Political and Economic Volatility in Important Markets

Jan. 31, 2014: Amid turmoil in international markets, there are a host of countries whose economic circumstances will be shaped ultimately by their geopolitical circumstances. A rush of repositioning in global capital markets has exposed very clear financial vulnerabilities in several countries. Though few countries are completely safe from the current economic turmoil, those caught in moments of political transition are particularly vulnerable. Indonesia, Ukraine, Thailand, India and Turkey are all countries where geopolitical shifts are intersecting with international economic volatility in a potent mix of potential instability. Read the full analysis here.

Emerging Market Turmoil and the U.S. Taper

Jan. 30, 2014: The U.S. Federal Reserve's decision to taper monetary expansion by another $10 billion Wednesday has major ramifications for world markets. In comparison to the total amount being spent on a monthly basis, the taper may seem gradual, but it has created an enormous hole in market demand. To put it in context, $10 billion of debt purchases is more than the average monthly portfolio investments into Turkey, India, Brazil, Indonesia, Thailand, Chile and Ukraine combined. The $20 billion that has already been removed from the market is roughly equivalent to the monthly flows of all those countries plus Mexico and Canada. 

The decision brings total U.S. monetary expansion down to $65 billion per month going forward until the next decision to scale down asset purchases in long-term treasuries and mortgage-backed securities. Ongoing purchases will add to an unprecedented $3 trillion growth in the balance sheet of the Federal Reserve since 2008. In the process, the Federal Reserve has played a key role in buoying global capital markets by sending investors who might otherwise have invested in U.S. assets searching elsewhere for a return. Read the full Geopolitical Diary here.

The U.S. Federal Reserve and the Taper

Dec. 19 2013: The U.S. Federal Reserve announced the long-anticipated beginning of what has become known as the "taper" Wednesday. The press conference announcing the decision, the last by outgoing Federal Reserve Chairman Ben Bernanke, allowed a peek into the mindset of an institution that has an almost mythical place in global economics. The Federal Reserve controls the dollar, and the dollar rules the world, or so the story goes. Indeed, the Federal Reserve has an enormous influence on increasingly complex and volatile global capital markets, which has very real implications for countries all over the world. Read the full Geopolitical Diary here.

U.S.: The Treasury Bill Renaissance

Dec. 10, 2008: A U.S. Treasury bill auction Dec. 9 resulted in investors eagerly seeking zero percent and even negative yields. Put simply, investors were willing to lock in a loss on their investment in order to guarantee that they would get most of their money back. The higher the demand for a bond, the less the issuer has to pay in interest.

In the world of financial trading, this is just about as desperate as traders get. As asset values collapse, those investing with borrowed money are forced to cover losses by either posting more collateral out of pocket or selling off assets – often at drastically reduced prices. This process, known as deleveraging, has investors of most stripes worried about further market collapse. Thus, even market participants who have not employed dramatic leverage have pulled their money out of most types of investments and plunged it into what is broadly considered the safest investment in the world: U.S. Treasury bills. Read the full analysis here.

Geopolitical Diary: Rate Cuts Nearing the Bottom

Dec. 8. 2008: Four central banks in Europe lowered their benchmark interest rates on Thursday. The European Central Bank (ECB) cut its rate by three-quarters of a percentage point to 2.5 percent, Swedish Riksbank by 1.75 points (a record cut) to 2 percent, the Danish central bank by three-quarters of a point to 4.25 percent, and the Bank of England (BOE) by 1 point to 2 percent (the lowest rate since 1951). New Zealand’s central bank also cut its rate by 1.5 points to 5 percent — a record and the bank’s fourth cut since July.

With investor, business and consumer confidence low across the board, these reductions are meant to spur consumption and keep the economy from weakening further. However, by dropping rates to such low levels, the Europeans are getting dangerously close to using up their last remaining policy option to encourage economic activity. Read the full Geopolitical Diary here.

United States: Shifting Risk from the Treasury to the Fed

Nov. 25, 2008: In the latest move to shore up U.S. debt markets, the Federal Reserve has introduced programs to fund not only mortgage-backed assets, but also assets backed by other consumer loans. The move marks another shift in government strategy by transferring certain risks from the Treasury Department to the Fed.

The global financial crisis started with the U.S. subprime housing market. Mortgage brokers extended credit to customers who probably should never have qualified for their mortgages. The brokers then sold those mortgages to banks and trading houses, which packaged them into blocks with other (healthier) mortgages and sliced them up to sell as tradable securities like stocks or bonds. Because mortgages normally are considered among the safest types of assets — homeowners tend to bite many bullets before failing to make their payments and becoming homeless — these securities traded at very low risk levels. Read the full analysis here.

Global Market Brief: The Biggest Piece of the Plan

Sept. 19, 2008: Details have yet to be fully released regarding a massive U.S. market intervention plan announced earlier today by U.S. President George W. Bush. We expect more details to follow shortly. Congressional leaders on both sides of the aisle have already signed off on the Treasury’s plan, so the process of making the deal formal should be hammered out in days, if not hours.

The biggest piece of the plan that we do know is that Congress will empower the Treasury to purchase distressed mortgage assets for rehabilitation. Read the full analysis here.

Global Market Brief: The Mortgage 'Bailout' Plan and the U.S. Economy

July 14, 2008: U.S. Treasury Secretary Henry Paulson has announced a "bailout" plan for the country's two biggest mortgage firms, Fannie Mae and Freddie Mac. Details remain sketchy, but assuming it does not end in unmitigated disaster, this bailout could alter how the American economy is run.

Fannie Mae and Freddie Mac are the colloquial names for the Federal National Mortgage Association and Federal Home Loan Mortgage Corp. Their mission is simple: translate preferential access to capital into more accessible funding for mortgage seekers. Fannie Mae was formed in 1938 as a government agency as part of an effort to mitigate the Great Depression by boosting the housing market. Fannie Mae was formally privatized, and had Freddie Mac hived off from it, in 1968 with the intention of injecting more competition into the market. Turns out things did not quite end up as intended. Read the full analysis here.

U.S.: Mortgage-Backed Securities and the Global Credit Crisis

March 24, 2008: The U.S. Federal Reserve Board and the Bank of England on March 23 denied a March 22 Financial Times report that they are considering making bulk purchases of mortgage-backed securities to ease the global credit crisis. Citing unnamed sources, the economics editor of the Financial Times had described the British central bank as being enthusiastic and the Federal Reserve as being "open in principle" to such purchases.

The argument for making this move is that the valuations of mortgage-backed securities have been marked down to such unrealistically low levels through "mark-to-market" accounting practices that the banks and financial institutions holding them are having to write down these assets well below face value. But while face value of these securities might be too high in the current deteriorating housing market on both sides of the Atlantic, actual house prices have not fallen by anywhere near the proportion of the derivatives they underpin. It was this massive write-down of asset values at Bear Stearns that caused its stock to crash, nearly bankrupting the firm and enabling JP Morgan Chase to pick it up at $2 a share. Read the full analysis here.

Geopolitical Diary: The Fed's Rate-Cut Decision

March 18, 2008: The U.S. Federal Reserve reduced its headline interest rates from 3 percent to 2.25 percent on Tuesday afternoon. The cut, which was a quarter point less than the consensus expectation of 1 percent, followed the Fed's March 16 redefinition of the rules of borrowing. Nevertheless, the U.S. markets did not plummet in disappointment.

It is always difficult to understand the Fed's reasoning. A guess would be that this actually was an attempt to instill confidence in markets. A full point cut might have been perceived as ongoing panic, while a smaller cut might have been seen as too much concern about inflation — not a trivial fear, but not good for the markets. A three-quarter point cut may have been an attempt to cut interest rates while still showing some confidence. Read the full Geopolitical Diary here.

U.S.: The Fed's Half-Percent Interest Rate Cut

Sept. 18, 2007: The U.S. Federal Reserve cut interest rates from 5.25 percent to 4.75 percent Sept. 18. The Federal Reserve has not cut rates since the months after Sept. 11, when the fear was global recession. A half-point cut is not a minor action, but instead a serious step the Fed does not undertake lightly, particularly as signs of strengthening inflation — whether they be import prices or higher energy costs — are becoming more prevalent. Such a sharp rate cut indicates that the Fed fears that either the United States is flirting with recession or it is already entering one, and the best way to turn the system around is to reduce the cost of capital. Read the full analysis here.

U.S. Economy: Rates and Recessions

Aug. 9, 2006: The U.S. Federal Reserve Board chose to hold interest rates steady at its Aug. 8 meeting, leading most market watchers to point to the decision as support for their own pet economic theories.

Regardless of what one thinks about the Fed, interest rates or tea prices in China, one thing is becoming abundantly clear: The U.S. economy is slowing, and it is facing a potential recession.

Second-quarter worker productivity figures came in at an annualized 1.1 percent, while gross domestic product (GDP) growth was 2.5 percent and labor costs rose 4.3 percent. Read the full analysis here.

Global Market Brief: Inflation Doves and the Icebergs Ahead

Nov. 8, 2004: Robert McTeer, chairman and CEO of the U.S. Federal Reserve Bank of Dallas, resigned Nov. 5 to become chancellor of the Texas A&M University system. His departure presages the beginning of a severe shift in U.S. monetary policy, which most likely will result in sharply slower economic growth globally.

The U.S. Federal Reserve is charged with keeping employment, growth and inflation in some sort of balance, with interest rates being the biggest tool in the box. Lower rates reduce the costs of borrowing — for a house, a credit card or Wal-Mart's or ExxonMobil's next major construction project — which directly or indirectly leads to hiring. The net result is more economic activity, higher growth and higher employment. The downside is that all the demand for resources, labor and even the credit itself increases the cost of doing business: inflation. Conversely, the Fed must on occasion raise rates to put the breaks on the economy, damping inflation at the cost of growth. Read the full analysis here.