MacroScope

from Global Investing:

Phew! Emerging from euro fog

Holding your breath for instant and comprehensive European Union policies solutions has never been terribly wise.  And, as the past three months of summit-ology around the euro sovereign debt crisis attests, you'd be just a little blue in the face waiting for the 'big bazooka'. And, no doubt, there will still be elements of this latest plan knocking around a year or more from now. Yet, the history of euro decision making also shows that Europe tends to deliver some sort of solution eventually and it typically has the firepower if not the automatic will to prevent systemic collapse.
And here's where most global investors stand following the "framework" euro stabilisation agreement reached late on Wednesday. It had the basic ingredients, even if the precise recipe still needs to be nailed down. The headline, box-ticking numbers -- a 50% Greek debt writedown, agreement to leverage the euro rescue fund to more than a trillion euros and provisions for bank recapitalisation of more than 100 billion euros -- were broadly what was called for, if not the "shock and awe" some demanded.  Financial markets, who had fretted about the "tail risk" of a dysfunctional euro zone meltdown by yearend, have breathed a sigh of relief and equity and risk markets rose on Thursday. European bank stocks gained almost 6%, world equity indices and euro climbed to their highest in almost two months in an audible "Phew!".

Credit Suisse economists gave a qualified but positive spin to the deal in a note to clients this morning:

It would be clearly premature to declare the euro crisis as fully resolved. Nevertheless, it is our impression that EU leaders have made significant progress on all fronts. This suggests that the rebound in risk assets that has been underway in recent days may well continue for some time.

So what exactly have investors and been doing while waiting for the fog to clear in Brussels?  The truth on most benchmark prices and indices is "not very much" -- at least not since world markets got the collywobbles in early August about US downgrades and debt ceilings, euro sovereign debt angst and double dip recession. Yet, since the European stocks nadir in late September prodded the Franco-German alliance into more serious action, there has been some impressive market gains of between 10 and 20% across most equity sectors and national indices. More broadly, after a year of intense political and financial turmoil across the globe, developed market equities are only down about 4% year-to-date -- a 10 point outperformance on emerging markets, for example.

And the clearing of the euro fog now allows investors to start looking beyond the Brussels cauldron and review how the rest of the world is shaping up. What they find, surprisingly for those drowning in disaster commentaries, is‘not all that bad – especially, but not exclusively in the United States. There's been a string of more positive economic data releases throughout October and these have continued through the back end of last week and early this week. The bellwether Philadelphia Fed industrial index rose to its highest in six months; U.S. durable goods orders (excluding volatile aircraft orders) rose at their fastest pace in six months in September; U.S. new home sales rose at their fastest in five months; business surveys show Chinese manufacturing is back expanding again in October for the first time in three months; U.S. power firms are reporting a pickup in industrial activity in H2, Ford has increased fourth quarter forecast for North American vehicle production. The U.S. Q3 earnings season hasn’t been half bad either – with a third of the S&P500 reported, some 70 percent beat forecasts and the main strength was in the industrial world. What’s more for markets, seasonal equity flows are typically in an updraft for the rest of the year, all things being equal. Fund managers already started rebuilding equity positions in September.

from Global Investing:

We’re all in the same boat

The withering complexity of a four-year-old global financial crisis -- in the euro zone, United States or increasingly in China and across the faster-growing developing world -- is now stretching the minds and patience of even the most clued-in experts and commentators. Unsurprisingly, the average householder is perplexed, increasingly anxious and keen on a simpler narrative they can rally around or rail against. It's fast becoming a fertile environment for half-baked conspiracy theories, apocalypse preaching and no little political opportunism. And, as ever, a tempting electoral ploy is to convince the public there's some magic national solution to problems way beyond borders.

For a populace fearful of seemingly inextricable connections to a wider world they can't control, it's not difficult to see the lure of petty nationalism, protectionism and isolationism. Just witness national debates on the crisis in Britain, Germany, Greece or Ireland and they are all starting to tilt toward some idea that everyone may be better off on their own -- outside a flawed single currency in the case of Germany, Greece and Ireland and even outside the European Union in the case of some lobby groups in Britain. But it's not just a debate about a European future, the U.S.  Senate next week plans to vote on legisation to crack down on Chinese trade due to currency pegging despite the interdependency of the two economies.  And there's no shortage of voices saying China should somehow stand aloof from the Western financial crisis, even though its spectacular economic ascent over the past decade was gained largely on the back of U.S. and European demand.

Despite all the nationalist rumbling, the crisis illustrates one thing pretty clearly - the world is massively integrated and interdependent in a way never seen before in history. And globalised trade and finance drove much of that over the past 20 years. However desireable you may think it is in the long run, unwinding that now could well be catastrophic. A financial crisis in one small part of the globe will now quickly affect another through a blizzard of systematic banking and cross-border trade links systemic links.

Dramatic ending to Greek tragedy

Greece is in the danger zone. Even as the country’s finance minister sought to reassure his euro zone counterparts at a meeting in Poland, Greek credit default swaps were pricing in a more than 90 percent chance of default, according to Reuters calculations of Markit data. Economists in a Reuters poll see a 65 percent chance of that happening, probably within a year.

Such fears recently sent jitters across financial markets, prompting some words of comfort from German Chancellor Angela Merkel and French President Nicolas Sarkozy that they are determined to keep Greece in the euro zone. But speculation is growing that Greece will default, and that it will be a messy ordeal. Here are some of the potential dangers if it occurs:

* Greece may be seen as setting a precedent for Portugal and Ireland, analysts said. Yields on peripheral euro zone debt could surge rapidly, making funding costs increasingly unsustainable as yields on Italian and Spanish 10-year bonds surge back towards 7 percent. The ECB could have to intervene more aggressively in the secondary bond market to the detriment of its balance sheet.

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.

from Global Investing:

Emerging consumers’ pain to spell gains for stocks in staples

Food and electricity bills are high. The cost of filling up at the petrol station isn't coming down much either. The U.S. economy is in trouble and suddenly the job isn't as secure as it seemed. Maybe that designer handbag and new car aren't such good ideas after all.

That's the kind of decision millions of middle class consumers in developing countries are facing these days. That's bad news for purveyors of everything from jeans to iphones  who have enjoyed double-digit profits thanks to booming sales in emerging markets.

Brazil is the best example of how emerging market consumers are tightening their belts. Thanks to their spending splurge earlier this decade, Brazilian consumers on average see a quarter of their income disappear these days on debt repayments. People's credit card bills can carry interest rates of up to 45 percent. The central bank is so worried about the growth outlook it stunned markets with a cut in interest rates this week even though inflation is running well above target

Don’t fight the Turkish central bank

Stop fighting the Turkish central bank. Since a shock interest rate cut earlier this month, the front end of Turkey’s bond yield curve has collapsed over 80 basis points, with two-year yields hitting seven-month lows of 7.84 percent. The curve is flattening as the 10-year sector starts feeling the heat as well. Whether it reflects investors’ faith in the central bank’s ability to safeguard economic growth while bringing down a record wide current account gap is another matter altogether. Bond investors have in fact been uneasy with the central bank’s experiments, fearing that overly loose monetary policy will cause an inflation shock down the road. But with more rate cuts clearly on the cards, investors are finding that Turkish rates, especially at the front end, are too attractive to miss. Especially as the central bank is shoring up the lira with daily dollar sales.

“Its difficult to go against the central bank. It’s been six months of mixed policy and finally international investors are getting the message,” says Luis Costa, head of CEEMEA currency and debt strategy at Citi. “Logically you should be paying long-end rates but it’s a challenging environment for that as the central bank bank is forcing the curve to be extremely flat.”
Markets are now pricing in another interest rate cut next week. How will markets react? The difference from the surprise rate cut on Aug. 3  is that other emerging central banks, fearful of a growth collapse, also now appear to be gearing up for policy easing. A dimming euro zone outlook means a poor outlook for exports from Turkey and other emerging markets. “There’s some realisation that the Turkish central bank may not be all that wrong,” says Zsolt Papp, who helps manage Swiss private bank UBP‘s emerging debt portfolio.

Investors have in fact realised Turkey is not overly concerned about inflation and that allows it more room to ease policy, Papp says, adding the moves in the Turkish curve indicate that is being priced in. Citi’s Costa agrees. “Policy is now clearly being driven by growth and that’s a massive game changer.”

from Global Investing:

Counting the costs of Hungary’s Swiss franc debt

The debt crises in the euro zone and United States are claiming some innocent bystanders. Investors fleeing for the safety of the Swiss franc have ratcheted up pressure on Hungary, where thousands of households have watched with horror as the  franc surges to successive record highs against their own forint currency. In the boom years before 2008,  mortgages and car loans in Swiss francs seemed like a good idea --after all the forint was strong and Swiss interest rates, unlike those in Hungary, were low.  But the forint then was worth 155-160 per franc. Now it is at a record low 260 -- and falling -- making it increasingly painful to keep up repayments. Swiss franc debt exposure amounts to almost a fifth of Hungary's GDP. And that is before counting loans taken out by companies and municipalities.

Hungarian families could get some relief in coming months via a government plan that caps the exchange rate for mortgage repayments at 180 forints until the end of 2014.  But the difference will have to be paid -- with interest -- from 2015.  Meanwhile, the issue threatens to bring down Hungary's banks which must pick up the cost in the meantime and will almost certaintly see a rise in bad loans --  no wonder shares in Hungary's biggest bank OTP are down 25 percent this month.  "(The franc rise) suggests a massive jump on banks' refinancing requirements going forward, " says Citi analyst  Luis Costa.

These overburdened banks will end up cutting lending to businesses, meaning a further hit to Hungary's already anaemic economic growth. ING analysts earlier this month advised clients to steer clear of Hungarian shares, "given the burden from (forint/franc) depreciation not only on loan-takers but also the implications this has for the domestic growth story."

Greek firewall looks porous

The second Greek bailout was aimed at ring-fencing euro zone contagion, but could unleash it instead.

Comments from rating agencies since euro zone leaders agreed to involve the private sector in a  Greek rescue plan suggest last week’s events have increased rather than decreased the risk of contagion in the medium-term, says Gary Jenkins of Evolution Securities.

Fitch ratings stated on Friday:

If the Irish and Portuguese economies and public finances are not firmly on a sustainable path going into 2013, when both will need to regain access to medium-term market funding, the potential precedent set by PSI (private-sector involvement) in the Greek package will be incorporated into Fitch’s assessment of the risks to bondholders and reflected in its sovereign rating opinions and actions.

from Davos Notebook:

Will Goldman’s new BRICwork stand up?

RTXWLHHJim O'Neill, the Goldman Sachs economist who coined the term BRICs back in 2001, is adding four new countries to the elite club of emerging market economies. But does his new edifice have the same solid foundations?

In future, the BRIC economies of Brazil, Russia, China and India will be merged with those of Mexico, Indonesia, Turkey and South Korea under the banner “growth markets,” O'Neill told the Financial Times.

Hmmm.  Doesn't quite grab you like BRICs, does it? The Guardian helpfully offers an amended branding banner of  "Bric 'n Mitsk" (geddit?). But which ever way you cut it, it's hard to see a flood of investment conferences and funds floating off under the new moniker.

from Reuters Investigates:

Let’s be ethical, economists say

Last month's special report “For some professors, disclosure is academic” has been making waves in the academic world, as this story shows:

Economists urge AEA to adopt ethics code: letter

By Kristina Cooke

NEW YORK (Reuters) - Almost three hundred economists have signed a letter to the American Economic Association "strongly" urging it to adopt a code of ethics requiring disclosure of potential conflicts of interests.

The 135-year-old American Economic Association, or AEA, does not have a code of conduct for its approximately 18,000 members. Over half of its members are academics, according to its website.