Cash flood reshapes investment universe

LONDON (Reuters) - A flood of cheap money in the global banking system being pumped by developed central banks is reshaping an investment landscape as the dollar plunges and capital chases higher yield in emerging markets.

Treasury Secretary Timothy Geithner (L) and Federal Reserve Chairman Ben Bernanke leave a ceremony to debut the new design for the US$100 note at the Department of the Treasury in Washington, April 21, 2010. REUTERS/Jim Young

The Federal Reserve’s promise to print more money if needed to shore up the U.S. economy, Japan’s yen-selling intervention and calls for more monetary easing in Britain have all but ensured interest rates in advanced economies will stay near zero for some time.

In the past week, those expectations have knocked the dollar to six-month lows .DXY, sending gold to record highs. The yen approached levels where Japan officially intervened, stirring talk of more action -- which in turn would pump more cash into the system.

With returns on investment staying low in advanced markets, massive amounts of cash are pouring into emerging economies.

Emerging stocks, measured by MSCI .MSCIEF, hit their highest level since July 2008 in the past week, as their correlation with U.S. stocks .SPX hit a 14-month low.

Emerging equity and bond funds have attracted nearly $80 billion in inflows this year, surpassing last year’s total, according to data from fund flow tracker EPFR. The Institute of International Finance expects broader flows into emerging economies to exceed $700 billion in 2010.

This means the “risk-on risk-off” mentality that dominated much of the post-crisis market is waning and lines are getting increasingly blurry between emerging and advanced economies.

“Emerging markets have graduated. We are moving into the world where a difference between advanced and emerging markets is becoming less important,” said Piero Ghezzi, head of economics research at Barclays Capital.

“It’s going to be a long time before any of the G4 countries will start tightening. Carry is going to play a larger role. When volatility is low, risk-adjusted carry is more attractive.”

Barclays sees Advanced Emerging Markets (AEM) as a new asset universe that would attract significant capital flows.

The make-up of developed and emerging markets may be changing too. The index compiler FTSE has just left Greece on its watchlist for a possible downgrade to AEM. If implemented, the move could prompt an exodus by index-tracking funds.

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“It is not just the shorter-term dynamics that favor emerging countries at the moment,” said Bill O’Neill, chief Europe, Middle East and Africa investment officer at Merrill Lynch Wealth Management.

He said the emerging market middle class -- expected to reach 1.5 billion by 2030 -- will drive purchasing power and domestic demand. Investment in power, water and other infrastructure should exceed $20 trillion over the next decade.

“These factors, coupled with commodity and export-orientated growth in emerging markets, all underline the longer-term strength of the region,” he said.


A wave of liquidity comes as the global economy is expected to expand at a healthy 4.6 percent this year, with some emerging economies growing at nearly 10 percent.

Credit Suisse estimates there is $6.2 trillion of excess leverage in the developed world, given the level of fiscal debt.

This would eventually stoke inflation in the long term, which would also help debt-laden governments reduce their fiscal deficits. Inflation-proof assets such as equities, gold and inflation-linked bonds would outperform.

The Swiss bank says real bond yields have fallen 55 basis points this year to less than 1 percent. A further fall in yields, possibly below zero, could suggest the market is underpricing inflation risks.

Credit Suisse estimates that every 1 percent drop in real rates boosts equity valuations by 20 percent.

In the coming week, investors should also be mindful of renewed concerns about the euro zone banking sector, after the premium to buy Irish government bonds rather than benchmark German bunds hit a euro lifetime high in the past week.

Investors are nervous about a possible restructuring of riskier subordinated debt issued by nationalized lender Anglo Irish Bank ANGIB.UL as government guarantees for the debt expire at the end of September.


The more money developed economies print, the higher inflows emerging economies would see, which may result in monetary tightening measures to curb inflation. This would attract even more capital flows, creating a vicious circle.

However, China’s recent move to allow its yuan currency to appreciate could disrupt this cycle.

The yuan rose 1.35 percent in the nine trading days to September 21, hitting levels above 6.70 per dollar for the first time since Beijing depegged it from the dollar in 2005.

An orderly appreciation of the yuan would ultimately help remove exchange rate undervaluation that has fueled China’s export sector and rebalance the Chinese economy away from exports and support domestic demand.

This in turn is positive for frontier markets.

They are benefiting from rising Chinese domestic and corporate purchasing power, including Ghana, which has just signed nearly $13 billion in loan deals with China aimed at funding energy, agriculture and transport projects.

The MSCI frontier market equity index .dMI7400000PUS has risen 8 percent this year, easily outpacing the broader benchmark .MIWD00000PUS and emerging stocks.

Editing by Susan Fenton