Research Radar: “State lite”?
The FOMC’s relatively anodyne conclusions left world markets with little new to chew on Thursday, with some poor European banking results for Q1 probably get more attention. Broadly, world stocks were a touch higher while the dollar and US Treasury yields were slightly lower. European bank stocks fell 2% and dragged down European indices. Euro sovereign yields were slightly higher, with markets eyeing Friday’s Italian bond auction. Volatility gauges were a touch lower and crude oil prices nudged up.
Following is a selection of some of the day’s interesting research snippets:
- Deutsche Bank’s emerging markets strategists John Paul Smith and Mehmet Beceren said they retain their negative bias toward global emerging market equities both in absolute and relative terms, highlighting Argentina’s expropriation of YPF from Repsol as another negative. “We anticipate that so-called state capitalism will continue to be a negative driver, as it has been since mid-2010, since the poor economic backdrop makes the corporate sector a tempting target for governments wishing to boost their popularity or find additional resources to add to the relatively low levels of social protection across most emerging economies.” They added that they remain overweight “state lite” emerging markets such as Taiwan, Mexico and Turkey and underweight Russia, China, Brazil and South Korea.
- Morgan Stanley’s James Lord thinks the rally in Hungary’s markets following Tuesday’s decision by the EU to reopen negotiations on financial assistance is justified but much may now be in the price. He said MS would prefer to wait for some pullback before looking for more bullish trades. On a relative basis, Hungary 5-year CDS is now 60bp wider than Spain’s and MS said that while this gap could close much further it was hard to see how Hungary CDS rates could trade below Spain. “Indeed, if Spain goes into serious financial trouble, it could represent a systemic risk for all Europe, and funding stress would likely increase substantially. Given the strong dependence of Hungary towards the EU, it would be difficult to argue for Hungary to trade through Spain on any sustained basis.”
- Ashmore Investment Management’s Jerome Booth restates his bullish case for emerging markets with 10 points that conclude with the line: “the best way to lose money without really trying is not to invest in emerging markets.” His points include warnings about equating past volatility with risk, passive investing (where he points out that only 12% of emerging debt is represented by available indices) and seeing emerging currency volatility against the dollar as an emerging problem rather than a U.S. one (“It is the dollar which is volatile”.)
- Legal & General Investment Managers’ Ben Bennett argues that central bank money printing will be needed for some time as banks’ bad loans are still way too high for them to be “in a position to drive the money printing presses once again”. Explaining QE as a nationalisation of money printing presses normally operated by the commercial banks, he says the success of either form of money creation can only be judged by the productive nature of use to which that money is put. The pre-crisis lending into the property bubble was negative case in point, and the relative success of QE lending to the banks will be even more complex to judge. “The investment lesson to be learnt is not to follow the money, but to analyse the usefulness of what it is being spent on.”
Hungary can seek IMF aid now. But can it cut rates?
The European Union has given Budapest the green light to seek aid from the IMF. (see here) In fact, the breakthrough after five months of dispute does not let Hungary completely off the hook — to get its hands on the money, Viktor Orban’s government will have to backtack on some controversial recent legislation, starting with its efforts to curb the central bank’s independence. It remains to be seen if Orban will actually cave in.
But markets are reacting as if the IMF money is in Hungary’s pocket already. There have been sharp rallies in Hungarian dollar bonds, CDS and currency markets (see graphic below from Capital Economics). The Budapest stock market has posted its best one-day gain since last November while the yield on local 10-year bonds have collapsed almost 100 bps. Hungarian officials are (a bit prematurely) talking of issuing bonds on world markets.
What investors are hoping for now is a cut to the 7 percent interest rate. Hungary’s central bank jacked up rates by 100 bps in recent months to defend the forint as cash fled the country. Now there is a chance those rate rises can be reeled back in. After all, the moribund economy could really use a dash of monetary easing. Thanasis Petronikolos, head of emerging debt at Baring Asset Management has been overweight Hungary and recalls that after 2008 crisis, the central bank was able to quickly take back its 300 bps of currency-defensive rate hikes.
In the aftermath of this, the central bank may be prompted to cut short term interest rates. If the risk premium comes down a lot, the central bank may feel that 7 percent interest rates are not justified. I’m expecting them to at least take this 100 bps back assuming they can reach an agreement with the IMF.
Hungary’s FRAs (forward rate agreement), are still pricing slightly higher short-term interest rates and have not yet reacted to the shifting picture. Many urge caution however on the rate cut expectations, noting that Orban and the IMF may struggle to reach common ground and the central bank will want to see money on the table before it actually acts.
Petronikolos is right in that the economy is moribund, credit growth has slumped and there is a big output gap. But headline inflation is running at 5.5 percent, well above the central bank’s 3 percent target, due to an increase in sales tax. Sandor Jobbagy, at CIB Bank in Budapest is one analyst who says inflation risks have forced him to push back the date of likely interest rate cuts.
A Hungarian default?
More on Hungary. It’s not hard to find a Hungary bear but few are more bearish than William Jackson at Capital Economics.
Jackson argues in a note today that Hungary will ultimately opt to default on its debt mountain as it has effectively exhausted all other mechanisms. Its economy has little prospect of strong growth and most of its debt is in foreign currencies so cannot be inflated away. Austerity is the other way out but Hungary’s population has been reeling from spending cuts since 2007, he says, and is unlikely to put up with more.
How did other highly indebted countries cope? (lets leave out Greece for now). Jackson takes the example of Indonesia and Thailand. Both countries opted for strict austerity after the 1997 Asian crisis and resolved the debt problem by running large current account surpluses. This worked because the Asian crisis was followed by a period of buoyant world growth, allowing these countries to boost exports. But Hungary’s key export markets are in the euro zone and are unlikely to recover anytime soon.
The other example is Argentina. It too recovered strongly from its 2001 crisis but its way out was default. Capital Economics writes:
There are arguments for why, in Hungary’s case, default might appear to be an attractive option. The economy runs both a current account surplus and a primary surplus (i.e. government spending is lower than receipts before interest payments are taken into account). This means that if the Hungarian government were to default and were to be barred from borrowing from abroad, it would still not be forced into drastic fiscal austerity or a painful current account adjustment via reduced domestic demand.
Moreover, the note says:
Sujata Rao, let me explain why this isn’t going to happen, a default that is. It would tarnish the PMs otherwise flawless reputation and image.
He rather resort to unorthodox financial strategies that slowly makes the people that can, move out of the country, and the rest will suffer the consequences of these strategies.
Hungary’s plan to get some cash in the bank
Hungary says it might borrow money from global bond markets before it lands a long-awaited aid deal with the International Monetary Fund. That pretty much seems to suggest Budapest has given up hope of getting the IMF cash any time soon. Given the fund has already said it won’t visit Hungary in April, that view would seem correct.
There is some logic to the plan.
Hungary desperately needs the cash — it must find over 4 billion euros just to repay external debt this year.
It is also an attractive time to sell debt. Appetite for emerging market debt remains strong. Emerging bond yield premiums over U.S. Treasuries have contracted sharply this year and stand near seven-month lows. Moreover, U.S. Treasury yields may rise, potentially making debt issuance more costly in coming months.
For Hungary’s government , the idea of a successful bond sale is particularly attractive as this will at a stroke improve its bargaining position with the IMF. That’s bad news, says Tim Ash, RBS head of emerging European research:
The problem is that getting cash in the bank may actually reduce the likelihood of the government actually finally cutting a deal with the IMF, so arguably increases market risk over the slightly longer term.
He concedes however:
The haves and have-nots of the (energy) world
Nothing like an oil price spike to bring out the differences between the haves and have-nots of this world. The ones who have oil and those who don’t.
With oil at $124 a barrel, the stock markets of big oil importers India and South Korea posted their first weekly loss of 2012 on Friday. But in Russia, where energy stocks make up 60 percent of the index, shares had their best day since November, rising more than 4 percent. The rouble’s exchange rate with the dollar jumped 1.5 percent but the lira in neighbouring Turkey (an oil importer) fell.
Emerging currencies and shares have performed exceptionally well this year. Some of last year’s laggards such as the Indian rupee have risen almost 10 percent and stocks have jumped 16-18 percent. But unless crude prices moderate soon, the 2012 rally in the stocks, bonds and currencies of oil-poor countries may have had its day. Societe Generale writes:
As oil prices are now flirting with $125 per barrel, it is reasonable to start thinking about the potential impact on global emerging markets of an oil price shock and the currencies likely to gain the most from elevated oil prices and those that won’t….Russia appears as the clear winner of a potential oil price shock, and the rouble is therefore the best hedge against this risk
The bank advises its clients to buy the rouble and sell the currencies of oil importing Israel and Hungary. In Asia it suggests selling the Korean won. It also recommended exiting long positions on the Turkish lira.
Russia is the clear winner. Revenues from the energy sector provide half the state’s income and according to the graphic below from SocGen, oil exports account for 15 percent of Russia’s economy. At the other end of the spectrum are Taiwan, Korea and Turkey where oil imports make up between 7-12 percent of GDP.
Hungary’s Orban and his central banker
“Will no one rid me of this turbulent central banker?” Hungarian Prime Minister Viktor Orban may not have voiced this sentiment but since he took power last year he is likely to have thought it more than once. Increasingly, the spat between Orban’s government and central bank governor Andras Simor brings to memory the quarrel England’s Henry II had with his Archbishop of Canterbury, Thomas Becket, over the rights and privileges of the Church almost 900 years ago. Simor stands accused of undermining economic growth by holding interest rates too high and resisting government demands for monetary stimulus. The government’s efforts to sideline Simor are viewed as infringing on the central bank’s independence.
So far, attacks on Simor have ranged from alleging he has undisclosed overseas income to stripping him of his power to appoint some central bank board members. But the government’s latest plan could be the last straw – proposed legislation that would effectively demote Simor or at least seriously dilute his influence. Simor says the government is trying to engineer a total takeover at the central bank. “The new law brings the final elimination of the central bank’s independence dangerously close,” he said last week. The move is ill-timed however, coming exactly at a time when Hungary is trying to persuade the IMF and the European Union to give it billions of euros in aid. The lenders have expressed concern about the law and declined to proceed with the loan talks. But the government says it will not bow to external pressure and plans to put the law to vote on Friday. That has sparked general indignation – Societe Generale analyst Benoit Anne calls the spat extremely damaging to investor confidence in Hungary. “I just hope the IMF will not let this go,” he writes.
Central banks and governments often fail to see eye to eye. But in Hungary, the government’s attacks on Simor, a respected figure in central banking and investment circles, is hastening the downfall of the already fragile economy. For one, if IMF funds fail to come through, Hungary will need to find 4.7 billion euros next year just to repay maturing hard currency debt. That could be tough at a time when lots of borrowers — developed and emerging — will be competing for scarce funds. Central European governments alone will be looking to raise 16 billion euros on bond markets, data from ING shows. So Orban will have to tone down his rhetoric if he is to avoid plunging his country into financial disaster.
But this week the tussle has intensified as the central bank has shrugged off Orban’s call for more “growth-friendly policies” and raised interest rates by half a point. The rate rise, the second in as many months, brings interest rates to 7 percent, sparking rage in the ruling party. But the central bank, quite logically, argues higher rates are necessary to protect Hungary’s currency, the forint, from further weakness. And it has signalled it is fully prepared to raise rates again at the next meeting if required.
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.
The ruling party Fidesz swept into power promising to create a new social contract that would subject the economic system to the “popular democratic will”. Ironically, the policies of Prime Minister Viktor Orban have made Hungarian markets more sensitive to the global sentiment than ever.
Domestic investor participation in local bonds and stock markets has fallen since the government controversially seized private pension fund assets to boost state coffers this year.
Average daily trading volumes on the Budapest stock exchange have slipped 25 percent this year while non-resident ownership of local-currency bonds are at elevated levels — as high as 40 percent — and estimated to be worth a considerable 4.8 trillion forints ($20 billion)
@ Intriped
Buffet said to CNBC that he was looking to buy up equity of large eurozone companies if the price was cheap enough.
The bearish eurozone headline splatter is the usual market fodder directed towards softening those prices.
Wouldn’t get too excited unless you are a shareholder.
Interest rates rise in Kenya, Uganda. Hungary next
Recent weeks have witnessed an interesting split between countries that are raising interest rates to fend off runs on their currencies, and those cutting rates to spur on growth — check out my colleague Carolyn Cohn’s recent piece on this topic (http://tinyurl.com/4x58ny6) .The frontier economies of Africa fall into the first category — Kenya this week jacked up rates by an unprecedented 550 basis points to ward off a currency collapse, while Uganda’s benchmark rate was increased by 300 bps.
Big stable economies such as Australia, Brazil and Indonesia have cut interest rates. On Wednesday, Romania became the latest country to do so. But an exception is investment grade Hungary, which may soon join the ranks of frontier markets in currency-defensive rate hikes.
It may also soon lose its investment grade status –at least one of the three big rating agencies is expected to soon announce a cut to the sovereign credit rating. That fear has triggered flight from the forint and short-dated bonds, pushing the currency to 2-1/2 year lows and causing significant flattening in the yield curve. The situation hasn’t been helped by signs the government is cooking up another sceme to subsidise indebted small businesses. More is to come, many predict –a ratings downgrade could see investors pull at least $1.2 billion euros from local bond markets. ING Bank estimates. That would be 10 percent of foreigners’ Hungarian bond holdings and would send the currency into a fresh tailspin.
The forint is down 9 percent this year to the euro, and Hungarians, holding a vast stock of euro- and Swiss franc-denominated mortgages, cannot really tolerate a much weaker currency. A rate rise seems like the only way out, says Societe Generale analyst Benoit Anne who predicts the Hungarian central bank will be sufficiently alarmed by the pace and scope of the forint’s fall to raise rates by 200-300 basis points. That rekindles memories of the October 2008 crisis when the bank was forced into a 300 bps rate rise to support the forint. Swaps markets are currently pricing a 100 bps rate rise — most analysts say that is too conservative.
The fact is investors have turned their attention to Hungary away from Turkey, where the central bank has stabilised the lira via a stealthy policy tightening exercise that boosted implied yields on the lira to around 9 percent, the highest in emerging markets. Hungary will have to do the same, says Anne who advises investors to sell the forint and buy lira instead.
True, Hungary’s position is a bit different from Turkey’s. Turkey has a massive balance of payments deficit but Hungary has a small surplus, equating to about 2 percent of its gross domestic product. Central bank reserves cover seven months of imports, a comfortable position compared to Turkey which had enough cash to pay for just over three months of imports. All this means the central bank has the option of intervening in FX markets first to support the forint, according to HSBC analyst Murat Toprak, who says Hungary’s moribund economy simply cannot cope with higher interest rates. But Hungary’s central bank tends to avoid intervention – other analysts point out that even in 2008, it resorted to rate hikes rather than digging into its reserves to defend the currency.
from MacroScope:
New twist in Hungary’s Swiss debt saga. Banks beware.
A fresh twist in Hungary's Swiss franc debt saga. The ruling party, Fidesz, is proposing to offer mortgage holders the opportunity to repay their franc-denominated loans in one fell swoop at an exchange rate to be fixed well below the market rate. This is a deviation from the existing plan, agreed in June, which allows households to repay mortgage installments at a fixed rate of 180 forints per Swiss franc (well below the current 230 rate). Households would repay the difference, with interest, after 2015.
If this step is implemented and many loan holders take up the offer, it would be terrible news for Hungary's banks. The biggest local lender OTP could face a loss of $2 billion forints, analysts at Budapest-based brokerage Equilor calculate. Not surprisingly, OTP shares plunged 10 percent on Friday after the news, forcing regulators to suspend trade in the stock. Shares in another bank FHB are down 8 percent.
But Fidesz' message is unequivocal. "The financial consequences should be borne by the banks," Janos Lazar, the Fidesz official behind the plan says. The government is to debate the proposal on Sunday.
OTP and its peers could be forgiven for feeling aggrieved. They are already saddled with the highest financial sector taxes in Europe and will almost certainly see a rise in bad loans as the economy stagnates and more Hungarians lose their jobs. They are also picking up the cost of the three-year exchange rate cap for mortgage holders.
The proposed plan may also have implications for the forint -- ING Bank chief EMEA economist Simon Quijano-Evans notes that if 200,000 to 300,00 people to take up the new offer -- as the government apparently expects -- the forint will weaken as these people buy Swiss francs to repay their debts. Based on average loan size, over 2 billion euros worth of forints could be sold, he estimates.
Banks' main hope now must be the central bank. The latter has responded to today's proposal with a warning that solutions to the debt crisis must not threaten the financial system's stability.
But the Fidesz government's capacity to spring nasty surprises on the banking sector will make investors even more defensive about Hungary. Quijano-Evans for one advises staying away from Hungarian equities and unhedged forint positions, noting that "the risk of the government going ahead with some sort of plan to the detriment of banks has increased strongly."
from MacroScope:
Emerging markets: Soft patch or recession?
Could the dreaded R word come back to haunt the developing world? A study by Goldman Sachs shows how differently financial markets and surveys are assessing the possibility of a recession in emerging markets. One part of the Goldman study comprising survey-based leading indicators saw the probability of recession as very low across central and eastern Europe, Middle East and Africa. These give a picture of where each economy currently stands in the cycle. This model found risks to be highest in Turkey and South Africa, with a 38-40 percent possibility of recession in these countries. On the other hand, financial markets, which have sold off sharply over the past month, signalled a more pessimistic outcome. Goldman says these indicators forecast a 67 percent probability of recession in the Czech Republic and 58 percent in Israel, followed by Poland and Turkey. Unlike the survey, financial data were more positive on South Africa than the others, seeing a relatively low 32 percent recession risk. Goldman analysts say the recession probabilities signalled by the survey-based indicator jell with its own forecasts of a soft patch followed by a broad sustained recovery for CEEMEA economies. "The slowdown signalled by the financial indicators appears to go beyond the ‘soft patch’ that we are currently forecasting," Goldman says, adding: "The key question now is whether or not the market has gone too far in pricing in a more serious economic downturn."
