Foreign investors still buying American
Overseas investors have yet to sour towards U.S. assets despite high government debt levels, according the latest figures on capital flows.
Including short-dated assets such as bills, foreigners snapped up $107.7 billion in U.S. securities in February, following a downwardly revised $3.1 billion inflow for January. At the same time, the United States attracted a net long-term capital inflow of just $10.1 billion in February after drawing an upwardly revised $102.4 billion in the first month of 2012.
The data showed China boosted purchases of U.S. government debt for a second month in February, but also some waning of demand for longer-dated securities.
Still, recurring fears that foreign investors might be scared off by high levels of U.S. debt have thus far proven overdone. Writes Millan Mulraine at TD Securities:
Overall, the massive foreign flow into U.S. assets in March suggests that US securities continue to enjoy healthy global appetite in time of fear (Treasuries) and times of hope (equities). The reallocation from Treasuries to shorter-term securities in February is broadly consistent with the risk-on tone that prevailed during the month, reversing the trend of the past few months, when concerns in Europe resulted in the flight to quality.
Even the downtrend in Treasuries may have been short-lived, said George Goncalves at Nomura, as evidence by the recent drop in benchmark 10-year yields to around 2 percent:
The going gets tougher for Italy and Spain
One trillion euros is a lot of money. And as we have previously noted on this blog it did a lot for stock markets early this year but not much for the real economy.
But recent bond auctions in the euro zone suggest the impact of two rounds of cheap 3-year ECB funding on the region’s struggling bond market may also be fading.
Italian three-year borrowing costs surged more than a full percentage point at an auction to 3.89 percent – its highest since mid-January.
Nick Stamenkovic, strategist at RIA Capital Markets says:
Clearly it shows investor appetite for Italian bonds even at the short end has diminished recently as the effects of the two LTROs (long-term refinancing operations) from the ECB dissipate.
That was not the only patchy bond sale recently. Italy’s one-year borrowing costs doubled at a sale of short-term bills on Wednesday and, just last week, Spain had to pay dearer to borrow through medium-term bonds.
The new jitters in the market have partly been fueled by Spain’s fiscal conundrum: austerity aimed at reducing its budget deficit risks choking off the very growth that is needed to repair the country’s fiscal position.
Ireland’s uneasy market comeback
Ireland, hailed as the poster child of euro zone austerity, is hoping to get back into the long-term bond market this year. But analysts say a hasty return could do more harm than good.
Its market position has certainly improved since it was pushed out of commercial markets and forced to seek a bailout, even though the population at large is still struggling with rigorous austerity.
Ten-year Irish yields have halved to just below 7 percent since July – before the European Central Bank began buying Spanish and Italian bonds in the secondary market to stabilise peripheral markets.
Irish CDS has also outperformed other euro zone strugglers, sliding 119 basis points to 605 bps over the same period while Spain’s climbed 168 basis points and Italy’s jumped 196 basis points, according to Markit data.
And Irish 10-year bonds have made total returns of 12.1 percent so far this year, second only to Italy in the euro zone, Thomson Reuters data shows.
Vultures swoop on Argentina
Holdouts against a settlement of Argentina’s defaulted debt are opening a new front in their campaign for a juicy payout more than a decade after the biggest sovereign default on record.
Lobbyists for some of the investors who hold about $6 billion in Argentine debt are in London to persuade Britain to follow the lead of the United States, which last September decided to vote against new Inter American Development Bank and World Bank loans for Buenos Aires.
Washington believes Argentina, a member of the Group of 20, is not meeting its international obligations on a number of fronts. Apart from the dispute with private bond holders, Argentina has yet to agree with the Paris Club of official creditors on a rescheduling of about $9 billion of debt. It has refused to let the International Monetary Fund conduct a routine health check of the economy. And it has failed to comply with the judgments of a World Bank arbitration panel.
In short, Argentina is not playing by the rules of the international game, says Rob Shapiro, a former U.S. under secretary of commerce, who is now co-chair of the Argentina Task Force America.
According to its website, the group’s aim is to “vigorously pursue” a “just and fair” reconciliation of the Argentine government’s default in December 2001 on some $95 billion of debt.
Its members and supporters include the delightfully named Montana Women Involved in Farm Economics (WIFE). Another is New York hedge fund Elliott Associates, which has bought distressed debt issued by a number of developing countries and sued them for repayment.
In 2000 Peru paid Elliott $56 million to settle a four-year fight after the hedge fund refused to accept the restructuring terms on offer.
Why Germany doesn’t want euro zone bonds
Ever wanted to know why Germany is not keen on single euro zone bonds? Look no further:
from Mike Dolan:
Sparring with central banks
Just one look at the whoosh higher in global markets in January and you'd be forgiven smug faith in the hoary old market adage of "Don't fight the Fed" -- or to update the phrase less pithily for the modern, globalised marketplace: "Don't fight the world's central banks". (or "Don't Battle the Banks", maybe?)
In tandem with this month's Federal Reserve forecast of near-zero U.S. official interest rates for the next two years, the European Central Bank provided its banking sector nearly half a trillion euros of cheap 3-year loans in late December (and may do almost as much again on Feb 29). Add to that ongoing bouts of money printing by the Bank of England, Swiss National Bank, Bank of Japan and more than 40 expected acts of monetary easing by central banks around the world in the first half of this year and that's a lot of additional central bank support behind the market rebound. So is betting against this firepower a mug's game? Well, some investors caution against the chance that the Banks are firing duds.
According to giant bond fund manager Pimco, the post-credit crisis process of household, corporate and sovereign deleveraging is so intense and loaded with risk that central banks may just be keeping up with events and even then are doing so at very different speeds. What's more the solution to the problem is not a monetary one anyway and all they can do is ease the pain.
Low interest rates and liquidity schemes can't solve what ails the developed world. Societies must accept that in order to alter their current perilous course they must undergo great change, moving away from entitlements to which they have become accustomed. The alternative is weak economic growth, a loss of competitiveness and negative external balances -- a loss of face and place in the global hierarchy.
As if to reinforce the underlying point that the developed world faces a protracted reform period that tests political, economic and social priorities, credit rating firm Standard & Poors' -- not the most popular company in corridors of power over the past year -- warned on Tuesday that it may downgrade the debt of "a number of highly-rated" Group of 20 countries from 2015 if their governments fail to enact reforms to curb rising healthcare spending and other costs related to ageing populations.
For Pimco, the political and social resistance to this sort of change is already showing itself to be significant both in Europe and the United States. People clearly don't want to see pensions and benefits cut but politicians have already grown government and sovereign indebtedness close to their maximum. Accommodative central banks that helped them get there only ended up fueling credit, consumption and housing bubbles and distorting the balance of the economy away from production and into an increasingly bloated financial sector. That, clearly, ended in tears as finance itself needed bailing out and compounded the sovereign debt burden.
So if harder, longer-term choices and reforms are now needed, central banks ability to continually reflate the world economy by monetary means alone is at best uncertain, Pimco argues. The risk of major upheavals along the way in Europe, for example, has the potential for major market volatility and economic seizures.
Money funds cut Europe exposure, slowly
Prime U.S. money funds further reduced their holdings of euro zone bank paper in December, although the pace of movement slowed while investors continued to hedge against any bank failures, J.P. Morgan Securities said on Wednesday. The slower movement out of euro zone bank paper was the result of money funds having already strongly reduced their holdings, J.P. Morgan said in a note to clients.
Euro zone bank paper continued to roll off in December from prime money fund portfolios but has seen some slowing as nearly 70 percent of these exposures have been eliminated from prime fund portfolios over the course of the past year. In spite of continued reductions in euro zone bank exposures, prime fund assets under management were basically flat for the second consecutive month reflecting some level of investor comfort in the level of risk in price fund portfolios as much of the cash that left euro zone bank paper has been reinvested in non-European banks and other high-quality products.
The prime money funds had small net outflows of $2.6 billion in December after net inflows of $4 billion in November, according to J.P. Morgan.
The taxable money fund market experienced a significant shift in composition in 2011 with prime money funds losing $177 billion in assets, and government money funds gaining $108 billion in assets as investors sought safety from turmoil in Europe.
Exposure to European bank credit fell by $347 billion last year, of which $331 billion was accounted for by reductions in euro zone bank credit, J.P. Morgan said. The company estimates the top three reductions in exposure by country of origin were to France, Germany and the United Kingdom.
The biggest increases in bank credit by country of origin were to Canada, Japan and Sweden.
Although increases to bank exposures in these banking jurisdictions offset some of the massive declines in European bank exposures, much of the cash that left European banks was reinvested into high quality assets such as Treasury bills and coupons, agency discount notes and coupons and muni variable rate demand obligations.
Europe sobers up after Italian auction
After a hopeful couple of weeks and the ”euphoria” caused by an agreement to tackle the euro zone debt crisis, financial markets got a reality check from Italy’s sale of 7.94 billion euros of government bonds. The debt met lower demand than at previous auctions, forcing the country to pay the highest premium since joining the single currency to sell 10-year debt.
The results suggest markets did not think the euro zone rescue deal — which includes an agreement on the write-down of Greek debt, recapitalisation of European banks and leveraging of the euro zone rescue fund – went far enough to restore investor appetite for Italian debt.
Italian yields rose as high as 6.03 percent near levels not seen since early August, when the European Central Bank first began purchasing Italian and Spanish bonds in the secondary market to bring funding costs down to more affordable levels. Brian Barry, analyst at Evolution Securities, says that move alone speaks volumes:
Today you’ve had a weak auction and yields are up … along the curve. I think that tells you all you need to know about what the bond market’s reaction to the summit is. Markets remain sceptical and there is no proof yet that what we have been given will solve the crisis.
The latest complaints are as follows:
* The private sector agreed to voluntarily accept a nominal 50 percent cut in its bond investments to reduce Greece’s debt burden. Does this go far enough to put it on a sustainable path? Twenty-four of 47 economists in a Reuters poll didn’t think so.
* The deal foresees a further leveraging of the bloc’s EFSF rescue fund to give it firepower of 1 trillion euros. Is that enough?
Italy bond spreads signal renewed concern
Spreads between Italian and German government debt are blowing out heading into a European Union summit on Sunday that investors are hoping will come up with some action to address the continent’s sovereign debt crisis. Spreads between 10-year Italian government debt and German bonds of the same maturity widened to 398 basis points on Thursday, making for the biggest gap since at least the fourth quarter of 1996, according to Reuters data.
Andrew Wilkinson, Miller Tabak’s chief economic strategist, expands on the implications:
You have to look back to March 1996 to see the spread’s last excursion above 400 basis points. That was when Italian government was trying desperately to meet Maastricht criteria and join the euro. I’m left wondering how pleased they are with that outcome in today’s market. They never bargained for a spillover from Greece lie this. With the French/German yield spread leading the way this week it looks like pressure will continue to build in to the weekend.
from The Great Debate:
A free lunch for America
By J. Bradford DeLong The opinions expressed are his own.
Former US Treasury Secretary Lawrence Summers had a good line at the International Monetary Fund meetings this year: governments, he said, are trying to treat a broken ankle when the patient is facing organ failure. Summers was criticizing Europe’s focus on the second-order issue of Greece while far graver imbalances – between the EU’s north and south, and between reckless banks’ creditors and governments that failed to regulate properly – worsen with each passing day.
But, on the other side of the Atlantic, Americans have no reason to feel smug. Summers could have used the same metaphor to criticize the United States, where the continued focus on the long-run funding dilemmas of social insurance is sucking all of the oxygen out of efforts to deal with America’s macroeconomic and unemployment crisis.
The US government can currently borrow for 30 years at a real (inflation-adjusted) interest rate of 1% per year. Suppose that the US government were to borrow an extra $500 billion over the next two years and spend it on infrastructure – even unproductively, on projects for which the social rate of return is a measly 25% per year. Suppose that – as seems to be the case – the simple Keynesian government-expenditure multiplier on this spending is only two.
In that case, the $500 billion of extra federal infrastructure spending over the next two years would produce $1 trillion of extra output of goods and services, generate approximately seven million person-years of extra employment, and push down the unemployment rate by two percentage points in each of those years. And, with tighter labor-force attachment on the part of those who have jobs, the unemployment rate thereafter would likely be about 0.1 percentage points lower in the indefinite future.
The impressive gains don’t stop there. Better infrastructure would mean an extra $20 billion a year of income and social welfare. A lower unemployment rate into the future would mean another $20 billion a year in higher production. And half of the extra $1 trillion of goods and services would show up as consumption goods and services for American households.
In sum, on the benefits side of the equation: more jobs now, $500 billion of additional consumption of goods and services over the next two years, and then a $40 billion a year flow of higher incomes and production each year thereafter. So, what are the likely costs of an extra $500 billion in infrastructure spending over the next two years?
Didn’t we just spend about 2 trillion dollars stimulating the economy? Why isn’t the economy any better than it is? The government has used other people’s money to do things that serve to get someone re-elected, not necessarily things that are of any benefit to the economy. I’m not an economist, but I agree with you on one thing – if the story is too good to be true, run, don’t walk from that deal.
