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Quietly clicking my way through Bloomberg last Sunday afternoon, I came across this:

Facebook Members Register Names at 550 a Second

Facebook Inc., the world’s largest social-networking site, said members registered new user names at a rate of more than 550 a second after the company offered people the chance to claim a personalized Web address.

Facebook started accepted registrations at midnight New York time on a first-come, first-served basis. Within the first seven minutes, 345,000 people had claimed user names, said Larry Yu, a spokesman for Palo Alto, California-based Facebook. Within 15 minutes, 500,000 users had grabbed a name.

Mein Gott, I thought to myself, if 550 people a second are doing something, they can't all be wrong. So I immediately signed up. Actually, this isn't my first experience with social networking since I did try Orkut out some years back, but somehow I didn't quite get the point. Either I was missing something, or Orkut was. Now I think I've finally got it. Perhaps the technology has improved, or perhaps I have. As I said in one of my first postings:

Ok. This is just what I've always wanted really. A quick'n dirty personal blog. Here we go. Boy am I going to enjoy this.

Daniel Dresner once broke bloggers down into two groups, the "thinkers" and the "linkers". I probably would be immodest enough to suggest that most of my material falls into the first category (my postings are lo-o-o-ng, horribly long), but since I don't fit any mould, and Iam hard to typecast, I also have that hidden "linker" part, struggling within and desperate to come out. Which is why Facebook is just great.

In addition, on blogs like this I can probably only manage to post something worthwhile perhaps once or twice a month, and there is news everyday.

So, if you want some of that up to the minute "breaking" stuff, and are willing to submit yourself to a good dose of link spam, why not come on in and subscribe to my new state-of-the-art blog? You can either send me a friend request via FB, or mail me direct (you can find the mail on my Roubini Global page). Let's all go and take a long hard look at the future, you never know, it might just work.

Don't Get Carried Away Now!

As Paul Krugman recently pointed out, one of the central points they made in the latest IMF World Economic Outlook was that recessions caused by financial crises tend to get resolved on the back of export-lead booms, with countries normally emerging from the crisis with a positive trade balance of over 3 percent of GDP. The reason for this is simple, since consumers are so laden-down with debt from the boom period, they are naturally more obsessed with saving than borrowing during the initial crisis aftermath. So much then for the typical crisis, and the typical exit. But musing on this point lead Krugman to an additional, rather disturbing, conclusion: since the present financial crisis is truly global in its reach, the habitual exit route to recovery will only work after we are able to identify another planet to send all those exports to (shades of Startreck IV). The joke may seem a rather exaggerated one, in poor taste even, but behind it there lies a little bit more than a grain of truth.

But not everywhere is gloom and doom at the moment, and on the other side of the world they woke up reeling from different kind of bounce last Monday morning, on learning that India’s outgoing government had been not only been re-elected, but had been thrust back into power on a much more stable basis. And that was not the only pleasant surprise in store for those reading their morning newspapers in London, Madrid or New York, since India's main stock index - the Sensex - shot up as much as 17% during early trading on receiving the news, while the rupee also surged sharply. So just one more time we find ourselves faced with the prospect of living in a rather divided world, where on one side we have growing and deepening pessimism, while on the other we see a burst of optimism, with someone, somewhere, getting a massive dose of that "let a thousand green shoots bloom" kinda feeling. Perhaps we should ask ourselves whether there is any connection?


Well, and to cut the long story short, yes there is, and the connection has a name, and it's called sentiment. Indeed sentiment is precisely why the recent (and highly controversial) US bank stress tests were so important. Their real significance was not for any relevance they may have from a US banking point of view (which was, of course, highly contested), but for the reassurance they can give market participants that there will not be another financial explosion in the United States (as opposed to a protracted recession, and long slow recovery), or put another way, to show the days of "safe haven" investing are now over. Risk is about to make a comeback, and the only question is where?

Which brings us straight back to all that earlier talk of coupling, recoupling, decoupling, and uncoupling which we saw so much of a year or so ago (or to Decoupling 2.0, as the Economist calls it). And to the world as we knew it before the the demise of Lehmann brothers, where commodity prices were booming like there was no tomorrow on the one hand, while credit- and housing-markets markets were steadily melting down in the developed economies on the other, where growth was being clocked up in many emerging economies at ever accelerating rates, while the only "shoots" we could see on the horizon in the US, Europe and Japan were those of burgeoining recessions.

The point to note here is not just that a significant group of investors and their fund managers spent the better part of 2008 busily adapting their behaviour to changed conditions in the US, Europe and Japan, but rather that a very novel set of conditions began to emerge, as the credit crunch worked its way forward and property markets drifted off into stagnation in one OECD economy after another. Just as they were finally announcing closing time in the gardens of the West almost overnight it started "raining money" in one emerging economy after another - as foreign exchange came flooding in, and the really hard problem for governments and central banks to solve seemed to be not how to attract funding, but rather how to avoid receiving an excess of it. Thailand even attained a certain notoriety by imposing capital controls with the explicit objective of discouraging funds not from leaving but from entering the country.

Then suddenly things moved on, and day became night just as quickly as night had become day as one fund flow after another reversed course, and the money disappeared just as quickly as it had arrived. Behind this second credit crunch lay an ongoing wave of emerging-market central bank tightening (during which Banco Central do Brasil deservedly earned its spurs as the Bundesbank of Latin America) with the consequence that one emerging economy after another began to wilt under the twin strain of stringent monetary policy and sharply rising inflation. Thus the boom "peaked" in July (when oil prices were at their highest), and momentum was already disapearing when the hammer blow was finally dealt by the decision to let Lehman Brothers fall in late September. By November all those previous positive expectations were being sharply revised down, with the IMF making an initial cut in its global growth estimate for 2009 - to 2.2 percent from the 3.7 percent projected for 2008. The World Bank went even further, and by early December was projecting that world trade would fall in 2009 for the first time since 1982, with capital flows to developing countries being expected to plunge by around 50 percent. By March 2009 they were estimating that the volume of world trade, which had grown by 9.8 percent in 2006 and by 6.2 percent in 2007, was even likely to fall by 9 percent this year.

Having said this, and while fully recognising that the future is never an exact rerun of the past - and especially not the most recent past - given that emerging economies have been the key engines of global growth over the last five years, is there any really compelling reason for believing they won't continue to be over the next five? Could we not draw the conclusion that what was "unsustainable" was not the solid trend growth which we were observing between 2002 and 2007, but rather the excess pressure and overheating to which the key EM economies were subjected after the summer of 2007? And if that is the case, might it not be that the "planet" we need to find to do all that much needed exporting to isn't so far away after all, but right here on this earth, and directly under our noses, in the shape of a growing band of successful emerging economies.

According to IMF data, the so called BRIC countries actually accounted for nearly half of global growth in 2008 - China alone accounted for a quarter, and Brazil, India and Russia were responsible for another quarter. All-in-all, the emerging and developing countries combined accounted for about two-thirds of global growth (as measured using PPP adjusted exchange rates) . Furthermore, and most significantly, the IMF notes that these economies “account for more than 90 per cent of the rise in consumption of oil products and metals and 80 per cent of the rise in consumption of grains since 2002”.

But behind the recent emerging market phenomenon what we have is not only a newly emerging growth rate differential, since alongside this there is also alarge scale and ongoing currency re-alignment taking place, a realignment driven, as it happens, by those very same growth rate differentials. The consequential rapid and dramatic rise in dollar GDP values (produced by the combination of strong growth and a declining dollar) has meant that a slow but steady convergence in global living standards - at least in the cases of those economies who have been experiencing the strongest acceleration - has been taking place, and at a much more rapid pace than anyone could possibly have dreamed of back in the 1990s, even if the long term strategic importance of this has been masked by the recent collapse in commodity prices and the downward slide in emerging stocks and currencies associated with the post-Lehman risk appetite hangover. Which is why, yet one more time, that simple issue of sentiment is all important, or using the expession popularised by Keynes "animal spirits".


Carry On Trading

But now we have a new factor entering the scene. The US Federal Reserve, along with many of the world's key central banks, has so reduced interest rates that they are now running only marginally above the zero percent "lower bound", and the Fed is far more concerned with boosting money supply growth to fend of deflation than it is with restraining it to combat inflation. Not only that, Chairman Ben Bernanke looks set to commit the bank to maintain rates at the current level for a considerable period of time.

In this situation, and given the extremely limited rates of annual GDP growth we are likely to see in the US and other advanced economies in the coming years, all that liquidity provision is very likely to exit the first world looking for better yield prospects, and where better to go than to to look for it than those "high yield" emerging market economies.

The Federal Reserve could thus easily find itself in the rather unusual situation of underwriting the nascent recovery in emergent economies like India and Brazil , just as Japan pumped massive liquidity straight into countries like New Zealand and Australia during its experiment with quantitative easing between 2001 and 2006. And the mechanisms through which the money will arrive? Well, they are several, but perhaps the best known and easiest to understand of them is the so called carry trade, which basically works as follows.

Stimulus plans and near-zero interest rates in developed economies boost investor confidence in emerging markets and commodity-rich nations whose interest rates are often in double figures. Using dollars, euros and yen these investors then buy instruments denominated in currencies from countries like India, Brazil, Hungary, Indonesia, South Africa, Turkey, Chile and Peru - which collectively rose around 8% from March 20 to April 10, the biggest three-week gain for such trades since at least 1999 . A straightforward and simple carry-trade transaction would run like this: you borrow U.S. dollars at the three-month London interbank offered rate of (say) 1.13% and use the proceeds to simply buy Brazilian real, leaving the proceeds in a bank to earn Brazil’s three-month deposit rate of 10.51%. That would net anannualized 9.38% - under the assumption that the exchange rate between the two currencies remains stable, but the real, of course, is appreciating against the dollar.

Other options which immediately spring to mind are Turkey, where the key interest rate is currently 9.25 percent, Hungary (9.5 percent) or Russia (12 percent). And the cost of borrowing is steadily falling - overnight euro denominated inter-bank loans hit 0.56 percent last week, down from 3.05 percent six months ago after recent moves by the European Central Bank to cut interest rates and pump liquidity into the banking system. The London interbank offered rate, or Libor, for overnight loans in dollars is thus down to 0.22 percent from 0.4 percent in November. And while the ECB provides the liquidity, the EU Commission and the IMF provide the institutional guarantees which - in the cases of countries like Hungary or Romania - mean that even is such lending is not completely free from default risk, they are at least very well hedged.

Indeed Deustche Bank last week specifically recommended buying Hungarian forint denominated assets, and according to the bank the Russian ruble, the Hungarian forint and the Turkish lira are among the trades which offeri investors the best returns over the next two to three months. Deutsche Bank recommends investors sell the euro against the forint on bets the rate difference will help the Hungarian currency gain around 10 percent over the next three months (rising to 260 from around 285 to the euro when they wrote). Investors should also sell the dollar against the Turkish lira and buy the ruble against the dollar-euro basket, according to their recommendations.

And it isn't only Deutsche Bank who are actively promoting the trade at the moment, at the start of April Goldman Sachs also recommended investors to use euros, dollars and yen to buy Mexican pesos, real, rupiah, rand and Russia rubles. John Normand, head of global currency strategy at JPMorgan, is forecasting a strong surge in long term carry trading as the recovery gains traction. Long trading, he says, is decidedly "underweight" at this point. Long carry trade positions held by Japanese margin traders, betting on gains in the higher-yielding currencies, peaked at $60 billion last July, according to Normand. They were liquidated completely by February, and have subsequently increased to around one third of the previous value (or $20 billion). “Only Japanese margin traders and dedicated currency managers appear to have reinstated longs in carry,” Normand says. “Their exposures are only near long-term averages.”

And Barclays joined the pack this week stating that Brazil’s real, South Africa’s rand and Turkey’s lira offer the “largest upside” for investors returning to the carry trade. A global pickup in investor demand for higher-yielding assets and signs the worst of the global recession is over “bode very well for the comeback of the emerging-market carry trade,” according to analyst Anfrea Kiguel in a recent report from New York. In part as a result of the surge in carry activity the US dollar declined beyond $1.40 against the euro on Friday for the first time since January. Evidently the USD may now be headed down a path which is already well-trodden by the Japanese yen.


India on The Up and Up.


But some of these trades are much riskier than others. Many of the countries in Eastern Europe who currently offer the highest yields are also subject to IMF bailout programmes, so they are with good reason called "risky assets". But others look a lot safer. Take India for example. As Reserve Bank of Indian Governor Duvvuri Subbarao stressed only last week, India’s “modest” dependence on exports will certainly help the economy weather the current global recession and even stage a modest recovery later this year. Of course, "modest" is a relative term, since even during the depths of the crisis India managed to maintain a year on year growth rate of 5.3 percent (Q4 2008), and indeed as Duvvuri stresses, apart from the limited export dependence, India's financial system had virtually no exposure to any kind of "toxic asset".

As mentioned above, the rupee rose 4.9 percent this week to 47.125 per dollar in Mumbai, its biggest weekly advance since March 1996, while the Sensex index rallied 14 percent for its biggest weekly gain since 1992.

And, just to add to the collective joy, even as Indian Prime Minister Manmohan Singh began his second term, and stock markets soared, analysts were busy rubbing their hands with enthusiasm at the prospect that the new government might set a record for selling off state assets, and thus begin to address what everyone is agreed is now India's outsanding challenge: reducing the fiscal deficit.

Singh, it seems, could sell-off anything up to $20 billion of state assets over the next five years as he tries to reduce the central govenment budget shortfall which is currently running at more than double the government target - it reached 6 percent of gross domestic product in the year ended March 31, well beyond the 2.5 percent government target. The prospect of a wider budget gap prompted Standard & Poor’s to say in February that India’s spending plans were “not sustainable” and threaten that the country's credit rating could be cut again if finances worsen. But just by raising 100 billion rupees from share sales and initial public offerings in the current financial year would reduce the fiscal deficit by an estimated quarter-point, at the stroke of a pen, as it were. And there is evidently plenty more to come from this department.

As a result of the changed perception that the new Indian government will now - and especially with the elections and the worst of the global crisis behind it - seriously start to address the fiscal deficit situation, both S&P and Moody’s Investors Service, have busied themselves emphasising just how the outcome gives India's government a chance to improve its fiscal situation. The poll result gives the government more “political space” to sell stakes in state-run companies and improve revenue, according to Moody’s senior analyst Aninda Mitra, while S&P’s director of sovereign ratings Takahira Ogawa commented that the result means “there is a possibility for the government to implement various measures to reform for further expansion of the economy and for the fiscal consolidation.”

So off and up we go, towards that ever so virtuous circle of better credit ratings, lower interest rates, rising currency values, and ever higher headline GDP growth, which of course helps bring down the fiscal deficit, which helps improve the credit rateing outlook, which helps... oh, well, you know.

And it isn't only India which is exciting investors at the moment. Brazil's central bank President Henrique Meirelles went so far as to warn this week against an “excess of euphoria” in the currency market, implicitly suggesting the bank may engage in renewed dollar purchases to try to slow down the latest three-month rally in the real. The central bank began buying dollars on May 8, and Meirelles’s latest are evidently upping the level of verbal intervention. The real has now climbed 20.5 percent since March 2, the biggest advance among the six most-traded currencies in Latin America, as prices on the country’s commodity exports rebounded and investor demand for emerging-market assets has grown. The currency is up 14 percent this year, more than any other of the 16 major currencies except for South Africa’s rand, reversing the 33 percent drop in the last five months of 2008.

Carry Me Home

Despite a number of outsanding worries about the emerging economies in Eastern Europe, the general idea that countries like India, Brazil, Turkey, Chile, Peru etc are firmly at the top of the list of the economies where current growth conditions are generally favorable seems essentially sound. Additionally, if this sort of argument has any validity at all it is bound to have implications for what is sure to be one of the key problems we will face during the next global upturn: what to do with the financial architecture which we have inherited from the original Bretton Woods agreement (or Bretton Woods II as some like to call it).

The limitations of the current financial architecture have become only too apparent during the present recession, since with both the Eurozone and the US economies contracting at the same time, the currency see-saw between the dollar and the euro has failed to provide any adequate form of automatic stabiliser. And since Japan's economy is in an even more parlous state -deep in recession, and desperate for exports - having to live with a yen-dollar parity which is at levels not seen since the mid 1990s can hardly be fun. This has lead some analysts to start to talk of a new and enhanced role for China's currency, the yuan, in any architectural reform we may initiate. But obviously, beyond the yuan we should also be thinking about the real and the rupee. However,I would like to suggest the problem we now face is a much broader one than simply deciding which currencies should be in the central bank reserve basket, and it concerns the central issue of how to conduct monetary policy in an age of global capital flows. During the last boom, comparatively small open economies like Iceland and New Zealand were on this receiving end, but this time round we face the truly daunting prospect of having global giants thrust into the same position, while the USD gets pinned to the floor, just as the Japanese yen was previously.

The problem is evidenty a structural one. The euro hit 1:40 to the USD on Friday (at a time when Europe's economies are in deeper recession than the US one is), while - as I said - the Brazilian central bank President felt the need to come out and warn against an “excess of euphoria” in the local currency market following an 18% rise in the real over 3 months. Officially, the euro surged as a result of news that the US might receive a downgrade on its AAA credit rating, but this justification hardly bears examination, given that around half of the eurozone economies could be in the same situation. Obviously currency traders live in a world where the most important thing is to "best guess" what the guy next to you is liable to do next, and in this sense the rumour could have played its part, but the real underlying reason for the sudden shift in parities is the return in sentiment we have been seeing since early May, and the massive and cheap liquidity which is on offer in New York.

Of course, the impact spreads far beyond Delhi and Rio. Turkey’s lira is also well up - and has now advanced 10 percent over the last three months - while South Africa’s rand is up 22 percent, making it the best performing emerging-market currency during the same period.

All good "carry" punts these, with Turkey’s benchmark interest rate standing at 9.25 percent, and Brazil’s rate of 10.25 percent. Even the ruble is up sharply, just as Russia's economy struggles to handle the rapidly growing loan default rates. The currency climbed to a four-month high against the dollar on Friday, making for its longest run of weekly gains in almost two years, hitting 31.0887 per dollar at one point, its strongest level since Jan. 12. The ruble was up 3.2 percent on the week - closing with its sixth weekly advance and extending its longest rally since September 2007 - and has risen 16 percent since the end of January. Russia's central bank has cut base interest rates twice since April 24 in an attempt to revive the economy, but the refinancing rate is still 12 percent - well above rates in the EU, the U.S., Japan and even quite attractive in comparison with those on offer in other emerging markets. The basic point here is that carry trade players can leverage interest rate differentials and benefit from the changes in currency valuation that these very trades (along with those made by other participants) produce. So all of this is truly win-win for those who play the game, until, that is, it isn't.

Not all of this is preoccupying - far from it, since the issues arising are in many ways related to the problem I started this article with: namely, who it is who will run the trade and current account deficits and do the necessary consuming, to make all those export-lead recoveries (even in China, please note) possible. Evidently the core problem generated during the last business cycle was associated with the size of the imbalances it threw up, and the impact on liquidity and asset prices that these imbalances had. If I am right in the analysis presented here, then we are all on the point of generating a further, and certainly much larger, set of such imbalances as we let the process rip in the uncordinated and unrestrained fashion we are doing. As you set the problem up, so it will fall. Floating Brazil and India is a very attractive and very desireable proposition. Consumers in those countries can certainly take on and sustain more leveraging. The two countries can even to some extent support external deficits as they develop. But they need to do this in a balanced way, an they do not need distortions. The world does not need more Latvias, Estonias, Irelands or Spains (let alone Icelands, and let alone of the size of a Brazil or an India). So policy decisions are now urgently needed to impose measures and structures which help avoid a repeat of the same in what is now a very imminent future. And despite all the talk of reform, very little has been done in practice. Talk of "tax havens" and the like sounds nice, and is attractive to voters, but all this is on the margin of things. What we need is global architectural reform, and policy coordination at the central bank, and bank regulation level, not to stop the capital flows, but to find a more sophistocated way of managing them.

Brazil's Economy Enters The Eye Of The Storm

by Edward Hugh: Barcelona

Brazil is in the middle of a storm at the moment, there can be no doubt about that. But the important point to note is that this storm is not of Brazil's making. The shock waves which are currently traversing all of Brazil's financial and banking institutions (as well as its real economy) are a reflection of a much broader "terremoto" which is erupting in all the major financial centres across the globe, from New York to London, to Frankfurt and on to Tokyo. And of course, when the developed world sneezes, it is the emerging markets who tend to catch the cold. So let's all just hope that this is all it is that the patient is suffering from at this point, a common or garden cold, and that we don't have an early case of pneumonia on our hands. Menawhile, botton down the hatches, since a hurricane is about to pass.

Response to the Crisis

Brazilian President Luiz Inacio Lula da Silva today authorized Brazil's central bank to buy loans from cash-starved banks and indicated the governments willingness to use the country's international reserves to ease a credit crunch that sent the Brazilian real to its lowest in two years and the stock markets right down. As part of the coordinated response to the crisis the central bank sold $1.36 billion in dollar swaps this morning, offering the contracts for a second straight day in an attempt to slow down the surging demand for dollars in the foreign exchange market. The bank sold 27,400 contracts of 46,050 on offer. On Monday the bank sold $1.47 billion of swaps, the first auction of the contracts since May 2006. The real gained more than 1 percent (to 2.176 per U.S. dollar) shortly after the sale of the swaps. The real plunged 7 percent yesterday.

The central bank has also announced it may also lend dollars to Brazilian institutions abroad. The government is also going to provide the state development bank with an additional 5 billion reais ($2.29 billion) to finance exports. The measures ``are important steps to shield the Brazilian economy from the impact of the international crisis,'' Meirelles told reporters.

Authorities are seeking to shore up confidence after Brazil's Bovespa benchmark stock index yesterday plunged to the lowest in 19 months, leading losses in emerging markets along with Russia. The Brazilian real dropped 6.2 percent as commodities, which account for about two-thirds of Brazilian exports, fell. Last week the central bank eased rules on reserve requirements for a second time in the same number of weeks to make more cash available for the banking system.

Stock trading was halted twice yesterday, for the first time since 1998. Trading was stopped after the Bovespa index dropped more than 10 percent at the open and then more than 15 percent in midday trading. The central bank sold $1.5 billion worth of currency swap contracts, the first sale of the kind since May 2006, to stem the real's losses. Brazil's currency has lost 21 percent in the past month against the dollar.

As a further indication of the extent of the present problem, the Brazil government today canceled a local bond sale. This was the first time this has happened in seven months, and offers a further sign of how the global credit crisis is beginning to squeeze Brazil's liquidity.

The Treasury shelved an auction of inflation-linked bonds, known as NTN-Bs, as the tumble in the real appeared to throttle demand for local assets. The Treasury had not announced the quantity of bonds it planned to sell.

The yield on Brazil's overnight futures contract for January 2010 delivery increased 28 basis points, or 0.28 percentage point, to 14.75 percent. The yield on Brazil's zero-coupon bond due in January 2010 rose 33 basis points to 14.88 percent, according to Banco Votorantim.


Emerging Market Bonds


But Brazil is not alone in being hit in this way, and emerging-market bonds had their worst week in four years last week as the deepening credit crisis raised global recession concerns and slammed the brakes on demand for higher-yielding securities. The extra yield investors demand to own developing-nation bonds instead of U.S. Treasuries has surged 109 basis points, or 1.09 percentage point, since the start of last week and reached 4.88 percentage points today (Tuesday), according to data from JPMorgan Chase and Co. The increase is the biggest since at least May 2004 and left the so-called spread at its widest since June of that year. The spread has swelled 1.89 percentage points since the end of August.

Until credibility is restored, we will not see people investing. Investors at this point seem to be unwilling to take any sort of visible risk. The cost of protecting developing nations' bonds against default rose considerably yesterday. Five-year credit-default swaps based on Argentina's debt soared 231 basis points yesterday, reach to 15.09 percentage points, the highest since the country restructured defaulted debt in 2005. That means it costs $1.509 million to protect $10 million of the country's debt from default. Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements.


Emerging Market Stocks

Emerging market stocks fell the most ever yesterday (Monday) and exchanges in both Brazil and Russia were forced to halt trading as the global banking crisis escalated in Europe and oil dropped below $90 a barrel. Brazil's Bovespa index was down 12 percent, while Russia's Micex Index dropped 19 percent after trading was halted three times. China's benchmark CSI 300 Index also fell 5.1 percent, its biggest one-day decline since August. The MSCI Emerging Markets Index slumped 11 percent, the biggest intraday loss since 1987.

This followed a week in which emerging-market stocks had the biggest weekly decline in seven years, led by banks and energy companies as commodity prices dropped on speculation the U.S. is headed for a recession. The MSCI Emerging Markets Index dropped 2.3 percent to 741.73, after a 3.4 percent decline yesterday. The index lost 10 percent this week, the most since the September 2001 terrorist attacks.





Brazil's Stocks


Trading on the Bovespa was halted twice yesterday as stocks tumbled 5,452.81 points to hit 39,064.51 at 1:50 p.m. New York. The Bovespa has now declined 36 percent in the past 30 days, and the index is now the world's worst performing major equity index in North and South America this year, down 51 percent on a currency-adjusted basis, after being the best-performing major market until June. Brazil's real plunged 6 percent against the dollar and Mexico's peso tumbled to a record low.

Emerging market stocks are now taking a severe hit after posting an annualized gain of 32 percent over the past five years as oil prices rose and commodities rose with oil hitting a record $147.27 and the Reuters Jefferies Commodities index reaching an all-time high in July. Brazil is the world's biggest producer of coffee, orange juice and sugar, and about half of Brazil's Bovespa index is constituted by raw material producers.


Central Bank Eases Reserves


Brazil eased requirements on reserves that banks must keep at the central bank for the second time in two weeks at the end of last week in response to worsening credit conditions sparked by the international financial crisis. The central bank now allows banks to meet up to 40 percent of their reserve requirements on time deposits by acquiring credit portfolios from other financial institutions. The measure is expected to free up to 23.5 billion reais ($11.6 billion) that are currently kept as government bonds deposited with the central bank, it said.

Interbank rates have soared as financial institutions worldwide hoard cash to meet future funding needs amid deepening concern that more banks will collapse. Governments in Europe and the U.S. rescued six financial institutions in the past week. The measure is ``intended to improve resources distribution in the national financial system in response to liquidity restrictions seen in the international market,'' the Brazilian central bank said.

On Sept. 24, policy makers delayed the introduction of higher rates for mandatory deposits from leasing companies by two months and raised the threshold on exemptions for cash, time and savings deposits. The measure added 13.2 billion reais to the financial system.


September Global Manufacturing PMI Shows Sharp Contraction

September seems to have been the ultimate "mensis horribilis" for industrial output internationally - and thus it is only natural to assume that Brazilian industry was also adversly affected - with global manufacturing activity contracting for the fourth consecutive month, and output falling to its weakest level in over seven years according to the JP Morgan Global Manufacturing PMI, which at 44.2 hit its strongest rate of contraction since November 2001, down from 48.6 in August (Please see the end of this post for some information about countries included and the JP Morgan methodology).


According to the JP Morgan report the retrenchment of the manufacturing sector mainly reflected marked deteriorations in the trends for production, new orders and employment. The declines in output and new work received were the second most severe in the survey history, while staffing levels fell at the fastest pace for over six-and-a-half years. The Global Manufacturing Output Index registered 42.7 in September, well below the 48.5 posted for August.

The sharpest decline in production was recorded for Spain, followed by the US, Japan and then the UK. Although the Eurozone Output Index sank to its second-lowest reading in the survey history, it was above the global average for the first time in four months. Within the euro area, France and Spain saw output fall at survey record rates, while in Italy and Ireland the contractions were the second and third most marked in their respective series. Germany, which until recently was the main growth engine of the Eurozone, saw production fall for the second month running and to the greatest extent for six years. Manufacturing activity in Japan fell to the lowest in over 6- years with the Nomura/JMMA Japan Purchasing Managers Index declining to a seasonally adjusted 44.3 in September from 46.9 in August.

At 40.8 in September, the Global Manufacturing New Orders Index posted a reading well below the neutral 50.0 mark. JP Morgan noted that the trends in new work received were especially weak in Spain, the UK, France and the US, with the all bar the latter seeing new orders fall at a series record pace (for the US it was the strongest drop since January 2001). The downturn of the sector led to further job losses in September, with the rate of reduction in employment the fastest since February 2002. Conditions in the Spanish, the UK and the US manufacturing labour markets were especially weak.

Russian manufacturing shrank for a second month in September, and in so doing registered its first back-to-back contraction since November 1998, as companies cut jobs and growth in new orders slowed, according to the latest VTB Bank Europe Purchasing Managers Report. The PMI came in at a seasonally adjusted 49.8, compared with 49.4 in August. The August reading was the lowest figure in three and a half years, according to the bank statement. On such indexes a figure above 50 indicates growth while one below 50 indicates a contraction.

Manufacturing in China contracted for a second month in August, underscoring the risk of a slump in the world's fourth-biggest economy. The Purchasing Managers' Index was a seasonally adjusted 48.4, unchanged from July, the China Federation of Logistics and Purchasing said today in an e-mailed statement.



India's industrial output growth bounced back again in July (the last month for which we have official data), reaching a five-month year on year expansion rate high of 7.1%. This follows a noted slowdown where output only rose by 5.4 percent gain in June, and 4.1% in May, according to data from the Central Statistical Organisation.




But if we come to look at the manufacturing PMI we will see that India's manufacturing output has also slowed somewhat, and expanded at its slowest pace in 14 months in September according to the ABN AMRO Bank purchasing managers' index. The PMI reading - which is based on a survey of 500 companies operating in India - fell to a seasonally adjusted 57.3 in September from 57.9 in August. This reading was the lowest since July 2007. Still 57.3 still suggests Indian industry continues to grow quite vigoursly, although the report did highlight the fact that the drop in the index was mainly the result of a decline in growth of new orders, and implied a deterioration in demand conditions, both locally as well as in export markets.


So basically this is where we get to learn what a global credit crunch means in terms of output and economic growth.

Brazil's's Industrial Output Weakens Too

Brazil's industrial output fell a seasonally-adjusted 1.3 percent in August from July, the largest monthly drop this year. On an annual basis, output rose 2 percent, the slowest pace since March, according to data from the national statistics agency in Rio de Janeiro.

And the situation seems to have deteriorated further in September, since the headline seasonally adjusted Banco Real Purchasing Managers’ Index (PMI) registered a 25-month low of 50.4, down from 51.1 in August.



GM And Fiat Cut Vehicle Output


One symptom of the way the slowdown is hitting the real economy is the recent announcement by General Motors and Fiat Spa's Brazilian units to cut vehicle output in the country in October and November after asking some workers to take vacations early. Last week GM asked workers at three of its plants in Sao Paulo state to take time off beginning this month. About 1,700 of Fiat's 15,000 workers at their Betim plant will take at least 10 days of vacation.

Car producers are cutting production after four central bank interest rates increases pushed car-loan costs higher and weakened demand. Auto registrations rose 4 percent to 244,800 units in August, the slowest pace in two years, according to Brazil's Automakers Association. That compares to a 33 percent increase in July. Fiat says the decision will lead to a 10 percent decrease in the company's daily production of 3,000 units.



JP Morgan Global Manufacturing PMI Methodology


The Global Report on Manufacturing is compiled by Markit Economics based on the results of surveys covering over 7,500 purchasing executives in 26 countries. Together these countries account for an estimated 83% of global manufacturing output. Questions are asked about real events and are not opinion based. Data are presented in the form of diffusion indices, where an index reading above 50.0 indicates an increase in the variable since the previous month and below 50.0 a decrease.

The countries included are listed below by size of global GDP share, and the figures in brackets are the % og global GDP in each case (World Bank Data).

United States (30.5), Eurozone (18.7), Japan (13.9), Germany (5.6), China (4.9),United Kingdom (4.5), France (4.0), Italy (3.2), Spain(1.9), Brazil (1.9),India (1.7), Australia (1.3), Netherlands (1.1), Russia (0.9), Switzerland (0.7), Turkey (0.7), Austria (0.6), Poland (0.5), Denmark (0.5), South Africa (0.4), Greece (0.4), Israel (0.3), Ireland (0.3), Singapore (0.3), Czech Republic (0.2), New Zealand (0.2), Hungary 0.2.

Brazil's Mid-month Inflation Lowest Since March

Brazil's inflation continues to fall back steadily. Brazil's mid-month inflation rate fell in September to its lowest level since last March, increasing speculation the central bank will take its time before deciding on future interest-rate increases. Consumer price inflation as measured by the benchmark IPCA- 15 index slowed for a third consecutive month to 0.26 percent, from 0.35 percent by mid-August, according to the latest data from the national statistics agency.

The annual inflation rate fell back to 6.2 percent from 6.23 percent at the end of August. The annual rate has now been reducing slowly but steadily since the July peak.




Inflation on non-food items accelerated to 0.41 percent in September, from 0.38 percent last month, the IPCA report said. The pressure on prices from strong demand was offset by a 0.25 percent drop in food prices, which compared with an equivalent increase last month.


Central Bank Reduces Reserve Requirements

An initial indication of the policy change which may be in the works came yesterday with a decision by the central bank to ease requirements for reserves that banks must keep at the central bank. In prinviple the decision is a response to the volatility in global financial markets following the uncertainty produced by the deepening of the financial turmoil in the United States.

Banco Central do Brasil have decided to delay the introduction of higher rates for mandatory deposits from leasing companies by two months and raised the threshold on exemptions for cash, time and savings deposits, according to a statement released yesterday. The measures will add 13.2 billion reais ($7.16 billion) to the financial system, the central bank said.

This move quite possibly represents an initial reversal of the central bank's policy of slowing domestic lending growth. Central bank policy makers began to tighten reserve requirements on cash deposits from lease underwriters last May, a move that was intended to remove as much as 40 billion reais from credit markets. Bank lending had climbed by a 33 percent annual rate in the 12 months ended July, following a 27 percent rise in 2007. The central bank will release August figures on Sept. 29.

Under the new rules, a reserve requirement of 20 percent of cash deposits from lease underwriters will now take effect on January 16, two months later than originally scheduled. The reserve requirement will then increase to 25 percent in March, according to the present central bank policy. Leasing is a common practice in Brazil, and effectively constitutes an alternative form of bank lending. Also under the new rules Brazilian banks will only have to keep part of their cash, time and savings deposits at the central bank if the reserve requirement exceeds 300 million reais, the central bank said. Previously, this threshold was 100 million reais.


Bank Lending Slows

The easing of reserve requirements is obviously an attempt to offset the impact of the credit and liquidity crunch on the real economy. Brazilian bank lending growth is already slowing, and lending growth this year is expected to fall to a 24 percent year on year rate, according to a recent survey of 26 banks by the Brazilian Banks Federation. This is down from the 27.8 percent growth rate registered in 2007, which was the fastest rate in the last 12 years. This drop is, in itelf, not such a bad thing, as one of the points we should be learning from the financial meltdown is that lending rates should not be allowed to increase dramatically, but the fall may indicate that there is more to come, and year on year lending growth rates of much below 20% would be a significant negative for the domestic Brazilian economy I think.

Lending in Brazil has now expanded more than 20 percent annually since 2004. The sharp increase in lending was driven by a decline in the benchmark lending rate to 13.75 percent from 25 percent. Job creation and higher wages have also contributed to credit expansion. On the other hand the price larger Brazilian companies are paying to raise money has risen to about 2 percent a year above the local interbank rate, up from 0.4 percent six months ago. This spike in risk premium is really a direct consequence of the financial turmoil which has followed the collapse of the U.S. subprime-mortgage market last year.

Car loans have been one of the main drivers of bank lending, and there are clear signs that these loans are now slowing, with evident negative consequences for the Brazilian automotive sector. According to Banco Itau Holding Financeira data - the bank is Brazil's second-biggest non-government bank by assets - their car loans were up by 62 percent in the second quarter, while Banco Bradesco posted a 49 percent car loan expansion.

This is the type of credit which may slow as the credit tightening bites. Domestic vehicle sales - which expanded an annual 33 percent in July - only grew by 4 percent in August, the slowest pace in almost two years.


The Real Continues To Wobble In The Wake Of Uncertainty

Brazil's real yesterday reversed earlier gains, falling on concerns the $700 billion U.S. financial system rescue may be delayed. The currency declined 0.5 percent to 1.8567 per dollar at 3:50 p.m. New York time, following the effective end to the day's trading in Brazil. The currency had earlier risen by as much as 1.4 percent following the announcement that Warren Buffett's Berkshire Hathaway was going to invest $5 billion in Goldman Sachs Group.

Brazil's real has been the biggest loser against the dollar among the 16 most-active currencies this month, declining by 12 percent. My view is that this volatility in the real will continue until the US financial markets stabilise, then, when the dust settles, we will really be able to see what the new global financial landscape looks like, but I am far from being pessimistic about the consequences for sound emerging markets like Brazil, au contraire, this is a developed markets crisis, not an emerging markets one. At the end of the day it is not unreasonable to imagine that some of the key emerging markets will be the net beneficiary of the turmoil, after all the uncertainty dies down.

Brazil Retail Sales Accelerated in July

The rate of increase in Brazil's retail sales accelerated again in July, indicating t that sustained domestic demand may well allow Latin America's largest economy to weather the fall in commodity prices rather better than expected. Retail sales were up an inflation corrected 11 percent in July, following a revised 8.2 percent increase in June. Sales rose in June at the slowest pace in 14 months, according to data from the national statistics agency.



Evidently domestic demand is still robust and four central bank interest rate increases since April have far from throttled Brazilian domestic demand, which had been contributing to the upward movement in annual inflation - to around 6.5% - well above the mid-point of the central bank's target range (4.5 percent plus or minus 2 percentage points), but still significantly below the levels seen in some emerging market economies (especially in Eastern Europe).

At the same time we need to exercise a certain amount of caution in interpreting this data. Month on month retail sales fell 0.2 percent in July from June, and this was the first drop in five months. Thus in part the acceleration in July is due to base effects from 2007. On the other hand, when cars and construction materials are added-in, retail sales were up 1 percent from June.

Vehicle sales rose 4 percent in August from August 2007, and this was the slowest pace in almost two years. The slowdown in car sales is being widely attributed to the impact of interest rate rises on car loan rates.



The prospect of sustained consumer spending against the backdrop of slower growth overseas and lower commodity prices suggests that the economy is far from the oft predicted growth slump, and that the central bank may well use the dramatic fall in oil and other commodity prices as a pretext for moving forward prudently on the borrowing costs front.


The central bank last week raised the Selic rate to 13.75 percent (up from 13 percent), in an attempt to cool demand and slow inflation. Most economists expect policy makers to raise rates further - to 14.75 percent perhaps - by year-end, but looking at the financial turmoil of recent weeks (which has its origin in developed and not emerging economy issues) I can't help feeling prudence (and a more watch and wait approach) may now be called for.

Brazil's Finance Minister Guido Mantega yesterday said that the turmoil in U.S. credit markets would slow Brazil's economic growth to about 4.5 percent in 2009 from 5-to-5.5 percent this year. This is all hard to quantify at this point. But the central argument he was making - that the Wall Street crisis won't stop Brazil from expanding - seems extremely valid to me. He is quoted as saying that under "other circumstances, Brazil would be on its knees right now", and again I cannot help agreeing, and I also don't understand why so many analysts seem to have so much difficulty getting hold of what is happening. We still seem to be in the world of knee-jerk reactions.