Global Investing

from MacroScope:

When the euro shorts take off

Currency speculators boosted bets against the euro to a record high in the latest week of data (to end December 27) and built up the biggest long dollar position since mid-2010, according to the Commodity Futures Trading Commission. Here -- courtesy of Reuters' graphics whiz Scott Barber, is what happens to the euro when shorts build up:



Can Eastern Europe “sweat” it?

Interesting to see that Poland wants to squeeze out more income from its state-owned enterprise (SOE) sector in the face of slowing economic growth and financing pressures.

Warsaw wants to double next year’s dividends from stakes in firms ranging from copper mines to utility providers to banks.

Fellow euro zone aspirant Lithuania has also embarked on reforms aimed at increasing dividends sixfold from what UBS has dubbed “the forgotten side of the government balance sheet”. It wants to emulate countries such as Sweden and Singapore where such companies are managed at arm’s length from the state and run along strict corporate standards to consistently grow profits.

Developing vs developed. Ratings convergence goes on

Watchers of ratings agencies might be wondering if a golden period of steady credit upgrades for emerging economies is coming to an end. This week brought a ratings downgrade for Egypt and an outlook cut for Turkey. Hungary is teetering on the brink of having its rating cut to junk. Across the emerging world, countries are struggling with weaker growth, still-high inflation and falling investment. Debt ratios are rising.  All this could bode ill for sovereign credit ratings.

But no fear. The so-called ratings convergence between developed and developing economies has some way to go yet.  Egypt and Turkey may have received bad news this week but there were ratings upgrades for Kazakhstan and Georgia. Emerging countries are still more likely to be upgraded than downgraded. Debt-ridden rich nations on the other hand face ratings cuts, including possibly the mighty United States.  JPMorgan points out that, emerging markets have enjoyed 35 upgrades this year, while developed sovereigns have suffered 32 downgrades and no upgrades.  The bank predicts an additional 22 upgrades for the developing world in 2012.

“The convergence trend appears likely to continue, since a total of nine developed market countries remain on negative outlook or review for a possible downgrade,” according to JPMorgan. Emerging economies have received 133 sovereign upgrades since 2008, the bank notes.  The last developed country upgrade that still stands?  Sweden’s move up to AAA — achieved in 2004.

Funding stress in the FX swap market

Signs of the wholesale funding stress are cropping up in the FX swaps market, with the premium for swapping euro LIBOR into dollar LIBOR over 3 months (so-called cross currency swap) rising to 141.5 basis points, which is the post-Lehman Brothers high.

The premium has skyrocketed in the past six months (back in May it was only 16.5bps) because European banks needing funds are forced to turn to the FX swap market, and other banks are reluctant to lend to European companies in the United States.

And it looks like the situation is going to get worse from here, because of weak dollar bond issuance by euro zone companies.

Hungary and the euro zone blame game

More tough talk from Hungarian officials on the ‘unjustified’ weakness of the country’s currency, which has dropped 11 percent against the euro this year to all-time lows.

This time, it’s central banker Ferenc Gerhardt arguing that the weakness of the forint is out of sync with economic fundamentals and blaming it on the debt turmoil in the euro zone.

Perhaps he should look a little closer to home.

Hungary’s drift from orthodox economic policy since the centre-right government took over the reins last year has made it the most exposed of eastern European economies.

from Jeremy Gaunt:

Why is the euro still strong?

One of the more bizarre aspects of the euro zone crisis is that the currency in question -- the euro -- has actually not had that bad a year, certainly against the dollar. Even with Greece on the brink and Italy sending ripples of fear across financial markets, the single currency is still up  1.4 percent against the greenback for the year to date.

There are lots of reasons for this. The dollar is subject to its country's own debt crisis, negligible interest rates and various forms of quantitative easing money printing -- all of which weaken FX demand. There is also some evidence that euro investors are bring their money home, as the super-low yields on 10-year German bonds attest.

Finally -- and this is a bit of a stretch -- some investors reckon that if a hard core euro emerges from the current debacle, it could be a buy. Thanos Papasavvas, head of currency management at Investec Asset Management, says:

Are global investors slow to move on euro break-up risk?

No longer an idle “what if” game, investors are actively debating the chance of a breakup of the euro as a creditor strike  in the zone’s largest government bond market sends  Italian debt yields into the stratosphere — or at least beyond the circa 7% levels where government funding is seen as sustainable over time.  Emergency funding for Italy, along the lines of bailouts for Greece, Ireland and Portugal over the past two years, may now be needed but no one’s sure there’s enough money available — in large part due to Germany’s refusal to contemplate either a bigger bailout fund or open-ended debt purchases from the European Central Bank as a lender of last resort.

So, if Germany doesn’t move significantly on any of those issues (or at least not without protracted, soul-searching domestic debates and/or tortuous EU Treaty changes), creditor strikes can reasonably be expected to spread elsewhere in the zone until some clarity is restored. The fog surrounding the functioning and makeup of the EFSF rescue fund and now Italian and Greek elections early next year  — not to mention the precise role of the ECB in all this going forward — just thickens. Why invest/lend to these countries now with all those imponderables.

Where it all pans out is now anyone’s guess, but an eventual collapse of the single currency can’t be ruled out now as at least one possible if not likely outcome. The global consequences, according to many economists, are almost incalculable. HSBC, for example, said in September that a euro break-up would lead to a shocking global depression.

Euro exit-ology

Whether or not it’s likely or even a good idea, talk of Greece leaving the euro is no longer taboo in either financial or political circles.  What is more, anxiety over the future of the  single currency has reached such a pitch since the infection of the giant Italian bond market that there are many investors talking openly of an unraveling of the entire bloc. But against such an amplified “tail risk”,  it’s remarkable how stable world financial markets have been over the past few turbulent weeks — at least outside the ailing sovereign debt markets in question.

Yet, focussing on the possible consequences for Greece of bankruptcy and euro exit has now become an inevitable part of investment reseach and analysis. In a note to clients on Tuesday entitled “Breaking Up is Hard to Do“, Bank of New York Mellon strategist Simon Derrick sketched some of the issues.

One issue he pointed out,  and one raised in the September Spiegel online report, was the chance of invoking Article 143 of the Treaty on the Functioning of the European Union, which permits certain countries to “take protective measures” and which could be used to allow restrictions on the movement of capital in order to prevent a flight of capital abroad.

from Jeremy Gaunt:

Democracy and Chaos are both Greek

It seems as if almost everyone was surprised by Prime Minister George Papandreou's decision to hold a referendum on the euro zone's bailout package for his country. At the very least, it can probably be said that he is weary of being hammered from all sides --  his own party, the opposition, the people on the street, Germany, the tabloid press, you name it.

A lot will obviously depend on what question is asked. Do you want an end to austerity, would get a clear yes vote. Do you want to leave the euro zone -- perhaps not.

Financial markets, however, do not initially appear content to wait.  Talk of an end-of-year rally is off the table (at least for now).  It's not exactly χάος (chaos) out there, but Papandreou's  experiment  in δημοκρατία (democracy) has sent the whole euro zone project into a new, risky phase.

Trash heap for sovereign CDS?

For all the ifs and buts about the latest euro rescue agreement, one of its most profound market legacies may be to sound the death knell for sovereign credit default swaps — at least those covering richer developed economies. In short, the agreement reached in Brussels last night outlined a haircut on Greek government bonds of some 50 percent as a way to keep the country’s debt mountain sustainable over time. But anyone who had bought default insurance on the debt in the form of CDS would not get compensated as long as the “restructuring” was voluntary, or so says a top lawyer for the International Swaps and Derivatives Association — the arbiter of CDS contracts.

ISDA general counsel  David Geen said there would be no change in the ruling to account for the size of the haircut:

As far we can see it’s still a voluntary arrangement and therefore we are in the same position as we were with the 21 percent when that was agreed (in July)