THE message to markets could not have been clearer. On the morning of May 4th, following a run on the peso, Argentina’s central bank raised interest rates by 6.75 percentage points, its third hike in a week. The interest rate now stands at 40%, up from 27.25% on April 27th.
Across town Nicolás Dujovne, the treasury minister, told reporters that Argentina’s budget deficit, which was 3.9% in 2017, would be brought down to 2.7% this year, rather than the previously stated target of 3.2%. After the announcements the peso strengthened by nearly 5% against the dollar.
The combined measures slammed the brakes on what was looking like the start of an escalating crisis. Argentina’s peso had fallen by a fifth against the dollar since the beginning of the year, making it the worst-performing emerging-market currency. But the measures also harm the prospects of growth—and of Mauricio Macri, the president.
The problems began in January, following the central bank’s decision on December 28th to loosen its inflation target for 2018 from 12% to 15%. The decision was taken at the behest of the government, which was concerned about the impact of high interest rates on economic growth. The bank then eased rates by 0.75 percentage points, causing expectations of inflation to rise. Investors began to question the bank’s independence, and its commitment to reducing inflation.
Their jitters intensified after 10-year US treasury yields rose above 3 per cent in late April. That prompted investors to withdraw money from emerging markets and other risky assets. Argentina was first in line. On top of inflation that has run at 25% over the past 12 months, investors were spooked by the country’s large foreign debt pile and a current-account deficit of 5% of GDP.
Political decisions within Argentina exacerbated the external shock. Foreign investors became keener still to sell Argentine bonds and buy dollars when the government brought in a new capital-gains tax in order to appease its opponents. Political tensions within Cambiemos, the governing coalition, over how quickly to reduce subsidies for energy and utility bills cast doubt on the government’s commitment to cut spending.
In the final week of April, faced with a rapidly weakening peso, and fearing the impact of the currency’s slide on inflation, the central bank sold $4.3bn of its dollar reserves over five days. Between April 27th and May 3rd it raised interest rates by six percentage points. But the moves had little effect. After the peso lost 7.8% of its value during trading on May 3rd, the bank decided to act more forcefully, hiking the interest rate up to 40%.
The measure appears to have averted a full-blown crisis, at least for now. “It’s a step in the right direction,” says Alberto Ramos of Goldman Sachs, an investment bank. Panic appears to have receded. But Argentina may not be out of the woods. The central bank will be braced for further downward pressure on the peso, particularly if inflation figures continue to disappoint.
That means interest rates will probably remain high for some time. “If the central bank cuts rates too early we risk seeing a rerun of the crisis we’ve just seen,” says Edward Glossop of Capital Economics, a consultancy. On May 4th Fitch, a ratings agency, downgraded the outlook for Argentina from positive to stable, citing high inflation and economic volatility.
With presidential elections not due until October 2019, Mr Macri has time to steady the ship. He had hoped the country’s economic situation would begin to pick up during the second half of the year, when inflation was expected to fall and the real value of wages was expected to rise. But a severe drought meant that prospect was already receding. Higher interest rates, and the extra fiscal tightening announced on May 4th, dim it even more, says Mr Glossop.
Mr Macri, and the central bank, are desperately trying to ensure that Argentina avoids repeating the experience of Brazil, which only got a grip on inflation after the longest recession in its history. “Will it take a big hit to the economy to finally break the back of inflation?” asks Mr Ramos. Argentines must hope not.
Japan still has great influence on global financial markets
IT IS the summer of 1979 and Harry “Rabbit” Angstrom, the everyman-hero of John Updike’s series of novels, is running a car showroom in Brewer, Pennsylvania. There is a pervasive mood of decline. Local textile mills have closed. Gas prices are soaring. No one wants the traded-in, Detroit-made cars clogging the lot. Yet Rabbit is serene. His is a Toyota franchise. So his cars have the best mileage and lowest servicing costs. When you buy one, he tells his customers, you are turning your dollars into yen.
“Rabbit is Rich” evokes the time when America was first unnerved by the rise of a rival economic power. Japan had taken leadership from America in a succession of industries, including textiles, consumer electronics and steel. It was threatening to topple the car industry, too. Today Japan’s economic position is much reduced. It has lost its place as the world’s second-largest economy (and primary target of American trade hawks) to China. Yet in one regard, its sway still holds.
This week the board of the Bank of Japan (BoJ) voted to leave its monetary policy broadly unchanged. But leading up to its policy meeting, rumours that it might make a substantial change caused a few jitters in global bond markets. The anxiety was justified. A sudden change of tack by the BoJ would be felt far beyond Japan’s shores.
One reason is that Japan’s influence on global asset markets has kept growing as decades of the country’s surplus savings have piled up. Japan’s net foreign assets—what its residents own abroad minus what they owe to foreigners—have risen to around $3trn, or 60% of the country’s annual GDP (see top chart).
But it is also a consequence of very loose monetary policy. The BoJ has deployed an arsenal of special measures to battle Japan’s persistently low inflation. Its benchmark interest rate is negative (-0.1%). It is committed to purchasing ¥80trn ($715bn) of government bonds each year with the aim of keeping Japan’s ten-year bond yield around zero. And it is buying baskets of Japan’s leading stocks to the tune of ¥6trn a year.
Tokyo storm warning
These measures, once unorthodox but now familiar, have pushed Japan’s banks, insurance firms and ordinary savers into buying foreign stocks and bonds that offer better returns than they can get at home. Indeed, Japanese investors have loaded up on short-term foreign debt to enable them to buy even more. Holdings of foreign assets in Japan rose from 111% of GDP in 2010 to 185% in 2017 (see bottom chart). The impact of capital outflows is evident in currency markets. The yen is cheap. On The Economist’s Big Mac index, a gauge based on burger prices, it is the most undervalued of any major currency.
Investors from Japan have also kept a lid on bond yields in the rich world. They own almost a tenth of the sovereign bonds issued by France, for instance, and more than 15% of those issued by Australia and Sweden, according to analysts at J.P. Morgan. Japanese insurance companies own lots of corporate bonds in America, although this year the rising cost of hedging dollars has caused a switch into European corporate bonds. The value of Japan’s holdings of foreign equities has tripled since 2012. They now make up almost a fifth of its overseas assets.
What happens in Japan thus matters a great deal to an array of global asset prices. A meaningful shift in monetary policy would probably have a dramatic effect. It is not natural for Japan to be the cheapest place to buy a Big Mac, a latté or an iPad, says Kit Juckes of Société Générale. The yen would surge. A retreat from special measures by the BoJ would be a signal that the era of quantitative easing was truly ending. Broader market turbulence would be likely. Yet a corollary is that as long as the BoJ maintains its current policies—and it seems minded to do so for a while—it will continue to be a prop to global asset prices.
Rabbit’s sales patter seemed to have a similar foundation. Anyone sceptical of his mileage figures would be referred to the April issue of Consumer Reports. Yet one part of his spiel proved suspect. The dollar, which he thought was decaying in 1979, was actually about to revive. This recovery owed a lot to a big increase in interest rates by the Federal Reserve. It was also, in part, made in Japan. In 1980 Japan liberalised its capital account. Its investors began selling yen to buy dollars. The shopping spree for foreign assets that started then has yet to cease.
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