Author Archive for Marc Chandler

Thinking about the Cost of College

By Marc Chandler, Global Head of Currency Strategy, Brown Brothers Harriman

The beginning of the new school year heightens the anxiety over the rising cost of higher education. The cost of a college education is increasingly beyond the means of average American family. Tuition has risen faster than inflation, student debt has soared and jobs are difficult to secure.

At the same time, it seems that more people are questioning the value of a college degree. The New York Federal Reserve’s Current Issues newsletter recently took a look these issues. The authors, Jaison R. Abel and Richard Peitz, also posted an article “The Value of a College Degree” on the NY Fed’s blog Liberty Street that looks at the cost of an associate and bachelor’s degree. They conclude that the benefits still outweigh the costs. While the cost have risen, the wages to workers without a two or four-year degree have fallen.

NPV College

These two Great Graphics come from their work and illustrates their conclusion. This first chart shows their calculation of the net present value of a bachelor’s degree between 1970 and 2013. It is expressed in constant 2103 dollars.

They estimate that the value of a four-year college degree fell from about $120,000 in the early 1970s to about $80,000 in the early 1980s. It then proceeded to more than triple in the next decade and a half to nearly $300,000 by the late 1990s. It has been surprising stable since. It has eased a bit in in the post-crisis period, but it remains near the all-time high.

Recoup College

The second chart shows how long one needs to work to recoup the cost of college. The authors use the discounted cash flows that were used to calculate the net present value to determine how many years it take to turn the cash flow positive. To say the same thing, after earning a four-year degree how many years does it take to recover the cost of the degree.

It shows that the time required to recoup the costs of a bachelor’s degree has fell significantly in the 1980s and then leveled off. In the late 1970s, it took nearly two decades to coup the cost of college. Now it takes about half as long.

The authors conclude that the value of a college degree remains near its historic highs, while the time to recoup the cost is near historic lows. This study is part of a larger work. In an essay earlier this year, the authors calculated the return on investment for the average colleges student was about 15%. In a subsequent report, the authors look at the distribution of the wages earned by college graduates and find that for a sizable fraction, a college degree has not paid off. College may be a negative investment for one in four who attend.

Spot the Secular Stagnation

By Marc Chandler, Global Head of Currency Strategy, Brown Brothers Harriman

This Great Graphic was tweeted by the Financial Acrobat. The charts show US and euro area GDP in log charts that also plot the pre-crisis trend.

It is clear that the crisis has thrown the US off its prior path, but it now appears to be on a parallel path, that is lower.

secular stagnation

Growth in the euro area has also broken down. It has yet to initiate a new expansion trend, which is in part, why some do think that it has not really and truly exited its recession.

One of the big macro views that has shaped the debate in recent months is the resurrection of the previously discredited “secular stagnation” hypothesis by Lawrence Summers. The concept was first proposed by Alvin Hansen in the 1930s. It died an ignoble death as the US (and world) entered a long expansion wave. Marxists, like Magdoff and Sweezy tried reanimating the theory in the late 1980s, but offered a considerably nuanced view.

Magdoff and Sweezy generally argued that while mature capitalism was prone to stagnation, there were a number of mitigating factors, like government spending and permanent government deficits. In an essay published in the early 1980s, Sweezy wrote: “Does this mean that I am arguing or implying that stagnation has become a permanent state of affairs? Not at all.”

Looking at chart on the left, the idea of secular stagnation in the US does not come to mind. The slope of the GDP in the euro area is not as steep as the US prior to the crisis and the economy appears to have gone no where in the last 6-7 years. Does this qualify as secular stagnation?

Chart of the Day: Inflation Fears are Rising

By Marc Chandler, Global Head of Currency Strategy, Brown Brothers Harriman

This Great Graphic was tweeted by, and comes from Deutsche Bank which used EPFR data.  The chart depicts the money flowing in and out of the ETFs and open-ended mutual funds that offer investors protection from inflation.

Such funds have been experiencing net new inflows recently.   With stronger US jobs growth, and clear signs that the Q1 contraction was not a precursor of a recession, investors have become concerned about inflation.    June CPI figures will be released next week (July 22).  The core rate has risen by a cumulative 0.7% in the three months through May, which is twice the past over the previous three month period.

The Fed’s preferred inflation measure is the deflator of personal consumption expenditures (PCE) and, as we have noted, CPI tends to run at a slightly faster clip than the PCE deflator.  In addition, with wage growth stagnant  and other measures slack in the labor market, it is difficult to envision a bout of demand-pull inflation  At the same time, commodity prices have weakened, and cost-push inflation does not look particularly likely either.

There have been a few inflation scares in the recent past.  There have been some spikes of inflows into such funds as some investors seek protection.  At the same time, US yields rose last year without inflation rising.  Some investors seek protection not from inflation per se, but from rising interest rates.  Funds investing in floating rate notes have also been popular in recent months.  Not only has the US Treasury issued floating rate notes, but so have many corporations.


Exaggerating the Dollar’s Demise

By Marc Chandler, Global Head of Currency Strategy, Brown Brothers Harriman

The headline of the Financial Times today reads “Paris rails against the dollar’s dominance.” It could have been written nearly any time in the past half century. After all it was a former French President Giscard d’Estaing, who as finance minister in the 1960s, complained about the “exorbitant privilege” that the US drew from the role of the dollar (the phrase is often attributed to Charles De Gaulle).

In the mid-1960s, Servan-Schreiber’s book, “The American Challenge” warned that through the dominance of the dollar, the US was colonizing Europe. In the early 70s, it was France’s demand for gold in exchange for US Treasuries that strained Bretton Woods arrangement to a breaking point.

The proximate cause of the latest reiteration of the traditional French position is the large fine imposed on one of France’s largest banks for violating US sanctions. As part of the penalty, the US took what appears to be an unprecedented step to deny the French bank the ability to clear dollar trades for a full year, starting in January.

BNP pleaded guilty to two criminal charges. It was fined almost $9 bln (2013 profits ~$6.5 bln). Nearly four dozen employees were disciplined. About a dozen lost their jobs, including the COO of the US operation. Top officials in the French government tried to lobby for a smaller penalty, including the President, Finance Minister and Foreign Minister. They warned that it could tilt the balance away from the free-trade agreement that is being negotiated. The central banker warned that it could accelerate efforts to diversify away from the dollar.

In explaining its rationale for a stiff penalty, US officials cited several considerations. First, the sheer volume of the transactions is notable. They are estimated to be near $200 bln. Second, was the egregious nature of the conduct and circuitous efforts to conceal the activity. Third, the illegal activity apparently continued after the inquiry began. Fourth, high ranking officials helped hinder the investigation. Fifth, previous fines on international banks were not functioning as an effective deterrent.

Russian President Putin, no fan of the dollar and US hegemony, claimed that the actions against BNP were an effort by the United States to get leverage over France to renege on its agreement to deliver two Mistrial amphibious ships to Russia. Putin claimed that the US offered to reduce the fine on BNP if the French complied.

There is simply no evidence for this claim, and it seems to be predicated on a naive view of the US government. However, it has not stopped many in the blogosphere from simply repeating Putin’s claim as if disinformation and attempts to sow discord is not a tool of the Russian President’s arsenal. While the Department of Justice and the Federal Bureau of Investigation were involved, the NY Financial Services Department and the Manhattan District Attorney appear to be the driving force and it is not clear that they would have acquiesced to the kind of linkage Putin suggests.

The point is that US government is not some kind of homogenous whole with uniform interests. Consider that the nearly $9 bln fine was split between the Federal government and the state governments. The NY Financial Services Dept received about 1/4 of the settlement and this will be turned over to the state’s general fund. The Manhattan District Attorney’s office will receive another quarter of the settlement. The bulk ($1.7 bln) will go to state and city governments, but about $450 mln, which is five times the office’s budget, will be used for its anti-crime activities. Surely, if the Federal Government tried to strong arm the local authorities, there would have been a push back and Putin would not be the only one to make the claim.

BNP was the seventh large bank caught in 5-year investigation of the Manhattan District Attorney’s office into violations of US sanctions. The investigation is ongoing, and it may include at least two other large French banks, as well as a large German and Italian bank. For some banks and bankers, the statement by a Standard Chartered official chafing under its own fine, expresses a shared sentiment: “You Americans,” he was quoted in the press saying, “Who are you to tell us, the rest of the world, that we’re not going to deal with the Iranians.”

One might disagree with which countries the US sanctions, but surely it is the right of a sovereign to make such a decision. Yet the claim that the sanctions allow the US to police business arrangement that do not involve Americans is not really true. Given the way the financial system operates, if dollars are used for trade or investment, the transaction likely involves a US bank in the US.

Moreover, the sanctions were not capricious, not publicized (unknown) or imposed after the fact. The sanctions against Sudan, which is where BNP’s violations were concentrated, have been in place since 1997 and were tightened in 2006. Press reports suggest that internal BNP documents showed that senior bank officials were well aware of the atrocities that led to the sanctions.

Banks were also warned. In 2006, the Bush Administration warned foreign banks doing business in the US that they would be prosecuted if they helped sanctioned countries. According to the Wall Street Journal, BNP told employees in 2007 that it would cease sanction-busting actions. Instead, it appears they developed an elaborate payment structure, routing transactions through satellite banks, which would strip crucial information off wire transfers as they passed through the US system and banks.

Even though many senior BNP officials appeared to have known about the deceit, the CEO indicated that breaking the sanctions was “something that goes against the grain of the bank.” It has taken steps to strengthen internal controls and going forward, all dollar transactions will be properly routed through NY. Reports suggest that other European banks are tightening their internal controls to ensure compliance with US rules.

The US struggles to convert its financial power into political influence. Consider who the US provides aid to, for example, and then look at how countries vote at the UN. This effort becomes all the more important in an era in which the US is war weary. The function the dollar serves in the world economy is a “public good”, like protecting the sea lanes and its nuclear umbrella. Surely, it can have some say in how that public good it provides is used.

The US is saying that if one is going to use the public good it provides, do not do so to aid an adversary. Do not use dollars to harm US interests, as its elected officials have defined it. If a bank wants to function as the central bank of Sudan, as BNP was accused, it cannot use the dollar.

Will this increase the pressure to diversify away from the dollar as Putin hopes and French officials claim? Probably not. The problem is the lack of a compelling alternative. When the euro was first launched, many argued at the time, that this was the first alternative to the dollar and business and investors would jump at the opportunity. They really haven’t. Many investors still harbor serious reservations about the longevity of the experiment in monetary union without political union. For a brief moment a few years ago, the possibility of a new monetary regime, based on the SDR, captured many imaginations for naught.

The internationalization of the Chinese yuan is being heralded as the latest dollar-buster. It is not. The swap lines it has set up with several dozen countries have not been used. Last month, MSCI declined to integrate Chinese shares into its global indices because of various market restrictions and lack of transparency. Investors need permission to invest in China (QFII or RQFII) and countries have to negotiate with China to set up off-shore yuan trading centers.

Less than a year ago, some observers were arguing that the cyber-currency Bitcoin could supplant the dollar. One large US bank even argued that central banks should put some of their reserves in it. The desire to find an alternative to the dollar is real, but the role of the dollar in the global economy has not changed very much in recent years. In many respects, whatever rise the Chinese yuan is experiencing appears to be coming at the expense of other currencies, not the dollar.

The safety, liquidity and transparency of the US Treasury market know no rivals. More than half of all cross-border loans and deposits are in US dollars. According to the Bank for International Settlements, the dollar is on one side of 87% of all the trades in the more than $5 trillion a day foreign exchange market (up from 84.9% in the previous survey). The dollar remains the benchmark price for oil and most commodities. When investors want to hedge their exposures, they use a dollar-denominated derivative market instrument.

The US often is accused being short-sighted and not playing the long-game. Yet, at the risk of deterring buyers of its debt, the Treasury Department’s semi-annual report on the international economy and foreign exchange market pulled no punches. It wants officials to stop buying Treasuries, which it sees as a way countries evade making the necessary adjustments to reduce imbalances that the G7 and G20 have advocated. In fining foreign banks for aiding its adversaries, the US says it will not provide the rope to the hangman. If aiding Sudan, Iran or Cuba increases the use of the yuan, euro or Bitcoin, that is risk that the US is willing to take.

Refresher: CPI and the PCE Deflator

By Marc Chandler, Global Head of Currency Strategy, Brown Brothers Harriman

On Thursday, the US Department of Commerce will publish the May estimate of personal consumption expenditure deflator. Last week, investors learned that the consumer price index rose at its fastest rate in two years.

Since extraordinary monetary policy measures were taken, some observers have warned of inflation risks lurking around every corner. With CPI rising above 2%, could they finally be right?

Not so fast. The Federal Reserve’s 2% inflation target does not apply to the consumer price index. Since mid-2012, the Fed has identified the core PCE deflator as its preferred inflation measure. There is a significant difference. The PCE measure of inflation tends to be lower than the CPI measure.

In part, the two measure different things. The CPI is calculated by the Bureau of Labor Statistics of the Department of Labor. The PCE is calculated by the Bureau of Economic Analysis at the Commerce Department. An important methodological issue is the weights for the different components. The CPI uses the same weights for several years, while the PCE deflator uses current and preceding expenditures to calculate the weights. One implication of this is that the PCE measure also allows for substitution of goods with rising prices for similar goods with stable or falling prices.

pce cpi

When it comes to health care expenditures, which played a large role in the sharp downward revision to Q1 GDP, CPI and PCE measure somewhat different things. The CPI calculus includes only the expenses employees pay, while the PCE deflator also includes money that employers spend for their employee health care.

The CPI is calculated based on surveys of more than 14,000 families and 23,000 businesses they patronize. All told some 80,000 consumer items are included. Sales taxes are included.

The PCE deflator calculation is completely different, though both the PPI and CPI measures are used. Essentially, and at the risk of over-simplifying, the PCE deflator is derived from production, which is at the producer price level. The PCE methodology converts the producer priced goods/services into consumer prices, adding profit margins, taxes and transportation costs.

In addition, other data is incorporated. For example, it incorporates the monthly retail sales report, and the price of food grown and eaten on the farm comes from the US Department of Agriculture. The dealers’ margin on used vehicles is pulled from the National Auto Dealers Association.

The core measure strips out food and energy, mostly. Recent definitional changes, however, means that the core PCE measure includes restaurant meals. These have been redefined to be food services. Pet food is also included, seemingly as part of the pet expenditures rather than as part of the food budget.

Over the past 10 and 20 years, headline CPI has averaged 2.4%. The PCE deflator has averaged 2.1% and 1.9% for the 10 and 20 year periods respectively, or 0.3 percentage points and 0.5 percentage points respectively.

It is widely documented that for at least the past half century, headline inflation converges to core inflation (and not the other way around). This may help explain why the Federal Reserve prefers core measures.

The chart at the top shows the core CPI (white) and core PCE deflator (yellow) over the past 20 years. Over the past five years, the core PCE has undershot core CPI by 0.2% on average. Over the past ten and 20 years, the undershoot has been 0.2% and 0.4% respectively. The persistent lower estimates of the PCE deflator means that the Federal Reserve is likely to tolerate what may appear to be an overshoot of CPI.

There appears to be two elements that produce a more subdued rise in the PCE measure. One is the substitution effect that is not incorporated into the CPI measure. The other is the way that hospital expenses and airfares are calculated.

The consensus calls for the May core PCE deflator to rise to 1.6% in May from 1.4% in April. If accurate, it will keep this measure 0.4 percentage points lower the core CPI. It is consistent with the Fed’s assessment that the economy is evolving toward the Fed’s mandates. Some observers will make hay of the substantial contraction in Q1 GDP, but this too should not alter the outlook for Fed policy. The Fed’s economic mandates, as we have discussed, are on employment and prices and both did indeed move in the (Fed’s) desired direction in Q1 and appear to have done so further in Q2.

An OIl Update

By Marc Chandler, Global Head of Currency Strategy, Brown Brothers Harriman

West Texas crude oil prices are near their best levels of the year. The front month futures contract is near $104.50 a barrel. The high, thus far, this year was set in early March near $105.20 a barrel.

Declining US inventories appear to be a factor. The EIA reported that inventories at Cushing have fallen to five year lows. This has been a trend since January as the southern tranche of the Keystone XL pipeline has been shipping oil to the Gulf refineries.

There are several geopolitical considerations and these appear to be underpinning Brent more than WTI oil. First, a break away al-Qaeda group reportedly has taken control of Mosul, Iraq’s second largest city and are in a position to disrupt the country’s energy infrastructure. The critical 600k km pipeline has been closed for repairs since early March. Those repairs have reportedly been disrupted.

Second, reports suggest that China’s demand exceeds what is needed for immediate economic use. China is building a strategic reserve In the January-April period, China appears to have imported about 600k barrels of oil a day. Although the government data is scarce, industry watchers estimate a third to a half of the oil is for the strategic reserves.

Government figures suggest China’s strategic reserves were around 141 mln barrels at the end of last year. In comparison, the US strategic reserves were just below 700 mln barrels in late May. The US strategic reserves are sufficient to cover a little more than a month of consumption (~37 days). It can hold about 95 days of imports according to industry estimates. China aims at establishing strategic reserves to cover 100 days of net imports that are something on the magnitude of 600-700 mln barrels. Its coverage of current consumption is estimated to be around three weeks currently.

Third, OPEC decided to maintain the 30 mln barrel a day ceiling for the fifth consecutive meeting this week. There was some thought that it may have chosen to boost output to offset the shortfalls of Libyan and Iranian output. In the middle of May, the IEA called on OPEC significantly increase production. Libyan output is on the magnitude of 1/10 of its pre-conflict levels. If the Iranians does not reach agreement on its nuclear program by the end of next month, the sanctions that were lifted will be re-applied.

It is not a factor driving prices, but we note that apparently under pressure from the US and the EU, Bulgaria has halted construction of a pipeline that would have carried gas from Russia that would have circumvented Ukraine. The South Stream pipeline would go under Black Seat to Austria through Bulgaria. Bulgaria is an EU member and is thought to be among the most pro-Russian member.

The EU itself has expressed opposition to the pipeline on grounds of being counter-productive to diversifying suppliers away from Russia. The US is opposed, it appears on general grounds, but also because the company being used to build the pipeline is controlled by a person who is on the sanction list. The work stoppage ostensibly took place due to an investigation into how the project’s contracts were awarded.

There does not appear to be a stable correlation between the G7 currencies and oil prices. However, we do see for most of the year; the Canadian dollar (not the US dollar against the Canadian dollar) was inversely correlated with the price of oil (60-day percent change basis). However, since the start of the month the correlation has turned positive, but barely so (0.16). This correlation is just above sterling’s (0.15) and is the same for Brent. Looking at a somewhat broader array of major currencies finds that the Australian dollar’s correlation is also at the highest for the year, but still low (0.22). Ironically, the Norwegian krone’s correlation to Brent is inverse (-0.13).

Macro Perspective on the Investment Climate

By Marc Chandler, Global Head of Currency Strategy, Brown Brothers Harriman

One of the key issues hanging over the market since April when the policy signals pointed to a move by the ECB in early June was precisely what it would do. In recent days, it has become clearer that the ECB is more likely to cut rates than initiate an asset purchase program.

There are three interest rates the ECB could. The first is the lending rate, which stands at 75 bp and marks the top of its interest rate corridor. Usually in low or falling interest rate environment, the rate ceiling is of lesser importance. However, a lower lending rate, under current conditions, cold help reduce the volatility of overnight rates (EONIA).

The second rate it could cut is the re-finance. It is at 25 bp and under the current policy setting, the ECB is willing to provide as much funds at this rate as banks want, limited only by the acceptable collateral. A 10-15 bp cut seems to be the consensus view. The ECB also could extend the period for which is it willing to provide full allotment (unlimited funds). There have been some calls to reduce the refi rate to zero, but this seems to be an outside possibility. Even though EONIA has traded above the refi rate, a lower refi rate may still exert, albeit, limited downward pressure on overnight rates.

The third interest rate that the ECB could cut, and the most controversial is the deposit rate. It currently stands at zero, and there is much talk that the ECB could set it at -25 bp. This would, in effect, tax banks for leaving excess reserves at the ECB. The tax would hit banks with the most surplus funds that hardest and these of course are mostly from core countries, excluding France. Banks from peripheral Europe and France may account for 20% of the funds at the ECB. These banks typically are net borrowers and so lower rates would also likely benefit them the most.

There are secondary effects of a negative deposit rate that may overwhelm these primary effects. It is important to recognize that such a measure has not been implemented by a large economic area. Even at the worst of its deflationary phase, Japan never forced banks to pay for the privilege of leaving funds with it. Banks are likely to pass on the negative rates to customers, as some banks did when Denmark adopted a negative deposit rate. This may lead to a change in the way corporations and institutional investors manage their euro balances.

The prospects of a negative deposit rate may be a factor weighing on the euro. However, more importantly, the recognition that an asset purchase scheme is somewhat less likely, has helped encourage increasingly nervous investors in the peripheral European bond markets. As we have noted, IMF and EU officials have expressed concern about the sustainability of the peripheral bond rally and some institutional investors has been quoted by the press indicating some profit-taking had begun.

The flows leaving the periphery appear to be returning to core bonds. Last week, 10-year Treasury and bund yields fell 13-14 bp. Gilts, with the help of a dovish BOE’s Quarterly Inflation Report and soft earnings growth data, outperformed with 17 bp decline in 10-year yields. In contrast, Italy’s 10-year yield rose 9 bp, Portugal 16 and Greece 59 bp. Spain fared best, with only a 2 bp increase in the 10-year yield.

Funds also seemed to move into emerging markets. The MSCI Emerging Market Index (equity) rose 2.5% last week, easily outperforming the major indices. Emerging market bonds also rallied. Some investors are also moving into eastern and central Europe, including Poland and Hungary. HSCB will report its flash manufacturing PMI survey for China at midweek and some sign that the world’s second largest economy is not slow further may also provide some support for emerging markets as an asset class.

Global monetary conditions will remain extremely accommodative. Soft US industrial output and manufacturing data on the heels of a disappointing retail sales report continues to discourage investors from taking too seriously St Louis Fed’s call for a rate hike as early as Q1 15. Even now the Federal Reserve is buying more long-term assets than it was when it first announced QE3+ in September 2012. The rally in short-sterling futures suggests the BOE has been successful in pushing out interest rate hike expectations. The BOJ is the main exception. It is leaning against expectations that it will have to increase its $70 bln a month of asset purchases.

The economic data scheduled to be released in the coming days is unlikely to change the basic economic assessment and policy outlooks. The FOMC minutes will do nothing to change perceptions that those officials that are emphasizing the economic slack, particularly in the labor market, are in a majority over those who are emphasizing the risks of such extremely accommodative monetary policy. The stronger than expected housing starts reported last week, is likely the start of some more constructive housing data, including existing and new home sales reports this week.

We do not expect the minutes from the Reserve Bank of Australia or the Bank of England to be very revealing. The RBA is clearly on hold and prefers a weaker currency. The BOE’s minutes have been trumped by the Quarterly Inflation Report. Next month’s Financial Policy Committee meeting is more important in terms of macro-prudential efforts to address housing. This will reinforce the BOE’s signal that it is in no hurry to raise rates.

Separately, it appears that UK consumer prices are stabilizing while retail sales should accelerate from the nearly flat (0.1%) rise in March. They will be reported Tuesday and Wednesday respectively.

The flash euro zone PMI will be reported on Thursday. It should not be surprising to see the PMI begin to move broadly sideways after the strong advance in recent quarters. That said, the real economy has not performed much different than the ECB expected. There is no evidence that the risk of deflation is sparking a downward spiral in demand as consumers postpone purchases in anticipation of lower prices.

Politics, rather than economics, may be the key talking points in the coming days, ahead of the EU Parliament election in the second half of the week, with results announced on May 25. Polls suggest that the anti-EU parties may draw as much as a quarter of the vote, with France’s National Front and the UK’s Independent Party doing particularly well, with implications for national campaigns. It appears to be a very close race between the center-right EPP and the center-left S&P.

The Ukraine presidential election will be held on May 25. That will likely begin a new phase in the crisis. Reports suggesting that non-uniformed combatants (Blackwater) maybe confronting non-uniformed Russian allied combatants in east Ukraine also appears to be mark a new phase. It continues to appear that the limited sanction regime is having a somewhat greater cooling off effect on Russia’s financial and trade ties than it may have initially appeared.

Perhaps it is Putin’s trip to China that may be the most suggestive of change. It might take Europe a few years to cut its dependency on Russian energy if it wanted. However, that is the direction that its strategic interest lie. Russia’s actions, especially the annexation of Crimea and its continued bully behavior towards Georgia and Moldova, has alienated it from the Europe. It must turn to Asia. Chinese officials are well aware of this. They hold the whip hand. It is an opportunity to secure low energy prices on a long-term contract. That this can turn into a strategic relationship is unlikely, but it may serve Russia and China’s interest independently to at least pretend this is possible.

For its part, China has adopted different tactics in Hong Kong, and Taiwan than Russia is on its borders. China would not accept Tibet, for example, of having a referendum on independence. It abstained in the UN Security Council vote to condemn Russia. To the extent the Russia’s actions in Europe frustrate the US effort to implement its Asian pivot, China is unlikely to undercut it.

China has its own problems in securing its territorial claims. The regional hostility toward Japan and the nationalistic impulse of Prime Minister Abe win little general support. The Philippines dispute with China may be dismissed as a client state of the US. However, the confrontation with Vietnam has escalated over the weekend, leading China to evacuate some of its citizens. Unlike Japan and the Philippines, Vietnam does not enjoy a security treaty with the US, leaving it more vulnerable to Chinese reprisals.

Lastly, the electoral victory in India of the BJP and its allies is encouraging investors and fanning the hopes of reform. In the five sessions, through May 15, foreign investors bought $1 bln of Indian shares, almost 20% of what was bought since the start of the year. Last week, Indian shares rallied 5% about 50% of what they had risen up until then. The rupee was the strongest of the Asian currencies last week appreciating 2% against the dollar. Before last week, it had gained about 3% since the start of the year. We expect Modi to enjoy a honeymoon that will be good for investors and recommend global investors embrace potential near-term profit-taking as a new opportunity to participate.


Chart of the Day: New DM-EM Equity Convergence

By Marc Chandler, Global Head of Currency Strategy, Brown Brothers Harriman

This Great Graphic, created on Bloomberg, depicts the MSCI equity index for the developed countries (orange line) and the emerging markets (white line).

dm em

The charts begins at the start of last year. In the first several months of 2013, DM outperformed EM. The big EM sell-off coincided with first hint from the FOMC about tapering. EM recovered and tracked the DM until October. A new phase of divergence, with DM outperforming again lasted into early March.

Since mid-March the performance is a study in contrasts. MSCI emerging market equity index is up about 8.4%. During the same time the developed markets index is up a little less than 1%.

In the foreign exchange market over this period, the dollar-bloc is the strongest. The Australian dollar is easily the best performer rising 3.3% against the dollar, followed by the Canadian dollar (1.7%) and the New Zealand dollar (1.5%). Sterling is a distant fourth, up 0.4%, and all this was recorded today. The other major currencies have lost ground against the dollar this period.

Among the emerging market currencies, the Brazilian real (5.8%), Colombian peso (5.5%) and Turkish lira (5.5%) have led the advance. Chilean peso (3.5%) and the Russian rouble (3.0%) round out the top five. As with the majors, the high yielding/high beta currencies has generally outperformed.