Well what do you know? For all the recent criticism of the dollar by leaders of the so-called BRIC economies, and the resulting fall in the US currency, Bloomberg reports on Wednesday that dollar bonds sold by the largest emerging-market countries are outperforming debt traded in reals, rubles and yuan.
This despite the fact that Russian president Dmitry Medvedev, Chinese president Hu Jintao, Indian prime minister Manmohan Singh and Brazilian president Luiz Inacio Lula da Silva called for a “more diversified” monetary system on Tuesday to reduce dependency on the world’s reserve currency. The four leaders were meeting in the Urals city of Yekaterinburg, where they planned to discuss buying each other’s bonds and foreign exchange – and more broadly, proposals to replace the dollar as the reserve currency.
But even as they spoke, it emerged that dollar bonds sold by China earned 11.4 per cent in the past year, more than double the 4.6 per cent for yuan-denominated debt, while Brazil’s US currency bonds returned 3.6 per cent even as real-based notes lost 4.9 per cent, and Russia’s dollar bonds outperformed with a 1.9 per cent loss compared with a 7 per cent drop in ruble debt, noted Bloomberg. India doesn’t have dollar-denominated debt.
Bonds sold in dollars have beaten domestic debt in part because Russia and China manage the ruble and yuan, explains Bloomberg. Those denominated in the US currency can trade more freely. The result – ironically – is limited foreign investment in local-currency bond markets. Only Brazil’s real is free-floating, while India imposes capital controls to protect the rupee.
Ultimately, however, it seems Russia is not really sure what it thinks of the dollar, given its sharply conflicting signals this week. On Monday, US Treasuries climbed after Russian finance minister Alexei Kudrin reassured markets that there was “no alternative” to the dollar, which he noted was in “good shape”. The next day, Moscow emphasised that the reserve currency issue would be on the agenda at the summit.
These wobbles followed last week’s G8 meeting at which IMF chief Dominique Strauss-Khan and others attempted to pre-empt a rapid decline in the dollar and talk the currency up.
In the view of CMC Market’s Ashraf Laidi, such dollar rhetoric as well as increased scrutiny over the durability of the 40-45 per cent rally in world equity indices is leading to a simultaneous retreat in risk appetite – and accompanying implications of broad gains in the dollar and the yen.
While an incipient retreat of 3-5 per cent in equities is inevitable in the short term, says Laidi, the extent of its dollar-supporting effect depends on escalating “event risk”, (eg, Latvia, negative earnings guidance, soaring yields) rather than profit-taking without discernible rise in volatility. A decline in G10 equities would also feed into declines in emerging markets, “where the bulk of risk-seeking cash is allocated”.
The big news in currencies, however has been sterling’s strong performance in the past days, relative to all risk-currencies except for Australian and New Zealand dollars, notes Laidi. The absence of negative news flow in UK banks combined with broadening evidence of stabilising house prices has helped fuel risk capital into the currency.
The dollar outlook however is not so rosy, according to some. Richard Grace, chief currency strategist at CBA in Australia, sees it declining, not least in the face of sterling’s improved performance. He notes five major reasons why sterling is likely to outperform in coming months:
- The UK economy is showing signs of improvement. Data suggests April was a major turning point for the UK economy. Exports registered their first monthly rise in April after five consecutive monthly declines; April imports rose for the first time in six months; industrial production rose in April for the first time in more than a year; net consumer credit accelerated in April after three months of modest growth; retail sales grew in the two consecutive months to April, the first time there has been two consecutive monthly gains since July-August 2008; UK house prices showed positive monthly gains in the three months to May; all three UK PMI leading indicators (construction, services and manufacturing) have shown a notable pick-up from their low points, and the June UK service PMI is back into expansionary territory (above 50) and performing better than the PMI’s in other countries.
- The relative improvement in the UK economy compared to the eurozone economy is reflected in the evolution of a narrowing eurozone minus UK 2009 expected real GDP growth spread.
- The UK trade weighted index has undergone a massive competitive depreciation, falling 31 per cent between January 2007 and December 2008, which should help the UK economy as global growth slowly improves. Already UK exports have turned positive in April.
- Despite S&P affirming the sovereign rating for the UK economy but revising down the outlook from stable to negative, the sovereign checklist for the UK economy stacks up better than the sovereign checklist for the US economy in four of the five major categories. The implication, in Grace’s view, is that currency-reserve managers are likely to reduce their dollar holdings as a way to reduce risk.
- The GBP/CHF exchange rate is likely to continue to appreciate, correcting its large 40% decline between July 2007 and December 2008. The rate of improvement in the UK economy is proving better than in the Swiss economy, a fact which could also buoy sterling.
In another glum note for the dollar, we’re looking at Tuesday’s commentary by MarketWatch’s Irwin Kellner, who notes that the Federal Reserve is creating dollars at such a rapid pace that “the dollar has only one way to go – down”. In his view, it’s nothing more mysterious than supply and demand.
Related links:
Russia’s win win – FT Alphaville
Another illogical Russian smackdown for US treasuries – FT Alphaville