Fed Sends Global Markets Reeling
Spain Uses Social Security Fund
BoA Sees US Double-Dip Danger
America No Longer Needs Chinese Money
Greek Crisis Refuses To Go Away
Hard-Nosed Fed Sends Global Markets Reeling
By Ambrose Evans-Pritchard | 24 August 2010
The yen smashed through resistance against all major currencies on Tuesday, reaching a 15-year peak against the dollar.
Wall Street and Western bourses have until now brushed aside worries that recovery in the US, Japan and southern Europe may be stalling— as have commodity markets— betting that 'the lords of finance' will come to the rescue with more liquidity if needed. Equity investors learned this week that they had misjudged the risk of a relapse as fiscal stimulus wears off, and seriously misread the willingness [[political ability?: normxxx]] of the US Federal Reserve to respond. Wrongly viewing Ben Bernanke's Fed as a 'soft touch', they took a fresh blast of quantitative easing for granted before it was agreed.
What has emerged since the acrimonious Fed meeting on August 10 is that Bernanke was unable to marshal a consensus behind fresh QE. Seven members argued that Fed should not take such a drastic step until the economy was in 'serious trouble', according to Wall Street Journal Fed-watcher Jon Hilsenrath. They settled on a compromise that the Fed should roll over holdings of bonds as they reach maturity to avoid passive tightening. But there was no deal on further action. Philadelphia's Charles Plosser grumbled that the Fed had sent "a garbled message".
More ominously, some Fed officials fear the central bank is already "pushing on a string" and does not have the means to revive the economy. Whether or not they are right, this comes as a psychological shock for investors schooled by the 'Greenspan Put' into thinking that there is a 'deus ex machina' in the wings. Market tensions have been simmering for days.
They erupted on Tuesday when Japan's yen smashed through resistance against all major currencies, reaching a 15-year peak against the US dollar. The Nikkei index buckled below 9,000 as yen strength pushed Japan's export industry deeper under water. Yields on 10-year bonds fell to 0.92% in Japan and record lows of 2.23% in Germany and 2.88% in the UK.
They hit 2.47% in the US, a Depression level. Irish spreads ballooned to the highest since the launch of EMU. Greek spreads neared 900 basis points, as if the EU's €110bn bail-out had never happened.
"This has been one of the most interesting days in finance ever," said Andrew Roberts, head of credit at RBS. "We are right at the tipping point. Yields are about to collapse even further, equities are about to turn over. The end game approaches, probably in next few weeks."
In the US, the 27% collapse in existing homes sales in July leaves no doubt that America's property market cannot stand on its own feet without the prop of homebuyer tax credits. "Home sales are in free-fall. These are truly dismal numbers," said Teunis Brosens from ING. The overhang of unsold homes has jumped from 8.9 months' supply to 12.5, higher than at any point during the Great Recession. Over 20% of mortgage holders are already in negative equity and home default notices hit 325,000 in July.
The Richmond Fed's manufacturing index showed a plunge in August expectations on Tuesday, with shipments dropping to 7 from 40 two months earlier, and the backlog of orders dropping to -1 from 22. This follows the Philly Fed's crash last week to -7. Stephen Lewis from Monument Securities said bond yields have dropped further than they did in the "flight to safety" extreme of late 2008, a sign that markets fear that underlying conditions are even worse today than they thought then. "Now they fear the global economy will remain in the mire for decades," he said.
For the Japanese this has become a nightmare. Their V-shaped rebound has been cut off short of its 2008 peak. Growth stalled to just 0.1% in the second quarter. Unemployment has been rising for four months.
Yet it is their curse to have a currency that strengthens at the wrong time, pushing them deeper into deflation. The Japanese repatriate their foreign wealth in storms, driving up the yen. The dollar-yen rate hit ¥83.6 yesterday, prompting [renewed] warnings from Toyko that intervention nears.
Finance minister Yoshihiko Noda said the moves were "disorderly" and posed a threat to stability. "I am watching currencies with great interest," he said. Goldman Sachs said the yen was now overvalued by 20%, or two "standard deviations" out of kilter.
It was even more over-valued against the dollar in the mid-1990s but that is scarcely relevant. Over 60% of Japan's rebound in exports has been driven by Asia, and only 13% by the US. What matters is the yen rate against China's yuan. That has reached a crucifying ¥12.4. The vice grips ever deeper.
Spain Uses Social Security Fund To Prop Up The Bond Market
By Ambrose Evans-Pritchard | 24 August 2010
Spain is putting all its eggs into one basket, and if it carries on like this, we may start to see a lot of Basques and Catalans crowding into one exit. The state pension fund— the €64bn Fondo de Reserva, known as the 'hucha de las pensiones'— is buying Spanish sovereign debt at a vertiginous pace. The financial daily Cinco Dias reports that the share of the Fondo's total portfolio 'invested' in Spanish government bonds rose from below 50% in 2007 to 76% in 2009.
The Social Security minister Octavio Granado said it will rise to 90% by the end of this year. It is clear from an analysis of the data that the Fondo is not just investing fresh revenues in Spanish bonds, but also rotating out of Dutch, French, and German bonds into Spanish debt. The Spanish government is also funnelling 90% of its 'sickness' fund into state bonds.
Evidently, Spanish savers are underpinning Madrid's Treasury auctions, whether they like or not. It is they who are mopping up the debt along with the European Central Bank as foreign creditors stay away. The Bank of New York Mellon said that its iFlow data on bonds reveal that foreign demand for Spanish debt has "dried up" again after a brief recovery in July.
There has also been some "net selling" of French bonds. I think we will hear more of that Gallic sub-plot over the next year. Here is a chart from the last annual report of the Cortes Generales, which is packed with detail:
Sr Granado said the "sole motive" for the purchases is to reap a higher yield. Spanish 10-year bonds were trading yesterday at 173 basis points over German Bunds. But there again, spreads on Greek bonds were at 853 points, so if yield is what you want— and if you believe EU assertions that default/EMU exit by any eurozone member is preposterous— then why not buy Greek debt? Unless, unless… but let's not belabour the point.
I am grateful to the splendid Edward Hugh at A Fistful of Euros for bringing this to my attention. Dr Hugh lives in Barcelona and is highly valued by the Spanish media as one of the few analysts who saw the whole disaster coming, and why it was coming— namely the perverse mechanisms of EMU on a peripheral economy in a catch-up-phase with a higher growth rate than Carolingia, and therefore a need for a higher interest regime (ceteris paribus) during the boom.
Just to be clear, Dr Hugh does not call for Spain to leave EMU, and nor do I. It is too late for that. As Brian Coulton af Fitch Ratings puts it, leaving EMU is like trying to remove the sugar from your coffee once you have stirred it in.
In my view the proper response at this late stage— after the EU elites have already been "asleep at the wheel" for a decade, in the words EU president Herman Van Rompuy— is for Germany to endure a phase of higher inflation for a few years to let Greece, Portugal, Spain, and Ireland claw their way out of their trap without succumbing to debt-deflation and a death spiral. Berlin does not yet understand that this is the unavoidable implication of Germany's EMU membership, of course, so we have a problem.
Spain is not alone in tapping its pension fund. Half the world is doing it. In Japan the DPJ government is dragging its feet on 'privatisation' of Japan Post, the biggest financial conglomerate on the planet, and holder of a big chunk of all Japanese sovereign bonds. The DPJ is clearly terrified of what may happen it loses its captive buyer, notwithstanding today's fall in yields on 10-year bonds to 0.92%.
Those yields will change in a hurry if and when psychology turns in the Tokyo market. Who else will fund a public debt reaching 225% of GDP this year (IMF data)? The Japanese can't count on the Chinese central bank to keep plugging the gap.
Of course, Britain also plays the game. It uses 'pension rules' to force its savers to buy Gilts. The US social security fund buys Treasuries. We all do it.
We are building up a nasty inter-generational clash by plundering the savings of current workers to fund a bloated state and an aging bulge of pensioners who— through no fault on their own: many even being forced to retire before they wanted to— have become ruinously expensive for a shrivelled tax base.
The issue for Spain is the motive for their CHANGE in policy. In effect, the country is upping the political ante. The Fondo's gamble may pay off nicely. But if Germany refuses to rescue Spain from debt-deflation by tolerating 5% inflation (in Germany), and if Spain's EMU adventure turns bad, then hard-working Spanish savers will have lost their final hedge. Let us call it the last roll of the dice.
BoA Sees US Double-Dip Danger From 'Fiscal Chicken'
By Ambrose Evans-Pritchard | 23 August 2010
Ethan Harris, the bank's chief North American economist, said early data for August suggest that "an already weak recovery is getting weaker" with a rising risk of a relapse into recession, yet the two parties seemed determined to outbid each other with austerity measures. "Politicians are clamouring for quick action, not to stimulate a dangerously weak economy, but to bring down the budget deficit. We strongly support efforts to bring down the deficit, but only once the economy is on a healthy growth trajectory," Mr Harris said.
The Democrats want to see an end to the Bush tax cuts for the wealthy: the Republicans want to cancel infrastructure projects designed to keep the building industry alive, arguing that it crowds out private enterprise. "We don't find either view compelling," Mr Harris said. "But the longer this game of chicken goes on, the bigger the risk of an economic accident."
"The most pressing concern to us is that absent new legislation, all of the Bush tax cuts expire at the end of this year. We estimate that would represent a 2% hit to household income. If such an increase were not reversed, we believe it could trigger a double-dip recession."
Bank of America said campaign populism was causing Washington to drift into the worst possible mix of policies: premature tightening without any credible plan for long-term control of entitlement spending, where the real threat lies. The Congressional Budget Office estimates that fiscal policy will swing from boost equal to 2% of GDP (annualised) earlier this year to a withdrawal of 2% by late next year, without a change of policy. This risks a shock to the system at a time when then inventory cycle is fading and the economy has failed to reach "escape velocity".
Yet a view is taking hold on Capitol Hill that federal spending is 'out of control' and has itself become the main threat to durable recovery. "More people believe that Elvis Presley is alive than that the stimulus created jobs," said Congressman Kevin McCarthy, a leader of the Tea Party movement. Bank of America said Congress was failing to heed the lessons of Japan, which raised consumption taxes in 1997 before recovery was strong enough. The argument— hotly disputed by monetarists— is that this tax set off Japan's downward spiral into deflation.
Nobel Laureate economist Paul Krugman has evoked parallels to the second phase of the Great Depression when President Roosevelt and the Federal Reserve slammed the brakes too hard, tipping the economy back into a severe slump. "Many economists regard this turn to austerity as a huge mistake. It raises memories of 1937, but despite these warnings, the deficit hawks are prevailing. The odds of a prolonged slump are rising by the day," he said.
Mr Krugman's arguments make an intellectual assumption that fiscal stimulus actually works in the way described by the "canonical New Keynesian" doctrine, the thinking that has dominated US policy elites for the last generation. Britain's experience over the last century raises serious doubts about such claims. The UK squeezed fiscal policy aggressively from 1931 to 1933 and again from 1992 to 1993, but offset this with monetary stimulus and devaluation.
This British cocktail of "tight-fiscal/loose-money" proved successful. The 1930s were the only decade of the 20th century when the UK outgrew the US. The same formula has in effect been adopted by the Cameron-Clegg coalition. Their approach has little in common with the US Tea Party revolt, yet it is equally disdainful of New Keynesian theory. There may be more than one way to skin a cat in economics.
America No Longer Needs Chinese Money, For Now
By Ambrose Evans-Pritchard | 22 August 2010
The cacophony of voices in Beijing questioning or mocking the credit-worthiness of the US is now deafening, from premier Wen Jiabao on down. The results are in any case manifest: US Treasury data show that China has cut its holdings of Treasury debt by roughly $100bn (£65bn) over the past year to $844bn. ZeroHedge reports that net purchases by the big three of China, Japan, and the UK (Mid-East petro-dollars) have been sliding for two years. In August they bought the least amount of US debt this year.
China is finding other ways to recycle its trade surplus and hold down its currency, buying record amounts of Japanese, Korean, Thai, and no doubt Latin American bonds. "Diversification should be the basic principle," said Yu Yongding, an ex-adviser to the Chinese central bank. Beijing is buying gold on the dips, or doing so quietly through purchases of scrap ores, or by deals with miners such as Coeur d'Alene in Alaska.
It is building strategic reserves of oil and coal, and probably industrial metals. State entities are buying up natural gas reserves in Africa and Central Asia, or oil sands in Canada, or timber in Guyana. Where this expansion runs into political barriers, they are funding projects— such as a $10bn loan to Petrobras for the deepwater oil off Brazil. Where all else fails, they are buying equities. All of this recyles China's reserve surplus away from US debt.
So it is a good thing that US citizens have stepped into the breach, investing a record $185bn into bonds funds this year (ICI data). JP Morgan describes this as "extraordinary prejudice", evidence of irrational fear. Or perhaps JP Morgan has an 'extraordinary prejudice' against bonds, arguably the shrewdest asset in a world where fiscal stimulus is being withdrawn before the rest of the economy has reached "escape velocity".
The inventory cycle is ebbing, manufacturing has tipped over, the workforce is still shrinking, and the economy is sliding into a deflationary rut. Above all, bond appetite reflects what David Rosenberg at Gluskin Sheff calls 'the new frugality'. Americans are saving again. Surplus nations are in for a nasty shock if they hope to feed off US demand as if nothing had changed.
Yet bond yields have fallen to nose-bleed levels. Ten-year rates are at an all-time low of 2.27% in Germany, and back to 0.92% in Japan's deflation laboratory. They have slid to 2.6% in the US.
When yields plumbed these depths over the winter of 2008-2009, latecomers burned their fingers badly. 10-year Treasury yields doubled in five months as the effects of zero Fed rates, quantitative easing, and $2 trillion of fiscal stimulus worldwide halted the downward spiral. This time yields may stay low for longer.
Fiscal and interest rate ammo has been exhausted, though not QE. I have little doubt that central banks can lift the West out of debt-deflation if needed with genuine QE— not Ben Bernanke's Black Box "creditism", or Japan's fringe dabbling. Whether they have the nerve or the ideological willingness to do so is another matter.
Does that mean bond yields must keep falling to unimaginable lows, as they have in Japan for twenty years? Perhaps, but Japan is sui generis (captive bond market, vast foreign assets, demographic atrophy), and the world has moved on. As Moody's said this week, the Great Recession has made sovereign debt suspect. "The burden of proof now falls on governments". Events have "fast-forwarded history", ripping away the 20-year cushion we counted on before the "adverse debt dynamics" of our aging crisis hits home.
Two epochal forces are colliding in the global bond market: core deflation is gathering force but the West is losing sovereign credibility just as fast. Arch-bear Albert Edwards at Société Générale advises clients to prepare for a violent policy swing from one extreme to the other [[I concur; but it will be driven by extremes of deflation/inflation: normxxx]]. First we deflate into the abyss: then we inflate hard rates to get out again. At some point the "euthanasia of the rentier" will wear off. Misjudge the sequence at your peril.
Greek Crisis Refuses To Go Away
By Ambrose Evans-Pritchard | 19 August 2010
A shopper walks by a shop offering discounts of up to 70% due to the economic crisis Photo: EPA
A report by HSBC said banks had lost 8% of their entire deposit base in the five months to May. "The Greek market has never, since the first data in 2001, experienced such attrition," said banking analyst Joanna Telioudi. While some withdrawals point to capital flight by wealthy Greeks, it is clear that households and companies are running down savings to make ends meet. The Athens Chamber of Commerce warned yesterday that its members are in "dire straits", with a majority facing a liquidity threat.
Simon Ward from Henderson Global Investors said Greek lenders are covering their funding gap through loans from the European Central Bank (ECB), which reached a record €96bn in July. "The question is how much eligible collateral they have left to take to the ECB. It must be nearing the limits," he said.
"What is worrying is that this is not just Greeks. Portuguese banks borrowed €50bn in July compared to €41.5bn in June. Together with Ireland and Spain they have borrowed €387bn from the ECB," he said.
Oli Rehn, the EU economics commissioner, said Greece has achieved "impressive budgetary consolidation and swift progress with major structural reforms", meeting the terms for a second loan under the €110bn rescue plan with the International Monetary Fund. Mr Rehn said "risks remain", warning that tax revenue was falling far short of the 16% rise targeted for the year. There was slippage by local governments and social security funds.
The green light from Brussels failed to offer any respite for Greek bonds. Spreads on 10-year Greek debt rose to 835 basis points over German debt. They are trading once again at the crisis levels of early May, before the EU launched its "shock and awe" rescue and the ECB began purchasing Greek bonds.
Stephen Lewis, of Monument Securities, said investors doubt whether the EU/IMF plan is workable without debt restructuring and devaluation, the usual IMF cure for countries with such problems [[but not possible for countries within the EU: normxxx]]. IMF documents show that Greece's public debt will rise to 150% of GDP after three years, even if the government complies fully.
"The markets suspect that Greece will have to restructure its debt sooner or later, and bondholders will be the losers. They don't believe that Greece's euro membership on present terms is economically viable. The country doesn't have the freedom it needs to get out of this crisis," he said.
Ian Stannard, a currency strategist at BNP Paribas, said investors have been unsettled by news that Spain is planning to soften its austerity package by renewing €500bn of rail and road projects. "The fear is that if Spain backtracks, then others like Greece are going to follow. This is creeping on to the radar screen," he said.
Mr Stannard said a report on Greece by Spiegel magazine entitled "Entering a Death Spiral" revived worries about political stability, painting a picture of a country nearing popular revolt. It said unemployment had reached 60% to 70% in depressed areas. "The entire country is in the grip of a depression," said Speigel. "Everything seems to be going downhill. The spiral is continuing unabated and there is no clear way out."
The Greek economy shrank by 1.5% in the second quarter, not helped by transport strikes that caused tourism revenues to fall 16% in June. The risk is that country finds itself chasing its tail, trying to sustain a rising stock of debt on a diminishing base. Critics suspect that Greece has already passed the point of no return for debt dynamics, and some IMF officials privately agree.
Willem Buiter, chief economist at Citigroup, said it remains unclear whether eurozone debtors can recover amidst severe fiscal tightening. "Europe's underlying problems have not been resolved. Medium-term worries over sovereign credit quality in periphery countries will probably resurface in coming months," he said.
Chris Pryce, of Fitch Ratings, said Greece is teetering on the edge of junk status but can still claw its way back. He expects the economy to contract by 4.5% to 5% this year, worse than official forecasts. But this is seen as manageable. The key is whether the pace of decline slows enough next year to make a dent in the deficit, and whether the country will accept yet another round of austerity.
"Everybody is away on holiday. When they get back they will have to face their miserable new world going into the autumn, and then we will see," he said.
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