Three Thoughts from London – Trade, Tail Risks and Violence

1) We woke up to disappointing trade data out of China, but equities rallying 5.0% on the usual refrain of more stimulus.

2) The risks are mounting in Malaysia.

3) The violence in Turkey is escalating, but the lira seems unperturbed, for now.

1) We woke up to disappointing trade data out of China, but equities rallying 5.0% on the usual refrain of more stimulus.  It’s hard enough to make any normative assessment of whether the country needs more stimulus, and even harder to try and guess the government’s reaction function. Looking just at the external competitiveness part of the equation, and in particular the real exchange rate variable, the arguments seem to be in favour of more stimulus. Using the BIS calculation, we can see that China’s REER (inflation adjusted and trade weighted) has appreciated well over those of its Asia peers. For example, China’s REER has appreciated 30% over the last 5 years, compared to a 17% appreciation for Philippines, 15% for Korea, and a 7% depreciation in the case of Malaysia.

10-08-2015 10-34-022) The risks are mounting in Malaysia. By close of markets on Friday, we had learned several things over the course of the week: (A) The country’s FX reserves fell below $100 bln for first time since 2010, down from a peak of 137 bln in May 2013; (B) Foreign investors have pulled out some $3 bln in funds from the equity market so far this year, the biggest outflow since 2008; (C) foreign ownership of local bonds (corporate and government) dropped by 2.4% in July to $52.7bln, the lowest since late 2012. (D) The currency is trading around a 17-year low; (E) The FTSE Bursa Malaysia is a few points away from its 2014 lows; (F) The corruption plot involving PM Razak has thickened and it is likely to get worse as opposition demands clarity on the “donations” that appeared in his account. The tail risks continue to get fatter here.
3) The violence in Turkey is escalating, but the lira seems unperturbed, for now. There was another car bomb attack on a police station, this time wounding ten people. Next there was an attack to the US consulate compound, followed by clashes with the Turkish security forces in a shootout in Istanbul which left two people dead. We still think that markets may be underestimating the risks emanating from the political situation, which is both geopolitical and domestic. On the latter, coalition talks between the ruling AKP and the main opposition party CHP will continue today. Despite some positive headlines, we still doubt that there is enough common ground between the two groups for a “grand coalition.”