Cut in U.S. stimulus programs creates turmoil

U.S. bonds more attractive | Investors pull money out of emerging markets, causing currencies to tumble

The strengthening U.S. economy is causing currency headaches in many of the top markets for Canadian agricultural products.

The improvement in the economy is lessening the need for the U.S. Federal Reserve’s stimulus programs, which have pumped $3 trillion into the economy since 2008.

The Fed is spending $85 billion per month buying up treasury notes and mortgage-backed securities, keeping borrowing costs artificially low.

“The Americans almost quadrupled their money supply with this massive injection of cash into the U.S. banking system,” said Hendrik Brakel, an economist with Export Development Canada.

With returns on U.S. bonds unattractive, investors put their money into corporate bonds and shares as well as emerging market currencies and bonds.

Brazilian bonds were providing investors with annual returns of eight or nine percent compared to one or two percent for U.S. bonds.

However, the U.S. economy is gradually recovering from the 2008 implosion. In May, the chair of the Federal Reserve said it plans to reduce the amount spent on the stimulus programs. That will cause U.S. bonds to become more attractive than those in emerging markets.

“It created a panic, and so you’ve got this money ripping out of emerging markets,” said Brakel.

The Indian rupee has fallen 13 percent since May 1 and the Brazilian real is down 12 percent.

“All this volatility is there just be-cause all these dollars that floated into the emerging markets are starting to flow back out,” he said.

It becomes more expensive to import Canadian agricultural products as currencies in emerging markets weaken. That is troubling because they are high growth markets.

Brakel said there is no end in sight to the currency volatility because the Federal Reserve hasn’t yet started reducing its monthly stimulus spending.

“It’s just the hint of that pullback has caused those currencies to tumble,” he said.

The first actual drop in spending will likely happen near the end of 2013.

“That will rattle markets,” said Brakel.

The Fed has also hinted that it will start raising interest rates in the second half of 2015, once the unemployment rate hits 6.5 percent.

Export Development Canada expects to see continued currency turmoil in emerging markets over the next two years.

“We figure there’s going to be quite a lot of volatility and a lot of nervousness associated with all this,” said Brakel.

However, the impact on agricultural exports could be muted because food demand is inelastic compared to other goods.

“We’re generally really bullish about (grain sales) to emerging markets,” he said. “It’s just that this is going to create a whole lot of instability in the coming years.”

However, one grain industry analyst said currency problems overseas are already hurting exports.

India is the eighth biggest buyer of Canadian agricultural exports and the leading purchaser of Canadian pulses.

Stat Publishing said Indian importers who contracted pulses in March and April are taking a huge financial hit because many of them are unable to hedge against currency volatility.

“Until India’s currency stabilizes, importers will be reluctant buyers,” Stat editor Brian Clancy wrote in a recent article.

“The longer that continues to be the case, the more it could hurt sales of Canadian pulses to the Indian subcontinent.”

Some Indian buyers have defaulted on contracts, forcing exporters to find a new home for their peas and lentils.

“This combination of reluctant buyers and a tangible risk of contract defaults could make it harder for Canada to meet its export sales targets for the coming marketing year,” said Clancey.

Brakel said one important emerging market is not affected by the currency fluctuations.

China is the second biggest buyer of Canadian agricultural exports ater the U.S. Investors were unable to invest in China’s currency because it is not convertible.

“There is really no consequence of this unwinding of (quantitative easing) for China,” he said.

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