Pangs of gilt(s) – again

Posted by Tracy Alloway on Feb 12 10:49. 1 comment.

Notice anything about the below chart, from RBC Capital Markets’ Richard McGuire?

The graph plots the 11 largest eurozone members — plus the UK — according to their expected stock of debt and structural budget deficit. More…

Notice anything about the below chart, from RBC Capital Markets’ Richard McGuire?

The graph plots the 11 largest eurozone members — plus the UK — according to their expected stock of debt and structural budget deficit. It’s meant to capture “market concern” over the size of the countries’ debt liabilities and the pace at which the debt burden is rising.

So Finland, at the bottom left of the chart, would be in the best position, with a low stock of debt plus a limited budget shortfall. In contrast, Italy has the highest stock of debt in the region but a relatively modest deficit. The UK, however, is clearly out on a limb in terms of its liabilities.

Which means, according to RBC:

. . . the UK appears the richest of any of the countries viewed here which makes intuitive sense given the scale of its budgetary shortfall, the yield compression that, until recently, was being affected via QE and the fact that, unlike the Eurozone periphery, the UK cannot hope for a bailout from its peers but can look for assistance in the form of a weaker currency.

Richest, in this sense, is a bad thing.

Related links:
Pangs of gilt(s), redux – FT Alphaville
Pangs of gilt(s) – FT Alphaville
Next to the trough – FT Alphaville
Nowotny talks contagion, exit strategies and all things peripheral – FT Alphaville interview

Germany’s export decision

Posted by Izabella Kaminska on Feb 12 10:37. 1 comment.

Following news on Thursday that the European Union will support Greece in its fiscal hour of need, it’s still the case that the cost of euro-peripheral bailouts will have to be borne by someone.

For the time being in Europe that means the community’s most productive members, More…

Following news on Thursday that the European Union will support Greece in its fiscal hour of need, it’s still the case that the cost of euro-peripheral bailouts will have to be borne by someone.

For the time being in Europe that means the community’s most productive members, ie Germany and France.

And on Friday BNP Paribas makes the valid point that for such costs to be made up, the likes of Germany will have to refocus exports towards markets outside of the European Union.

That’s because demand from within Europe is just not there.

To wit the following chart:

Friday’s German Q4 GDP figures, meanwhile, confirmed just how much that shift is needed. German growth — without the support of government emergency measures, including subsidies for car purchases — came in flat compared with the previous three months, according to the country’s statistical office. The market had been expecting 0.2 per cent growth.

This was despite a rise in exports. As Reuters reported:

Exports rose by 3 per cent on the month in December, pushing foreign demand above the year-ago level for the first time in 14 months.

The above showing just how dependent Germany’s economy is becoming on foreign demand for its exports.

Which means, according to BNP Paribas, an envitable weakening of the euro to come:

The German GDP for Q4 is much weaker than expected, showing a flat q/q reading against the consensus for 0.2% q/q growth. This risks the overall eurozone growth coming in much weaker than expected. Indeed, it was expected that the growth readings at the periphery of Europe would be weak, but the countries at the core of Europe were expected to put in a far more robust performance. However, the initial readings from Germany suggest that weakness in the Eurozone is far broader than initially anticipated. This will add to the euro’s problems.

A weaker euro though will of course be helpful to boosting Germany’s ex-EU exports.

Related links:
If I had a pound, peseta, drachma or a deutsche-mark…- FT Alphaville
German economy grinds to a halt – FT

Corporate bonds: The rot sets in as gold shines

Posted by Gwen Robinson on Feb 12 09:29. 4 comments.

It’s happening… corporate bond markets are already in the grip of that “massive case of indigestion” that commentators were warning about last month. But the mounting risk aversion to sovereign debt, More…

It’s happening… corporate bond markets are already in the grip of that “massive case of indigestion” that commentators were warning about last month. But the mounting risk aversion to sovereign debt, amid contagion fears over the Greek debt crisis, could be providing a (very mild) panacea.

From Bloomberg on Thursday:

Investment-grade debt sales are drying up and returns on high-yield bonds have turned negative for the year as investors wait to see whether European leaders can contain Greece’s budget crisis.

Borrowers in the US and Europe sold $5.96 billion of high-grade securities this week, the least this year and about 90 percent less than the average $52.9 billion, according to data compiled by Bloomberg. Speculative-grade, or junk, bonds in the US have lost 0.09 percent in 2010 after gaining 1.52 percent in January, Bank of America Merrill Lynch index data show.

While relative borrowing costs in the US remained steady [on Wednesday] and prices to insure against defaults fell, Huntsville, Alabama-based telephone service provider ITC Deltacom Inc canceled a $325 million bond sale, citing “current market conditions.”

But fears over the “Greek factor” in sovereign debt has this week helped narrow the extra yield investors demand to own corporate bonds instead of Treasuries. As Bloomberg reports, that spread narrowed 1bp to 170bps on Wednesday – having widened from this year’s low of 160bps on Jan 14, after narrowing from 443bps a year ago.

Meanwhile, as the FT reported on Wednesday:

European bond investors believe that the worst is still to come for sovereign debt and are more gloomy about the sector than any other fixed income category, according to a survey to be released by Fitch Ratings on Tuesday.

Of 63 of Europe’s top 100 fixed income fund managers surveyed, 70 per cent expect fundamental credit conditions to deteriorate for sovereign debt and 55 per cent forecast that spreads will widen further.

In fact, notes the FT report, the expected performance of sovereign credit “stands in stark contrast to just about every other debt instrument where investors foresee strong improvements in categories such as emerging markets corporate debt and investment grade corporate bonds”.

But in the view of CLSA’s Christopher Wood, investors should be piling into gold, gold, gold – oh and Asian assets or currencies. In his weekly investor newsletter Greed&Fear, Wood says:

A sovereign debt crisis in the West is coming sooner or later though it is probably not right now. This is why the recent correction in gold is an opportunity to buy more bullion and more gold mining shares.

Gold, in Woods’ view, remains the best hedge against the “almost inevitable Western currency debasement which will be the consequence of the increasingly untenable welfare states and related social security systems”.

The next best hedge, he adds, is Asian currencies and Asian assets. While many would broadly agree with his point about gold and even Asian currencies, some may question his confidence in Hong Kong property. However, he reasons, the recent correction is a buying opportunity in relevant stocks while the continuing supply crunch is a “reason to remain fundamentally bullish on Hong Kong residential property”.

As we noted recently, when it comes to Hong Kong (and mainland China) property prices, it really depends on who you want to believe.

Related links:
For corporate bonds, a week is an eternity – FTAlphaville
China: “It’s simply because people are rich now” – FTAlphaville
Faber lashes out, again- FTAlphaville
Gold backwardisation fears revisited – Oh! Oh! – FTAlphaville

Goldman asks, is sovereign strain Europe’s subprime?

Posted by Tracy Alloway on Feb 12 09:21. 5 comments.

We’ll spare you the suspense.

The answer, according to Goldman Sachs analysts Ben Broadbent and Nick Kojucharov, is no, it probably isn’t. Or, at least it won’t be as long as defaults stay below a certain threshold. More…

We’ll spare you the suspense.

The answer, according to Goldman Sachs analysts Ben Broadbent and Nick Kojucharov, is no, it probably isn’t. Or, at least it won’t be as long as defaults stay below a certain threshold.

Here’s the thrust of their (brief) analysis:

That the authorities say they will take such action is no surprise, and we believe they’ll be successful in safeguarding stability— should the need arise. Nevertheless, as was the case after past financial crises, government debt is rising sharply as the private sector de-levers, and history shows that incidences of sovereign default increase after financial crises. As a result, sovereign spreads have widened and, with a share of that debt held by banks, some have wondered if this could be ‘the European subprime’.

Needless to say, the ramifications of an outright default anywhere in Europe would be considerable. But, in scale at least, the problem looks considerably smaller than subprime. European banks’ exposure to sovereign debt is half that of US banks to mortgages in mid-2007. We find that, under some reasonable assumptions, it would take the default of nearly half of non-German Euro-zone government debt in order to replicate the hit to banks’ balance sheets that was inflicted by the US mortgage crisis. To us, that seems a very tall order.

So the first point is really that European banks are less exposed to government bonds than US banks were to mortgages in the year before the subprime crisis.

The government bond market itself is smaller in Europe, according to Goldman. It’s equivalent to roughly 65 per cent of GDP versus the nearly 80 per cent of the mortgage market and US GDP.

Plus, the European banking sector’s share of the government debt market is also smaller, at 25 per cent, than the US banks’ share of mortgages, as the below chart should show:

There’s a bit of a caveat here:

This is not to say that other owners [of sovereign debt] wouldn’t react adversely to asset write-downs. In response to an explicit sovereign default that triggers a formal accounting loss and a hit to capital, European insurers—who own around €1trn of government bonds (our estimate)—might have to raise more capital and reduce holdings of other, risky assets. This would depress equity prices and tighten financial conditions. There might also be wealth effects on spending by households, who probably own over €1trn-worth of sovereign debt.

But the US mortgage crisis has taught us that it is the leveraged institutions that play the most important role in transmitting and amplifying the original shock through the rest of the economy (see ‘More Thoughts on Leveraged Losses’, US Economics Analyst 08/10, March 7 2008). The distribution of the at-risk asset, and in particular the proportion held by banks, therefore matters.

Back to the question at hand then — possible European bank losses on sovereign debt.

The US mortgage crisis inflicted first-round losses equivalent to about 4 per cent of GDP, according to Goldman, half of which fell on the banks. By Goldman’s estimates the hit for Europe’s banks shouldn’t be as high — in fact it should be something like losses equivalent to 0.3 – 0.7 per cent of GDP.

Here then is Goldman’s heavily-conditioned conclusion:

Even for economists happy to accept approximation, this is an uncomfortably imprecise exercise. We are also reluctant to offer ranges of our own. While we think noncommercial funding for the most at-risk sovereign (Greece) will probably be required, our central expectation is that such funding will eventually be forthcoming and that the chances of outright default are very low, particularly across the Euro-zone as a whole. But the uncertainties involved are considerable.

It’s also true that we have restricted ourselves to only a very limited comparison and that, even without outright default, changes in the perceived risk of it can still tighten financial conditions. Notably, there has been a clear cross-country correlation in the past three months between changes in sovereign CDS and the performance of banks’ equity prices (Chart 6). As sovereign debt cheapens, funding costs go up for everybody, inflicting immediate damage on the most leveraged institutions . . .

As a summary comparison it’s helpful to think of what’s required to match the two. We’ve estimated that the initial hit from US mortgage losses was worth 4% of GDP, of which a half fell on leveraged-sector balance sheets. To get the same aggregate impact from Euro-zone sovereign losses, assuming losses-given-default of 35% (the baseline assumption in the CDS market) and remembering that debt is around two-thirds annual GDP, you’d have to expect a default rate of 18% (over whatever horizon you think is relevant).

If we assume that German sovereign debt is essentially risk-free, that means a 24% expected default rate in the rest of the Euro-zone. If you believe that what matters is the losses borne by the banks—and there’s no doubt that the leveraged sector played a key role in the amplification and propagation of the original hit in the US mortgage market—that threshold rises to close to 50%.

Could this be the European subprime? Yes, but only if Europe suffers a wave of sovereign defaults unprecedented in scale and at significantly lower levels of debt (relative to revenue) than those of the past.

So this shouldn’t be Europe’s subprime as long as defaults and correlations stay within an expected range.

Where have we heard that before?

Related links:
Bank Grεεkery – FT Alphaville
US banks have $176bn in exposure to troubled Europe, BarCap says – FT Alphaville
Banks, insurers and sovereign debt - FT Alphaville
Next up for Europe, covered bond catastrophe? – FT Alphaville

Bond on bonds – disaster ahead

Posted by FT Alphaville on Feb 11 19:05. 16 comments.

By the FT’s Chris Flood

Government bond markets are facing a decade of “disastrous returns”, according to Tim Bond, head of asset allocation at Barclays Capital.

Bond reckons unfavourable demographic trends mean long term-yields in the US and UK will double from current levels over the next ten years, More…

By the FT’s Chris Flood

Government bond markets are facing a decade of “disastrous returns”, according to Tim Bond, head of asset allocation at Barclays Capital.

Bond reckons unfavourable demographic trends mean long term-yields in the US and UK will double from current levels over the next ten years, moving up to around 10 per cent by 2020.

In its 2010 Equity Gilt Study, Barclays said its analysis of the interaction between demographic trends and bond yields suggest the era of low and stable long-term interest rates is over.

Effectively, the models are suggesting that the shrinkage in the high savings population cohorts and an expansion in the retired population will alter supply demand dynamics in the debt capital markets in a profoundly negative manner.

Ageing populations will lead to an explosion in government debt over the long run:

The unfavourable shift in dependency ratios, combined with sharply increased spending on pensions and healthcare is likely to cause a sustained deterioration in primary fiscal balances and a continuous increase in government debt to GDP ratios.

IMF and OECD projections suggest that the effects of ageing alone will increase debt ratios by 50 percentage points of GDP over the next 20 years:

For the advanced G20 economies, the government debt/GDP ratio is projected to rise from 100% in 2010 to 150% in 2030. Over the subsequent 20 years, debt ratios for these countries are anticipated to rise further, increasing to 275% of GDP by 2050.

And of course the deterioration in government finances — as a result of the credit crisis — has worsened the starting point for the future path of rising indebtedness due to demographic factors:

The deterioration in budget deficits has also provided a notable setback to many countries’ strategies for dealing with the long-run effects of aging. Although fiscal discipline has been weak in the US and UK over the past decade, the larger European economies had certainly been following fiscal policies designed to reduce deficits in the short run and thus clear the decks for the anticipated increase in borrowing over the long run. This strategy has now been de-railed by the widening of deficits stemming from the credit crisis.

Mr Bond says it is difficult to avoid the conclusion that national savings within the advanced economies will be insufficient to meet domestic requirements:

The common assumption that future savings flows from the large developing economies will be a ready source of finance for the ageing advanced economies is most probably flawed. The projected trajectory for old age dependency ratios in countries like Brazil, China or Russia are as severe as in the US. It is highly implausible to believe that Africa, the Middle East and India will be capable of funding the rest of the world’s growing population of retirees.

Because the rise in old age dependency ratios is common to virtually all significant economies, the idea that a redistribution of global savings flows from surplus to deficit nations might mitigate the impact of ageing on bond markets is a false comfort.

Barclays also says the risk premia embedded in nominal bond yields is likely to rise, as history shows that higher inflation – sometimes hyperinflation – can be the end result of unsustainably high debt/GDP ratios.

Although such an outcome is by no means an historical inevitability, it is certainly the case that high debt ratios increase the temptation for policymakers to engineer higher inflation as a soft option for containing debt/GDP ratios.

Pragmatically, we can take the view that when investors focus on the nearubiquitous trend for substantial increases in debt burdens, they will demand a higher longterm inflation risk premium.

Mr Bond admits that a decade of rising bond yields as forecast by Barclays demographic models appears unlikely from our present, deleveraging, post-crisis perspective, and notes that past few years have been characterised more by an abundance of savings relative to productive investment opportunities.

However, it is likely that this phase represents a high-water mark, to be followed by an inexorable turn in the demographic tide. Over the next two decades, the boomer generation will age into retirement and run down their accumulated savings. An era of capital abundance will gradually turn into an era of capital scarcity. Government debt burdens will rise sharply, with the risk premium demanded for financing these debts increasing as private sector net savings flows dwindle. Given the broad international context for these trends, with similar developments afflicting almost all the world’s major economies, the means by which the government debt burdens are eventually curtailed is unclear. As a result, government bond yields are likely to require a significant rise in risk premia to cover the eventuality of default, either outright or through inflation.

How to say ‘more please’ in Chinese

Posted by Gwen Robinson on Feb 03 10:20. 1 comment.

For a prime example of investor chutzpah, look no further than China Investment Corp, the country’s mega sovereign wealth fund, which has just done a deal with Apax to invest €685m (£599m) in the UK private equity group’s €11.2bn buy-out fund. More…

For a prime example of investor chutzpah, look no further than China Investment Corp, the country’s mega sovereign wealth fund, which has just done a deal with Apax to invest €685m (£599m) in the UK private equity group’s €11.2bn buy-out fund.

Even after heavy domestic criticism – and some international derision – for spending $3bn two years ago to acquire 10 per cent of Blackstone just before shares in the US buy-out group tanked – CIC has come roaring back with a big appetite for big deals. This after sitting on the sidelines for most of last year with about 90 per cent of its available funds in cash.

And CIC’s masters are evidently just as hungry for deals. Beijing is now preparing to inject another wack of “shopping” money which, as the FT reported in December, is likely to be a similar amount to the initial $200bn with which it set up CIC in 2007.

This time, CIC is taking a new approach with its Apax deal. As the FT reports on Wednesday, the deal “could tempt other private equity groups” to look to China. As it explains:

Apax offered investors in its latest fund the option to transfer as much as €800m of their unfunded commitments – the part of their investments still to be called for future deals – to the Chinese fund.

This gave CIC, which did not invest in the fund initially, access to Apax’s future investments, while allowing investors who were over-exposed to private equity or short of cash to escape from commitments to fund future deals.

According to the FT, the deal is the first of its kind and could be a model for other private equity groups to deal with cash-strapped investors without shrinking their funds.

As part of the deal, CIC has also acquired a 2.3 per cent stake in the Apax Partners LLP, the UK group’s management company. By buying into Apax’s management, it joins GIC and Future Fund, the Singaporean and Australian sovereign wealth funds, which bought 7.7 per cent of Apax last year.

The proceeds of the sales would go into a permanent capital vehicle to invest in Apax’s future fundraisings, noted the FT.

Apax is certainly wasting no time in making the most of what it portrays as some very shrewd deal-making.

Martin Halusa , Apax’s chief executive, was quoted crowing saying: “This is a real coup, it is a really innovative solution that no one else has come up with, offering a better version of a secondary trade for investors.”

Apax Europe VII has made 15 investments, including UK publishing group Emap, Weather Investments, an Italian tele-coms group, and D+S Europe, a German e-commerce company.

These investments amounted to a negative annual return of 38 per cent last year, according to Calstrs. But in buy-out game, investors regard it as one of the better performing big buy-out funds, adds the FT.

Curious, then, that CIC chairman Lou Jiwei, told a forum in Hong Kong last month that the fund’s top priority this year was investing in emerging markets, particularly Asian ones, where “opportunities are more plentiful than elsewhere”.

Related links:
China sovereign fund focuses on emerging markets – WSJ

The other European deficit problem

Posted by Izabella Kaminska on Feb 03 13:15. Comment.

The European Commission’s position on Greece may have been the key focus of market attention on Wednesday, but there was another country that also managed to draw some criticism from Brussels.

That country was Poland: More…

The European Commission’s position on Greece may have been the key focus of market attention on Wednesday, but there was another country that also managed to draw some criticism from Brussels.

That country was Poland:

Feb. 3 (Bloomberg) — Poland needs to take “sizeable” measures to bring its deficit down to the European Union limit by the 2012 deadline, the European Commission said.

There are “considerable risks attached to the fiscal strategy of the Polish authorities,” the commission, the EU’s Brussels-based executive, said in a report today. “Even taking into account the better-than-anticipated growth prospects, further sizeable consolidation measures” will be needed to cut the deficit to below the EU ceiling of 3 percent of gross domestic product.

Poland’s deficit swelled last year to 6.4 percent of GDP, the commission estimates, as tax revenue dropped and the government stepped up spending in a bid to boost the economy. This year, the deficit could widen to 7.5 percent, the third- largest projected among the 10 eastern members of the EU, according to commission forecasts.

The commission warned Poland that “new stimulus measures should be avoided, the 2010 budget be strictly implemented, windfall revenue be allocated to deficit reduction, and additional consolidation measures be prepared for the following years.”

Despite the above, governmental clashes over the country’s euro convergence plans and fiscal tightening measures persist.

Prime Minister Donald Tusk was expected to approve an updated plan for 2014 eurozone entry by Tuesday, dismissing junior-coalition partner concerns over the tightening path involved.

Nevertheless, by Wednesday (European) lunchtime the plan was still awaiting approval.

On the flip side, Tusk is said to be committed to the deal going through no later than February 9. If it does, Poland would then be on track to cut its deficit below 3 per cent of GDP by 2012.

Not that the recent delays haven’t worried some in the market.

Danske Bank analysts commented on Wednesday:

Last night the Polish Prime Minister Donald Tusk announced that the government had not approved the euro convergence plans, as the junior partner in the government coalition, the Polish Peasant Party (PSL), had some doubts. This is clearly bad news and is an indication that PSL does not support Finance Minister Rostowski’s plans for fiscal tightening.

The full EC report can be found in the usual place.

Related links:
Is Poland selling itself for nothing? – FT Alphaville
The EMEA debt dog – FT Alphaville
Poland is the new Hungary, says BNP Paribas- FT Alphaville

Mainland rates likely to rise, says adviser

Reuters in Shanghai Feb 02, 2010

The mainland might increase interest rates once consumer inflation exceeds the one-year benchmark deposit rate of 2.25 per cent, a prominent government adviser said yesterday. Policymakers have traditionally been nervous whenever inflation-adjusted bank deposit rates turn negative in case savers pull their money out of the bank and put it into assets such as property and shares."

The mainland might increase interest rates once consumer inflation exceeds the one-year benchmark deposit rate of 2.25 per cent, a prominent government adviser said yesterday. Policymakers have traditionally been nervous whenever inflation-adjusted bank deposit rates turn negative in case savers pull their money out of the bank and put it into assets such as property and shares.Ba Shusong, a senior research fellow at the Development Research Centre, a think tank under the State Council, said Beijing could raise interest rates ahead of the United States Federal Reserve to dampen inflationary expectations at home.But it still not known whether China will just raise deposit rates or both deposit and lending interest rates, Ba said. The one-year lending rate stands at 5.31 per cent. The People's Bank of China controls both the deposit and the lending rate.Many economists have argued that Beijing would not raise interest rates before the Fed because a premium in China's favour could result in stronger capital inflows. But Ba said capital inflows may not be as great as expected if higher borrowing costs cooled the property sector.China's consumer price index rose 1.9 per cent in the year to December. Economists expect inflation to accelerate in coming months, but Jiao Jinpu, a researcher with the central bank, said price pressures were unlikely to be fierce enough to trigger a rate rise in the first quarter.Turning to the yuan, Ba said there is a heated debate among researchers on whether China should let the currency rise. Beijing is likely to take a cautious approach to exchange rate policy, especially as the export sector is still weak, he added."

The mainland might increase interest rates once consumer inflation exceeds the one-year benchmark deposit rate of 2.25 per cent, a prominent government adviser said yesterday.
Policymakers have traditionally been nervous whenever inflation-adjusted bank deposit rates turn negative in case savers pull their money out of the bank and put it into assets such as property and shares.

Ba Shusong, a senior research fellow at the Development Research Centre, a think tank under the State Council, said Beijing could raise interest rates ahead of the United States Federal Reserve to dampen inflationary expectations at home.
"But it still not known whether China will just raise deposit rates or both deposit and lending interest rates," Ba said.

The one-year lending rate stands at 5.31 per cent. The People's Bank of China controls both the deposit and the lending rate.
Many economists have argued that Beijing would not raise interest rates before the Fed because a premium in China's favour could result in stronger capital inflows. But Ba said capital inflows may not be as great as expected if higher borrowing costs cooled the property sector.

China's consumer price index rose 1.9 per cent in the year to December. Economists expect inflation to accelerate in coming months, but Jiao Jinpu, a researcher with the central bank, said price pressures were unlikely to be fierce enough to trigger a rate rise in the first quarter.

Turning to the yuan, Ba said there is a heated debate among researchers on whether China should let the currency rise. Beijing is likely to take a cautious approach to exchange rate policy, especially as the export sector is still weak, he added.

How do you say ‘Notice’ in Greek?

Posted by Tracy Alloway on Feb 01 11:23. 6 comments.

Mark Wednesday in your European Sovereign Struggle calendars.

For that’s the day, February 3, that the European Commission is expected to publish its review of Greece’s Stability Programme. EU members are required to submit these programmes to the Commission every January for review, More…

Mark Wednesday in your European Sovereign Struggle calendars.

For that’s the day, February 3, that the European Commission is expected to publish its review of Greece’s Stability Programme. EU members are required to submit these programmes to the Commission every January for review, but, given recent Hellenic tribulations, it’s no surprise that Greece’s will attract extra attention this year.

So, with that in mind, here’s some background info on past Stability Programmes, courtesy of Mark Wall, part of Deutsche Bank’s excellent fixed income team:

The Stability Programme reviews are detailed documents and the conclusions are not binary (pass/fail). However, to help judge a review we can do a comparative analysis of last year’s Stability Programme reviews for the main euro area member states and look at the kinds of conclusions that are drawn and what member states are ‘invited’ to do in light of those conclusions.

Word count is informative. Those deemed to have “sound” public finances (Netherlands and Finland) have the shortest conclusions; those facing risks have much more detailed conclusions (Figure 1). It is likely Greece’s review will be on the lengthier side.

More important is the tone of language used. There is clear gradation in the language used in the reviews of the Stability Programmes, more so than in the Excessive Deficit Procedure recommendations. Reviews of those member states facing the greatest risks or offering the least credible policy solutions have the gravest tone. Examples of the grading of the language used in last year’s reviews are:

• Most positive language: “sound budgetary position” (Netherlands), “public finances are sound” (Finland), “measures adopted…regarded as welcome and adequate” (Ireland), “sizeable fiscal stimulus…welcome as it is commensurate with the scale of the economic downturn” (Germany).

• Common complaints: the most frequent criticisms in the Stability Programme reviews are (1) a “favourable macroeconomic outlook”, i.e., that the growth assumptions are too optimistic and will underpin the consolidation less than is assumed and (2) a “lack of information” regarding the consolidation measures.
• Most negative language: “restoring fiscal sustainability…an absolute priority” (Spain), “adjustment path is not fully backed up with concrete measures” (Spain), “absence of crucial information…severely hampered the possibility to assess the credibility of the deficit” (Belgium), “not backed by a well-founded medium-term budgetary strategy” (Belgium), “clearly subject to considerable downside risk” (Belgium), “lacks ambition” (Belgium).

. . . What can we expect from this year’s review of the Greek Stability Programme? Given the seriousness of the situation in Greece, we would expect use of the most negative language. Indeed, this was already the case in last year’s review of Greece’s Stability Programme (see a copy of last year’s review in the Appendix to this article). Perhaps we should expect harsher language still.

There is no clear failure grade in the review of Stability Programmes, just degrees of criticism and levels of requests. Looking back at the reviews from a year ago, the most that the Commission asked was for Belgium to re-submit its Stability Programme. The Commission may not ask Greece to re-submit per se, but if the Commission judges, with the help of its review of the Stability Programme, that Greece has not yet taken sufficient action to correct its deficit, Greece may decide to re-work its Programme or do similar to prevent an escalation into sanctions in the middle of this year.

Along with its review of the Stability Programme, the EC will also publish a timeframe for its Excessive Deficit Procedure against Greece. These procedures are aimed at getting deficits back below Maastricht limits (3 per cent of GDP) by setting various targets and deadlines.

Greece is currently aiming to correct its excessive deficit by 2012, a year earlier than its previous pledge of 2013. Most other member states with excessive deficits have been set a target of 2013, with a deadline of June 2 2010 to “take effective action.”

In December, the EC already concluded that Greece had not taken effective action to fix its deficit. If it determines, this time around, that Greece has still not taken effective action, it could issue a Notice to take such action. And this, is where things get tricky.

Back to Wall:

The question is not so much the harshness of the review or but whether the Commission asks for a ‘Notice’ to take effective action to be issued to Greece. Having concluded in December that Greece had not taken effective action to correct its excessive deficit, the Commission is due to decide whether or not to issue a ‘Notice’, the next step in the escalation of the Excessive Deficit Procedure. If a ‘Notice’ were issued, it would represent an escalation of the Excessive Deficit Procedure and put Greece one step closer to sanctions.

Given that “escalation” isn’t quite what the European Commission is going for, in terms of the Greek situation, at the moment, it’s worth asking whether they really would issue such a Notice.

The DB analyst, for one, thinks yes — potentially:

… the Commission is obliged to apply EU law. Not issuing a Notice when it is deemed necessary would undermine its credibility.

The initial response to a Notice would likely be negative. But the issuance of a Notice has two positives. First, it would demonstrate the credibility of the Stability and Growth Pact and its ‘corrective’ arm, the Excessive Deficit Procedure (it was at the Notice stage that the Pact failed in 2003). Second, if the Notice results in more detailed consolidation plans from Greece, it could lead to selfreinforcing positives, with perceptions of a better, more sustainable consolidation and increased market confidence.

However, issuing a Notice puts Greece one step closer to sanctions. After a Notice is issued, Greece would have four months to demonstrate that effective action has been taken. Otherwise, the Commission will recommend moving into sanctions (i.e., a non-interest bearing deposit of up to 0.5% of GDP).

Related links:
Greece to outline plan for economic stability – FT
What’s next for Greece under EU budget rules? – Reuters
Greek tragedy - FT Alphaville

US Housing Bubble v2.0

Posted by Tracy Alloway on Feb 01 10:02. 14 comments.

Here’s one thing that the Sigtarp’s quarterly report to Congress, released on Saturday, made very clear; propping up house prices is now an explicit goal of the US government.

So explicit in fact, that the Special Inspector General for the Troubled Asset Relief Program has knocked up this little chart to show how various policy programmes (Hamp, More…

Here’s one thing that the Sigtarp’s quarterly report to Congress, released on Saturday, made very clear: propping up house prices is now an explicit goal of the US government.

So explicit in fact, that the Special Inspector General for the Troubled Asset Relief Program has knocked up this little chart to show how various policy programmes (Hamp, MHA, etc.) lead to higher houseprices:

See? It’s like crystal.

As the report states:

Supporting home prices is an explicit policy goal of the Government. As the White House stated in the announcement of HAMP for example, “President Obama’s programs to prevent foreclosures will help bolster home prices.”

In general, housing obeys the laws of supply and demand: higher demand leads to higher prices. Because increasing access to credit increases the pool of potential home buyers, increasing access to credit boosts home prices. The Federal Reserve can thus boost home prices by either lowering general interest rates or purchasing mortgages and MBS. Both actions, which the Federal Reserve is pursuing, have the effect of lowering interest rates, which increases demand by permitting borrowers to afford a higher home price on a given income.

Similarly, the Administration is boosting home prices by encouraging bank lending (such as through TARP) and by instituting purchase incentives such as the First-Time Homebuyer Tax Credit. All of these actions increase the demand for homes, which increases home prices. In addition to direct Government activity, home prices can be lifted by general expectations among homebuyers of future price increases.

Questions related to moral hazard on a postcard to the below please.

The White House
1600 Pennsylvania Avenue, NW
Washington, DC 20500

The Federal Reserve
20th Street and Constitution Ave.
Washington, DC 20551

The Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, DC 20220

Related links:
Serial bubbles – FT Alphaville
Hamp, what is it good for? – FT Alphaville
Interest rates and the housing bubble: less maestro, redux – FT Alphaville
Goldman says US gov’t boosted home prices by 5% – FT Alphaville

Shock, horror: ‘irresponsible’ pricing in China IPOs

Posted by Gwen Robinson on Feb 01 09:18. 2 comments.

Beijing’s regulators have injected a few more jitters into China’s nervy but always hyperactive stock markets – taking a swipe at “irresponsible” pricing of IPOs.

As the FT notes on Monday, the statement has fuelled speculation that Beijing could temporarily halt the new issue market in order to introduce fresh pricing rules. More…

Beijing’s regulators have injected a few more jitters into China’s nervy but always hyperactive stock markets – taking a swipe at “irresponsible” pricing of IPOs.

As the FT notes on Monday, the statement has fuelled speculation that Beijing could temporarily halt the new issue market in order to introduce fresh pricing rules.

Official media quoted Zhu Congjiu, an official of the China Securities Regulatory Commission, as saying institutions were “irresponsibly driving up” IPO prices. The remarks come amid an increasingly lackluster investor response to mainland IPOs.

Last week, China XD Electric became the first Chinese stock in five years to end its first day of trading below its IPO price. And several other recent large offerings have only seen single-digit, first-day percentage rises, while others have suffered declines in subsequent sessions.

Zhu, according to the official China Daily, told a seminar on IPO reform: “Some institutions are simply profit driven and are not responsible when proposing a price. This has helped drive up IPO prices.”

Last year Chinese equity raisings accounted for four of the top 10 offerings worldwide by size, and a whopping 45 per cent of global IPO volume – or a total $50.4bn worth of shares, according to Dealogic.

Now, the rumblings from Beijing’s regulators suggest the shine might be wearing thin very quickly in the great casino of China’s markets.

China equity analysts say that CSRC is planning to implement new IPO price setting and underwriting rules in an effort to encourage “more rational pricing” of new offerings – and that approval of new IPOs could be suspended until those take effect.

Already, however, some analysts are saying the lukewarm take-up of recent mainland IPOs shows that investors, at least, are showing more “rationality”.

But China’s authorities are no strangers to the art of over-kill. And already, there are suggestions that Beijing will delay its long-awaited move to allow foreign companies to list on the mainland.

As the FT adds, a senior Shanghai government official was quoted at the weekend saying China was unlikely to allow foreign companies to list on the Shanghai stock exchange in the first half of this year.

That could have implications for HSBC and some other “red-chip” companies – mainland companies listed only in Hong Kong – that have been considering Shanghai listings.

If – as some believe – there is some truth to the Sunday Telegraph’s report about HSBC eyeing a big stake in one of China’s top three banks, a mainland listing is crucial for the British bank.

But such a move by HSBC would also require some hugely significant mainland reforms. Currently, foreign investors are restricted to stakes of 20 per cent each and a combined 25 per cent for all foreign investors in Chinese banks.

For now, we can safely say that the politics of IPO activity in China’s mainland markets remain all about domestic companies and – increasingly – “rationality” and “responsibility”.

Related links:
China IPO fears after CNC debut- FT
Edward Chancellor: Speculators’ animal spirits – FTfm
China to dominate IPOs in 2010, analysts – ChinaBizNow
China eclipses US in IPOs – FT

Is this the big one?

Posted by Tracy Alloway on Feb 01 08:50. 5 comments.

Two big investment banks, UBS and JPMorgan, are on Monday asking themselves whether the current bear is “the big one” in terms of market corrections, or just a minor hiccup.

There’s a host of things that could be making markets nervous — the sovereign situation in Europe, More…

Two big investment banks, UBS and JPMorgan, are on Monday asking themselves whether the current bear is “the big one” in terms of market corrections, or just a minor hiccup.

There’s a host of things that could be making markets nervous — the sovereign situation in Europe, financial reform for US banks, and expected monetary tightening in the US, UK and China.

Despite the jitters though, both UBS and JPM aren’t worried — just yet. Their strategy teams think this is a small correction along a recovery-driven rally that has much further to go.

Here’s what UBS’ (European) equity strategy team, led by Nick Nelson and Karen Olney, say:

We do not believe that this is the end of the bull market
Three disparate catalysts have triggered the current correction: Chinese monetary policy, US bank reforms and Greek fiscal concerns. Although risks have risen, we believe that each of these individual events will most likely turn out to be manageable and, in themselves, will not d.e-rail the global economic recovery.

Equity market fundamentals are still intact…
Falling equity prices and rising earnings have left European equities as cheap as they have been since the July 2009 correction (12m forward P/E of 11.5x now versus 11.0x at the low of last summer). And this is on year 1 of recovery – longer-term measures, such as a Shiller P/E, suggest significant upside. European equities also look attractive relative to other European a.sset classes (2010E dividend yield of 4.0% versus a 3.2% 10-year German bond yield).

…but big changes within the market
Cyclicals’ performance relative to defensives was rolling over before the current correction. We continue to favour a barbell approach at a sector level and would argue that we are past the sweet spot for cyclical outperformance, even with our forecast for a global economic recovery back to trend.

And JPM’s European strategists Mislav Matejka and Emmanuel Cau:

The last week’s trading is showing how rapidly the sentiment is changing and how fragile the investor confidence was to begin with. In Q4 the general desire was to add further to market exposure, but majority didn’t want to chase into the year end, deciding to wait for a pullback, for better entry levels. It is interesting that now that correction is unfolding, instead of looking at this as the long awaited opportunity to add into, the overall sentiment today is that it is better to wait, that there is too much uncertainty and too many moving parts to consider. However,if it weren’t for this poor news flow in the first place, the stocks wouldn’tbe trading at levels of last October again.

The question is whether what we are witnessing over the past fewdays is a game changer? Is “buying the dips” going to fail as a winning strategy this time?Acknowledging the potential for markets to create their own future outcomes, we point out the following:

In the background, the reporting season is so far delivering good results. Out of 197 S&P500 companies that reported to date, 77% have beaten on EPS line, with average beat of 16%. Perhaps more interestingly, while in Q2 ‘09 45% of non-financial companies beat on revenues, and in Q3 58%, in Q4 so far the proportion stands at 71%. For the majority of corporatesthat have reported, the analysts are having to raise their ‘10 estimates, which ultimately means that every percent the market falls, it becomes a percent cheaper.

Second, credit cycle is showing further signs of turning, as evidenced in the results of most banks. This is one of the key conditions for the sustainability of recovery.

Third,despite the latest few prints which were higher than expected, the 4-week run-rate of jobless claims is consistent with outright positive payrolls right now.

Fourth, while Greek debt situation remains precarious (不穩的;危險的), and the market is starting to entertain contagion risk, we note that in the case of Romania, Latvia and Hungary the announcement of a financial assistance program managed to stabilisemarkets relatively swiftly. The worst outcome for all parties concerned is the default, but JPM believes solvency is not the issue, rather the lack of credibility which can/will lead to liquidity risk, ultimately calling for outside assistance.

Fifth, The start of the Chinese policy tightening, while detrimental to the market sentiment and raising the potential for policy mistake, could ultimately be seen as a positive, as a sign that growth recovery appears robust enough to allow policymakers to refocus on asset bubble concerns.

Sixth, the recent turn in the currency trends, with some Euro weakness, should remove one of the headwinds for European exporters.

Lastly, while we are cognisant that the market can drive valuations to much lower levels than would be at first deemed reasonable, it is perhaps worth mentioning that stocks trade on 11.5x this year’s earnings, in addition to the EPS integer moving up.

We advise adding to positions on weakness and would revisit this view if jobless claims were to move back towards 500k, if Greek default becomes a reality or if manufacturing leading indicators roll over.

So, investment banks are advising clients not to worry.

Contrarian indicator or what?

Related links:
JPM equity strategy presentation – The Long Room
Teun’s tightening tactics – FT Alphaville

What a difference six months makes, in the CEE

Posted by Gwen Robinson on Feb 01 08:32. Comment.

In early 2009, central and eastern Europe (CEE) was the region “most blighted by the financial crisis”, as Lex reminded us last week. There were real concerns for foreign banks with big CEE exposure – above all from Austria, More…

In early 2009, central and eastern Europe (CEE) was the region “most blighted by the financial crisis”, as Lex reminded us last week. There were real concerns for foreign banks with big CEE exposure – above all from Austria, Italy and Scandinavia.

And you might recall, the IMF was preparing to bail out some of the region’s most stricken countries and rating agencies were moving to downgrade big lenders to the region, amid a general feeling of crisis.

Less than a year later, a report in Monday’s FT shows yet again how yesterday’s crisis can indeed become today’s boom — and the cycle can all too easily begin again (our emphasis):

Central and eastern European markets have been the strongest performers in the world in the past six months, in a sharp turnround of fortunes as the concerns of investors have switched to the mounting debts in the developed world.

These markets have been buoyed by the determination of governments in the region to straighten out their public finances, even as some draw on the support of the IMF.

In contrast to eurozone members, such as Greece, which saw a collapse in its bond markets last week, investors have been impressed by the performance of the region’s stronger economies, such as Poland, as well as those that have been assisted by the IMF, such as Hungary and Latvia.

Indeed, as Shahin Vallee, emerging market strategist at BNP Paribas, told the FT: “This is a story of public finances. If you compare Hungary and Greece, then Hungary, the emerging market country, is a safer bet.”

Consider: since the end of June, the region’s stocks have risen 39 per cent, against 24 per cent for emerging markets as a whole and 17 per cent for the developed world, according to FTSE indices.

The cost to protect government debt against default has also fallen sharply in countries such as Poland and Hungary, compared with steep rises in developed world nations, such as Greece and Portugal, over the same period.

In currency markets, the Polish zloty, one of the most liquid in eastern Europe, has jumped 10 per cent against the euro in the past six months.

Not only that, as the FT reported in mid-January, big lenders to the region are now betting that recovery will take hold this year.

Putting its money where its proverbial mouth is, UniCredit of Italy plans to open 100 branches across central and eastern Europe; Austria’s Raiffeisen International is launching an internet-based banking service; and Erste, also of Austria, is opening 70 branches in Romania, home to its largest CEE business.

Not surprisingly, this follows signs of a pick-up in credit growth in some countries, such as Poland, in late 2009,

But — and there’s always a `but’ in these turnround situations — analysts warn that eastern Europe could be derailed by debt problems in the industrialised world and the stalling of the global recovery.

Last week, most stock markets fell, dragged lower by the fall in the Greek bond markets and fears of contagion elsewhere.

As one emerging markets strategist told the FT:

“Hungary and Latvia have impressed investors with their reforms, but they have a long way to go to get their books in order… Like all emerging markets, they could easily suffer a big sell-off over the coming weeks if the sovereign risk of the developed world increases…The emerging markets are not decoupled from the developed world.”

In a December post highlighting the downside to the CEE rebound, FT Alphaville warned of the region’s growing addiction to borrowing in foreign currency for everything from second homes to TV sets.

So much, according to Reuters, that the European Bank for Reconstruction and Development expressed concern that, even though FX loans nearly blew out the region earlier in the year, most countries and institutions had failed to learn anything from the episode.

Sound familiar?

Related links:
A week when politics ruled the markets - PrudentInvestor
Greek debt crisis - FT.com
Review of central and eastern Europe – FT
Poland not so strong afterall? – FTAlphaville