Euro zone may struggle with its own Lost Decade
Additional Reporting by Andy Bruce and polling by Rahul Karunakar and Sumanta Dey.
As Europe’s crisis drags on, the prospect of a Japanese-style lost decade of economic malaise is becoming increasingly real, according to a new poll. Half of the bond strategists and economists surveyed by Reuters are now expecting just such an outcome.
Many market participants have dismissed the fall of two-year German bond yields below their Japanese counterparts as being merely a result of a crisis-fueled flight to quality bid. Two-year German yields are now close to zero, offering returns of only 0.02 percent. By contrast, equivalent Japanese bonds are yielding 0.11 percent.
But a significant portion of analysts in a Reuters poll see something more sinister in the rapid narrowing of the premium investors require to hold German debt over Japanese bonds. One half of those polled – 12 out of 24 – said it is likely the euro zone is close to entering a period of prolonged low or no growth and inflation and low interest rates, with the other half saying it was unlikely.
According to Stephen Lewis, chief economist at Monument Securities:
I don’t really see an early end to the financial crisis in the euro zone. I think it’s very unlikely that Germany and the other countries will see eye to eye in the course of this year. That’s going to keep the euro zone economy looking very weak for the next several quarters.
Europe’s economy stagnated in the first quarter of 2012 and is expected to shrink 0.4 percent this year, according to another recent Reuters poll. Data on Thursday certainly pointed in that direction, suggesting even wealthier countries like France and Germany are also starting to feel the pinch.
Resolving Shirakawa’s conundrum
The governor of the Bank of Japan, Masaaki Shirakawa, says he is confounded by the still very low level of Japanese government bond yields given the country’s elevated debt to GDP ratio of over 200 percent. Speaking on an IMF panel over the weekend, he offered a rather unintuitive explanation for the phenomenon:
It seems difficult to explain the case of Japan in light of conventional wisdom. One frequently offered explanation is that the ample domestic savings in Japan have absorbed the issuance of JGBs and the share of JGBs held by foreign investors is very small. But a more fundamental explanation is that the stability in the current bond yields reflects market participants’ expectations that fiscal soundness will be restored through structural reforms imposed in the economic and fiscal areas.
Most economists think Japanese yields are low because of continued expectations for deflation and weak economic growth. But for Shirakawa, it seems, it is public confidence in future fiscal restraint that is keeping bond yields low. Except he then contradicts this point by saying weak confidence in future fiscal reforms is also simultaneously undermining consumer spending:
At the moment, such expectations are not firmly backed by concrete reform plans. The public therefore restrains spending on concerns over future fiscal developments. This constitutes one factor behind sluggish economic growth and mild deflation. If this is indeed the case, the experience of Japan indicates a possibility that a cumulative increase in government debt combined with weak economic growth expectations might generate deflationary pressures.
Not so, argues Ugo Panizza, head of debt and finance analysis at the United Nations Conference on Trade and Development. He and co-author Andrea Presbitero find no causal link between high debt levels and weak economic growth.
Christopher Sims, a Nobel-winning economist and Princeton professor also on the panel with Shirakawa, had a much simpler explanation for why Japanese yields are low while Europe’s face steady upward pressure even though both economies are struggling with soft growth:
The pain in Spain – redux
Spain’s borrowing costs are likely to soar at an auction of 12- and 18-month T-bills after its 10-year yields were pushed through the totemic 6 percent level on Monday. The history of the euro zone debt crisis shows that once above 6 percent the spiral accelerates and before you know it you’re at 7 percent – the level generally seen as unsustainable for state financing.
Worryingly, Spain is dragging Italy’s yields up in its wake. But in Spain’s case, there are strong reasons for caution about imminent disaster. The government cannily used ECB-created benign market conditions in the first part of the year to shift nearly half its annual debt issuance needs already and the banks – which look like they will need recapitalization at some point – are well funded for now having also loaded up on the European Central Bank’s three-year liquidity splurge.
We also know Europe’s banks, too scared to invest elsewhere, are depositing 700-800 billion euros back at the ECB daily. If Madrid could engender a shift in confidence, some of that money could flow back into its bonds, particularly by Spanish banks.
There is no getting away from the fact that confidence has evaporated since Prime Minister Mariano Rajoy ripped up Spain’s 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. Government sources told us yesterday that Madrid may intervene to curb regional finances, which account for around half of national public spending, in return for some help in raising finance from the markets which some are finding difficult. Ministers meet the regional government heads on Wednesday. They have to present plans to save around 15 billion euros in early May.
Today, Madrid aims to raise up to 3 billion euros and will then try to sell up to 2.5 billion of longer-term bonds on Thursday. 12-month yields stood at around 2.7 percent on the secondary market yesterday whereas the last 12-month auction was done at a yield of 1.4 percent, so a big jump is inevitable.
The only other possible sentiment shifter in the short-term would be if the IMF managed to raise significant new crisis-fighting resources which could be deployed to defend a country like Spain (even though Christine Lagarde insists the monies would be used to help non-euro zone nations inadvertently caught up in the backwash). Overnight, she was quoted by Italy’s Il Sole 24 Ore as saying she was after more than $400 billion. EU sources have told us similar — $400-500 billion. That’s less than was first talked about and there are doubts it is deliverable.
Will U.S. criticism affect Japan’s FX stance?
Currency analysts are divided over whether U.S. criticism of Japan’s forex policy will change Tokyo’s currency stance. While some say it could raise the hurdle for further Japanese intervention, others think it might not have much impact. Rob Ryan, FX strategist at BNP Paribas in Singapore says the effect will be limited given uncertainty about the Japanese economy’s outlook and current levels of dollar/yen and cross/yen pairs.
“I think if they (Japanese authorities) feel they have to intervene, they will intervene,” Ryan says, adding that a dollar drop down to the “low 76s” might be enough to prompt further action from Japan.
The U.S. Treasury Department said in its semi-annual report on international exchange rate policies issued on Tuesday that the U.S. did not support Japan’s recent bouts of solo FX intervention, adding that they took place when volatility in dollar/yen was relatively low. USD/JPY was currently trading at Y77.98, not too far from a record low of Y75.311 hit on Oct. 31, when Japan conducted massive yen-selling intervention.
Are Treasuries the new JGBs?
Anemic economic growth in the United States has sparked fears the country was entering a Japan-style “lost decade.” The comparison also has implications for government bond markets. Some traders see the U.S. Treasury market’s new, lower-yielding structure as eerily reminiscent of trading patterns seen in JGBs (Japanese government bonds). Says George Goncalves at Nomura:
There has been much debate since the start of the ’08 credit crisis over whether the US is turning into Japan and if so how to trade it. We have spent a fair deal of time over the last two years developing a framework for how US rates investors can leverage these insights to “Trading USTs like JGBs.” […] One thing is clear: momentum trading starts to wane and narrower ranges will become the norm in a low yielding world with the Fed on perma hold meanwhile a lack of alternative fixed income products is still forcing investors to buy USTs.
This does not mean that investors can remain permanently bullish on Treasuries, however, Goncalves warns.
Many accounts have now subscribed to the view that the UST markets are turning Japan-like, but we caution that as with all range-trading periods, buying at the lows in a range that is stretched is still a dangerous proposition. Look at the JGBs experience in 2003 for a warning to those calling for even lower USTs rates from here.
Drop in Fed custody holdings reflects FX interventions
A sharp recent drop in the Fed’s holdings of U.S. Treasuries for foreign central banks probably reflects the effort by many developing economies to stem rapid declines in their currencies, not some frightening move by the likes of China out of U.S. bonds. That’s the argument put forth by Marc Chandler at Brown Brothers Harriman, who notes the pullback of recent weeks appears to have been the most dramatic since the Asian financial crisis of the late 1990s.
His reasoning makes sense: a September spike in the U.S. dollar was accompanied by steep plunges in the exchange rates of many emerging economies. Still, Chandler remains puzzled as to why the selling accelerated to a hefty $21 billion even as the dollar reversed course in the last week:
This is the seventh consecutive weekly decline and over this period, custody holdings have fallen an average of about $12-$12.5 billion a week, making this past week quite large relative to trend. It likely reflects foreign central banks’ selling of Treasuries to intervene to support their currencies rather than a dumping of Treasuries to diversify reserves or as a protest to such low interest rates.
Yet the difficulty with this hypothesis is that during the week through Wednesday, most emerging market currencies have generally risen against the dollar. This generalization holds true for East Asia which is suspected to use the Fed’s custodial services. For some of the run the dollar was appreciating in general, so private sector dollar buying offset the official selling, but now — over past week — it would seem like the central banks and the private sector have been on the same side selling dollars.
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.”
APEC’S always in fashion
One of the most closely guarded secrets at the APEC summit in Japan’s port city of Yokohama this weekend is not what the Asia-Pacific leaders might say about currencies and global imbalances. No, that’s all going to be thrashed out at the G20 meeting Thursday and Friday in Seoul. The big topic of speculation here at the Pacifico Yokohama Convention Center is what the leaders will wear when they gather for the annual class photo that concludes the meetings.
U.S. President George W. Bush (L) and his Russian counterpart Vladimir Putin wear Chilean ponchos at APEC meeting in Santiago in 2004. REUTERS
The last time Japan hosted the Asia-Pacific Economic Cooperation summit was 1995 in Osaka. There the leaders, apparently trying to depict the Japan Salaryman look, came out in business suits. Nobody remembers much about that APEC meeting, except that it took place in the magnificent, gold-embellished Osaka Castle.
In fact, APEC summits are rarely memorable for much beyond the fashion show and the intriguing historical settings in which they are often staged. The 1994 summit in Bogor, Indonesia is enshrined in the annals of APEC for the “Bogor Goals” that were agreed there. Leaders committed to achieving “free and open trade and investment” by 2010 for developed economies and 2020 for developing ones, giving the group its blueprint for the future. The 21 summiteers in Yokohama are expected to declare that the five industrialised members have passed their Bogor tests. Another eight in the developing wing have asked to be assessed as well, proud of their record in cutting tariffs and red tape.
I covered the 1994 summit, when Bill Clinton famously kept Indonesian President Suharto waiting and pacing on the portico of the 18th-century Bogor Palace. Everyone was watching Bill work the crowds, while Suharto ostentatiously looked at his watch, peacocks screeching in the bushes. I’ve covered nearly half of the annual summits since they began in Seattle in 1993 when Clinton began the fashion show tradition by outfitting the leaders in black leather bombardier jackets. That was kind of a cool look for everybody.
Former U.S. President Bill Clinton (3rd from left) joins Indonesian President Suharto (to Clinton’s right) in waving to the media at the 1994 summit in Bogor, Indonesia. REUTERS
Since then they’ve been decked out in native attire ranging from the sublime to the ridiculous. Previous meetings have seen the leaders don Chilean ponchos, Chinese silk jackets, batik shirts, Korean Hanboks, Vietnamese silk tunics, Mexican sombreros, New Zealand sailing jackets, and Australian Drizabone raincoats. The funniest photo has to be the one from the Santiago summit in 2004 when they all trundled out in Chilean ponchos that made them look they were auditioning for a part in Joseph and the Amazing Technicolor Dreamcoat. Vladimir Putin looked like he had been stuffed inside a box made of raccoon skins in his chamanto.
Investment week: Punch drunk and hard to startle
This week’s rehashing of European banking concerns – related variously to the Basel III impact on German banks, the ongoing morass re Anglo Irish Bank or any other scare story you want to exhume — provided the latest excuse for a global markets wobble as September kicked off. Yet, with some justified head-scratching over what really was new to the world this week as opposed to last week, price moves showed little conviction. Most losses were quickly recouped and decibel level of the commentariat, still frantically competing to warn you of the next disaster, toned down.
The world’s major sovereigns and banks have big financial problems, no doubt, and Europe more than its fair share. The rescues of the Spring did not provide a silver bullet and genuine repair will likely take a painfully-long time. But we’ve also had a lot of time to adequately discount these risks and the marketplace at large is already positioned extremely cautiously. That’s why the idea of sudden, blind panic on these long-running sagas seems just a little OTT – especially against a relatively stable, if bruised, economic backdrop. The bigger issue many investors are grappling with is the growing difficulty in making money in a hyper-cautious, low-growth environment. Ask Stanley Druckenmiller. If he threw in the towel because money-making conditions are just lousy, then you can be sure others see the same. Anecdotally at least, pressurised hedge funds – who faced rising redemptions through the summer – are ultra-cautious about open positions and seem quick to cut and run on even the slightest gain, long or short. (A bit like continually shouting ‘bank!’ on reaching £100 pounds on The Weakest Link!) Big institutional funds, meantime, are sufficiently uncertain about the market and economic direction that many are already keen to lock down for the remainder of the year and are hugging benchmarks to preserve whatever capital they have without resorting to zero-yielding cash or barely-more-attractive TBonds. U.S. midterms in November only add the caution. In short, it will take a pretty major positive or negative surprise to truly set these markets alight and there is every chance we won’t get a decisive one for some time. We already have historically high vol and caution – but relative steady, unspectacular conditions for all that. The smart money may simply be tempted to buy or sell any hysterical extremes. Is may even be possible that some are tempted to foster a long-absent patience gene?
As to next week? There’s welter of new economic data to maybe add some flavour. The biggest potential movers are August China production and investment stats (now, oddly, being released Saturday rather than Monday) and then US retail sales, Philly Fed and German ZEW indices later in the week. On the issue du jour re European banks/sovereigns, an informal EU summit on Thursday provides the main set-piece – but BIS central bankers meeting in Basel this weekend and Spanish and Italian debt auctions next week may add their own spice.
The Japanese yen intervention theme will likely rumble, with the Japanese Democrats leadership poll and BOJ Tankan playing a part. China will also likely find renewed political heat stateside, as the US election campaign adds an edge to a congressional hearing on China’s FX policy on Wednesday as well as the monthly Treasury/TIC flow data. All the above have their own ability to surprise — but few seem game changers in themselves.
Japan the rule, not the exception
Japan may well have looked like the odd-one-out after Monday’s news its economy grew 0.1 percent over the second quarter – about the feeblest expansion possible.
Europe’s big players were already in full swagger after posting growth second quarter growth that often exceeded predictions, and the U.S. economy – although clearly slowing – still expanded at a decent pace over the same period.
But looks are deceptive, especially from preliminary three-month snapshots of the rich-world economies, and Japan’s lethargy is probably still the rule, not the exception.
That’s the message from Reuters monthly polls of more than 250 economists, who see quarter-on-quarter growth in the likes of the euro zone and United States hovering around half a percentage point for some time yet.
Last week’s news of an explosive 2.2 percent quarterly growth rate for Germany and 1.0 percent for the wider euro zone could prompt forecasters to bump up their predictions in the September poll. Yet there was little sign of them upgrading growth forecasts in the last UK poll, conducted after similarly surprising news that Britain’s economy grew at its fastest pace in four years in the second quarter.
So it wouldn’t be a shock if our poll respondents conclude Europe’s vigorous second quarter was flash-in-the-pan stuff. Indeed, Bank of England policymakers said the strength of second quarter growth in the UK was “probably erratic”, according to the minutes of their August meeting released on Wednesday.
Widening austerity measures in Europe, worrying unemployment trends in the U.S. and a bunch of encouraging and discouraging economic indicators mean economists will likely remain cautious with their predictions.
Japan is history, the true ‘has-been’ of economic powers. Remember when these guys were going to rule the world woth their economic prowess? Seems like a million years ago. Gregg Easterbrook posted an excellent column on this yesterday – well worth a read.
