Can trade talks, US Fed clear ‘dark­en­ing skies’?

The Star Malaysia - StarBiz - - News - Plain speak­ing YAP LENG KUEN star­[email protected]­tar.com.my Colum­nist Yap Leng Kuen is look­ing at po­ten­tially volatile mar­kets.

JOB cuts, lower profit fore­casts, cost cut­ting, wor­ries on debt in the US and else­where and con­cerns about China’s econ­omy are putting a strain on the global econ­omy.

It looks like this new year is be­gin­ning with not much good news, even the on­go­ing US-China trade ne­go­ti­a­tions are scant on de­tails. De­scribed as “speed dat­ing,” the talks seem to be mov­ing back and forth be­tween Bei­jing and Wash­ing­ton, and from mid­dle to higher lev­els.

All this time, the as­sur­ance is that it is pos­i­tive while the de­mands from the US side are said to be “dra­co­nian,” there is un­cer­tainty whether the two sides are still far apart on is­sues re­lat­ing to, for ex­am­ple, in­tel­lec­tual prop­erty.

Hope­fully, their so-called speed dat­ing does not hit “speed bumps” as hasty mar­riages may not al­ways end well.

It may be so far, so good but con­crete re­sults are re­quired in a sit­u­a­tion that can be con­sid­ered ur­gent, where eco­nomic con­di­tions have sud­denly turned for the worse

Both par­ties have wasted a lot of time; when they should be find­ing a res­o­lu­tion much ear­lier, they were tus­sling with tar­iffs and counter tar­iffs and the sit­u­a­tion de­te­ri­o­rated.

Af­ter an ini­tial rally, mar­ket sen­ti­ment could not be sus­tained on this trade op­ti­mism for which pos­i­tive re­sults are es­sen­tial in re­build­ing the con­fi­dence that was bro­ken in the months of in­tense trade fight.

“A res­o­lu­tion of trade ten­sions be­tween ma­jor economies could lift sen­ti­ment and sup­port global in­vest­ment and trade,” said World Bank in its lat­est “Dark­en­ing Skies” re­port.

New US tar­iffs and the re­tal­ia­tory re­sponse of trad­ing part­ners now af­fect al­most US$430 bil of global im­ports; about 2.5% of global trade is af­fected by tar­iffs that were im­posed last year, said World Bank.

More than 5% of global trade would be im­pacted if all new tar­iffs un­der con­sid­er­a­tion are slapped, in the event present talks fail. Dis­or­derly fi­nan­cial mar­kets also dent con­fi­dence and busi­ness sen­ti­ment.

The Fed turn­ing cau­tious and pa­tient on fur­ther in­ter­est rate hikes tem­po­rar­ily calms sen­ti­ment In mar­kets which have largely dis­counted these fur­ther in­creases.

How­ever, com­plaints of over­tight­en­ing does not only in­volve ag­gres­sive Fed rate hikes (four last year) but also its monthly with­drawal of liq­uid­ity, cur­rently at US$50 bil, un­der its bal­ance sheet re­duc­tion cur­rently on au­topi­lot.

Is that too much of a dou­ble whammy – rais­ing rates and at the same time, suck­ing out stim­u­lus liq­uid­ity, called quan­ti­ta­tive eas­ing (QE), it in­jected into mar­kets since the 2008 fi­nan­cial cri­sis.

Amidst these tight­en­ing ef­fects, mar­kets are try­ing to size up how much “sub­stan­tially smaller” will the Fed bal­ance sheet get, and how long it would take for the bal­ance sheet to get to a more nor­mal level.

With no an­swers in sight, the un­cer­tainty does not bode well for mar­kets.

Fol­low­ing the 2008 fi­nan­cial cri­sis, the Fed had in­jected US$4.5 tril­lion into mar­kets via bond pur­chases; that amount has now shrunk to about US$4 tril­lion as the Fed re­duces its bal­ance sheet.

With re­serves drop­ping at a faster rate than the shed­ding of US Trea­sury and mort­gage bonds, there is a pos­si­bil­ity the Fed may slow down the pace of de­cline in re­serves.

The Fed has shed about US$400bil of bonds but re­serves have dropped to US$1.51 bil at the end of 2018, com­pared with a peak of US$2.7 tril­lion in 2014, ac­cord­ing to a Reuters re­port.

“The pace of de­cline de­pends on how fast the bonds pur­chased un­der QE pro­grammes ma­ture and get rolled off the Fed’s bal­ance sheet. Some­time this year, the roll-off will peak and then, fall off,” said Pong Teng Siew, the head of re­search of In­ter Pa­cific Se­cu­ri­ties.

The pos­si­bil­ity of a faster than ex­pected tight­en­ing of global fi­nanc­ing con­di­tions is among the risks of dis­or­derly fi­nan­cial mar­ket de­vel­op­ments.

With mar­kets ex­pect­ing a pause in rate hikes while the Fed is still in­di­cat­ing per­haps two more in­creases, a sharper than ex­pected rise in US bor­row­ing costs may cause fi­nan­cial stress that has con­ta­gion ef­fects.

The Fed is now pa­tient in wait­ing for data to show up, but con­tin­ued US growth (the pay­roll re­port showed 300,000 jobs added in De­cem­ber al­though the US gov­ern­ment shut­down can af­fect the re­lease of data for Jan­uary) can send it back into rate hik­ing mode on an ar­ti­fi­cially strong econ­omy.

Mar­kets that are ral­ly­ing on pos­i­tive head­lines are sadly miss­ing the point that even with­out rate hikes, the con­tin­ued rolloff in the Fed’s bal­ance sheet, has the ef­fect of tight­en­ing.

It is a frag­ile sit­u­a­tion that is com­pounded by ex­tremely beaten down val­u­a­tions; the “dark­en­ing skies” are not go­ing to turn bright any­time soon.

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