Fall in world reserves sparks liquidity concerns

THE decline in world central bank reserves is being monitored as a protracted fall will likely affect liquidity and hence, stockmarkets.

Past correlations between the fall in world reserves and the FBM KLCI indicates a potentially volatile period ahead.

World central bank reserves have fallen for the fifth week since a peak in the week ended April 27; the FBM KLCI had peaked on April 20, and had generally declined since then.

The last peak for world central bank reserves was on Aug 1, 2014, following which they declined to their lowest level in January 2017; they went on a rebound that lasted until April 2018.

Almost coinciding with the peak level of world central bank reserves, following the week ended July 11, 2014, the FBM KLCI had started on a general decline for a protracted period.

“Since the dollar makes up 63% of world central bank reserves, the reduction in the Fed balance sheet will lead to a further drop in these reserves as money flows back to the United States, causing a shortage of dollars in the financial system,” said Pong Teng Siew, head of research, Inter-Pacific Securities.

Eventually, this shows up as a fall in liquidity in the financial system; in equities, rapid sales may trigger sharp price drops.

The Fed plans to lower the balance of Treasuries and mortgage-backed securities by US$420bil in 2018; by up to US$600bil in 2019 and every year onwards, until it decides that “the balance sheet has been normalised”.

Three rounds of asset purchases from 2008 to 2014 had pushed the Fed’s balance sheet from US$800bil in 2006 to US$4.5 trillion.

The Fed’s plan to unwind its bond purchases, initiated after the 2008 financial crisis as a stimulus programme, is proceeding like clockwork, even during the sell-off in February this year.

“It won’t take Wall Street whining seriously until credit starts to freeze, and credit markets are far from that,” said Business Insider.

One argument for ending these bond repurchases is in case the Fed needs to restart the bond buying programme during a future recession.

Already some expect the US bond yield curve to flatten and possibly invert, in one or two years, indicating a negative outlook on the economy.

Central bank chiefs of India and Indonesia had urged the Fed to slow down on its stimulus withdrawal, pointing to the huge US debt issuance, together which may cause an emerging market (EM) crisis that could also hit developed markets.

Indonesia had seen investors dumping US$1.9bil of government bonds since the end of March. It had raised rates twice last month to defend its currency.

Affected by the EM rout, India’s rupee is down 4.6% against the dollar. For the first time since 2014, India raised its benchmark rate.

“The US economy is on a stronger growth trajectory; it is tailoring its dollar monetary policy to the requirements of its own economy, not those of other countries,” said Pong.

Conditions will get tighter if the European Central Bank’s stimulus programme ends in September.

“But the magnitude of portfolio outflows this time compared with previous episodes such as during the Fed’s Taper Tantrum of 2013 (when investors panicked on news that the Fed would stop repurchasing bonds) and concerns on the China economy in 2015 (when growth was weakest in 25 years).

“Capital outflows are unlikely to trigger a broader EM crisis and contagion risks of EM asset classes associated with the weakest links in Argentina and Turkey,” said Lee Heng Guie, executive director, Socio Economic Research Centre.

Broadly, this is due to improved fundamentals in terms of fiscal budgets, current account balances, external debt exposure and exchange rate flexibility.

With more timely information, investors are regarded to be more discriminating.

India and Indonesia, two victims of the 2013 Taper Tantrum, now have lower current account deficits.

Will Malaysia raise rates?

“There is no threat of high inflation. With some adjustment and deferment of public consumption and spending, no drastic change in local rates is expected,” said Danny Wong, CEO, Areca Capital.

“Monetary policy is likely to favour growth in view of lower spending in infrastructure projects,” said Thomas Yong, CEO, Fortress Capital.

“The foreign exchange market seems relatively contained amid net foreign selling of domestic equities and bonds,” said Lee.

Will the stockmarket hold up?

“After a month of adjustment, following the change in government, Bursa Malaysia is likely to revert towards the trend in regional EMs,” said Yong.

“Conducive business environment with better government policy will attract foreign direct investments and foreign inflows,” said Wong. “Higher earnings and expansion in price to earnings will drive the market higher.”

Columnist Yap Leng Kuen hopes that fundamentals will prevail.