Reuters Summit-Forget QE3, focus on foreign reserves-JPM’s Chang

By Herbert Lash and Daniel Bases

NEW YORK (Reuters) – A massive build-up in foreign reserves in emerging markets should snuff worries about the end of the Federal Reserve’s bond-buying program, the global head of emerging market research at JPMorgan said Monday.

The rapid accumulation of foreign reserves and the conservative stance central banks take when investing them means U.S. Treasuries are a major target for those funds, supporting the market as the Fed ends purchases.

The increase in foreign currency reserves last year was about $885 billion, of which 80 percent was held by emerging markets, said JPMorgan’s Joyce Chang. By the end of the year, foreign currency reserves are expected to be close to $11 trillion, she said.

“If you think about that number, that’s almost 50 percent higher than all of QE2,” Chang said. She was referring to the Fed’s $600 billion bond-buying program slated to end June 30 that is known as quantitative easing, or QE2.

The pace of reserves accumulation has surprised on the upside, and has helped suppress bond yields in the U.S. Treasury market the past couple of years, Chang said.

Seasonal factors could cut foreign buying of U.S. Treasury debt by one-quarter this summer, but central banks have few options when buying assets with their reserves, she said.

“If you’re accumulating that much in foreign exchange reserves there aren’t many places it can be deployed,” she said.

Growth of foreign currency reserves in the developing world is just one factor that indicates the amazing strength of emerging market economies, she said.

Emerging markets are expected to grow 6.1 percent this year compared to 2.2 percent for the developed world, a rate that when combined with the level of their foreign reserves speaks volumes about the health of the developing world, Chang said.

“Any indicator that you look at, whether it is the fiscal or the debt indicators, still favors emerging markets,” Chang told the Reuters Investment Outlook Summit in New York.



Chang remains bullish on emerging markets. JPMorgan’s 6.1 percent growth rate was revised from an earlier forecast this year of 5.9 percent.

A record $125 billion in corporate bond issuance in emerging markets in the first five months of the year is another strong indicator for the developing world, Chang said.

Growth in emerging markets corporate issuance is so strong Chang predicts it will match the size of the U.S. high yield market by 2014. The market cap for JPMorgan’s global high yield index right now is $860 billion. The outstanding size for dollar-denominated corporate debt is about $650 billion.

“You have a lot of issuance over the last few months, but longer-term this is still a market where very much that growth story is still intact,” Chang said.

“You could have this be a market that is $800 billion to $1 trillion over the next couple of years quite easily,” she said.

The strong fiscal policies of governments in emerging markets and their low debt profile suggest emerging markets will remain in good shape for the foreseeable future.

“This could be cyclical but it could be a much longer cycle than we have had in the past. You could be looking at a 25-year cycle,” Chang said.

“Everyone says it is cyclical. Well the debt transformation and the fiscal transformation is one that developed countries will have to bear the burden of for years to come,” she said.

China, of course, is key to the emerging markets story. A misstep by authorities on social issues could prove worrisome.

However, a high savings rate equal to more than 50 percent of gross domestic product, government control over the banking system, an undervalued currency and continued migration from rural areas to cities point to sustainable Chinese growth.

“That’s why it has been very hard for me to buy into the China hard-landing scenario. I don’t see how you can hard land in that much water,” Chang said. (For more on the Reuters 2011 Investment outlook Summit, see) (For summit blog: (Reporting by Herbert Lash; editing by Andrew Hay))