Friday, 22 June 2012

Bank downgrade - yawn. Europe downhill. Spain

Banks downgrade
Moody’s has been doing a hatchet job on banks across Europe recently and yesterday saw Moody’s downgrade 15 large international banks. For some reason it came as a shock to many. I do not really get the point. The markets have known for years that something was wrong in the banking sector. The banks are forced to increase their capital base, reducing their profitability. Households are deleveraging, reducing income for the banks. So why is it a surprise that banks are a worse business now than before? The chart below compares global banks (blue line) to global equities (red line). Banks have underperformed the market badly – the market participants have been voting with their feet for years.

The “Flash” PMI for the Eurozone and for some of the larger countries were released yesterday. It was very bad reading, as the European contraction continues. The German index showed an accelerating contraction. German export orders continue to fall rapidly. The only question one can ask is how long it is allowed to continue. I wrote on Thursday that domestic and international pressure on Merkel to change her economic policies were mounting. Yesterday’s data release just confirms that economic policies in Europe must change and the sooner the better. IMF Chief Lagarde seized the opportunity to tell the German government that joint debt would be a very useful element in solving the crisis. I remain optimist that they will. Germany will find it in her own interest to adjust. The only question is when.

For a comparison, look at Industrial Production in USA (red line) and in the Euro-zone (blue line). Europe’s output has been falling whereas the US output has been increasing. The difference? The degree of austerity.

Two international consultancies had been asked to conduct an independent review of the capital injection needed to salvage the Spanish banks. They ended up with a maximum of 62bn EUR. Just some months ago the Spanish government believed that 25bn would be enough. Or at least that is what they said. Two weeks ago the same government asked for 100bn in help from the Euro-zone.

I think the 62bn is good news, on the condition that the two consultancies have built in enough buffers in to compensate for the continued recession in Spain that will increase the credit losses. At this moment it is not important if the necessary capital is 62bn or 100bn. We just need to get to a point where the markets finally begin to believe that the number is final. 

Monday, 11 June 2012

Finally, a move to rescue banks

Spain asked for a bailout from the EU and the other EU countries appear to have accepted it. It is not a general bailout as known from Greece, Portugal and Ireland, but limited to assistance in recapitalising the ailing savings banks. Apart from my firmly held conviction that the method chosen is the most expensive for everybody, it was positive that something happened.  Even if the details will take some weeks to hammer out, I think it is important to understand that this step is more momentous than the three previous bailouts. Finally the EU is moving to resolve the situation with Europe’s sick banks.

Importantly, the oversight with the package appears not to go to EU and IMF, but only to the EU and it is not a general control of the country’s spending, but only a control of the banking sector. It may be an important pointer that we are moving towards a “banking union” with a joint euro-zone banking regulator.

It ought also by now be clear that the crisis is not only about public sector debt. The four countries that had seen the strongest increase in private sector debt in 2000/2007 are also those where the banking sector is in deepest problems. UK, Spain, Ireland are involved in major rescue actions for their banking sector and the economies are suffering from protracted recessions or zero growth.

The fourth, Denmark, has escaped a deeper economic crisis because of a very efficient mortgage financing system, and relatively healthy public finances. But the economic growth is anaemic, the banking sector is still in deep trouble, and more than a quarter of the country’s banks have closed. The largest bank, Danske Bank, only survived through generous government loans.

Greece is in deep trouble because of public over spending to the tune of 15 per cent of GDP. Portugal needed its bailout because of a sclerotic economy and its government is fighting to rush economic reforms which should have been implemented 10/15 years ago.

So the lesson is that 1) bailouts are different from case to case, 2) it is good that EU is finally getting some focus on the banks and 3) private sector indebtedness is at least as important in the current economic crisis as the public sector debt. 

Portugal obtained EU’s accept to spend some 6.6 bn EUR out of its emergency facility to recapitalise the country’s four largest banks. Good news for two reasons: another banking rescue as in Spain, and it appears that the costs can be covered without increasing the emergency facility. It is a sign that Portugal’s economy is moving the right way. 

I still do not exclude that the best solution would be to keep the emergency facility in place until 2014 instead of 2013. We will see.

The German opposition may have some luck flexing its muscle (it controls the Bundesrat and could delay all legislation) and appears to have forced Chancellor Merkel to accept some kind of growth initiative for Germany. That is absolutely fine, it is completely in line with the fact that general elections will take place next year, but it is not enough. We still need more pressure on the government to accept something like the "redemption fund" that would change investors' perceptions of European government debt.

Five steps to European Happiness
Well, not quite. But the events in Spain, Portugal, and Germany are small steps in the right direction. All of them fall within the five requirements I listed back in December 2011. Here is the link to my blog post from back then.

Wednesday, 6 June 2012

Bank rescue. Chicken

Bank rescue
Today is the day where the EU should present its blueprint for salvaging the EU banks. In principle it is simple. We need an EU banking regulator, a deposit guarantee, and a big bag of money. But then the problems begin. Which authority should be given to the EU banking regulator? Who should be covered by the guarantee? And who is to pay? Enough open questions to ensure that it will take quite a while to make the scheme work.

There is one big issue that deserves some attention. EU has had as a principle to “protect smaller shareholders” who are supposedly “innocent” as regards the banks’ reckless lending practices. This principle stands in the way of something very important, the ability of the state/regulator/government to take full control over an insolvent bank.

Only by taking full control it becomes obvious to start the necessary process: to sell the non-performing assets, while the now government-owned banks can continue the activities that are absolutely indispensable in the society, namely payments and lending. 

It would then become possible to obtain an honest estimate of the losses. Eventually, it will lead to much smaller costs for the tax payers.

The key is of course that it is possible to temporarily suspend normal reserve requirements, because there is a deposit guarantee in place. As long as such a guarantee is in place, a nationalised bank can in principle operate without a capital base. 

It obviously requires that all shareholders must be wiped out. On this point I am more adamant that the EU Commission. It is normal capitalist logic that one can lose money through bad investments. There are no “innocent” investors. Protecting small investors should not stand in the way of providing a much larger public good: a restored and restructured banking sector.

The venerable game of Chicken is played in a variety of ways. One is when two young men on motorbikes race towards each other on the white line. He who first veers away from the line is Chicken. If both stay the course, there is no Chicken. Only two dead bikers.

Germany’s Finance Minister Schäuble has given an interview in Handelsblatt. Under the heading “No easy way out for Europe”, Schäuble says “If government debts are made collective, and it leads to lower bond yields in the debtor countries, it would reduce the pressure to solve the problems”. Written in black on white: Germany resists an EU solution because it would remove the pressure on the debtor countries.

Apart from the fact that Mr S forgets that Spain’s government debt is lower than that of Germany, he says in plain words that Germany is playing Chicken with the rest of Europe.

Could that end up as badly as Motorbike Chicken? I am not alone in fearing just that. Germany’s former Foreign Minister Joschka Fischer has written an analysis of the European problem. He ends it with the following warning: “Germany destroyed itself – and the European order – twice in the twentieth century... It would be both tragic and ironic if a restored Germany, by peaceful means and with the best of intentions, brought about the ruin of the European order a third time.”

It cannot be stated any clearer than this.

Friday, 11 May 2012

Whoops! Helicopter. Euro.

The drama of the Spanish banking sector is getting worse. The government has asked the (savings) bank sector to increase loss provisions from 54 bn EUR to 166 bn EUR to cover potential losses on loans to construction companies and developers: It would not be that bad, if it also covered potential losses from loans given to property buyers. Some estimate that making reasonable provisions for such loans would mean that the banks would have to make provisions of 270 bn EUR. That would effectively kill the sector.

Spain is rapidly approaching an Irish situation, with one important difference: the Spanish government has not been silly enough to guarantee anything. The problem is quickly beginning to look like a situation where it will be impossible for the government to bail out the banks by injecting capital. I am afraid that at some point in time it will be impossible for the government not to explore the “Swedish model”, of nationalisation without any compensation to shareholders, flotation of huge chunks of bad loans, and a later re-privatisation of healthy banks.

The good news is that EU is now clear in offering Spain an extension of the time limit to reduce government deficit to below 3% of GDP. In return Spain has to accept an “audit” of the plan to rescue the banking sector. I am not entirely sure that such a plan really exists.

Spain is a living testament to the complete misunderstanding that this crisis is about government debt. It is not it is about total leverage of the economy, public AND private. Spain and Ireland (and Denmark) had healthy government finances but a hugely leveraged private household sector as the crisis began. Healthy government finances proved to be no help.

More Whoops!
JP Morgan-Chase admitted to have lost some loose change, USD 2bn and counting, on their Prop Trade activities, i.e. speculation for the bank’s own books. Of course that old devil, mark-to-market, was to blame (together with poor risk management and failing organisational oversight). If only JPM had been allowed to book the positions at prices that suited the bank better insted of being mercilessly forced to book the positions at market prices, things would not have run out of hand.

To me it sounds as if the arrogance of the pre-2007 period is coming back with a vengeance. As they say in French “Chasser le naturel, il revient au gallop”.

The good news is that such a loss is a major setback for Wall Street’s lobbying activities, aimed at weakening the legislative efforts to curb Prop Trade, the so-called Volcker rule.

Helicopter Ben gets company
Fed Chief Ben Bernanke got the nickname early in his career because he advocated QE programmes to stave off financial crises. Now Citi’s chief economist Willem Buiter joins Ben in the helicopter. Buiter recommends even more radical easing of the monetary policy than seen so far. Buiter is not just any bank economist. He was a highly respected academic economist and a member of Bank of Englands Monetary Policy Council before taking the jump to the big paycheque in Citi. It is just six weeks ago that Buiter claimed that Spain was heading for a debt restructuring. The reason: the government is not strong enough to recapitalise the savings bank system.

Now Buiter sees that the monetary initiatives by the world’s central banks are becoming increasingly ineffective when combined with a banking system in full deleveraging mode. Add the death-by-austerity fiscal policies in Europe. Buiter suggests Central Banks to lend money directly to the private sector, circumventing the banking system.

And some good news
The Euro has been weakening recently (no, it is not really the dollar that has gained, if you measure on a trade-weighted basis), and the usual chorus of anti-EU megaphones have trumpeted that as a sign of the Euro-zone’s imminent collapse.

For those who remember my writings last year in the autumn, I am strongly in favour of a weaker currency. I am even in favour of parity with the USD. It should not happen too quickly and disorderly, though. But for sure it would help on Europe’s economic situation. As long as Europeans still find it cheap to shop in the US, there is something wrong with the terms of trade.

Wednesday, 9 May 2012

Overstepping the limits. Banks. US economy.

Overstepping limits
German member of ECB’s management Jörg Asmussen gave an interview in Handelsblatt that almost – almost - gave me sympathy for outgoing French President Sarkozy. Sarko once famously hissed at former ECB chief Trichet that as an unelected civil servant, Trichet’s role was not to decide on politics. That should be left to politicians.

Mr Asmussen, who is a career civil servant, clearly oversteps all limits for public statements from the ECB. He lectures Greece – where no government is formed. He lectures incoming French president Hollande. He gives rather precise policy designs – namely that the deadly austerity policy must be continued at any price. His only admission is that the austerity drive may be “complemented” with a growth initative. Mr Asmussen repeats the views of Bundesbank, and acts like a mouthpipe of the most conservative politicians in Germany. This is not the way for a high ranking member of the ECB to gain friends. Such a rant from Asmussen would have served him a stinging rebuke if there had not been a power vacuum in France and Greece.

Spain dodges an important decision
The Spanish government has apparently decided to yet again recapitalise a local savings bank, Bankia, created by merging 7 smaller regional lenders. The top management, including highly respected former central bank chief Rato, has resigned. The problem with giving the banks more money instead of nationalising them is that it does not solve the issue of the bad assets, in this case loans to real estate development. In the USA, the government gave money to the banks (without demanding a management change) and lifted a huge amount of bad debts off their balance sheets.

The bad news is that according to all statistics, Spanish property prices have nowhere fallen enough. More bad loans will arrive.

The Spanish banking crisis will not be solved until the government decides how to handle the bad debt. I still believe there is a simple solution: Package it and sell it in the markets. It may mean that the banks are insolvent. Some of them should then be allowed to fold.

Denmark enforces tougher rules on bad bank loans
The Danish banking sector – which started the banking crisis as one of Europe’s most fragmented – is reeling under new, tougher rules for loan provisions. After three years where dozens of local banks have gone belly up, the Danish regulator’s no nonsense approach is likely to force more bank closings. Prospective loan provisions are likely to exceed all market expectations and may push some more of the weaker banks into insolvency. Last year, tighter practices led to the first senior debt loan losses in Europe and it shut many Danish banks out of the interbank market.

It is ironical that the country which arguably is further ahead in the cleaning up of its bank sector is being punished by the financial markets. It compounds the problems of getting the economy going again. It proves the old adage: it is better to fail conventionally than to excel alone. It is better to pretend the problem of bad loans does not exist than to get it out in the open.

US need more QE??
A number of pundits are trying to change the tone of the economic debate in the US. Some disappointing economic data have created renewed doubts about the future growth. It is interesting to see the difference between perception and reality. The reality is that the US economy is chugging along with virtually all of the economic indicators pointing to continued growth. It is particularly good news that small and medium sized companies are getting more optimistic.

However, the perception is that data are disappointing. You cannot be disappointed if you did not have expectations. And we have seen everybody (and his dog) revising forecasts upwards in the past three months as the US economy recovered from a mini-slowdown in Q3 of last year. Now the growth is stabilising – and we get disappointing news in comparison to the new, more optimistic expectations. Following the time honoured practice of economists and other pundits, it could lead to 2-3 months of disappointment. Even if there really isn’t anything to be disappointed about.

Monday, 7 May 2012

European elections

The elections in Europe largely had the outcomes expected last week. However, it did not come as any great relief to the markets. What was two days ago a potential political uncertainty is now a confirmed political uncertainty. This adds to the uncertainty created by the horrible data indicated by the “Flash PMI” numbers last week. It is interesting that the uncertainty only affects the stock markets and the Euro. All other kinds of risk assets are holding up nicely. It rhymes with our perception that this is a completely normal rotation between the asset classes, driven by a readjustment of growth expectations. It is confirmed by our proprietary risk indicators, which remain low. This is not a repeat performance of the 2011 market collapse.

Hollande won the French election and will now have to face the reality. That reality is a country with high unemployment, slow growth, slow productivity growth, and a twin deficit as both government and external balances are in minus. He will not be able to fix any of that with the economic program presented during the election campaign. Rumours are also that he will face a wave of redundancies from large French companies – companies that Sarkozy allegedly leaned upon to make them postpone firings until after the elections. His first foray into the international scene will be a visit to Berlin, where he will be reminded that agreements are there to be respected.

However, the EU commissioner for economic affairs, Olli Rehn, has already indicated that the pact could be interpreted in a more flexible way – which probably means that the budget targets will stand but that the deadline for their implementation. German Finance Minister Schäuble has spoken of Hollande’s need to “save face”.

What the practical outcome will be is still uncertain. My guess is that some kind of growth initiative plus a de facto (even if not official) delay in the deadlines for cutting the budgets.

The preliminary results of the general elections pointed to a hung parliament, where the parties behind the debt restructuring agreement command exactly half of the seats in the new parliament. A motley crew of parties opposing the agreement form the other half. For the financial markets the issue will be whether this will now lead to an actual default on the reduced government debt. It is too close to call, by my impression is that a weak coalition will be formed between parties in favour of staying inside the EU, and – by extension – to respecting the agreements. It may then survive a few months.

Local elections in the German state of Schleswig-Holstein gave an important pointer to the mood among Germans voters. Chancellor Merkel’s party experienced a slight loss, The main opposition SPD gained and most of the votes came from the minority partner in the current government, the liberal FDP. Merkel’s coalition is somewhat weakened, but mainly because of the plight of the coalition partner. So far it has no practical implications for her government.

What it means
All of this will probably keep the stock markets on their toes in the short term. There appears to be two main strands of thinking out there, and the market movements can be interpreted as result of the mood prevailing at any given mood. There are those who (still) believe that it is possible to cut one’s way to growth, and those who believe that excessive cutbacks will kill growth.

So far, the latter camp has been right. While nobody contests the necessity to increase budget discipline, it is obvious that Europe’s growth is tanking because of public sector cutbacks. And a lack of funding to small and medium-sized companies. We expect that the stock markets will remain jittery in the days to come and that EUR will continue to weaken. 

Friday, 4 May 2012

A possible change to Europe's austerity

The French presidential elections on Sunday will be followed by elections to the parliament in June. So if all the opinion polls are right, France will have a new president and a new majority within a few weeks.

For Europe this could have a significant effect. Francois Hollande, who appears to become France’s next president has been very clear that he wants changes to the current “Fiscal Compact”, the code name for Europe’s German-inspired austerity programs, by which all Euro-zone member state must have cut their budget deficits to 3 per cent of GDP by 2013.

Data released this week point to a sharp downturn in the economic activity in Southern Europe and in France. Economic activity is also stalling outside the Euro-zone and unfortunately there is no other explanation than government cutbacks. All of this will eventually hit Germany, whose growth is strongly dependent on the growth in the export markets. With the rest of Europe slowing, Germany’s economy is bound to follow.

All over Europe voters are throwing out politicians who have been managing the crisis and are now connected with the austerity programs. The “hard core” of the Fiscal Compact is crumbling. The Dutch government has resigned as the far-right PVV refused to support domestic budget reductions. In Finland, the True Finns party has adopted a similar position.

This creates an interesting situation. Will Hollande cave in, faced with Merkel and Schäuble, and give up on his election rhetorics? Or will Merkel and Schäuble realise that keeping Europe on track will require that France is fully on board and that this can only be obtained by relaxing the economic policy? Most pundits expect the first.

My guess is that Germany will “cave in”.

In practical terms it could imply that the 3% budget targets will be postponed by a year or two. All kinds of EU funds will be used to provide assistance in long term financing to southern Europe. It will reach from Infrastructure funding to long term financing. Portugal and Ireland will probably be able to negotiate a 1-year extension of their bail-out loans.

All of this will happen in the face of determined resistance from the Bundesbank.

Does it sound too good to be true? Well, maybe. But Germany is not controlled by a strict economic philosophy alone. There is a political dimension to it as well, and Chancellor Merkel is a politician with strong instincts.

Having failed to explain to German voters what the packages to Greece, Portugal, and Ireland were all about, Merkel is now facing German voters fed up with “paying for Europe”. Local elections in the coming days will give an important indication of the strength of the dissatisfaction. If the results are a strong showing for the Social Democrats, Merkel will be weakened politically and will need to adopt her policies well in advance of the next national elections to be held in 2013.

The only way of getting out of that situation is to make sure that growth will resume soon. So far Germany’s leading politicians and Bundesbank have acted as if Germany alone was immune to the crisis. That perception has allowed them to treat lack of growth in the other European countries with something akin to disdain.

A combination of a crumbling Eurozone “hard core”, a sharp drop in exports and political resistance from German voters could change Merkel’s mind.

On top of that, remember that for the longer term political prospects in Europe, Germany cannot afford to alienate France. Germany needs Europe as much as Europe needs Germany.

If I am not right in assuming that growth will be back on Europe's political agenda, things could get worse than they are now. I hope I am right.

Friday, 27 April 2012

Hollande. S&P. Spain. US GDP.

Expecting Hollande
The expectation of Francois Hollande winning the French Presidency has triggered some shuffling of feet in Berlin, Frankfurt, and Bruxelles. In Berlin, Chancellor Merkel tries to make sure that Hollande will feel welcome when he arrives for the first of his foreign visits, probably already on the day after the election. On the other hand she is also clear that the Fiscal Pact is not up for renegotiation. However, she subtly changed her language about the necessity of balancing the budget. Now it is needed “over time”.

Francois Hollande on his part said that when he arrives in Berlin, the French people will have given him a clear mandate for renegotiation.

Not particularly surprising, Bundesbank believes that the “fiscal consolidation” should continue. Even if the negative growth makes it increasingly difficult for many countries to actually consolidate.

And perhaps the best news is that the Eurocrats in Bruxelles are discretely pointing out that there is enough legal leeway in the Pact to actually relax it quite a bit. “The pact is not stupid”, as an anonymous source have succinctly put it. Changes must be approved by a majority. Germany holds no veto in this matter.  

Spanish Downgrade
S&P Downgraded Spanish government debt by two notches from A to Bb. Yawn. The press has ignored it. The downgrade happens after everybody has found out there is something wrong in Spain.

Spain takes the bull by the horns
Sorry, could not let that one pass! The Spanish economy minister has announced that the Governent will force a sale of real estate assets from the crisis Cajas. He expects foreign real estate funds to bid for the property. It confirms my impression that Spain are more hands on handling their banking crisis than many other countries. Unfortunately, forcing a firebrand sale of assets will likely leave a colossal hole in the balance sheets of the local savings banks, that the government will then have to fill. It would be better first to nationalise the banks.

Stronger than expected labour market data, an increase in Consumer Spending and better data from the US housing market has made most US economists upgrade their expectation for today’s release of US GDP data. They now expect an annualised growth rate of between 2.5 and 3.0 per cent.

Adam Posen, an American member of the Bank of England Monetary Policy Board, has explained why things are better in the US: There is no austerity programs, and companies are not as dependent on banks for financing as in Europe. European small and medium-sized companies depend critically on bank loans they cannot get. No further explanations are necessary.

Wednesday, 25 April 2012

Austerity backlash on its way

How stupid are the markets?
Faced with a growing unease over the effects of the austerity programmes, German Chancellor Merkel and her spokespersons are making it clear – this lady is not for turning. The message from Berlin is that there is no alternative to the “balanced budget”  fiscal pact, and that “Europe’s Credibility” is identical to the ability of respecting budget discipline.

No, Europe’s credibility (or rather, that of the Euro-zone) depends on the ability to find a cure for the current predicament that does not kill the patient. Continuing with cutbacks in an economy with negative growth is suicidal.

To the best of my knowledge, suicides committed to prove credibility has never led to anything but a passing admiration and a shaking of the head. Too bad, so sad.

Anyway, The Dutch government collapsed on the issue. If Hollande wins the French elections, the “core” of the “Team Austerity” has shrunk to one member, Germany. With upcoming local elections in Germany we will see how strong that core really is.

As for the alternatives, are there really any? Of course, it is just a question of not putting on the ideological sunglasses on. Germany could add to domestic demand. France could unleash an economic revolution by privatising the state-controlled behemoths that increasingly hampers French competitiveness. Spain could (temporarily) nationalise the Cajas and move on, in particular with reforming the dysfunctional labour markets. All of Europe could postpone the insane idea of forcing the banks to deleverage amid the economic crisis. And so on.

British recession
The UK GDP numbers for Q1 have just been released and they showed a second consecutive quarter of negative growth. Construction fells sharply, and there is no growth in the biggest sector. The service sector. Consumers are squeezed by higher oil prices, government cutbacks, slow income growth. Oh, and then there is the problem of having too large debts related to buying property.

All of this is not surprising. A possible cause for concern is that UK exports are not doing any better after a long period of  a weakened currency. Maybe because things are not looking too good in the export markets, either.

Where did the money go?
ECB President Chairman Draghi gave a testimony to the Economic and Monetary Affairs Committee of the European Parliament. Draghi clearly asked the politicians to put growth back on the agenda. And he revealed a concern (which I share): The huge loans granted to the banks are not flowing into the economy in the form of loans to businesses and consumers. Draghi is optimistic that it will happen with time.

The question is: how long time does Draghi expect this will take?

On a lighter note
FT today carries this little story about Italian Banking. Enjoy. Or cry.

Monday, 23 April 2012

Hollande. Europe's growth is slowing.

French presidential contender Francois Hollande of the Socialist Party came out with most votes in the first round of the French presidential elections. He will now face incumbent president Sarkozy in the second round in two week’s time. Opinion polls have persistently shown that Holland would win the second round hands down. Assuming that he wins, there will probably also be snap parliament elections.

Markets are now nervous that a new French government will challenge the German-imposed austerity programmes. Hollande has been clear that he wants to renegotiate the basis for the euro-zone “fiscal compact”. I have previously been quite convinced that faced with German determination, Hollande would back down quickly. But it seems that one of the austerity stalwarts, the Netherlands are also beginning to have second thoughts about the austerity programme

Growth has slowed markedly in the Netherlands in the first months of the year. It has now led to the Anti-Immigration party PVV to refuse supporting the EUR 16bn cutbacks, required for the country to meet the demands of the Fiscal Pact. Party Chairman Geert Wilders demand new parliamentary elections, in order “to allow the voters to decide” on the “Brussels diktat”. The open question is whether the other political parties can find an agreement to force through further savings as the economy is slowing.

Bank of Spain released its quarterly survey this morning and it is not uplifting. Economic growth in Q1 is falling, demand as well as supply is contracting. Employment is falling at a rate of 4% per year. BoE points out that private sector demand is weak and the decline in house prices has accelerated to a rate of more than 7% per year. So far, exports have been a growth driver. That has also stopped, but is more than balanced by a strong fall in imports. Add the significant budget cutbacks. Ugly!

This morning’s “Flash” PMI for the Eurozone and for Germany were not good news. Essentially, they point to a stronger rate of decline in Europe now at the start of the second quarter. I am certainly uncomfortable with this, as it demonstrates what has been visible in the Euro-zone monetary data, that bank lending is not reflecting a recovery.

I need some time to think this one over. My expectation has been that Germany would do nicely, and that the rest of Europe would be past the maximum downdraft forced by the austerity programmes. With Germany as the motor, I had expected Europe’s recession to end now. I may have been mistaken on two elements: Germany’s growth is still more driven by exports than by domestic demand – which means that the economic activity in the other European countries affect key export sectors. And the austerity programmes in Italy, France, UK, Spain and elsewhere may have more power in pulling down the economies than expected.

If this is the case, we will see Europe – including the UK - tanking under the weight of its own mistakes (the accelerated austerity programmes) while the US will do relatively fine because of the absence of austerity programmes for now.

If France and the Netherlands join Italy in a criticism of Germany regarding the austerity programmes, we are entering a phase of new political dynamics. The austerity programme may come under heavy fire, eagerly helped by the London-based financial press who will find it a brilliant opportunity to counter the increasing German influence on the continent. We may be looking at a renewed round of crisis meetings.

It will only confirm my opinion that the German zero-deficit ideology was destabilising for the economic growth. I will be happy if the rest of Europe comes to its senses and oppose Germany’s wrong designs. I am not sure I will be happy about the way it happens. It could be messy.

Wednesday, 18 April 2012

Spain. IMF.

Mr Market has got something right
You will not often catch me saying something positive about the large majority of financial market participants. In the past couple of days, I have found several pieces that have left me thinking whether the markets are actually getting something right.

In Spain, all signs point to disaster. The story is well-known by now. A host of weakly banks have fuelled a housing boom. The growth falls, property prices begin to fall, banks end up in deep trouble, and that accelerates the economic downturn. Government finances deteriorate sharply. Add Spain’s notoriously ineffective labour market.

In Berlin, Paris, and Bruxelles, politicians are still shocked that Greece was “forced” into a de facto bankruptcy. The response is that the market “attacks” are best countered by draconian austerity measures.

The markets now appear a good deal more sophisticated than that. Bond markets are not afraid of government deficits as such. Bond markets are afraid of losing money. That leads to the critical point: Markets are not afraid of the Spanish budget deficit, but they rightfully fear that a German-style austerity policy will make things worse and lead to a “death spiral”, which eventually increases the default risk.

So far it appears that this analysis is better than the one made by the European politicians: in order to meet the EU demands to the budget deficit in 2013, the Spanish government introduces policies making it close to impossible to reach the goal.

Suddenly I find myself siding with the bond markets. Weird feeling, indeed.

Has adjusted its growth forecast for the EU-zone upwards. From -0.5% to -0.3% in 2012. Wow, let’s have a party! This is entirely for public consumption. No economist worth his salt believes that forecasts can be made that precise (and in 98% of the cases they are wrong anyway).

The most important is that IMF strongly pushes the European politicians to make it their “overarching priority” to prevent a renewed escalation of the debt and growth crisis. IMF also tells Europe to get more busy in resolving the problems in the banking sector. IMF identifies two major obstacles to a resumption of normal growth in the Western economies, fiscal consolidation and bank deleveraging. I totally agree.

In the cases of USA, UK, Spain, and Denmark another factor is at play, a heavy increase in household debt related to property investment, all happening while property prices were booming. That complicates the situation in those four countries. In the US there is no political consensus to fight the budget deficit and hence no austerity. In Denmark the government debt is sufficiently low that dramatic action can be postponed. But have a look at UK and Spain.

Friday, 13 April 2012

EBF. Spain. Seasonality

There is now less than three months until the European banks have to meet EBA’s strict demands for a Tier 1 Capital of 9 per cent. I have repeatedly been highly critical of the decision to force the banks into a rapid deleveraging at a point in time when the European economies are being hit left right and centre by austerity programs. Not surprisingly Christian Clausen, President of the European Banking Federation (EBF) is also highly critical. In his criticism, he adds a couple of points that are worth noting.

His first point is that the new standards are often so weakly formulated that the banks tend to be more careful, rather than aggressive, when implementing the standards. Another point is that in order to meet new demands for net stable funding, the interbank market need to provide funding to the tune of 1.9 tn EUR, which is frankly impossible.

While I agree with some of Clausen’s views, it is worth remembering that the banks themselves created the mess that politicians are now trying to get them out of. Shame that the same politicians managed to make a mess out of the rescue mission.

I continue to be surprised about the lack of precision in the financial press when it comes to bailouts. Reading the most recent batch of comments about Spain’s economic problems, the reader would be excused for believing that Spain faced bankruptcy. It could also seem that the European bailout funds are not sufficiently large as their total volume more or less corresponds to Spain’s government debt. It is nonsense.

Greece got a debt restructuring. It means that a large proportion of the country’s government bonds were declared null and void, and new ones with a lower nominal value were issued instead.

Portugal and Ireland got what is now popularly referred to as a “bailout”. It is a credit line, established for a limited period in time, allowing the countries to cover their financing needs from other EU countries. Such credit facilities allow the countries to bypass the market, and the idea is to reduce the financing costs temporarily while the countries try to get their economic house in order,

Such a credit facility is not related to the overall outstanding debt, but to the financing and refinancing needs for the term of the facility. If it is e.g. a three year period, it is assumed that 10-year bonds will be dealt with on market terms later.  

Spain may opt for such a facility if the short term yields continue to climb. But it has nothing to do with 10-year bond yield climbing past 7 per cent, as the press has had it.

In order for a country’s debt/GDP ratio not to increase, the average yield on the outstanding debt cannot exceed the nominal growth of the GDP. That is exactly the purpose of “bail-out packages”, and explains why the interest paid on the credits are lower than market rates.

The most recent job numbers from the US came out a bit worse than expected after a number of months with better than expected numbers. While being highly interesting from a political point of view, the data are probably simply a result of the milder than normal winter in the US.

Job data are always seasonally corrected, as everybody knows that bad winter weather leads to short term layoffs. When the winter is milder than expected, fewer people are laid off. Seasonal correction mechanisms are based on several years of data and adds some jobs. The result is an overshoot. Unless you are familiar with this mechanism, you will have a tendency to adjust your forecasts upwards.

But around March, the effect of the warm winter disappears out of the statistics as the seasonal correction does not add those extra jobs in the spring. So suddenly your fresh optimistic forecasts collide with the seasonal correction mechanism. And the data disappoint. Interesting to see if we are in for more disappointments.

Friday, 30 March 2012

Dividend stocks. Firewall. Spain.

Dividend stocks and other retail products
The stock market is ever busy in the eternal search for new “themes”, i.e. stories that can persuade investors to buy and sell and thereby generate the commissions needed for the business.  As interest rates have fallen, one particularly hyped theme has been “dividend stocks”.

The story has been that if you could not count on stocks to appreciate steadily each year, then at least you could borrow money at low interest rates and invest in stocks that would give you a better cash flow, i.e. dividends. I have never met any theoretical explanation that could make me understand why “dividend stocks” should be more attractive than any other stocks.

In Germany a group of researchers have now worked for a bit on the “dividend stocks”. Their verdict is clear: dividend stocks do not offer a better return on investments over any relevant time horizon than any other group of stocks. But for sure the many new products based on “dividend stocks” have generated a nice commission (plus loan margins) for the finance sector.

Caveat Emptor. We’re just saying.

Another “new-new thing” is investment in volatility. For private investors who do not even know what it is all about! With the predictable results.

The EU summit in Copenhagen seems set to decide that the total emergency facility to help troubled countries (and banks) will end up at EUR 800bn as the Germans finally seem to understand that the larger the facility, the smaller the probability that it will ever be used.

Yesterday, I referenced a study from the Swiss National Bank. There you would find a chart indicating that the Spanish residential property market is still significantly overvalued, and we are NOT talking holiday property here. When that information is combined with PM Rajoy’s new inititatives to cut the public sector deficit by a whopping 3.2 per cent of GDP we have all but a guarantee that Spain will remain mired in recession for a while. Personally i have a hard time believing that Spain will meet the German-imposed deficit targets in 2013. When will they ever learn?

At the same time Spanish trade unions are demonstrating against reforms that would actually make it easier to create new jobs.

Not funny at all. We will hear more of that story soon.

Thursday, 29 March 2012

Queen. UK. EU M3. US jobs.

Pity the poor elderly. Even the British Queen Elizabeth II cannot celebrate her 60 years of ribbon-cutting, crowd-weaving, and banqueting, without having bad conscience that the celebrations will “push the UK economy back into recession”. The press has eagerly sunk their teeth into the story.

The warning words come from another elder, Sir Merwyn King of BoE. His point is simple. By giving the entire country a(n extra) day off, UK will miss one day of economic output in Q2. One day out of 65 working days is about 1.5%. So if the UK lose 1.5% of output in Q2, for sure it would turn out a negative quarter, given the sluggishness of the UK economy. My advice to the worried central banker is to invite UK consumers to buy as many flags, mugs, hats, memorial medallions and what not to give the retail trade a boost.

UK growth
GDP growth for Q4 in the UK came out negative and we have a hard time being really surprised. UK consumers have been among the most leveraged in Europe, the housing bubble have been among the biggest, and the impacts on the public finances of the faltering banking sector among the largest in Europe.

Looking at the underlying data, it is clear that the UK consumers continue to consolidate. In combination with continued spending reactions in the public sector, it will take a long time to get the growth going again. For some food for thought, about house prices, look at this little study by a couple of economists from the Swiss National Bank.

I continue to be worried about the growth of the Eurozone money stock (M3). The headline number came out positive (+2.8% yoy), but dig a little, and you will find out that banks’ lending is still slowing and grew only by 0.3% in February. Bank lending to the public sector grew by 0.6%.

Does this prove that the huge amount of 3-year loans given to the banks “does not work” as in particular the UK financial press have been trumpeting?

No, The LTRO loans were not even intended for that. Their purpose was a) to avoid a major liquidity squeeze in the European inter-bank market, and b) to allow the banks to receive a colossal subsidy by using the money to buy government bonds. In that respect the LTRO loans work just fine.

But it does prove that when banks are reluctant to lend and borrowers are reluctant to borrow, the limits of monetary policy have simply been reached.

US Jobs
There is no doubt, the US economy has created more jobs than expected due to “unseasonably warm weather” – the methods used for seasonal adjustment of the employment data all but guarantee this result.

But is this enough that we should call off the optimism about the recovery in the US labour market. I think not. In fact, if one sums up all the micro data, it is surprising that the unemployment rate is not falling any faster than is the case. We may see a sharp drop in the months leading up to the presidential elections.

Given that the Republicans seem bent on choosing an unelectable candidate, falling unemployment would all but guarantee Obama’s re-election. My pious hope is that he would use a second mandate more constructive than the first. 

Wednesday, 14 March 2012

Dirrty. Bank Stress. Italy.

Dirty underwear
My, my. At Goldman Sachs things certainly are not as they used to be. One Greg Smith, an executive director with GS’s London office resigned today and felt it necessary to publish his goodbye to the firm as a Op-ed in New York Times. His point is that the company’s culture has turned into one of short term maximisation of profits instead of building long-term relationships to the clients.

Smith agrees perfectly with William Cohan, who in a book last year gave the same picture of the firm. Are we surprised? No, or at least we ought not to be. But the cabal of greedy bankers will just close ranks. As said a commentator: “Maybe he’s made a sufficient amount of money in his life that he isn’t particularly bothered if he isn’t employed in financial services again and works in a completely different world like teaching.”

With this kind of attitude, it is clear how much work the banking sector still has to do to position themselves as a part of the broader society and not as the gods who have the right to rip their clients off at will.

US bank stress test
Federal Reserve has subjected 19 banks to stress tests, and in the aftermath of the test, it has become clear that Fed wants to use it as a verdict on the bank’s desire to pay dividends.

Under a rather severe set of assumptions regarding the economy and the markets, 15 out of 19 banks were found to be able to keep their capital while continuing to pay dividends and re-purchase its own stock. Citigroup was found not to meet the capital requirements, together with Wells Fargo, Suntrust, and Ally Financials.

Interestingly, the take from the financial markets were that Fed’s required capital is waaaay to high, that the companies should be allowed to proceed with paying dividends, and that they are now so strong that nothing can break them down.

We rest our case. One ought to remind readers that Citigroup received most help of all US banks in 2008.

No talk of needing to adapt to a new reality, where banks have to accept living with lower RoE.

In January, Italy’s industrial production fell by 2.5% from December. That is not good news and again turns attention to Italy as a potential problem after a good run that saw the country’s refinancing costs fall strongly since late November.

For Europe, the number was an increase of 0.2 per cent, pulled by Germany’s positive reading of 1.5%. Europe may be pulling out of the recession, but significant differences persist between North and South. 

Tuesday, 13 March 2012

China. Spain.

China I
Since China last week announced that its new target for growth was 7.5% and not 8%, the financial markets have been busy discussing with themselves if this was a good or a bad thing. The verdict is mostly that it is a bad thing.

I do not agree. It is only natural that after a 10%-a-year growth target 15 years ago, and years of growth in the 8% to 9% range, growth will slow further. China still generates new jobs at a blistering pace as a growth rate of 7.5% in the world’s 2nd largest economy generates a lot more $$$ than growing the world’s 20th largest economy by 10%.

And 7.5% growth is not just 7.5%. In national accounting, increased imports count as a negative growth element. So China’s long and slow turn towards a growth driven by domestic demand and higher imports rather than exports will necessarily see a negative contribution to growth coming from a steadily worsening trade balance.

So all in all, the slower growth rate is nothing to be worried about. Guess we can sell them some luxury goods...

China II
But there is something else to worried about. China’s reorientation of the economic growth will inevitably lead to a worsening of the current account position. Pulled by its incredible export success over the last decade and a half, China has become one of the largest creditor nations on earth.

The gigantic trade surpluses paired with a fixed exchange rate has given China a huge need to purchase US treasury bonds. If they had not done so, the currency would already have been dramatically stronger than it is now.

The flip side is that China by this policy effectively has allowed the US of A to run similar trade deficits without suffering the traditional consequence of a weaker currency and (much) higher bond yields.

The stock market manages to spook itself when China comes out with a monthly current account deficit. In fact, the US bond market ought to be the most concerned. This asset class has profited the most from huge Chinese demand. It is in that space the adjustment to a smaller Chinese surplus will happen.

Unless of course the USA suddenly falls in love with savings and postponed consumption. When pigs fly.

Spain’s PM Rajoy challenged the new EU budget orthodoxy by announcing that Spain would end up with a higher budget deficit than expected in 2012. His statement last week was initially met with a deafening silence.

But now, some days later, the Euro-zone members are recovering from the surprise, and predictably, they now demand further cuts. Rajoy pointed out that deep cuts already had led to slower-than-expected economic growth, and appears unlikely to cave in, at least not without provoking a debate about the wisdom of punishing depressed economies with further cutbacks.

The outcome of that debate will be interesting as a measure of the strength of the backlash against the German dominance in EU budget matters.

Thursday, 8 March 2012

Risk-on/risk-off is off. Weidmann

The rather dramatic market movements in the past days can of course not be explained by the stories in the headlines since nothing this week is different from what it was last week.

This caused us to go over the totality of our indicators to see if there was something new. It has led me to slightly revise my view on the world. Ignoring some of the fine print, my new contention is that the risk-on rally is over. Instead we have entered a more normal phase where rotation between asset classes will be the normal driver of dynamics. There will again be room for stock picks, value investing, ratings arbitrage, automatic trading algorithms and what not.

We have come to understand the risk-on/risk-off as something that applies in extraordinary situations. Those situations are when the correlation between asset classes increases enough to make diversification irrelevant. All of our risk indicators have dropped sharply and have now begun to stabilise at “normal” levels. It means that risk-on/risk-off slides into the background.

The financial markets react to changes, relative and absolute. Now that the risk situation has nearly normalised, it is only normal that market attention moves on to something else. The market, after all, is the ultimate ADHD child.

Will risk-on/risk-off trades come back into fashion? Probably. There are enough things out there that have just been plastered over. But it is impossible to predict, so we just reserve the right to react when it happens.

Another Weidmann
Quite a spat is building between Bundesbank and ECB. Bundesbank chief Weidmann is intensely critical of ECB’s policy of covering everything and everybody in cheap liquidity. In particular, Weidmann is worried that the cheap liquidity could create a situation where “banks are discouraged from taking action to restructure their balance sheets and strengthen their capital base”.

Since Weidmann can safely be assumed not to be a complete idiot, this statement shows in all its horrifying clarity how much Bundesbank ideology is isolating the institution from seeing what is going on in the real world.

ECB is trying to counter the strongly negative effects on economic growth coming from thedisastros demands that the banks strengthen their capital base right at the point where German-driven budget cuts bite the hardest. With such friends in Bundesbank, the European economy will certainly not need enemies anytime soon.

Wednesday, 29 February 2012

ECB's new LTRO continues the reflation wave

The European banks decided to borrow 529 bn Euros from the ECB at 1% in three years. Not quite what I had expected (600 bn), But more than last time (489 bn). Good enough.

Looking at the euro-zone money supply data shows that these loans are not channelled into lending to companies or individuals outside the banking sector. In other words, the money is either placed on deposit in the (central) bank, used to buy risk-free assets (government bonds, pfff!) or loaned out to other companies in the financial sector, who then invest in securities.

Aggregating the ECB's lending activities with QE programs in Britain and Japan and the recent relaxation of the Chinese reserve requirements, the world's central banks - minus the U.S. Fed – have added up to EUR 2200 bn to the international banking system, much of it in 2012. The U.S. QE programme amounted to USD 2360 bn, about EUR 1750 bn. While the U.S. has stopped further supply, there is no sign that the other central banks are about to stop their programs, and today's ECB loans were another big step in that direction.

I find it interesting that this topic has largely been ignored by the headlines, while the US equivalent program received a lot of attention. But there is no doubt that the monetary stance remains highly accommodative, and thus strongly supportive of financial assets of any kind.

Some fear it will lead to inflation tomorrow. That will not happen. Especially not as long as the world has a huge overcapacity.

Monday, 27 February 2012

G20. Italy. Oil

The G20 meeting did not produce anything tangible. Some of the developing countries, led by Brazil, said that they would help adding funds to the IMF if Europe would support them in getting more influence in the organisation. Since it is just a question of reinvesting the trade surpluses, countries like China and Brazil are simply trying to get maximum effect out of minor changes to their management of accumulated trade surpluses.

Not surprising that they try. But this is probably not the way to obtain an otherwise completely justified readjustment of influence in the IMF.

Perfectly justified, Germany came under pressure to show leadership. In return, Germany indicated that EFSF and ESM will be allowed to coexist for a time, temporarily increasing the “firewall” made by EU to protect the weaker countries in the EU.

In short, a major non-event.

Retail sales plummeted in December. The numbers did not look good at all. But it is too early to worry seriously. Most of Italy’s holiday shopping is early in the month (Saint Nicolaus’ day on 6 December), and that coincides with the morose sentiment right after Monti becoming PM on 13 November. We believe that there is a good chance that this is a one off.

Crude oil appears to be taking all the headlines and we are now seeing the traditional gamut of explanations that oil will go through the roof: China is growing, the world economy is growing, oil producers are running at max capacity, geopolitical problems can cause oil transports to be blockaded. And so on.

Markets are at least ignoring the fact that the threat of an Iranian blockade has anyway decreased dramatically in the past weeks, with intensive contacts between the Iran and the US.

I think there is one factor that should be taken into consideration. When the US introduced the QE2 programme in 2010, all commodities took off, as this asset class is small and illiquid compared to bonds and stocks.

The US has since then stopped adding liquidity, but ECB, BoE, BoJ, and PBoC (China) have taken over and are now flooding the money markets with liquidity. More to come from ECB tomorrow. Even if US is sidelined, reflation is still very much the talk of the town.

In the past four years, virtually all positive investment returns have been driven by the assets that reacted most strongly to the changes in the various reflation initiatives

Maybe we will have to look no further to find the true reason for oil’s price increase. But we can of course wonder why commodities, including oil, only reacts now, with a delay of several months. It will be a job for historians to find out why.

Thursday, 23 February 2012

Greece. Europe's recession. Banks.

Not unimportant, but irrelevant
I received a couple of comments from readers who felt I was not right in claiming the Greek deal is unimportant. Of course it is important. For the Greeks, who have a huge job to do, if they want to turn the country into a modern welfare state within the next generation. Scores of reports have made it abundantly clear that the country’s political system and central administration rather deserve to be classified as third world.

The deal is also important for EU, who has essentially promised to prop up Greece, for as long as Greek politicians are serious about improvement.

Of course the deal is important for the banks, who have been forced into taking a haircut. But they have again and again been asked to make sure that their balances and provisions were adjusted to the coming reality of a haircut. If they have not done so, they only have their own pigheadedness as an excuse.

A few hedge funds piled in, hoping to be able to make a killing on a legal technicality. If they disappear as a result of their wrong bets, well, that is what capitalism is about.

So it is not that the Greek deal is irrelevant. It is just irrelevant for investment decisions. Of course we will have a chapter 2 and 3 and 4, but increasingly it will be question between EU and Greece. The financial markets are out of that loop.

Europe’s recession will end
Instead of trying to figure out how the next Greek bust-up will unfold, headlines could focus on the two real important factors in Europe. They are intertwined. It is the ill-conceived austerity programmes (“Pain without gain”) and the situation in the region’s banks. Neither of those have anything but a passing connection with Greece.

I have tried to introduce the two time dimensions in the markets, EHT (economist hypothesis time) and RMT (real market time). I have argued that for those of us who operate in RMT, Greece is only a sideshow. Those who operate in EHT still spend their time pontificating on the precise depth and length of Europe’s recession.

Using our own indicators, we have argued that Europe’s recession would reach its depth around a month ago and that signs of a moderate recovery would abound around the end of the first quarter. Despite some minor fluctuations, we are still on track for that scenario to unfold. The residual uncertainty concerns only the strength of the recovery. Given the austerity drive, it does not look good. But there is a world of difference between a 2% growth rate in the second half and the “depression” everybody feared in late November.

Europe’s banks
I am far more concerned about the banks. The equally ill-conceived idea of forcing the banks to solidify their balances at the same time may still give some highly undesired results. In the US, the banks were given a big check. In Europe, no real decisions have been made yet - with the predictable consequence that credit is not growing. It was highly symbolical of the difference that Wells Fargo bought an 11bn loan portfolio from BNP Paribas. European banks are still shrinking.

Under normal circumstances, the combination of fiscal austerity and abundant liquidity should drive interest rates and exchange rates down. But these are not normal circumstances. We are in the biggest deleveraging drive in 80 years. It short-circuits the normal rules in the textbooks.

Europe’s monetary policy is a huge subsidy to the banks. But it may not be enough. And it is not good news that there is no common plan for solving the problems. Increasingly we see a new North-South Divide. In the north and the UK, the problems are attacked head on. In the south, the governments still cosy up to the banks. Bank lobbies are still stronger than the democracy in some countries.

But this is all in EHT. In RMT, the European banks represent the strongest possible cyclical bet on the end of Europe’s recession. Or to be more precise: The strongest possible cyclical bet on market beliefs that Europe’s recession has ended. Curious, isn’t it?