Spanish Bond; a licence to kill?
Back to the familiar grist of a Spanish bond auction today. This one has real power to move global markets as it offers up a 10-year bond for only the second time this year. Because of the ECB’s three-year money glut and the general point that uncertainty rises the longer you stretch the timeframe, shorter-term paper has been a much easier sell.
10-year yields broke above the portentous 6 percent level for the first time since late November earlier this week though they have since ducked back down.
Madrid is looking to sell up to 2.5 billion euros of 2- and 10-year bonds – a relatively small amount which should attract the requisite demand. But yields will climb. The last 10-year auction went at 5.4 percent. On the secondary market those yields are now around 5.8.
Given markets are positioned for a solid sale, there is clear downside risk if it doesn’t happen.
One potential problem is that the big buyers of Spanish and Italian bonds have been domestic banks, which are not in the rudest of health and would be even more exposed if sovereign yields head yet higher. The IMF said yesterday it expected Italian banks to buy 223 billion euros in domestic government bonds this year, with Spanish banks buying 135 billion. The IMF also warned that Europe’s deleveraging banks will shrink their assets by $2.6 trillion over the next two years, further starving the real economy of credit.
France will sell up to 8 billion euros of debt, including new 2-year bonds and up to 3 billion euros of inflation-linked paper. The auctions are expected to go smoothly, with markets apparently sanguine about the first round of presidential elections on Sunday. The second round, which polls suggest will anoint socialist Francois Hollande, who is intent on tinkering with some of the EU’s crisis policies, could be a different matter.
Focus starts to switch to Washington where G20 policymakers are starting to gather ahead of the IMF spring meeting. A deal on finding $400 billion plus of new crisis-fighting funds for the IMF appears to be coming together. As of last night, the Fund said it had got $320 billion in commitments so far. Add that to the new $500 billion euro zone rescue fund and it’s possible that market sentiment will start to shift. But, as the United States and Canada are pointing out, a firewall, no matter how big, does not solve the root problems of the crisis.
The Italian job
As we exclusively reported last night, Italy will delay by a year its plan to balance the budget in 2013. That Rome is no longer aiming for a zero budget deficit next year is very different from Spain which has upped its 2012 deficit goal to 5.3 percent of GDP, way above the 3 percent EU limit (though it is aiming for that in 2013).
Italy’s move also makes eminent economic sense to find a little fiscal leeway given it is already in a recession that is likely to deepen. Initial market action suggests investors buy into the sense of it rather than viewing it as the wrong direction of travel.
The drive to find $400 billion or more of new crisis-fighting funds for the IMF seems to be slowly falling into place. The euro zone is good for about half of it. Japan, Sweden and Denmark committed a total of $77 billion between them yesterday and it is hoped that the British and others, most notably China, will also come to the table. Germany says the deal must be done at the IMF spring meeting at the end of the week. That is not a certainty.
After some steep stock falls, markets have calmed. Bund futures and European stocks are pretty much flat. One of the most profound questions right now is whether markets are seriously spooked by Spain or are merely booking profits and allowing a routine correction to happen after a stellar first quarter – particularly for stock markets – before delving back in again.
Spain remains front and centre for the markets. Today, its government embarks on another crucial quest – to persuade/cajole/force its autonomous regions to come up with the cuts, including in painful areas like health and education, to meet stiff deficit targets this year and next.
Confidence in Spain has evaporated since Rajoy ripped up an 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.
Spain’s other big headache is the health of its banks, still trying to get out from under colossal property market bad debts after that bubble burst. Late yesterday, the central bank approved all 135 Spanish banks’ plans to boost capital by around 54 billion euros in total (most independent experts say far more will eventually be needed) but said some may struggle. We get the latest bad loans data for Spanish banks later.
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.
from Global Investing:
EM growth is passport out of West’s mess but has a price, says “Mr BRIC”
Anyone worried about Greece and the potential impact of the euro debt crisis on the world economy should have a chat with Jim O'Neill. O'Neill, the head of Goldman Sachs Asset Management ten years ago coined the BRIC acronym to describe the four biggest emerging economies and perhaps understandably, he is not too perturbed by the outcome of the Greek crisis. Speaking at a recent conference, the man who is often called Mr BRIC, pointed out that China's economy is growing by $1 trillion a year and that means it is adding the equivalent of a Greece every 4 months. And what if the market turns its guns on Italy, a far larger economy than Greece? Italy's economy was surpassed in size last year by Brazil, another of the BRICs, O'Neill counters, adding:
"How Italy plays out will be important but people should not exaggerate its global importance. In the next 12 months the four BRICs will create the equivalent of another Italy."
Emerging economies are cooling now after years of turbo-charged growth. But according to O'Neill, even then they are growing enough to allow the global economy to expand at 4-4.5 percent, a faster clip than much of the past 30 years. Trade data for last year will soon show that Germany for the first time exported more goods to the four BRICs than to neighbouring France, he said.
"Post-crisis, these countries will be our passport out of this mess."
But there has to be a payoff for this kind of increased financial clout, he warns. Developing countries are increasingly disgruntled about the the richer world's strangehold on global policies via the International Monetary Fund and the World Bank and most have responded coolly to the call for additional funds for the IMF which is fighting to stem the euro zone malaise. An attempt last year to install a representative of the developing world at the helm of the IMF for the first time ever fell apart, with Europe retaining the position. But emerging countries could make a bid for the World Bank chief's position this year, a position traditionally held by a U.S. citizen. O'Neill said the West had to bow to the new reality:
"You can't have it both ways...This game of 'You have the IMF and I have the World Bank' has to stop or these institutions are going to lose their relevance."
He is also dismissive of fears China is headed for a so-called hard landing, a sharp slowdown of growth, potentially leading to unemployment, a property crash and social unrest in the world's No. 2 economy. "A lot of people (in the West) want China to have a hard landing, " he said. "And that's because it isnt us."
Growth not enough to ease inequality: Oxfam
Rising income inequality in rich nations has cast doubt on the old adage, often upheld by the economics profession, that a rising tide lifts all boats. A new report from Oxfam reinforces the notion that wealth does not trickle down of its own accord. The anti-poverty advocacy group says sometimes actively redistributive policies may be needed to address huge income gaps. It also says that, contrary to conventional economic thinking, such policies will directly contribute to better growth rather than impede it.
Inequality, often viewed as an inevitable result of economic progress, in fact acts as a brake on growth. Among the best ways to assure inclusive, sustainable growth and fight poverty, finds the study, are policies that reduce inequality. […]
Inequality erodes the social fabric, and severely limits individuals’opportunities to escape poverty. Where income inequality is high or growing, the evidence is clear that economic growth has significantly less impact on poverty: a trickle-down approach does not work.
The report notes that the United States is the most unequal of the world’s wealthy nations – but that’s old news. More interesting is the finding that even strong rates of growth will not be enough to lift more people out of poverty over the next decade, particularly in the less wealthy G20 nations. The report found that inequality increased in 14 of 18 G20 countries since 1990 despite rapid rates of growth in some countries. Oxfam recommends the following:
The exact policy mix should be tailored to each national context, but policies in successful developing countries suggest the following starting points:
- Redistributive transfers
- Investment in universal access to health and education
- Progressive taxation
- Removal of the barriers to equal rights and opportunities for women
- Reforming land ownership, ensuring the right access to land and other resources, and investing in small-scale food producers
What kinds of redistribution would this involve? Oxfam turns to the United Nations’ Economic Council for Latin America and the Caribbean for answers:
ECLAC suggests that cash transfer programs in Latin America typically have three objectives:
- To alleviate poverty through direct income transfers
- To provide incentives for investment in human capacity-building
- To bring the target population into the social protection and promotion networks
Politically impossible? Perhaps. But Oxfam says some countries have already taken some steps successfully, with impressive results.
from The Great Debate:
How Europe can stave off a crisis
By Gordon Brown The views expressed are his own.
It was said of European monarchs of a century ago that they learned nothing and forgot nothing. For three years, as a Greek debt problem has morphed into a full blown euro area crisis, European leaders have been behind the curve, consistently repeating the same mistake of doing too little too late. But when they meet on Sunday, the time for small measures is over. As the G20 found when it met in London at the height of the 2009 crisis, only a demonstration of policy intent that shows irresistible force will persuade the markets that leaders will do what it takes. An announcement on a new Greek package will not be enough. Nor will it be sufficient to recapitalize the banks. European leaders will have to announce a comprehensive -- around 2 trillion euro -- finance facility; set out a plan to fundamentally reform the euro; and work with the G20 to agree on a coordinated plan for growth.
For three years it has suited leaders across Europe to disguise Europe’s banking problems and, citing the blatant profligacy of Greece, they have defined the European problem as simply a public sector debt problem. And it has suited Europe’s leaders to call for austerity (and if that fails, more austerity) and forget how the inflexibility of the euro is itself dampening prospects for growth, keeping unemployment unacceptably high and weakening Europe’s competitive position in the world today. Indeed, Europe’s share of world output has now fallen to just 18 percent. And it is a measure of how it is losing out in the growth markets of the future that just 7.5 percent of Europe’s exports go to the emerging markets that are responsible for 70 percent of the world’s growth.
When I attended the first ever meeting of the euro group of leaders in October 2008 there was astonishment when I reported that Europe's banks had bought half America’s subprime mortgages and there was incredulity when I said that European banks were far more at risk than U.S. banks because they were far more highly leveraged. Since 2008, as American banks have tackled their toxic assets, they have written off 4 percent of their loans and raised the equivalent of another 4 percent in new equity. But euro area banks have written off just 1 percent of their loans, and have raised their capital base by only 0.7 percent, leaving them highly vulnerable even before their exposure to sovereign debt has become a central issue. Their vulnerability is increased because they have always been far more dependent for their funding on the short term and confidence-dependent wholesale markets, and countries within the euro zone are able to do far less in the face of capital flight than, say, Britain.
Of course in 2008, governments could fund the rescue of indebted banks; in 2011, indebted governments are finding that more difficult. For they know that even after they recapitalize the banks, they have still to deal with the even bigger financial problem of funding the borrowing needs of the most at-risk countries: Greece, Ireland, Spain Portugal and Italy, which could cost as much as $2 trillion in the years to 2014.
It is thus clear that the 400 billion euro rescue fund, the European stability fund, is wholly inadequate to address this profound failure across the European financial system, and that without a mechanism for fiscal coordination the euro cannot easily survive. A few days ago, U.S. Treasury Secretary Tim Geithner said that “the critical imperative is to ensure that the governments and the financial systems under pressure have access to a more powerful financial backstop.”
I believe that only an impenetrable firewall will show the determination of European leaders to head off the crisis and save Europe from a new recession. I know of all the doubts about a new but temporary role for the ECB, but it is unlikely that any other organization has the resources for quick action. But the IMF should back them up, funding their contribution through loans from the oil states and China. It may now be impossible to avoid hundreds of billions in bank de-leveraging and liquidations, but a coordinated approach with the support of the international community could provide the breathing space for what matters -- the reform of the euro.
I believe politics to be a very cruel game and those who enter to be either viciously ambitious or incredibly naive. That still leaves room for intelligence. Gordon Brown shows some in this article.
from Global Investing:
Russia’s babushka time-bomb
The babushka, that embodiment of Russian grandmotherly goodness that has spawned iconic dolls and inspired a Kate Bush song, poses one of the gravest threat to the Russian economy.
Moscow-based investment bank Renaissance Capital also expects this segment of the demography to spur politically risky pension reforms.
Russia's pension system is coming under increasing strain thanks to growing life expectancy -- particularly among women -- and a shrinking labour force due to the collapse in birth rates in the 1990s.
Since the introduction of the current system, the average life span of the Russian man has risen to 63.4 years, up from 58.7. Over the same period of time, the life expectancy for the country's women has risen to 75.4 years, up from 71.9.
Russian women are thus likely to claim a pension for 20 years after retirement at 55. Compare this to the three to four years that the average Russian man gets.
Little wonder that it's the babushka segment of the demographic that is giving Russian policymakers cause for pause.
"This is becoming expensive. Russia spends 6 percent of GDP on pensions compared to just 1 percent of GDP in Mexico." writes Renaissance Capital Chief Economist Charles Robertson in a note.
from Davos Notebook:
Groundhog Day in Davos
The programme may strike a different note -- this year's Davos is apparently all about Shared Norms for the New Reality -- but much of the discussion at the 41st World Economic Forum annual meeting in Davos this month will have a distinctly familiar ring to it.
Last January, the five-day talkfest in the Swiss Alps was dominated by Greece's near-death experience at the hands of the bond market and recriminations over the role of bankers in the financial crisis, as well as worries about China's rapid economic ascent and a lot of calls for a new trade deal.
Fast forward 12 months and not much has changed.
Ireland has joined Greece in the euro zone's intensive care unit and Portugal and Spain are getting round-the-clock monitoring. The annual round of bankers' bonuses is once again stirring up trouble. China looms larger than ever on the global stage, after overtaking Japan in 2010 to become the world's second-biggest economy. And trade ministers who signally failed to make headway last year say they really must get down to business when they meet on the sidelines of Davos this time round.
For a sense of the deja vu, take a look at the WEF's latest hot-off-the-press report on Global Risks -- a 50-page tome on the spider's web of interconnected threats now facing the world. Not much progress in addressing them has been made, it seems. Government debt and the danger of sovereign default remains top of the risk hit-list, alongside macroeconomic imbalances, the fragility of the economic recovery and resource limits. It is a very similar litany as a year ago.
Worryingly, while the threats remain all too visible, the report's authors conclude that the world is now uniquely vulnerable to any further shocks in the wake of the financial crisis.
APEC’s robots stealing the show
A guide at the “Japanese Experience” exhibition talks to Miim, the Karaoke pal robot, on the sidelines of the APEC meetings in Yokohama, Japan on Nov. 10. REUTERS/Yuriko Nakao
Miim is one of the more popular delegates at the APEC meetings in Yokohama Japan. She sings. She dances. She tosses her shoulder length hair. She may not be able to spout an alphabet soup of APEC acronyms like the other Asia-Pacific delegates. But she’s still pretty lively. For a robot.
This week’s meetings of the Asia-Pacific Economic Cooperation forum have been earnest and most comprehensive . Foreign and trade ministers issued a 20-page statement about all the things they talked about — a giant free trade zone, protectionism, the Doha round, easing restrictions on businesses, simplifying customs procedures, promoting green industries, cooperating on health and security, you name it. They also have been, and pardon my French here, excruciatingly dull. So far, the meetings and their stupefying statements have been a testimonial to Japan’s skill at stating the ambiguous. Call it the opaque meetings. Journalists from around the Pacific rim have been desperately trying to find news as the 21 APEC leaders gather for their annual pow-wow this weekend.
The annual “silly shirts” photo shoot, in which leaders don native attire for the class picture of their summit is usually good news fodder, but is going to be a big let-down this year. The leaders are merely being asked to show up wearing “smart casual” for the photo shoot on Saturday night, before they head inside for a Kabuki show.
Which brings us back to Miim, the karaoke robot. She, er it, is one of 130 exhibits on display at “Japan Experience”, a government-sponsored exhibition in the Pacific Yokohama convention center where the APEC meetings are taking place. The exhibit also features “personal mobility vehicles”, a cyborg suit named HAL that enables the wearer to lift really heavy stuff and perform heroically in disaster relief, a talking delivery robot, cute robotic seal pets for use in pediatric therapy, and much other cool stuff .
“Welcome to APEC Japan 2010,” the anatomically correct Miim says. ”This exhibition shows Japan’s strengths and attractions. Please see, feel and touch advanced technology and initiatives of Japan.”
Investment Week: From the Trenches…
Early September skirmishes turned this week into full-scale “currency wars”, to use Brazil’s terminology. Dramatic language, but not unwarranted. The markets have taken Fed signals of preparation for further money printing as an effective attempt at a dollar devaluation, allowing the country export its deflationary pressures overseas via capital outflows to higher-yielding developing countries.
The major developing nations, for all the arguments favouring currency revaluations of 20-25% over the next couple of years, are not going to stand idly by and watch that happen overnight. But their attempts to offset the impact of soaring local currencies and attendant asset bubbles merely floods local economies with cash at a time when fighting inflation — not deflation — is their priority. Brazil has raised the red flag, but the likes of Turkey and Taiwan are also registering fears about the impact of another bout of US monetary pump priming. Meantime, the gloves are off in the US-China yuan row; possible trade measures are being invoked in DC; and there is little chance of cooler heads prevailing this side of the US mid-term elections. This story will run.
What’s certain is the G20 finance meeting in South Korea on Oct 22 has significant work to do. Next week the battle lines are already drawing up at the Asia-Europe summit in Brussels (and China’s PM Wen and Japan’s PM Kan both travel) and then the annual IMF/G7 meetings in DC. The key US September payrolls report on Friday, for good measure, may be the deciding data set for the Fed to pull the trigger on QEII. And also meeting next Thursday is the Bank of England, itself back in a QE frame of mind if you listened this week to one of its policymakers Adam Posen
But apart from a sliding dollar and rampaging emerging markets, the most interesting development this week was the steep euro climb in the face of some severe credit/debt/banking scares in Dublin and even Lisbon. Although the FX market focus is clearly on the Fed and interest rate differentials (rate futures are showing a yawning gap between US and euro zone interest rates over the next year or two) the euro rise a remarkable turnaround from the Spring when every sovereign debt wobble led to existential euro lunges.
One reason for the shift is credibility in the ample EFSF rescue fund (now AAA-rated) and its ability to cope with any fallout from nasty but relatively containable debt problems like Ireland’s. The other is that the main source of sovereign debt contagion – the impact on other creditor euro zone banks – is has been dampened since the recent EU stress tests allowed local regulators to identify and isolate (and possibly merge etc?) the most exposed banks. And finally, the aggregate euro zone economic, employment and credit data remains surprisingly strong through Q3 and the ECB seems able to continue to gradually withdraw excess liquidity – in stark contrast to the Fed. The ECB meeting next Thursday will be an important sounding on its intentions going forward.
The problem for Europe is that a rising currency means you are losing the currency war….
