A plan for a plan is not a plan, says HSBC on Friday.
And this is the reason why QT is the risk now, not QE.
Quick explainer: QT is what HSBC’s senior FX strategist Daniel Hui et al are calling quantitative tightening — a.k.a. the opposite of quantitative easing.
In response to the G20′s final communiqué on Friday, they write:
It is not surprising that to agree to agree on a framework, is much less actionable than an agreement to actually act. In the final communiqué, what was newly announced was an enhancement to the Mutual Assessment Process (MAP), which will now assess “persistently large imbalances” against “indicative guidelines”.
However, it is telling that an agreement even on which indicative guidelines (e.g. current accounts) would be used could not be agreed upon. This will only be decided in 1H 2011 by Finance Ministers and Central Bank Governors, with the aid of the IMF – in other words an agreement to agree later.
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It seems very clear that this G20 statement will do little to really stem the near-term trend towards more unilateral policymaking. The US will continue its QE2 program until it meets its objectives, and the EM central banks will continue to counter QE with QT (quantitative tightening).
In the current environment though, QT may also be summed up as currency unilateralism.
More specifically, it’s the idea that to counter QE in the west, emerging markets in particular, will feel the need to tighten money supply instead.
Yes. Tighten. Not ‘devalue’ or ‘loosen’.
This makes sense if you believe the US is pretty comfortable with QE because its economy is still set up to export much of the inflation it creates.
As Hui explains:
It was widely assumed that, absent an agreement, inclined EM regulators would wait until after the G20 meetings to move forward with plans to implement more QT. As it turned out, some policymakers, particularly in Asia, in fact pre-empted the G20 meetings with a rash of such QT announcements happening this week leading up to the G20 communiqué.
That China should move pre-emptively to deflect appreciation pressure says much about the general concern about the weight of capital inflows – given China has the most controlled and closed capital account in the region. The phenomenon of hot money inflows adding to additional pressure for RMB appreciation, and complicating overall FX and monetary management, is as old as the debate over RMB appreciation itself – this is why two-way volatility has been such a prominent characteristic of China’s new FX regime since June.
Moves to reinforce China’s existing exchange control rules and other measures to discourage speculation is not new, but the degree to which they have been enforced this week has been surprising and unprecedented. On Tuesday, the Chinese State Administration of Foreign Exchange (SAFE) announced seven measures to strengthen the management of FX operations1. The primary target seems to be
speculation suspected to be occurring through otherwise legitimate onshore corporate activity.
On top of China, he adds, there have also been recent tightening or capital protectionist moves from South Korea, Indonesia, Taiwan and the Philippines, as well as some in Latin America.
And all this partially explains the volatility which has flown into FX markets ever since QE policies began.
Best to think of it in simplified terms like this: The current set-up sees the US and much of the non-manufacturing ‘west’ export inflation by bidding up prices for goods or assets in emerging markets. In turn, these countries import deflation by underpaying for goods, which would otherwise be much more expensive to buy if domestically produced.
But as everyone knows, even despite the global crisis, inflationary forces are still on the prowl in emerging markets. Meanwhile, deflation is now ‘the’ risk back in the US.
It’s almost like the two forces have overshot and switched over.
Realistically the US should try to stop exporting all that inflation, and hold a bit of it back for itself — perhaps by encouraging a domestic manufacturing base to be developed again, à la the German suggestion.
Obviously, the problem with that policy is that it takes time to incubate– something the US definitely didn’t have time for back in 2008.
The hope with QE was clearly to splash a bit of inflation back into the domestic system as quickly as possible but to rely on those deflationary forces flowing back from EM to dampen any long-term inflation risks.
But here’s the thing, QE’s intended aim has always been to support assets rather than consumer prices.
Too much of that effect may now be pouring directly into EM via hot money flows seeking yields, rather than through trade. Not only does this heighten the risk of inflation double-backing into the US (the west is stealing our yield!), it risks destabilising real home-grown and non US-export dependent growth in emerging markets too.
The temptation for quantitative tightening in emerging markets suddenly becomes abundantly clear.
It’s sort of like EM markets saying: “We’ll keep our yields for ourselves, thank you very much!” And “No, we don’t need a weak currency anyway, because we’re no longer dependent on you for our growth.”
Of course, if QE2 flows are prevented from securing high yields in the only places that still really generate growth, they’ll eventually be forced back into the low-yielding environment of the west.
While that could eventually encourage money to flow into riskier assets like equities — what the Fed wants — it could also see everyone paying much more for everything else as well.
In other words, QT equals inflation risk in the US.
Related links:
Emerging markets at risk from a gigantic bubble - FT
Investing in local currency bond markets – NBER
Global imbalances and EM financial markets – FT Alphaville