Chart of the Day: Frontier Markets Fixed Income Yields

We would be wise remind ourselves first of the definition of the impossible trinity: it is impossible to have (a) a fixed exchange rate, (b) absence of capital controls and (c) an independent monetary policy.

Remember that. I’m going to come back to that.

So Silk Invest has this going on:

“The chart on the right hand side compares currencies in terms of Purchasing Power Parity. What the graph tells us is that the adjusted value of the Brazilian Real is similar to the US$, while most frontier market currencies are systematically undervalued.”

2013.01.23.Frontier Markets yields

The problem I’ve always had with Purchasing Power Parity is that it assumes equivalent standards of living across markets when in fact that is very rarely the case. Put another way, a dollar may buy more in Brazil than in Vietnam, but this says nothing about what the average citizen in either of those countries needs to sustain a living.

But that’s an argument for another time and another context. Otherwise, this is a very compelling chart. A couple things off the top of my head:

The market interventions we’ve been seeing Switzerland’s central bank doing the past year are obviously not working. Or rather they are, but it isn’t enough.

Brazil in this context I’m willing to dismiss as an outlier due to other “currency war” measures similar to the Swiss situation (and by the way I never thought I would be thinking of those two countries in the same sentence).

Actually the striking thing to me here lies at the opposite extreme, specifically the Ghana-Zambia-Vietnam triangle, which I readily acknowledge up front is an even more absurd discussion framework than Brazil-Switzerland, but then that’s the world we’re living in right now. But I’m not making this up — the left chart has indicative yields from Vietnam and Zambia virtually identical at the bottom of the barrel while Ghana’s indicative yield blows everyone else away; on the right side, Ghana’s and Zambia’s PPP are the highest before Brazil while Vietnam is third from the bottom. Surely this isn’t a coincidence?

Here’s what I see: Ghana and Zambia are commodities-driven economies and the relatively high PPP (followed immediately by Nigeria I might add) is clearly an expression of this dependency. Vietnam, meanwhile, is dealing with the blowout of a bubble collapse that seems to be taking longer than some people anticipated.

On the left side, theoretically speaking, Ghana should be where Vietnam is and Vietnam where Ghana is. We’re seeing 20+% yields here for Ghana because of Ghana’s higher inflation rate and the Bank of Ghana’s attempts to shore up the cedi, which seem to have proven half-effective at best. And we’re not seeing higher yields in Vietnam because the State Bank of Vietnam has of late been flooding the banking system with cash, driving up demand for debt investment, thereby pushing yields down. This is a better place than Vietnam was in a few years ago, but if we play out the string we can see the limits to this policy. That is, keep flooding the system with liquidity and at some point inflation will return to where it was in 2008 and yields will  have to rise again.

The Impossible Trinity strikes again.

I should point out, if it isn’t obvious by now, that while high yields are nice for investors, they are also a sure sign that something isn’t quite right in the economy (or company).

In any event, none of this situation is any way sustainable but like many other unsustainable situations elsewhere in the world, when it corrects itself is anyone’s guess.

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