| LONDON, Sept 13
LONDON, Sept 13 U.S. money printing has ignited
currency wars in the past but a third round of Fed stimulus
could prove less inflammatory as weakening economies dampen
investors' enthusiasm for emerging markets.
The U.S. Federal Reserve appears set to launch additional
bond-buying at its Thursday meeting, or at least signal the
timing of the operation, known as quantitative easing, or QE.
The unconventional stimulus however is widely perceived by
emerging policymakers as an attempt to devalue the dollar
against their currencies - a currency war, as Brazil has dubbed
Past QE bouts have indeed triggered almost Pavlovian
reactions among investors to sell down the dollar and buy
higher-yielding, higher-risk currencies, assets and commodities.
The unprecedented inflows of yield-hunting cash pushed
emerging currency values up about 7 percent in the half year
following QE1, Thomson Reuters data shows, while local currency
debt gained 15 percent. More QE in 2009 and 2010 added to gains,
pushing some currencies to record highs.
Some fear more of the same in 2012.
Chile's finance minister Felipe Larrain said this week that
QE3 was a matter of concern for countries with floating
currencies. Even before the announcement, the Chilean peso has
surged to 4-1/2 month highs against the dollar.
Larrain may be right to worry. The peso is supported by a
high 5 percent interest rate and the central bank has been
reluctant to lower it because domestic growth is robust.
But the picture elsewhere is different. Quite simply,
emerging currencies are no longer an outright buy as their
economies slow and yield premia are eroded.
Kieran Curtis, who runs an emerging debt fund at Aviva,
notes that the majority of emerging currencies, including
China's yuan, have lost ground versus the dollar this year as
economic growth has slowed and central banks from Brazil to
South Korea have cut interest rates.
So not only is the interest rate differential between U.S.
and emerging interest rates smaller than in the past,
inflation-adjusted interest rates are actually negative in many
"The immediate gut reaction will be for currencies to
strengthen but we'll probably see less of the QE spilling to
emerging markets than last time," Curtis said.
"Investors are slightly less comfortable with emerging
currencies now than they were."
Indeed, a dollar-based investor would not have made much
money on emerging domestic bonds this year if not for falling
yields, caused by rate cuts. That's the reason 80 percent of
investment flows to emerging debt in 2012 have gone to dollar
As exports falter, Asia's once-mighty current account
surplus has dwindled, Brazil has swung into a deficit and
balance of payments gaps in countries such as India, South
Africa and Turkey are not far off record highs.
"(In 2010) expectations of growth in Asia were very high;
now overall, globally it is a slowdown, in South East Asia and
China in particular," Thailand's central bank governor Prasarn
Trairatvorakul told Reuters this week.
Domestic demand in most countries is not robust enough at
this point to offset an export collapse, and that points to more
interest rate cuts ahead, analysts say.
Emerging currencies have firmed in recent weeks on the Fed
QE hopes as well as the improving euro zone picture. QE3 would
be "a helpful but insufficient condition" for this rally to be
extended, say UBS analysts.
"The health of the global business cycle is a far more
important driver for emerging currencies than the size of the
Fed's balance sheet," UBS told clients, adding it was not
positioned aggressively for emerging FX strength versus the
Second, the assumption of more Fed bond buying seems to be
priced into most asset prices. And many reckon QE may have lost
its power as markets interpret the continued recourse to
money-printing as a sign of desperation.
"The first QE wave was different from what we had ever seen
before from the Fed or any Western central bank," said Philip
Poole head of global and macro strategy at HSBC Global Asset
Management. "But each successive wave is less powerful ... there
is a law of diminishing returns."
Poole notes that emerging central banks are prepared this
time for QE's side effects and will not hesitate to counter with
direct dollar buying, rate cuts or even capital controls which
now have the blessing of the International Monetary Fund.
Brazil, for instance, has already been acting. It intervened
this week to push down the real which had firmed to three-week
highs on Fed expectations.