Aurelia Butler

A storm is brewing in emerging market debt. The Federal Reserve’s aggressive campaign against inflation has boosted the dollar. Add disruptions to the energy and food markets caused by the war in Ukraine, and you have the biggest set of challenges to developing economies for years. The yield spread between the JPMorgan EMBI Global index — a benchmark index of dollar-denominated EM sovereign bonds — and safe US Treasuries has surged in recent days. Over the past year, the EMBI index has risen from about 300 to more than 400 basis points, according to Bloomberg data.Sri Lanka offers a prime example of how external shocks can cripple a country. Its stock market has plummeted 64 per cent in dollar terms this year. Public anger over rising food and energy prices triggered the collapse of the government last month and pushed the south Asian nation to default on its debt. It is unlikely to be the last. The World Bank reckons almost 60 per cent of the lowest-income countries were in debt distress or at high risk of it before Russia’s invasion of Ukraine this year. EMs face more than $5.5tn of bond and loan redemptions in 2022, according to the Institute of International Finance. The most vulnerable countries have high debt and limited foreign exchange reserves. Egypt, Tunisia and Pakistan are among those in talks with the IMF for rescue packages. In sub-Saharan Africa, Ghana, Kenya, South Africa and Ethiopia stand out as being high risk. In the past, EMs could count on cheap money created by loose monetary policies in the west to paper over problems. No longer. Rising interest rates in the developed world have curbed foreign investors’ risk appetite. At 18 per cent, foreign participation in local bond markets is at its lowest point since 2009, the IIF noted.US retail investors are shunning EM debt. More than $38bn has flowed out of specialist mutual and exchange traded bond funds since the start of the year, according to EPFR data. The exodus will continue. More

US mortgage rates have surged by the most in 35 years as inflation soars and interest rates rise, threatening to leave many first-time homebuyers on the sidelines.The average interest rate on a 30-year fixed rate mortgage jumped by more than half a percentage point to 5.78 per cent, the highest level since November 2008, according to mortgage provider Freddie Mac. The weekly increase was the sharpest since 1987. The rate was 3.2 per cent at the start of the year, while a year ago, before the Federal Reserve embarked on an aggressive campaign to raise interest rates, the 30-year fixed rate mortgage averaged 2.93 per cent.The rapid acceleration has threatened to cool a strong housing market, as Americans — many working from home during the coronavirus pandemic — took advantage of lower mortgage rates to buy housing, in the process driving prices to record highs. But the recent rise in mortgage rates has threatened affordability for new homebuyers, slowing housing demand.“The average homebuyer today now faces higher mortgage repayments as a share of their income than last seen at the peak of the mid-2000s boom,” said Matthew Pointon, senior property economist at Capital Economics. “With cautious lenders not set to loosen mortgage lending standards, that will shut many potential buyers out of the market. Indeed, the first-time buyer share has recently dropped to 13-year lows.”Homebuyers stunned by the rapid climb in mortgage rates can look to the Federal Reserve’s efforts to tame US inflation that reached a fresh 40-year high last month, as well as rising inflation expectations, which suggest Americans are becoming more concerned about the outlook and their finances. The Fed on Wednesday raised its benchmark rate by 0.75 percentage points, the largest increase since 1994. “These higher rates are the result of a shift in expectations about inflation and the course of monetary policy,” said Sam Khater, Freddie Mac’s chief economist. “Higher mortgage rates will lead to moderation from the blistering pace of housing activity that we have experienced coming out of the pandemic, ultimately resulting in a more balanced housing market.”Moderation is already starting to show up in the data: the rate of US new home construction fell in May to the slowest pace since April 2021. US housing starts fell 14.4 per cent month on month to an annualised pace of 1.5mn, according to the commerce department. Building permits, considered a leading indicator of the housing market, fell 7 per cent from the previous month to an annualised pace of 1.69mn.Sentiment among homebuilders declined for the sixth consecutive month in June, as inflation and higher mortgage rates weakened demand for new homes.Sellers have also started to take note, with Redfin on Thursday reporting that the number of for sale homes with price drops reached a record 22. 4 per cent in the four weeks that ended June 12.The recent jump in mortgage rates was calculated before the Federal Reserve’s rate-setting meeting this week. Fed officials have signalled the policy rate could rise well above 3 per cent by year end.“Mortgage rates tend to get priced off the 10-year [Treasury note] yield for fixed-rate mortgages,” said Joshua Shapiro, chief US economist at MFR. “Mortgage rates will probably rise further, but I think we’ve seen the bulk of the increase.”Still, high interest rates will slow economic growth, which will impact consumer spending, leading to a decrease in home sales. Nancy Vanden Houten, lead economist at Oxford Economics, said there is a chance that long-term interest rates could steady. “If the Fed’s aggressive stance leads to a slowing in economic growth and inflation, long-term interest rates may stabilise,” said Vanden Houten. “Or start to decline even as the Fed continues to raise short-term rates.” More

When Jay Powell, Federal Reserve chair, tried to explain the rationale for the Fed’s 75-basis point interest rate increase on Wednesday, he was essentially addressing two different audiences. One group were the “Fed watchers”, investment professionals armed with historical charts who can parse price trends — and so-called dot plot projections — with a dispassionate eye.The second (far bigger) audience consists of ordinary mortals, most of whom are probably baffled by what is going on. After all, as Powell admitted, an entire generation of Americans is “experiencing [inflation] really for the first time”, since inflation like this has not occurred for 40 years. Moreover, non-economists usually have only a vague idea of how monetary policy is supposed to work. It is much harder, after all, to ascertain what a 75bp rate rise really means than to interpret the price of petrol displayed on a garage forecourt.This gap in perceptions matters — as Powell himself knows only too well. One reason why the Fed hiked rates this week is that tangible consumer price data emerged last Friday showing an annual inflation rate of 8.6 per cent.However, the second big, albeit less noticed, trigger was that last Friday also delivered data which showed that consumers expect 5.4 per cent and 3.3 per cent inflation rates over the next one and three years, respectively, a sharp increase. Some economists might retort that the public tends to be very bad at forecasting. Fed officials would appear to agree: the governors’ dot plot forecasts, created with underlying technical models of supply and demand, imply marked future falls in inflation rates. One hopes the models are correct. But the problem with inflation, as the legendary former Fed chair Paul Volcker often observed to friends, is that it can easily take on a life of its own. In other words, expectations become self-fulfilling. Or, to put it another way, Powell is not just waging a battle in the markets, but also with consumers’ minds. And that second fight is becoming increasingly challenging.To understand why, consider the work of behavioural economists such as Meir Statman, who have studied the psychology of price rises around the world. As Statman told an inflation symposium in New York this week, consumer reactions to price trends are often distorted by five psychological factors.One is “framing”. Since consumers normally rely on yardsticks like prices to parse economic trends, they feel disorientated if “inflation distorts the dollar yardstick”, Statman says. Thus, they often succumb to the so-called “money illusion”, where they only focus on nominal prices and rates, not “real”, inflation-adjusted, ones. The second factor is “fear”, which is fuelled by this disorientation. The third is “availability”, or the ease with which data can (or cannot) be seen. And the fourth and fifth issues are “confirmation” and “representativeness” shortcuts. These include the tendency for people to only notice information that fits their pre-existing ideas, and to interpret data by “extrapolating from the recent past into the future”.All five patterns matter right now. The speed at which inflation has surged has disorientated many people. Moreover, consumers are being bombarded by some highly “available” (ie visible) numbers, such as the 60 per cent year-on-year rise in petrol prices. It is natural for them to use that as a proxy for the wider inflation rate, however inaccurate, and project it forward, out of fear. Then there is the “confirmation bias” issue. A Pew survey released in May showed that 70 per cent of Americans view inflation as “a very big problem”, topping other concerns by a wide margin. However, there is a stark partisan split: although 84 per cent of Republicans are alarmed about inflation, only 57 per cent of Democrats are — never mind that they presumably face the same price rises. It is easy to explain this: Republican leaders are constantly talking about inflation because they want to attack the White House. That, in turn, shapes consumer perceptions. This matters. As Robert Shiller, another behavioural economist, notes, the “narratives” we spin for ourselves about the economy not only reflect economic reality, they shape it, in a self-fulfilling manner — even if those narratives do not match macroeconomic models.So what can Powell do? On Wednesday, he tried to reframe the popular narrative by constantly uttering the phrase “price stability”, and stressing the Fed’s commitment to it. However, he also acknowledged that the central bank is now tracking so-called headline inflation (that is, the gross number, which reflects consumers’ spending), instead of just “core” inflation, the seasonally adjusted figure that it typically prefers. This is a sign that the Fed knows public perceptions are important.But the hard reality is that Powell will struggle to win the battle for peoples’ minds — never mind the markets — while petrol at $5 a gallon is still a readily “available” number. Moreover, energy costs cannot be controlled with 75bp rate rises. That is why he is now determined to keep wage growth under control, even at the cost of higher unemployment. And it is why America is probably sliding towards a bout of stagflation — even if this is not a word that Powell himself would [email protected]  More

It is hard to keep up some days with Boris Johnson’s government. Barely has one hullabaloo died away before another one crowds out the space for rational discussion about what has just happened.On Monday this week Johnson first tabled legislation on the Northern Ireland protocol which has been declared illegal both in Brussels and by a clear balance of the most prominent legal minds in the UK. The dust had barely settled on this before Johnson was questioning the UK’s membership of the European Convention on Human Rights after a court in Strasbourg intervened on Tuesday to stay the deportation of migrants to Rwanda. And then on Wednesday night Lord Geidt quit as Johnson’s ethics adviser after being put in an “odious” position over a decision to continue steel tariffs.Viewed from Brussels there is a sense of dizzying political decay in London as Johnson wrestles with the controls of a government that now appears to be in a near-perpetual tailspin. This week the European Commission debated and then responded to the UK’s threat to unilaterally rip up the protocol, which governs post-Brexit trade in Northern Ireland. Given the one-sided nature of the UK legislation, Brussels is increasingly coming to view that, as one senior EU diplomat put it to me, “the UK is not looking for a negotiated compromise”.Which leaves the Northern Ireland protocol process stuck on all fronts — London, Brussels and Belfast.On the EU side, the European Commission — as predicted in previous editions — has taken what Mujtaba Rahman at the Eurasia Group neatly describes as the “firm but serene” approach. It has restarted the legal proceedings that it halted last year in order to create space for negotiation. Now the UK is eschewing that negotiation by tabling a unilateral approach, this is a logical response. Beyond that, the EU has not overreacted. At the same time, it was clear at the meeting of EU ambassadors in Brussels this week that patience is wearing thin. Major EU countries, including Germany, have asked the Commission to prepare to be able to use “all available instruments” under the Trade Cooperation Agreement to retaliate should the UK put the protocol bill into law. But we know this is some way off.On the UK side, it is still not obvious how or when that happens. The DUP continues to refuse to enter power sharing until the bill becomes law. This is a problem for the government since legislation has been justified primarily as a plan to “rescue” the Good Friday Agreement by restoring the executive. Whitehall insiders tell me that Liz Truss has agreed the bill will not get a second reading until the DUP moves, so without a fresh cabinet decision, the two sides are now locked in a game of chicken. How long the patience of the rightwing of the Tory party will put up with this remains to be seen. And even if this hurdle is overcome and the bill clears the Commons, it seems certain the Lords will ensure that the bill takes 18 months or more to get on to the statute book.It is far from certain, at this point, what breaks the impasse. But given that 24 hours is now a long time in politics, you can see why the European Commission’s approach is essentially ‘wait and see’.As for the bill itself, it is — to quote Jonathan Jones QC — an “extraordinary” piece of legislation. It automatically “switches off” the parts of the protocol that cover the trade, state aid and the ECJ (see clauses 12, 13, 14) and then, as I reported ahead of time on Monday, in clauses 15 and 18 confers “do whatever you like powers” on UK ministers to ‘fix’ any other elements of the deal. Only three articles of the protocol are explicitly protected.Even though, as Jones says, this is far more wide-reaching and egregious than the Internal Market Bill 2020 (which triggered Jones’s resignation) the government has avoided the admission made by Brandon Lewis back in 2020 that this is a breach of international law. It has done this by obtaining some legal top-dressing that argues that the “doctrine of necessity” provides a “clear basis” for unilateral action, in this case to protect the Good Friday Agreement. But the truth is that it is very difficult to find a serious lawyer that isn’t in the pay of the British government that agrees with this view, because (as the government’s original, but rejected advice observed) the protocol has a safeguard mechanism (Article 16) which they haven’t even tried. As Lord David Pannick QC et al observed in a letter to the Times this week the doctrine of necessity requires “grave and imminent peril” to which the state in question has not contributed. In these circumstances, “It is impossible to understand how those criteria could be satisfied.”And all legal flummery aside, it’s hard to see how the government can argue it is trying to rebalance the Good Friday Agreement by entirely taking one side (the DUP) over the other, when a majority of Northern Ireland Assembly members support the continuation of the protocol. Jonathan Powell, who was around at the inception of the 1998 agreement, sets out the reality with great clarity here. This all adds up to a pretty desultory state of affairs. Inside the narrow crucible of Westminster, where a prime minister is fighting for his political life, perhaps some of the above makes narrow political sense. But in the wider world — as Michael Gove has rightly warned during recent Cabinet discussions — this obviously illegal approach to resolving the difficulties posed by the protocol contains significant international reputational risk for the UK. What do you think of the Johnson government’s latest gambit? Email your thoughts to [email protected]. Brexit in numbersThis week’s chart comes courtesy of a new study by Professor Jun Du and research fellow Oleksandr Shepotylo at Aston University on the effects of trade frictions on the UK’s exports to the EU. Their modelling isolates the costs caused by both phytosanitary (SPS) requirements and other technical barriers to trade and finds that the EU-UK Trade and Cooperation Agreement (TCA) had “a strong, negative, and significant impact on UK bilateral trade with the EU”.As my colleague Nick Peterson reports, the consequence was that UK exports to the EU fell by 15.6 per cent, or £12.4bn, in the first six months of last year because of those trade frictions.It is perhaps worth recalling Lord David Frost’s speech in Brussels in February 2020 ahead of the TCA negotiations where he breezily dismissed studies on the effects of trade barriers as exaggerated. He said: “But, in brief, all these studies exaggerate — in my view — the impact of non-tariff barriers, they exaggerate customs costs, in some cases by orders of magnitude.” Well, as William Bain, head of trade policy at the British Chambers of Commerce, points out these findings obviously accord with evidence that has been piling up from companies that SPS requirements “have had a deeply negative effect on UK exports to the EU”.And these impacts are not going away, according to Du and Shepotylo who find the negative effects “are spread across a range of industrial sectors and in all EU countries/export destinations” and “do not appear to be ‘teething problems’”.The negative impacts of the low-ambition deal Frost negotiated have been obscured both by Covid-19 and continued government insistence trade is back to normal. So while this research might be stating, or rather proving, the obvious, clearly it does need stating still. And, finally, three unmissable Brexit storiesMy colleague Martin Sandbu also parses the Johnson government’s legislation in his Free Lunch newsletter this week and he is not impressed either. “It is dishonest, hypocritical, and — depending on what you think it is meant to achieve — likely to be ineffective at best.”We wrote about the UK-EU dispute over the Horizon Europe flagship scientific research programme a few weeks ago. Anjana Ahuja, a science commentator, addresses the topic in her most recent FT column and concludes that the UK’s withdrawal from the programme would make “a mockery of the government’s self-proclaimed ambition to turn the UK into a global science superpower”. Agriculture is the largest integrated industry across the island of Ireland. But the UK government’s hardline approach to the protocol is proving a nightmare for Northern Ireland’s dairy farmers, as my colleague Jude Webber discovered on a recent trip to Craigavon in County Armagh. More

JERUSALEM (Reuters) – Israel’s central bank said on Thursday it was teaming up with the Hong Kong Monetary Authority and the Bank of International Settlements’ (BIS) Innovation Lab to test the feasibility of a central bank digital currency (CBDC) for retail.The test will be cyber-security secured and in the proposed model, the intermediaries will have no financial exposure from customers holding or transferring CBDC, resulting in reduced risk and costs, the Bank of Israel said.The so-called Sela project, led by the BIS Innovation Hub’s Hong Kong centre, is planned to begin in the third quarter and findings will be published by the end of the year.The Bank of Israel has stepped up its research and preparation for the possible issuance of a digital shekel to create a more efficient payments system after first considering issuing a CBDC in late 2017.”Providing an efficient payment system that will increase competition in the payment market is one of the primary motivations we’ve identified for a possible issuance of a digital shekel – an Israeli CBDC,” Bank of Israel Deputy Governor Andrew Abir said in a statement.Last month, the bank said that while it had received public support, it had yet to make a final decision on issuing a digital shekel.The joint project will explore the feasibility of a two-tiered architecture where there is no financial exposure of the intermediaries involved in the transaction, unlike traditional ways of central bank funds being provided to the public via commercial banks.”This architecture is assumed to have several benefits: less financial risk for the customer, more liquidity, lower costs, increased competition, and wider access,” the Bank of Israel said. More

SANTIAGO (Reuters) – Chile’s government is set to push forward its tax reform plans, including a bill on mining royalties, by the end of this month, a top cabinet member to President Gabriel Boric told Reuters, legislation that could impact the world’s top copper producer.Giorgio Jackson, a former student leader alongside Boric and now his Minister Secretary-General of the Presidency, said tax adjustments were a key focus, essential to raising funds to pay for overhauling social programs from education to health.”On June 30 we are going to make the announcement of the entire tax reform and we are going to start with a couple of bills immediately. One of them is the mining royalty,” he said late last week at his office in La Moneda, the presidential palace.He added tax reform was a “necessary condition” to make the changes 36-year-old Boric’s leftist government had promised when he came into office in March, though a separate mining royalty plan that builds upon a bill currently making its way through congress is also key.”For us that’s a priority, probably number one,” he said.Boric, approaching 100 days in office, won strong support in an election last year but has seen his popularity tumble amid high inflation and ongoing social unrest including in the country’s south and questions over migration in the north.Jackson said the tax reforms would “boost” Chile on par with other mineral-rich nations, bringing funds to support research and development of new growth areas for the world’s top copper producer and the second largest producer of lithium.”There is an opportunity Chile has with copper, with lithium, to use them and imagine a different productive system,” he said.He admitted that tax reforms were never an easy sell, especially with inflation in the Andean country at its highest since the 1990s and economic growth expected to only grow weakly this year despite soaring global metals prices.”When you’re in a bonanza and good times or in bad times, they always say why are you going to do it now?” he said. “There’s never a good time to do tax reform.”Chile is also in the process of overhauling its market-orientated Constitution which dates back to the military dictatorship of Augusto Pinochet. That process, which stemmed from social protests in 2019, has been hit as support for the new document has dwindled, with the risk it could fail to pass.Jackson said that “unnecessary controversies” through the process had left some people disillusioned, but hoped support would pick up again once the draft was finalized in July. The final referendum vote is in September. More