Now via WSJ this virtuous circle of exported inflation by central bankers into Asia seems to be "working" ... now it will be interesting to see if the Chinese eat the inflation themselves or try to export into U.S. Walmart stores via higher prices.
- While many investors have been fixated on the European debt crisis, concerns have been quietly building about the potential for inflation problems in emerging markets.
- The fear isn't that emerging-market countries will return to the kind of hyperinflation that was so damaging in the past. Rather, the worry is that high food and energy prices, combined with capacity constraints and the Federal Reserve's easing move in the U.S., will force emerging-market central banks to raise interest rates more aggressively than is currently expected.
- That's especially the case in some Asian countries, which are seen as having kept interest rates inappropriately low because of concerns about the strength in their developed-market trading partners, such as the U.S.
- "They probably have let inflation go further than they otherwise would," says Robert Horrocks, chief investment officer at emerging-markets specialists Matthews Asia Funds. As a result, "there is a real risk that these economies get overheated."
- That could throw a monkey wrench into the expectation that emerging-market assets and commodity prices will rise as investors chase high-yielding assets. It could also create periods of disruption that send investors to safe-haven assets like the U.S. dollar, defying broad-based expectations that emerging-market currencies will rise.
- "Over the next six months, the biggest single issue investors will need to factor into their decisions is how inflation is likely to affect the landscape," saysRichard Yetsenga, global head of emerging-markets currency strategy at HSBC in Hong Kong.
- There's a "growing urgency" among Chinese officials to get monetary policy to a more appropriate stance, analysts at RBC Capital Markets wrote in a research note published Friday. "This should prompt more decisive action in the weeks and months ahead," including multiple interest-rate increases, the RBC note predicted. China's tightening, and expectations for more, have contributed to declines in Chinese stocks, with the Shanghai Composite Index down 12% this year.
- Indonesian shares are up 44% this year, Thai stocks are up 35%, and the main stock indexes in India and Singapore are up more than 9%. As a result, says Matthews's Mr. Horrocks, "there's no valuation cushion" for stocks should central banks of these countries become more aggressive than expected in tightening monetary policy. "Valuations are anywhere from 10% to 20% above long-term averages," he says.
- Based on officially set rates, in South Korea the real interest rate is negative 1.6% and in Singapore it is negative 3.3%—both very accommodative levels, notes Natalia Gurushina, director of emerging-markets strategy at Roubini Global Economics. In contrast, she says, the real interest rate in Brazil is 5.6%.
- "On average in emerging Asia…there's more room to normalize rates," Ms. Gurushina says. This should play out first with higher long-term interest rates—and lower bond prices—in countries facing inflation pressures. Yields would then move higher across all maturities as monetary-policy tightening becomes more aggressive.
- For emerging-market economies, food and energy prices play a bigger role in inflation pressures than in developed economies. This has been a big problem for countries such as Indonesia, where inflation is at 5.7%, and India, which saw inflation surge well into the double digits over the summer before settling back to 8.6% in October.
- "People are not focused enough on the rise in commodity prices…and what that does in emerging-market economies," says Ruchir Sharma, head of global emerging-markets equities at Morgan Stanley Investment Management. "Beyond a certain point, a rise in commodity prices is not conducive to emerging markets."
[Nov 16, 2010: Shanghai Plunges as China Contemplates Price Controls as Hot Money Inflows Stoke Inflation]
[Nov 2, 2010: Australia and India Continue to Hike Rates in the Face of Central Bank Easy Money Campaigns in U.S., Japan, (and UK Soon)]