One of the biggest stories of this summer, as previewed originally here in November of 2014, has been the dramatic shift in the direction of capital flow from toward emerging markets (and China), to away from emerging markets (and China). The reason for this has been the double whammy of the soaring dollar, and the collapse in oil prices which as we said one year ago, would lead to the first negative global petrodollar export balance in 18 years...
... a topic which the IIF finally picked up and expanded on last week when it likewise calculated that capital outflows from emerging markets are on track to exceed inflows this year for the first time since 1988.
We first dubbed this phenomenon Reverse QE, a name which Deutsche Bank subsequently "reverse-engineering" into Quantitative Tightening, a different name for the same thing - the removal of excess liquidity from the market by way of obtaining liquidity for existing reserve assets, also known as "selling."
However, while Reverse QE, or QT, or whatever one wants to call it has become traditionally associated with Emerging Markets and petroleum exporters, nobody had linked it with one of the most advanced Developed Markets in the world which also happens to be an oil exporter, the market with the largest sovereign wealth fun in the world: Norway.
That is about to change because as Bloomberg reports, "the future may already be here", a future in which Norway's gargantuan $830 billion sovereign wealth fund, the product of two decades of capital accumulation courtesy of Norway's vast petroleum reserves and oil trade, is forced to begin liquidating its vast assets.
According to Bloomberg, Norway could as soon as next year start making withdrawals from its massive $830 billion sovereign wealth fund, which is a nest egg for "future generations."
The start of asset sales marks a historic shift for said "nest egg" which was not supposed to be tapped for many more years. Unfortunately for Norway, which has already spent recent years using a growing chunk of its oil revenue to plug deficits while at the same time building the wealth fund...
... tax revenue from petroleum extraction are down 42% which means budget spending in 2016 will outstrip income.
The real problem for Noway is simple: the very procyclical plunge in oil prices.
As Bloomberg calculates, taxes collected on petroleum extraction reached 138 billion kroner in the first three quarters of the year, down over 40% from 238.2 billion kroner in the same period a year earlier, according to Statistics Norway. But while oil-linked revenues are plunging, spending is going nowhere but up:
The government said in May its non-oil budget deficit, or spending in real terms, would be a record 180.9 billion kroner ($21.6 billion). With its crude output waning and prices falling, the government saw petroleum income dropping to 251.6 billion kroner this year, almost 30 percent lower than its October projections. Those estimates assumed oil at about $69 a barrel.
Brent crude has averaged $56 so far this year, and has been below $50 for the past several months, presenting a huge challenge: how to tap the revenue shortfall.
The answer is simple, if unpleasant: break open the piggy bank, or in this case, start selling the securities held in the Norwegian sovereign wealth fund.
“We have reached a point where we will from now on see that the oil-corrected balance will be above the cash flow -- that’s based on oil prices increasing slowly in the future,” said Kyrre Aamdal, senior economist at DNB ASA in Oslo. Tapping the fund’s returns marks a turning point that wasn’t expected to come for “several more years,” he said.
Tapping the fund to cover budget needs comes at a time when the managers of the fund, set up to safeguard the wealth of future generations, warn that it also faces diminished returns ahead amid record-low interest rates.
To be sure, government officials, terrified of revealing the unpleasant truth to the people, are pretending that the funding shortfall can be covered only with dividend and interest income:
Government officials and economists contend that only investment returns from the fund will be used for the budget, meaning it will not actually shrink in size. By using interest and dividends to cover the deficit, “no one will ever need to break the piggy bank,” said Knut Anton Mork, senior economist at Svenska Handelsbanken AB in Oslo. Oeyvind Schanke, chief investment officer for asset strategies at the Oslo-based fund, said in an interview last month it will be able to use the cash it gets from dividends and bond interest payments to make shifts in the portfolio, rather than having to sell assets.
Populist rhetoric aside, the SWF will have no choice but to sell: "capital coming into to the fund has already started to dwindle. Inflows were just 17 billion kroner in the first half of this year, compared with a quarterly average of 60 billion kroner over the past 10 years. Central bank Governor Oeystein Olsen, who oversees the fund as head of the bank’s board, said in February that oil around $60 would mean transfers to the fund "may come to a halt."
Oil is now nearly 20% lower, and as goes the price oil, so go the inflows into the fund. Which means that any month now, if not already, Norway will shift from net buyer of global financial assets to a net seller, in the process joining the Emerging Markets and, of course, China in soaking up even more liquidity, mostly USD-denominated, out of the market, in the process removing much of the liquidity injected by the Fed and its peer central banks.
This situation will only deteriorate that much further, and force the wealth fund to sell even more assets should the Fed hike rates, pushing the dollar even higher, and sending the price of oil crashing below. In fact, the coordinated selling of US-denominated assets will be precisely the catalyst that sends the global stock market tumbling, and ultimately serve as the catalyst for NIRP and/or QE4.
The only question is whether Yellen has finally figured this out and will proceed straight to the NIRP/QE4 part or whether she will subject the market to 6-9 months of gut-wrenching volatility as the world's largest sovereign wealth fund realizes what it means to try to sell billions of assets into an illiquid, bidless, market.
In the meantime, and completely independent of what Yellen does in the near future, what was until recently a parabolic move higher in assets...
... is about to see its first ever decline.