Research Radar: Beyond Hollande and Holland…
Markets have been dominated this week so far by the fallout from Sunday’s French presidential election, where Socialist Francois Hollande now looks set to beat incumbent conservative Nicolas Sarkozy in the May 6 runoff , and the collapse of the ruling Dutch coalition on Monday. Public anxiety about budgetary austerity in Europe was further reinforced by news on Monday of a deepening of the euro zone private sector contraction in April. That said, euro equity, bond and currency prices have stabilised relatively quickly even if implied volatility has increased as investors brace for another month or so of political heat in the single currency bloc. The French runoff is now on the same day as the Greek elections and May 31 sees Ireland going to the polls to vote on the EU’s new fiscal compact. Wall St’s volatility gauge, the ViX, is back up toward 20% — better reflecting longer term averages — and relatively risky assets such as emerging market equities remain on the back foot. The euro political heat and slightly slower Q2 world growth pulse will likely keep markets subdued and jittery until mid year at least. At that point, another cyclical upswing in world manufacturing together with the passing of the EBA’s euro bank recapitalisation deadline as well as the introduction of the new European Stability Mechanism may well encourage investors to return at better levels.
Following are some interesting tips from Tuesday’s bank and investment fund research notes:
- JPM economists reckon finding the reason behind the backup in US weekly initial jobless claims over the past couple of weeks is key to assessing whether a sub-par March payrolls report is repeated in April. It says it’s possible the claims jump move is a seasonal factor as unadjusted claims are closely tracking 2007′s pattern and Easter holidays fell on the same dates in both years. If 2007 was repeated, there would be a sizeable late April drop in claims and JPM looks for some of that on Thursday with a 14,000 forecast drop. (Reuters poll consensus is for a 11,000 drop)
- Following the surprise news last week that dovish Bank of England policy maker Adam Posen is no longer voting for more UK money printing, Barclays FX team said it’s turning more positive on the UK economy and also says sticky inflation may mean the Bank of England’s current monetary stance may be too accommodative. As a result, it lowered its euro/sterling 3-month forecast to 0.79 from 0.84. However, it cautioned about being short euro/sterling until after Wednesday’s Q1 UK GDP report, which it said could come in weaker than expected due to temporary factors. (Reuters poll consensus is for a 0.1% rise Q/Q)
- As everyone watches the FOMC outcome on Wednesday, Bank of New York Mellon‘s Simon Derrick highlights widespread expectations of further Bank of Japan easing and asset purchases on Friday. He reckons the economic arguments for more easing in Japan may be sound but it’s worth considering whether BoJ governor Masaaki Shirakawa may want to start facing down heavy political pressure for endless BoJ easing.
- Rabobank‘s emerging markets team flag their concern about Poland’s zloty, which has been one of the best performing currencies of the year so far. They say the zloty is a high “Eurozone beta” play, seen in the correlation of the eur/pln rate with composite euro periphery sovereign CDS spreads, and as a result will suffer if euro tensions rise further over the next month or two.
Hair of the dog? Citi says more LTROs in store
Just as global markets nurse a hangover from their Q1 binge on cheap ECB lending — a circa 1 trillion euro flood of 1%, 3-year loans to euro zone banks in December and February (anodynely dubbed a Long-Term Refinancing Operation) — there’s every chance they may get, or at least need, a proverbial hair of the dog.
At least that’s what Citi chief economist Willem Buiter and team think despite regular insistence from ECB top brass that the recent two-legged LTRO was likely a one off.
Even though Citi late Wednesday nudged up its world growth forecast for a third month running, in keeping with Tuesday’s IMF’s upgrade , it remains significantly more bearish on headline numbers and sees PPP-weighted global growth this year and next at 3.1% and 3.5% compared with the Fund’s call of 3.5% and 4.1%.
But its euro zone calls are gloomiest of all. First off, it sees two consecutive years of economic contraction of the bloc as a whole — a 1.0% shrinkage this year followed by 0.2% drop in 2013. Against this dire backdrop, it expects Spain to be forced to seek Troika (EU, IMF and ECB) support later this year that will be focussed on recapitalizing and restructuring its ailing banks and it also expects both Portugal and Ireland to need second bailouts from the same source.
And with that sort of pressure from deleveraging, austerity, sovereign debt stress and recession , the ECB will have to bring out yet another punchbowl, it reckons.
We expect that renewed EMU strains will prompt the ECB to launch at least one more multi-year LTRO and continue to pencil in one or two more rate cuts by end-2013.
Yet, just like the euphoric effects of both the binge and “morning after” drink, the problem with LTRO is that it risks causing more problems than it solves by tying the banks of weak peripheral euro states ever closer to their ailing sovereigns.
Is Ireland back on track?
In a week in which euro zone debt fears returned in earnest for the first time in 2012, a positive investment tip about one of the three bailed out peripheral euro economies was eye-catching in its timing. RBS on Thursday issued a recommendation to its clients to buy the bonds of one of Ireland’s main commercial banks Bank of Ireland.
Now, financial markets have for some time priced Irish government debt more positively that either Greece or Portugal, in large part due to the country’s superior private sector growth prospects and the government’s seeming acceptance of and adherence to the austerity targets demanded in return for European bailout funds. That said, there is little end in sight to problem of banks bad debts and mounting mortgage arrears and few signs of recovery in a housing market where prices are down some 50 percent from pre-crisis peaks. Moreover, Ireland has scheduled a referendum on the new euro fiscal pact for May 31 and, if it’s rejected, the country could lose access to future euro emergency funds.
But, in a note entitled “The Celtic Tiger is coming back on track”, RBS credit strategists Alberto Gallo and Phoenix Kalen took a positive tilt on developments and recommended investors snap up the 8.45% yield available on the senior unsecured bonds of ailing, government-backed Bank of Ireland — the country’s “main viable bank”. The bonds mature in 2013 and had an original coupon of 4.625%.
The broad RBS argument is that Irish banks are tackling their problems, deleveraging more than banks elsewhere on the euro periphery, using less ECB liquidity and doing fewer sovereign carry trades. But the main reason for the trade is that they do not expect government support for the banks to be removed before the maturity of these bonds next year and therefore feel the 8.45% yield now available is a pretty good compensation for interim risks of deposit flight and those emanating from exposure to the still-dire local housing market. What’s more, this yield is a premium to the 10-year Irish government bond yield of some 6.9 percent even though the banks continue to be effectively gauranteed by the sovereign. The reason for the premium is the risk the government backs away from that pledge, something very much at the centre of the debate about rescheduling promissory note payments to the shell of failed real estate lending behemoth Anglo Irish Bank.
These risk premia reflect fears that the Irish government could reverse its support for bank debt, in our view. The IMF and EU are showing more flexibility for Ireland and have agreed last week to the exchange of the next promissory note payment for government debt. That said, we think concerns on senior bank debt haircuts are overdone, and particularly so for Bank of Ireland. First, haircuts are not necessary, as Ireland is currently on track with its fiscal targets. Second, a voluntary bank haircut would have negative systemic consequences for funding, potentially shutting both banks and the sovereign out of primary markets. Compared to the little amount of outstanding senior debt, this is unlikely to happen. Third, our economists expect the Irish referendum will centre on the fiscal compact, not on EMU membership.
Yet , confidence in a steady Irish recovery is far from universal. Irish economist and commentator David McWilliams, for one, sketches a far gloomier picture in his latest take on the state of the Irish banks on Thursday.
Other overseas economists are similary wary of the Irish turnaround. On Wednesday, Germany’s Commerzbank said the country was struggling to control its budget deficit just as much as the other euro periphery countries and while tax revenues were ahead of schedule, social security spending was also higher to more than offset that.
I like the commentary Reuters provides. I was reading a similar article on monetarilyspeaking.com and they mad similar suggestions regarding Irelands economic situation. None the less both sites give a unique perspective
Irish SWF: Died Nov 2010 aged 9
National Pensions Reserve Fund, born April 2001, died November 28th, 2010; survived by a sister, Nama.
Irish Times wrote today an obituary for Ireland’s sovereign wealth fund NPRF, which was originally set up at the start of the last decade to plug future pension shortfalls.
But it never lived to fill this purpose. The 25-billion euro NPRF, which boasts its membership to the world’s elite SWF club, has died a sudden death although it has been suffering a capital haemorrhage last year, when the government amended the rule and used 7 billion euros to recapitalise its battered banks. The grim fate of NPRF also raised concerns about the viability of long-term capital: after all, sovereign wealth funds were billed as a provider of global financial stability as they invest in risky assets in the long-term.
“From its birth, however, there were fears that the fund would flirt with potentially disastrous investments, such as dotcoms, which were fashionable at that time. Indeed, the decision to require the fund’s managers to engage in stock-picking rather than simply acting as a passive “index fund” tracking the whole investment market served to push up costs,” the paper wrote.
“The State’s distinct lack of an ethical investment policy also proved controversial – tobacco vendors Philip Morris, Imperial Tobacco and British American Tobacco; cluster bomb makers such as Lockheed Martin, Raytheon and Thales; and Iraq war profiteer Halliburton were among its hottest stock picks.”
The NPRF suffered a fatal blow on November 28 when the government directed around 10 billion euros of the fund’s capital to prop up “black hole” banks.
I think that this is a very one sided article.
We all know that property values move in cycles and the investments by the Irish National Pensions Reserve Fund in the largest property in Europe, if not in the world, will eventually come around. It is the original developers who will lose out because their equity will not ever recover enough to overtake the continuing interest charges. These interest charges will accrue to the NPRF.
Also remember that they have taken preference shares in the two irish banks and these too will recover in time and generate a capital gain as well as a return of the loan funds.
from MacroScope:
Europe’s over-achievers and their fall from grace
Ireland's fall from grace has been rapid and far worse than that of its counterparts, even Greece. But life in the euro zone has still been one of profound growth, as it has for most of the other peripheral economies.
Take a look first at the progress of PIGS (Portugal, Ireland, Greece and Spain) GDP since 2007 when the global financial crisis took hold. In straight comparisons (ie, rebased to the same point) Ireland is far and away the biggest loser. Portugal is basically where it was.
But now take the rebasing back to roughly the time that the euro zone came together. First, it shows that Ireland's fall is from a very high place. The decade has still been one of profound improvement in cumulative GDP even with the last few years' misery. But it is front loaded.
Perhaps most interesting, however, is what the second graph (courtesy Reuters' Scott Barber) says about the PIGS and the euro experiment. Despite major financial and market crises, Greece, Spain and Ireland have all seen their economies accumulate at a higher rate than the euro zone average. Only Portugal has been below average -- a perennial slow grower.
Could any of this outperformance have been attained outside the euro zone? Probably not. But the question now is whether the current troubles are going to wipe out everything that has been achieved.
from MacroScope:
Falling out of the euro zone?
The periphery economies of the euro zone are suddenly in the spotlight. Credit rating agency Standard & Poor's has cut its outlook on Ireland's sovereign debt to negative. It worries that fiscal measures to recapitalise banks and boost the economy might not improve competitiveness, diversity and growth -- all making it harder to manage debt.
Next came Greece. S&P basically put the country on watch with a negative bias. The global financial crisis has increased the risk of a difficult and long-lasting struggle to keep the Greek economy on track, it said.
All this is a long, long way from the unravelling of the euro zone -- it just got a new member, Slovakia, after all. But the subject has been raised. Gary Dugan, chief investment officer of Merrill Lynch's wealth management arm, told a group of reporters in London recently that he expected political calls to quit the currency to be heard in some member countries as the global recession bites. He added that it wouldn't happen, but that the talk could weaken the euro.
The Centre for European Reform, meanwhile, says the idea of ructions in the euro zone should not be dismissed out of hand.
-- The current economic crisis threatens to exacerbate the tensions within the euro zone. There is a serious risk that the growth prospects of struggling euro zone economies will be handicapped for many years by their inflexibility and the external surpluses of other euro zone member states. If so, investors will lose confidence in the credit-worthiness of governments and firms in these countries, leading to a dramatic increase in their borrowing costs --
It cites various options for the euro zone to deal with this. The 'nuclear option' would be for insovent countries to default and leave.
Fanciful or the next big crisis?
