Moody’s: The Knock-On Effects of a Tighter Fed

A strong dollar will “dent” US economic growth and cause further problems for G20 nations Moody’s classes as vulnerable, including Turkey, South Africa, and Brazil, the ratings agency predicted.

The firm has cut its 2015 growth forecast for the US from 3.2% to 2.8% in its latest Global Macro Outlook report, due to the strength of the dollar and the effects of poor weather in the first quarter of the year, which reduced economic activity.

“The majority of countries across Latin America, China, and Asia look challenged.” —Stephen Jones, Kames CapitalMoody’s warned that a “disorderly reaction” to rising interest rates could have significant effects around the world as the dollar was likely to strengthen further.

While the dollar has already appreciated due in part to capital inflows from investors, Turkey, South Africa, and Brazil remained on the other side of the trade, with outflows causing their currencies to decline, Moody’s said.

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“A disorderly reaction to US monetary tightening would prompt falls in asset prices globally and increases in risk premia and trigger a significant further appreciation of the US dollar,” wrote Marie Diron, a Moody’s senior vice president for credit policy. “This could happen if investors needed to adjust swiftly their expectations of future monetary policy towards what is currently projected by the Federal Reserve.”

The recent declines in the Turkish lira and South African rand indicated that economic activity in the two countries would be “negatively affected,” Diron added, while weak growth in Brazil meant the second-largest emerging economy was at risk of a deeper recession. Brazil has already recorded three consecutive quarters of negative GDP growth.

Separately, Kames Capital CIO Stephen Jones has warned that emerging markets “have had their day in the sun” and were being “battered” by currency flows and weak commodity prices.

In contrast, Jones highlighted India’s strong performance in 2014 due to “positive political change” and its position as an energy importer, meaning it benefited from low prices.

“Investors can point to India as a brighter spot, but certainly the majority of countries across Latin America, China, and Asia look challenged,” he said.

Moody’s Diron predicted India would be the fastest-growing G20 nation in the next two years, with GDP growth forecasted at 7.5%.

“Lower oil prices will reinforce gradual growth-enhancing reforms to support robust economic activity over the forecast period,” Diron said. “We forecast ongoing moderate inflation which will enable better planning of investment. Lower inflation will also raise real incomes, profits, and overall GDP growth.”

Diron’s report also projected a “moderate” impact on the Eurozone if Greece was to exit the currency bloc. The country is currently negotiating with the International Monetary Fund and the European Central Bank over the terms of its bailout package, and slipped back into recession in the first three months of the year.

“Trade and financial linkages between Greece and the rest of the monetary union are small,” Diron said, with French and German banks having reduced their exposure to Greece, and only 0.5% of German and French exports going to the struggling country.

“A 20% fall in Greek imports would imply a 0.1% direct impact on German and French exports and no measurable effect on GDP,” Diron added. However, Greece risked a “very deep and long-lasting recession” if it exited the Eurozone.

A stable government and new entrants into the UK de-risking market indicate that activity is likely to increase later in the year, according to consultancy LCP.

“The result of a Conservative majority should provide a more stable backdrop for transactions over the rest of 2015.” —Charlie Finch, LCPThe first quarter of 2015 was significantly quieter than the corresponding period in 2014, LCP said, with just £804 million ($1.3 billion) in new buy-out and buy-in business completed.

“The result of a Conservative majority should provide a more stable backdrop for transactions over the rest of 2015,” said Charlie Finch, partner at LCP. “Further, movements in bond and swap markets since the general election have made pensioner buy-in pricing more attractive for many schemes.”

He added that the entrance of Scottish Widows as a new provider later this year would “provide welcome additional insurer capacity”. The Lloyds Bank subsidiary is building a team with a view to becoming active in the second half of 2015.

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“In combination with Partnership and Just Retirement, who are now writing more significant volumes of business at the smaller end of the market, this ensures continued competition across pension schemes of all sizes,” Finch said.

Legal & General continued its recent dominance in terms of new business volumes in the first three months of the year, writing £644 million—80% of the Q1 total. In 2014 L&G was responsible for almost £6 billion of the £13.2 billion in total new business.

LCP Q1 de-risking report Source: LCP

The second quarter has started with more activity, including Rothesay Life’s £675 million buy-in of Lehman Brothers’ UK pension, which is set to become a full buy-out later in the year.

Yesterday, Rothesay announced it was to take on £1.2 billion of individual annuities from Zurich UK Life as the insurance group sought to de-risk its portfolio.

As well as standard buy-ins and buy-outs, two major longevity swaps were completed in the first quarter. Scottish Power offloaded longevity risk valued at £2 billion to Abbey Life, while the Merchant Navy Officers’ Pension Fund established its own insurance subsidiary to take £1.5 billion of longevity risk off the table.