Operation Twist has been launched and the US Federal Reserve will now buy back $400 billion worth of long-dated Treasuries in a bid to bring down long-term interest rates; at the same time it will sell an equal amount of short-term bonds. Unlike in previous rounds of stimulus therefore, the balance sheet won?t expand. In other words, there?s no QE3 for the moment and the impact of Operation Twist on interest rates, economists reckon, could be much the same as it was when the Fed started buying back $600 billion worth of bonds last November. Taking a cue the yield on the ten-year Treasury fell to 1.87%, the lowest in many decades. The Fed has already said it wants to keep interest rates exceptionally low until mid 2013, hoping that will kickstart a sputtering US economy.
But the fact remains that interest rates are already very low and despite that US consumers haven?t yet been tempted to borrow?George Soros? believes the US is already in a double dip. That means it?s going to be a while before consumers start spending and some of that was reflected in the Fed chief Ben Bernanke?s rather bleak outlook on the economy, which also dwelt on the strain in the financial markets. Also, a solution to the sovereign debt crisis in Europe seems far away even if the Bank of England, like the ECB before, it seems to be moving closer to buying back bonds. And growth is slowing even in economies like Germany.
It?s true the emerging economies may be far better off than the developed world in the sense they?re far less leveraged. But they have their own set of problems, the biggest being inflation, in economies like India?s. Moreover, China may just have a problem with its banking system as pointed out by the IMF.
A recent report by Schroders noted that in 2009 Chinese banks lent the equivalent of 31% of Chinese GDP and in 2010, 21% of GDP. As if these weren?t large enough numbers, if the off-balance sheet loans are taken into account, the total system growth was 39% of GDP in 2009 and 34% in 2010.
There?s way too much credit in the world?s second largest economy and a fair amount of this is with the local governments and may not come back to banks. Official local government debt numbers are close to $11 trillion RMB and this does not include local government state-owned enterprises.
How China manages its bad loans will be key to the world economy but the good bit is that the yuan has appreciated more than 10% this year so far. The other piece of good news, in a world that?s going to grow at just 4% this year, is that prices of commodities are dropping off lead by copper, now close to a one ?year low.
But even lower crude oil prices haven?t brought much cheer given how sharply the rupee has fallen off in the past month and it?s surprising foreign investors haven?t sold more. Indeed until the sovereign debt problems in the Eurozone are resolved, it?s hard to see too much money moving into equities.
In the week to September 7, equity funds saw $15 billion move out, though the numbers were skewed by redemptions from a single fund, excluding which about $5 billion was withdrawn. But it?s possible large pools of capital, like Goldman?s Alpha Fund, will dry up.