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from MacroScope:
Euro zone may struggle with its own Lost Decade
Additional Reporting by Andy Bruce and polling by Rahul Karunakar and Sumanta Dey.
As Europe’s crisis drags on, the prospect of a Japanese-style lost decade of economic malaise is becoming increasingly real, according to a new poll. Half of the bond strategists and economists surveyed by Reuters are now expecting just such an outcome.
Many market participants have dismissed the fall of two-year German bond yields below their Japanese counterparts as being merely a result of a crisis-fueled flight to quality bid. Two-year German yields are now close to zero, offering returns of only 0.02 percent. By contrast, equivalent Japanese bonds are yielding 0.11 percent.
But a significant portion of analysts in a Reuters poll see something more sinister in the rapid narrowing of the premium investors require to hold German debt over Japanese bonds. One half of those polled – 12 out of 24 – said it is likely the euro zone is close to entering a period of prolonged low or no growth and inflation and low interest rates, with the other half saying it was unlikely.
According to Stephen Lewis, chief economist at Monument Securities:
I don't really see an early end to the financial crisis in the euro zone. I think it's very unlikely that Germany and the other countries will see eye to eye in the course of this year. That's going to keep the euro zone economy looking very weak for the next several quarters.
Europe's economy stagnated in the first quarter of 2012 and is expected to shrink 0.4 percent this year, according to another recent Reuters poll. Data on Thursday certainly pointed in that direction, suggesting even wealthier countries like France and Germany are also starting to feel the pinch.
from Global Investing:
Three snapshots for Thursday
Fears that Athens is on the brink of crashing out of the euro zone and igniting a renewed financial crisis have rattled global markets and alarmed world leaders, with Greece set to figure high on the agenda at a G8 summit later this week. This chart shows the impact on assets since the Greek election:
Euro zone banks now account for only 8% of total euro zone market value - they were over over 20% of the market in 2007:
Japan's economy rebounded in January-March from a lull in the previous quarter, shaking off the pain of a strong yen and Europe's debt crisis on solid consumer spending and rebuilding from last year's earthquake.
from Breakingviews:
Asia’s bonds look shinier as Europe and China slump
By Wayne Arnold
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
Asian bonds seem likely to gain from growing anxiety about Europe and China. The region’s robust finances have made its sovereign debt a safe haven as larger economies sputter. An indiscriminate sell-off would hurt everyone, but Indonesia, Japan and the Philippines all have qualities that should give them greater resilience.
Worse-than-expected economic data from China and the prospect of a Greek exit from the euro zone have sparked a stampede from risk assets. Investors fear global growth will slow, and that the sell-off will snowball. One way bleaker conditions in Europe could reach Asia is through its banks. European lenders pulled at least $135.8 billion in credit out of Asia in the second half of 2011, according to the Bank for International Settlements.
Asian sovereign bonds should benefit from weaker growth, lower inflation and lower interest rates. The safest are those that are also less vulnerable to outflows. Indonesia, for example, has public debt of less than a quarter of GDP - even Germany owes three times as much. It has relatively little short-term external debt and a much lower reliance on credit from European banks than other Asian economies. Yet the government’s 10-year bonds yield 4.7 percentage points more than Treasuries.
Japan, despite bonds that yield less than Treasuries and a government debt 1.5 times larger relative to its economy than Greece’s, is safer still. Foreigners own less than 7 percent of its bonds, which limits the potential for forced selling, and Japanese deflation has kept demand steady. By contrast, foreigners hold 80 percent of Australia’s government debt.
The most unlikely refuge is the Philippines. Though impoverished, its government has managed to build a $76 billion foreign reserve buffer, equivalent to almost six times its short-term external debt, and finances 95 percent of its public debt at home. Yet Philippine bonds still pay 4 percent more than U.S. Treasuries. Such trades are still risky - not everyone wants to go long the Philippine peso. But the worse things get elsewhere, the more palatable that risk may seem.
from Global Investing:
Big Fish, Small Pond?
It's the scenario that Bank of England economist Andrew Haldane last year termed the Big Fish Small Pond problem -- the prospect of rising global investor allocations swamping the relatively small emerging markets asset class.
But as of now, the picture is better described as a Small Fish in a Big Pond, Morgan Stanley says in a recent study, because emerging markets still receive a tiny share of asset allocations from the giant investment funds in the developed world.
These currently stand at under 10% of diversified portfolios from G4 countries even though emerging markets make up almost a fifth of the market capitalisation of world equity and debt capital markets. In the case of Japan, just 4% of cross-border investments are in emerging markets, MS estimates.
But change is on its way. MS surveys show most classes of global institutional investors intend to boost allocations to emerging markets, including the more conservative investor groups -- Japan's $1.3 trillion government pension insurance fund, for instance, plans to start buying emerging equities later this year. MS analysts calculate allocations to emerging markets could rise 3.5% over the next five years.
That may not sound like much until one realises the true scale of the global pool of investable institutional assets and compares them with current market cap values in developing countries . These assets currently exceed $212 trillion, meaning a 3.5 % allocation increase will bring over $2 trillion into emerging markets. That's over half the capitalisation of EM equity market, more than 80% of bond markets and a third of the combined market cap of both sectors.
Take a look at some more numbers:
-- Based on current market values, a 1% increase in allocation to EM by pension and insurance funds represents a $524 billion flow to EM assets.
from Breakingviews:
Samsung moves on from Japan to nibble at Apple
By Wayne Arnold
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
The Japanese may have pioneered the model of a vertically integrated electronics manufacturer, but Samsung looks to have perfected it. The Korean company started by pulling apart Japanese TV sets, then reverse-engineered the manufacturers’ business model. By avoiding their missteps, it’s driving them out of TVs and carving up the smartphone market with Apple. Now, as more business is coming from emerging markets, Apple needs to watch out for Samsung’s still-growing appetite.
Samsung, which made its name in televisions, is more of a smartphone company. Phones account for most of its sales, and earnings growth. It sells more of its Galaxy product than Apple does iPhones. Yet Samsung is still turning a profit on everything it makes. It has a larger share of the global TV market than Panasonic, Sharp and Sony combined, and is making money. It even makes money on LCD panels and memory chips.
Japanese companies say they are hurt by the rising yen, which erodes earnings abroad. Korea’s won has fallen 29 percent against the Japanese currency in the past decade. On average, though, the won has dropped only about 1.7 percent a year. The cheap won was probably most helpful to Samsung in the 1980s, when the price advantage gave it breathing space to make up ground on quality.
Samsung did learn from its neighbours’ mistakes, though. Japanese firms made their own parts, and avoided trading with rivals. Samsung is a major supplier of chips and screens to competitors like Apple. The Japanese cannibalised the TV market by developing both LCD and plasma-screen. Samsung bet on LCDs. The Japanese stuck to a more profitable home market for mobile phones. Samsung discovered a new world of profit overseas.
The problem for the Japanese - and Apple - is that Samsung can now outmuscle them. Sony spent only half the $2.4 billion Samsung shelled out on R&D last quarter. And though Apple’s investments are ample, it is having to turn to Sharp and Sony to reduce its reliance on Samsung for high-end components.
from Global Investing:
The “least worst” option?
Western governments saddled with mountainous debts will "repress" creditors and savers via banking regulation, capital controls, central bank bond buying and currency depreciation that effectively puts sovereign borrowers at the top of the credit queue while simultaneously wiping out real returns for their bond holders. So says HSBC chief economist Stephen King in his latest report this week called "From Depression to repression".
Building on the work of U.S. economist Carmen Reinhardt and others, King's focus on the history of heavily indebted governments applying "financial repression" to creditors arrives at several interesting conclusions. First, even though western governments appeared successful in using these tactics to reduce massive World War Two debts alongside brisk economic growth during the 1950s and 1960s, King argues that the debt was cut mainly by the impressive economic growth and tax revenues during that "Golden Age" - and this was mostly down to the once-in-a-century period of relative peace that involved unprecedented integration and cooperation among western governments also engaged in a Cold War with the Soviet Union. Compared to this boost, the financial repression was a "sideshow", he reckons. To show that, he applies
Instead, King says governments will adopt this repression tactic anyway just to stave off draconian austerity now and prevent a destabilising surge in economy-wide borrowing rates. This will effectively reduce the amount of credit to the rest of the private sector, or at least elevating its cost, while reducing the pressure on governments to cut the debt levels quickly. The net result, then will likely be "persistently lower growth", whatever your conclusion about the desirability of state or the market allocation of resources.
And, in the absence of an obvious alternative, repression may also be the "least worst" option, King argues.
from MacroScope:
Resolving Shirakawa’s conundrum
The governor of the Bank of Japan, Masaaki Shirakawa, says he is confounded by the still very low level of Japanese government bond yields given the country’s elevated debt to GDP ratio of over 200 percent. Speaking on an IMF panel over the weekend, he offered a rather unintuitive explanation for the phenomenon:
It seems difficult to explain the case of Japan in light of conventional wisdom. One frequently offered explanation is that the ample domestic savings in Japan have absorbed the issuance of JGBs and the share of JGBs held by foreign investors is very small. But a more fundamental explanation is that the stability in the current bond yields reflects market participants’ expectations that fiscal soundness will be restored through structural reforms imposed in the economic and fiscal areas.
Most economists think Japanese yields are low because of continued expectations for deflation and weak economic growth. But for Shirakawa, it seems, it is public confidence in future fiscal restraint that is keeping bond yields low. Except he then contradicts this point by saying weak confidence in future fiscal reforms is also simultaneously undermining consumer spending:
At the moment, such expectations are not firmly backed by concrete reform plans. The public therefore restrains spending on concerns over future fiscal developments. This constitutes one factor behind sluggish economic growth and mild deflation. If this is indeed the case, the experience of Japan indicates a possibility that a cumulative increase in government debt combined with weak economic growth expectations might generate deflationary pressures.
Not so, argues Ugo Panizza, head of debt and finance analysis at the United Nations Conference on Trade and Development. He and co-author Andrea Presbitero find no causal link between high debt levels and weak economic growth.
Christopher Sims, a Nobel-winning economist and Princeton professor also on the panel with Shirakawa, had a much simpler explanation for why Japanese yields are low while Europe’s face steady upward pressure even though both economies are struggling with soft growth:
from Breakingviews:
Don’t blame Japan for foreign CEO departures
By Wayne Arnold
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
It’s not Japan’s fault that the country is losing foreign CEOs. The country’s insular culture may have added to the frustration of departing bosses at Nippon Sheet Glass, Olympus and even Nomura. But merger pains, fraud and headstrong directors are problems everywhere. The more they go abroad, the more Japanese companies will have foreign executives.
It’s tempting to see Craig Naylor’s departure from the helm of NSG as part of a broader allergic reaction to foreign best practice. After all, Michael Woodford was booted by Olympus last October, while Jesse Bhattal quit as Nomura’s head of wholesale banking in January. A month later, Howard Stringer stepped aside at Sony. Naylor’s predecessor, Stuart Chambers, left after just 15 months on the job.
Yet the revolving door at NSG doesn’t necessarily indicate distaste for foreign ways or faces. Chambers, who was recruited from Pilkington after NSG bought it in 2006, apparently genuinely wanted to spend more time with his family in the United Kingdom. Naylor, who previously spent 36 years at DuPont, was plucked out of retirement at the age of 62. Now NSG is installing a German as COO and keeping a British Pilkington veteran as CFO. That leaves four non-Japanese on its 11-member board.
Comparisons with Olympus also look a stretch. Like the electronics group, NSG’s balance sheet includes a high proportion of goodwill - the result of its Pilkington purchase. But Naylor’s departure may have more to do with the company’s sliding earnings, particularly as Europe’s crisis and cuts in solar panel subsidies hit sales. In February, the company slashed projections for the year to March 31 from a 15 billion yen profit to a 2 billion yen loss, and said it would cut 12 percent of its workforce.
Besides, it’s not as if Japanese boardrooms are totally devoid of foreigners. Stringer is still Sony’s chairman and Carlos Ghosn still runs Nissan. There will be more: As foreign shareholdings rise and more Japanese retire, demand for international management skills will rise. A shrinking home market and a strong yen are pushing companies to buy into new markets overseas. More companies will undoubtedly tap non-Japanese to navigate. Some will work out. Others will say sayonara.
from MacroScope:
The pain in Spain – redux
Spain’s borrowing costs are likely to soar at an auction of 12- and 18-month T-bills after its 10-year yields were pushed through the totemic 6 percent level on Monday. The history of the euro zone debt crisis shows that once above 6 percent the spiral accelerates and before you know it you’re at 7 percent – the level generally seen as unsustainable for state financing.
Worryingly, Spain is dragging Italy’s yields up in its wake. But in Spain’s case, there are strong reasons for caution about imminent disaster. The government cannily used ECB-created benign market conditions in the first part of the year to shift nearly half its annual debt issuance needs already and the banks – which look like they will need recapitalization at some point – are well funded for now having also loaded up on the European Central Bank’s three-year liquidity splurge.
We also know Europe’s banks, too scared to invest elsewhere, are depositing 700-800 billion euros back at the ECB daily. If Madrid could engender a shift in confidence, some of that money could flow back into its bonds, particularly by Spanish banks.
There is no getting away from the fact that confidence has evaporated since Prime Minister Mariano Rajoy ripped up Spain’s agreed deficit target for 2012 without consulting his partners. One way of clawing it back could be a framework that would guarantee the autonomous regions would agree to tough debt-cutting measures.
Last year’s ballooning of the deficit beyond forecast was in large part down to the regions’ spending. Government sources told us yesterday that Madrid may intervene to curb regional finances, which account for around half of national public spending, in return for some help in raising finance from the markets which some are finding difficult. Ministers meet the regional government heads on Wednesday. They have to present plans to save around 15 billion euros in early May.
Today, Madrid aims to raise up to 3 billion euros and will then try to sell up to 2.5 billion of longer-term bonds on Thursday. 12-month yields stood at around 2.7 percent on the secondary market yesterday whereas the last 12-month auction was done at a yield of 1.4 percent, so a big jump is inevitable.
The only other possible sentiment shifter in the short-term would be if the IMF managed to raise significant new crisis-fighting resources which could be deployed to defend a country like Spain (even though Christine Lagarde insists the monies would be used to help non-euro zone nations inadvertently caught up in the backwash). Overnight, she was quoted by Italy’s Il Sole 24 Ore as saying she was after more than $400 billion. EU sources have told us similar -- $400-500 billion. That’s less than was first talked about and there are doubts it is deliverable.
from Global Investing:
Japanization of euro zone bonds?
Fear of many years of stagnation in the major western economies has everyone fretting about a repeat of the "lost decades" that Japan suffered after its banking and real estate bubble burst in the early 1990s. Indeed HSBC economists were recently keen to point out that U.S. per capita growth over the noughties was already actually weaker than either of Japan's lost decades.
But in a detailed presentation on the impact of two years of soveriegn debt crisis on euro zone government bond holdings, Barclays economist Laurent Fransolet asks whether that market too is turning into the Japanese government bond market -- where years of slow growth, zero interest rates, current account surpluses and captive local buyers have depressed borrowing rates for years and turned JGBs into an increasingly domestic market dominated by local banks, pension funds and insurers. Non-residents hold less than 10 percent of JGBs, compared to more than 50 percent for the EGB as a whole, and Japanese banks hold up to 35 percent of their own government bond market.
But is the euro government market heading in that direction after successive crises have seen foreign investors flee many of the peripheral markets of Greece, Portugal, Ireland and even Italy and Spain? Fransolet argues that the seniority of substantial European Central Bank holdings built up in the interim (now about 15 percent of each of the five peripheral markets) may be one reason why these foreign investors will be wary of returning. Meantime, euro zone banks, who have traditionally held a high 20-25 percentage point share of euro government markets, withdrew sharply late last year amid balance sheet repair pressures but have rebuilt holdings again sharply in early 2012 after the ECB's liquidity injections -- particularly in Italy and Spain.
In answer to the longer-term question of whether euro bonds will turn into a more insular market dominated less by interest rate signals than liquidity, regulatory and balance sheet issues, Fransolet is equivocal. On one level they are still very different -- state-sector holdings of euro debt are still far from Japan's, the euro market has clearly fragmented and net new issuance of euro debt is also still way below Japan.
However, the trend is clearly toward a more domestically driven market in the periphery of euro bloc in particular and local banks are becoming bigger players. And, crucially, although foreign investors may not return en masse soon, their impact on those markets via futures and CDS markets and index weightings may still be high.
