Wobbling into crisis

This week’s antics in emerging markets just prove the truth of the old market saying: “money goes where it’s treated best”. When yields the world over are being squeezed lower as printed money chases asset prices higher, investors have to travel far to find acceptable returns.

If that means lending to Rwanda for ten years at a rate of just under 7% (as investors did last April), so be it. What could go wrong in a world propped up by endless quantitative easing (QE)?

But when there’s even a hint that the squeeze on yields might stop – or worse still, reverse – investors’ appetite for exotica collapses. Why lend to the Rwandan government, or risk investing in Turkey, when the promise of higher interest rates in much safer countries looms on the horizon?

With the Federal Reserve promising to reduce the amount of money it prints this year, higher rates from the US central bank remain a while off – but markets have already decided that the next move is up.

Of course, the argument goes that we needn’t fret, because a crash will see central banks crank up the presses again. We wouldn’t rule that out, particularly if there’s a severe spillover to US markets. But given that this is pretty much the consensus take on things, it’s worth considering that this view may be too sanguine.

The US, despite some significant problems, also enjoys some big advantages right now. Its banks are healthier than those of most developed economies. The potential of shale gas may or may not have been overstated, but it is already allowing the US to attract jobs and business back from emerging markets. And while the stock market looks expensive and vulnerable to a correction, the Fed can’t switch tack every time there’s a 1% wobble.

And if the Fed doesn’t print, who will? As emerging markets are learning, it’s hard to run loose monetary policy in your own country when the world’s top economy even hints at tightening up.

Japan can get away with it – one reason we like it as an investment – as could Europe (though it’s not keen to do so). But for many others, as India and Turkey have shown this week, the only feasible direction is to raise rates from here.

Britain is not immune. We were helped in the early days of the crisis by the government talking a good game on ‘austerity’ – but more crucially, monetary policy was loose everywhere else too. As that ends, Mark Carney will face a tough choice. Start raising interest rates, risking a pile-up in the housing market and by extension the banks, or leave policy too loose and risk a collapse in sterling.

Our Roundtable experts this week give their views on how to fix our financial system, and what they’d do in Carney’s shoes. Of course, changes on the scale they discuss would require a crisis. But perhaps we’ll get one.

Merryn

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