unilateral changes to the contract conditions should be permitted.

To watch: The Kuria will start the debate on 16 December. The completion date is unclear, but the government will announce its final relief package for FX borrowers as soon as the ruling is announced. The government is aware of the importance of preserving financial stability, and we believe it is unlikely to opt for an immediate and extreme resolution, even in the case of a harsh ruling from the court (i.e., immediate conversion in HUF at a preferential rate). However, the court ruling may provide legitimacy to drastic solutions that may be implemented over the course of several years. The Hungarian case may also prove to be a template for other countries with widespread FX loans.

10. Faulty bailouts

Ukraine can play contradictions between the EU and Russia for too long and end up with nothing after all. The country can fail to secure timely IMF funding early next year for political reasons (just as it did over the past two years), as well as fail to get any new loans from Russia without full membership in the Russia-led Customs Union (the key condition from Russia). As a result, domestic financial markets can destabilize, triggering a renewed currency run from the population in such a scenario. The latter could push the National Bank of Ukraine’s reserves below critical levels and force disorderly UAH devaluation and/or default.

To Watch: Be aware of NBU FX reserves dynamics. We estimate US$15bn (US$20.6bn as of 1 November) as a critical level, with reserves below it potentially forcing FX policy change. Any Ministry of Finance success in rollover of the FX debt can help to keep reserves above this critical level.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/bUQQZec4j1E/story01.htm Tyler Durden

While moderate recovery in growth and inflation is BofAML’s rates team’s base case, there are numerous risks to that forecast. The risk of tapering is already quite well known and they suspect it may not result in the significant market-moving event many expect when it actually happens; however, the following downside and upside risks threaten BofAML’s central scenarios for 2014 as well.

 

Via BofAML,

1. Downside risk from US inflation

This is probably the most important risk the market is underpricing, in our view. We forecast US real GDP growth will accelerate to 2.6% in 2014 while inflation will continue to hover at current levels. With weaker fiscal headwinds, and the potential for the Fed to taper very gradually, we see a risk that the data may surprise to the upside. This could benefit EM via the trade channel. However, if the output gap narrows by more than commonly estimated due to lower potential growth or higher structural unemployment, US inflation could increase faster than we forecast. This would primarily impact the belly of the US and EM curves.

To watch: Growth improvements without a corresponding healing of the labor market could be a sign of a structural rise in unemployment. We would also watch long-run inflation expectations in the University of Michigan Consumer Sentiment Survey, core inflation readings, and wage growth data.

2. Upside risk from European inflation

Continued disinflation is a worrisome risk to the European economy in the coming quarters. In our Global Economics Year Ahead, our EU economists argue that the biggest risk to debt dynamics is persistently weak inflation. Worsening debt dynamics or fiscal slip-ups combined with uncertainty surrounding the banking exercise could reignite negative sentiment. CEE FX and yields would move lower. However, this may prove a trading opportunity. The ECB would likely respond with an LTRO to combat such weakness. Also, the ECB could turn aggressive with the LTRO, or even embark on weakening the EUR. Given these risks, we maintain a bullish HUF bias versus the EUR, and prefer to fund long BRL and MXN positions against the EUR.

To watch: CPI readings and fiscal performance in the periphery, particularly in Spain given the relatively large primary deficit, should be a focus. Also look for shifts in the ECB’s stance on extraordinary measures; we are already seeing some of this with the discussion of negative deposit rates.

3. Downside risk from China hard-landing

We expect growth to pick up slightly in 1H14 before moderating in 2H14 and then again in 2015. This will require fine-tuning from the authorities, balancing still ambitious growth targets with the planned shift in the composition of domestic demand towards consumption. Doing so, while reining in the property sector, may be no easy task. A sharper deceleration of growth would impact commodity prices negatively. Exporters like Brazil, Argentina, Peru, South Africa, Indonesia and Colombia would be hurt. ZAR could be most at risk given the continued current account concerns.

To watch: Pay attention to sharper rhetoric from authorities regarding the property sector, especially after the raising of minimum down payments in Shenzhen and Shanghai. Also, our ChinaLEAP indicator (MECILEAP Index <GO>) and credit data should provide leading information on activity.

4. Mixed risks from the BRIC election season

There will be important elections in two of the BRICS in 2014: Brazil and India. Both are in great need of fresh thinking to enact much-needed structural reforms after growing evidence of slowing potential growth (see GEMs in Focus: On surfers and workers). In Brazil, the polls suggest the risk of an opposition victory is very low, certainly lower than what we believe it is on the basis of the country’s relatively poor economic performance. An opposition victory would likely result in improved policy management and faster implementation of structural reforms.

In India, there is some risk of a hung Parliament, where neither national party is able to form a government. If this materialized, it would likely exacerbate pressures on the INR due to the continued threat of political instability and a lower chance of structural changes, especially in the infrastructure sector. Alternatively, a strong and decisive outcome with a stable coalition government led by either national party could benefit the INR, one of the most undervalued currencies according to Compass (down 13%).

To watch: Watch out for the evolution of polls in both countries. On 8 December, state poll results in India will be released. Then, national elections will take place around April/May 2014; Brazil’s presidential elections will be in October 2014.

5. Russian bear comes out of its cave

We see some chance that President Vladimir Putin will decide to reshuffle the government and/or push much-needed reforms in order to spur the stagnating economy, despite possible high political and social costs. An ambitious privatization agenda and improvements in the investment climate would fuel capital inflows, supporting EXD and LDM. Less positively, “reforms” could also take the form of tighter supervision of businesses and even greater state control of the economy.

To watch: Any government reshuffle could be a sign of impending changes, with personalities of new government officials most likely setting the direction of the change. The likelihood of changes will most likely increase after the politically important Winter Olympics in February.

6. Brazil gets ratings downgrade

S&P already has a negative outlook for Brazil and we believe a ratings downgrade could be coming next year. It is still unclear whether government efforts to curb public lending will be sufficient to contain fiscal risks. As we pointed out in a recent Brazil Viewpoint, the structural fiscal dynamics are still expansionary, and this may force the central bank to hike rates more than what we currently forecast. In other words, the current fiscal policy may prove inconsistent with Bacen’s objective of lowering inflation. Although Selic futures price in more hikes than we forecast, it is for these reasons why we view the riskreward as unattractive and prefer to stay square.

To watch: Pay attention to the evolution of the primary fiscal surplus and whether this converges on the target of 2.3% of GDP from 1.6%, and whether authorities actually follow through with their intentions to slow public lending in the face of weak growth

7. Tail risks to the Mexican reform tiger

Everybody loves Mexico, but there is a risk that the disappointment with the fiscal reform extends to the restructuring of the energy sector, which we expect to be enacted in 2013-14. Our base case is for the reform to constitute a productivity-enhancing game changer for the country. We see both upside and downside risks. The reform could allow production contracts for the riskier projects as well.

On the negative side, the reform could prove insufficient to entice foreign oil companies and open up the sector, which would have a large negative market impact. An upside surprise is more likely than a negative one, in our view, but the latter would have a more significant market impact. Prospects of lower foreign direct investment flows would weigh on the MXN, which is one of our top FX picks next year (vs EUR).

To watch:< /strong> We expect constitutional changes to be approved by 15 December while secondary laws may not be approved until 1Q14. The devil will be in the details of implementation with respect to private sector participation through profit-sharing contracts, the lowering of Pemex’s fiscal burden and private electricity generation.

8. Geopolitics rears its ugly head

Saudi Arabia and Israel may become increasingly worried about Iran in the next six months, possibly even resorting to tactics that would shake the region’s stability. Beyond the interim period, the deal may not live up to expectations given what appears to be little commitment at the top level in Iran. Therefore, medium-term risks to oil prices will remain.

Countries with relatively higher shares of energy in their CPI baskets could have upward pressures on their local curves if prices tend to adjust rapidly (e.g., Chile, CEE, Turkey or India), or to their CDS curves if governments tend to take the brunt of the adjustment (e.g., Indonesia).

To watch: It will be important to see how domestic politics in Iran change over the next six months with respect to the deal, as well as the stance of the other regional powers, Israel and Saudi Arabia. Actions by the US Congress could also derail the process.

Global sentiment could sour if tensions escalate between China and Japan over islands in the East China Sea. Japan and the US have yet to comply with the Chinese introduction of an air zone around the islands, which leaves room for tensions to escalate. The latest developments increase the risks for error and misjudgment, but the market is unlikely to increase the risk premium for now. There are risks that this may spill over into retaliatory economic policies (trade, investment, tourism).

To watch: The US recently tested China’s air defense zone and further US involvement could prevent some escalation by reducing the boldness of some hawks in China.

9. FX mortgages lawsuits in Eastern Europe

Lawsuits against banks on FX mortgages have appeared in several Eastern European countries, introducing new uncertainty on potential future compensation costs for banks but also providing the opportunity to reach a final resolution to the legacy stock of FX loans. In Hungary, the Kuria, which is the highest court, is due to give guidance on FX loans validity (outstanding stock US$17bn) and whether unilateral changes to the contract conditions should be permitted.

To watch: The Kuria will start the debate on 16 December. The completion date is unclear, but the government will announce its final relief package for FX borrowers as soon as the ruling is announced. The government is aware of the importance of preserving financial stability, and we believe it is unlikely to opt for an immediate and extreme resolution, even in the case of a harsh ruling from the court (i.e., immediate conversion in HUF at a preferential rate). However, the court ruling may provide legitimacy to drastic solutions that may be implemented over the course of several years. The Hungarian case may also prove to be a template for other countries with widespread FX loans.

10. Faulty bailouts

Ukraine can play contradictions between the EU and Russia for too long and end up with nothing after all. The country can fail to secure timely IMF funding early next year for political reasons (just as it did over the past two years), as well as fail to get any new loans from Russia without full membership in the Russia-led Customs Union (the key condition from Russia). As a result, domestic financial markets can destabilize, triggering a renewed currency run from the population in such a scenario. The latter could push the National Bank of Ukraine’s reserves below critical levels and force disorderly UAH devaluation and/or default.

To Watch: Be aware of NBU FX reserves dynamics. We estimate US$15bn (US$20.6bn as of 1 November) as a critical level, with reserves below it potentially forcing FX policy change. Any Ministry of Finance success in rollover of the FX debt can help to keep reserves above this critical level.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/bUQQZec4j1E/story01.htm Tyler Durden