Not-so-Safe Bonds, Tax Inanities and Economic Weakness
The Supply of 'Safe' Bonds Is About to Get Smaller …
Moody's announced on Tuesday that it is putting Germany, Luxembourg and the Netherlands on 'negative watch'. This means that there is now a danger that the already severely shrunken club of AAA rated euro area member nations will decline from four to one – only Finland has been exempted from the warning. Maybe it wasn't such a bad idea to ask Spain for collateral in return for providing aid.
It is anyway faintly ridiculous that there are still government bonds deemed to be 'safe havens' when the great bulk of the issuers of said bonds are up to their eyebrows in debt and and have unfunded liabilities that consist of numbers that actually manage to strain the imagination a bit. As an example, US treasury bonds have become an irresistible magnet for money seeking safety in spite of the current administration increasing the public debt by more than 50% in just four years. Of course the US economy may have a better chance to get back on track than many others and it is not entirely inconceivable that public debt growth will slow down again, but after four years of $1 trillion plus budget deficits this rationalization is surely becoming more threadbare by the day.
The status of Germany's bonds as safe haven material can only be explained by the growing expectation of a break-up of the euro area, which would likely leave holders of German bonds with paper denominated in an appreciating currency. No other calculus makes any sense whatsoever, given that Germany is guaranteeing the bulk of the bailouts.
Actually, given the dearth of highly rated bonds, an eventual downgrade of the remaining AAA rated euro area sovereigns may initially not really endanger the flow of money into these bonds. For instance, France's bonds have attracted big inflows recently, which is testament to the fact that neither a downgrade nor the pursuit of insane economic policies are necessarily an obstacle to attracting funds at extremely low interest rates.
The main reason why bond buying is the preferred course of money that has been scared out of its complacency is likely the fact that many of the markets concerned are deep and very liquid and allow for large transactions to be made without unduly influencing prices. Money held by investors must go somewhere, and when economic uncertainty increases, it goes inter alia to the debtors considered the safest on a relative basis. This does however not necessarily mean that these debtors are truly safe.
The Moody's announcement came at what can be safely considered an especially inopportune moment. This has actually become a quite predictable ritual – whenever the euro area debt crisis flares up, a flurry of downgrades or 'negative watch' announcements tends to ensue, and they invariably seem extremely ill-timed. It would be more realistic though to state that the credit rating agencies remain behind the curve, a fact that is brought home to them whenever the debt crisis worsens.
In spite of the fact that the threat of a future downgrade probably won't change much for Germany in practical terms, it was not welcomed in Berlin.
„Chancellor Angela Merkel’s government said Germany will remain Europe’s haven during the financial crisis, pushing back against Moody’s Investors Service’s decision to lower the outlook on the country’s top credit rating.
The risks in the euro zone are “not new” and Germany remains “in a very sound economic and financial situation,” the Finance Ministry said. In counterpoint to Moody’s, it cited the verdict of financial markets that have rewarded Germany with record low borrowing costs.
“Germany will, through solid economic and financial policy, defend its ‘safe haven’ status and continue to responsibly maintain its anchor role in the euro zone,” the Berlin-based ministry said in an e-mailed statement. “Together with its partners, it will do everything to overcome the sovereign debt crisis as rapidly as possible.”
Euro-area bonds fell today after Moody’s lowered the outlook to negative for the Aaa credit ratings of Germany, the Netherlands and Luxembourg. Moody’s cited “rising uncertainty” over Europe’s debt crisis.“
Please keep one of the highlighted phrases above in mind: the verdict of the markets is that German Bunds are 'safe' and hence Moody's has it all wrong.
Germany's 10 year Bunds actually sold off slightly following the announcement – only to bounce again later in the day to end at a yield of 1.23%. So even though US treasury yields fell to another record low on Tuesday, Germany can still finance itself even more cheaply than the US.
Germany's 10 year yield ended Tuesday at 1.23%, only a shade above its recent record low.
The complete statement from Moody's on the outlook change can be found here. It essentially lists the usual litany of woes with regards to the deterioration of the euro area crisis as the main reason for the change in the ratings assessment.
Transaction Tax Inanity About to Go Live
Since we have mentioned France above, it may be a good time to remember that the absurd financial transaction tax is going to become reality in France as of August. Allegedly it is designed to 'deter speculation' and France's government has bandied a few fantasy numbers about as to what it is allegedly going to bring in. Perhaps not surprisingly, the tax will be twice as high than was originally mooted. So one of the warnings we gave regarding this tax ca n be said to be coming true: they're already raising it – even before it has been implemented. This was likely the fastest tax hike in all of history, and a hike by 100% to boot.
The fairly tale that banks and hedge funds will end up paying it has oddly not been repeated lately, perhaps because the inventors of the tax realize how ridiculous that sounds. What the tax will definitely do is raise the cost of capital and destroy what's left of the liquidity found at the Paris stock exchange. Trading volumes have already collapsed in keeping with the large secular bear market the French bourse is going through. 'Speculation' meanwhile will not be deterred in the least. As numerous observers have noted, speculators will simply begin trading vehicles that are not yet within the ambit of the tax – such as CFD's (contracts for difference, a form of spread betting not unlike futures trading in practical terms).
The French government not only fantasizes about the revenues the new tax will bring in, it also asserts that it intends to collect the tax 'worldwide'. This is to say that if one were to e.g. trade a French ADR listed on the NYSE, Mr. Hollande and his merry pranksters think they can come and collect the transaction tax every time a trade happens. This idea is utterly absurd. French stocks are not particularly appealing anyway, given that the bear market remains in force, and this tax will make them even less so. Meanwhile, CFD trading houses are rubbing their hands. As Bloomberg reports, the 'quest for loopholes' is in already full swing.
As it were, nobody can possibly accuse the current French government to be in possession of economic literacy in any shape or form, so all of this is par for the course. The friendly looking uncle waving at us from his automobile is a wolf in sheep's clothes.
The perpetually surprised looking French president waves at the crowds.
(Photo via The Independent)
The bear market in French stocks, which are no higher today than they were shortly after the 2003 low.
Economic Weakness Persists
It is the time of the month when Markit showers us with its flash PMI data, and they continued to make for grim reading for the most part. A notable exception was the HSBC China manufacturing flash PMI, which showed a slowdown in the contraction, clocking in at a somewhat better 49.5, a five month high.
While flash PMI data tend to be slightly revised once all the data have been compiled in full, they are usually quite close to the final numbers.
The euro area composite flash PMI actually managed to remain at the same pace of contraction as last month (with a reading of 46.4), but the manufacturing PMI continued to make new lows and has now hit a fresh 38 month low of 43.6.
Needless to say, this is an extremely weak showing. We want to once again stress that the manufacturing sector remains the by far largest and most important sector of the economy in terms of its gross output. GDP statistics do not reflect this fact, as they leave all production of raw and intermediate goods by the wayside. However, investors and economists should pay heed to manufacturing data precisely because they are far more important than is generally believed.
Euro-zone composite, services and manufacturing 'flash' PMI. The decline in the manufacturing PMI is already worse than in the 2000 – 2001 recession.
As has lately been observed more and more often, Germany's PMI numbers were especially weak, with the composite PMI suffering the biggest decline since June of 2009 and falling to 47.3 from 48.1 last month.
The manufacturing PMI dropped to 43.3, obviously a rather disconcerting level, down from 45 in June. The manufacturing output index fell even more sharply, to 42.8. As is the case in the euro area as a whole, the composite was helped by the realtively better showing of the services PMI.
France's manufacturing flash PMI landed at exactly the same level as Germany's, namely at 43.3 – with the main difference that the decline from the June reading was even steeper, which was at 46. However, France's services PMI climbed back into expansion territory with a reading of 50.2, up from 47.9 in June. This slowed the overall pace of contraction to its smallest rate of change in four months.
German composite PMI and GDP – the composite has been held up by a still relatively strong service sector.
However, the number that really gave the US stock market a jolt later in the day – after a weak opening in the wake of the intensifying credit crisis in Spain – was the release of the Richmond Fed manufacturing business survey, which was yet another big 'miss' – this is to say, it came in vastly below already subdued expectations. The chart of the composite index speaks for itself:
The Richmond Fed business conditions survey tanks to its lowest level since 2009.
Markit's US Flash manufacturing PMI fell to 51.8, also the lowest reading since 2009, although still clinging to expansion territory. It should be pointed out here that the Markit US PMI is not the same as the official ISM reading. For instance, in June Markit's PMI was at 52.5, while the ISM plunged into contraction territory. It was a very weak report anyway.
The complete reports of the flash PMI and survey data discussed above can be downloaded or navigated to here:
Cyprus to Need More Money then Expected
Cyprus, the minnow among the euro nations at the bailout trough, suddenly needs more money than was initially assumed. Isn't it miraculous how these bailouts always get out of hand? The newest fashion seems to be that they get out of hand already in the run-up to their consummation.
As the WSJ reports:
„A delegation of international lenders visited Cyprus on Monday amid signs that the country will need at least €13 billion ($15.8 billion) of aid—more than previous estimates—as it struggles to recapitalize its banking system, which has been hammered by the deepening debt crisis in neighboring Greece.
According to Cypriot government officials, the delegation from the European Commission, the International Monetary Fund and the European Central Bank—known as the troika—planned to present their estimate of the island's financing needs including some €9 billion for the banks and €4 billion for the government's own financing needs.
That's more than the €10 billion to €12 billion that Cypriot officials privately estimated two weeks ago when the troika wrapped up a first fact-finding visit to the island.
"The main focus will be on the banking sector," the Cypriot finance ministry said in a statement. "The main aim of the meetings is the further discussion of various issues, including the assessment of macroeconomic trends, prospects for public finances and the recapitalization needs of the financial sector." The meetings are expected to conclude by Friday.“
To be fair, the commercial banks in Cyprus are victims of the Greek PSI deal. Moreover, €13 billion is not an amount which a weathered eurocrat or troika delegate will be batting an eye over any longer. However, all these billions here and there are really beginning to add up by now and a decision regarding what to do about Spain is yet to be made.
A Few Additional Remarks on Spain and Italy
Both Spain and Italy have seen a marked flattening of their yield curves in recent days, a strong sign of bond markets in distress. In fact, it is quite normal for the yield curves of bailout/default candidates to invert.
Spain's finance minister de Guindos has met with his German counterpart Schäuble, who donated a few words of dismay and expressions of support to the Spanish cause (but not one euro cent). As Bloomberg reports, the two were of one mind that Spain's interest rates are too high, but essentially blamed markets for 'getting it wrong'. So you see, the Moody's warning on Germany's rating is meaningless because the message of the markets trumps a credit rating any day. In Spain it is the other way around – the markets just 'don't get it'.
“German Finance Minister Wolfgang Schaeuble and his counterpart from Madrid said Spain’s borrowing costs don’t reflect the strength of its economy as they pledged to work toward deeper integration to fight the debt crisis.
“The current levels of interest rates on sovereign debt markets don’t correspond to the fundamentals of the Spanish economy,” Schaeuble and Spanish Economy Minister Luis de Guindos said after meeting in Berlin yesterday in a joint statement that also praised Spain’s deficit-cutting efforts.”
Now this sentence about interest rates 'not reflecting the fundamentals of Spain's economy' could easily be misinterpreted. Are they too high or still too low? After all, the major fundamental fact about Spain's economy is that it is in a depression. With unemployment close to 25% and vast swathes of the banking system de facto insolvent, what else should one call it?
Well, one eurocrat – a certain Thomas Wieser – recently described it as an 'unpleasant situation', which doesn't sound quite so dire.
The ECB also seems to show little interest in spreading interventionist cheer in Spain's direction – not yet, anyway. However, it seems clear that if the situation continues to fester over the summer – as looks increasingly likely – Spanish yields will have little incentive to do anything but rise further. A yield curve inversion would very likely seal the deal on the necessity for a bailout or a debt restructuring. However, try to imagine what will most likely happen if Spain indeed received a full-scale bailout (which by the way cannot really be financed at the moment anyway).
It is almost certain that Italy would then become the center of attention. Spain may already be a bridge too far in terms of the euro area's bailout capacity, but Italy most definitely is. There simply is no-one who could be reasonably expected to bail out Italy.
As a result we think that the current phase of the crisis is an especially important and delicate one. It should be noted in this context that Mario Draghi has lately become a fount of cryptic remarks, among which there was reportedly the assertion that the 'preservation of the euro is part of the ECB's mandate'. Things that are part of the central bank's mandate can by definition not be in conflict with its cherished rule book, right? It is likely anyway nothing but Germany and the BuBa that stand between said rule book and the next best window.
Meanwhile, the OECD is now pushing for the ECB to deploy the heavy artillery of its happily unlimited balance sheet:
“A full-blown Spanish bailout can be averted if the European Central Bank starts buying the nation’s bonds in large quantities, the head of the Organization for Economic Cooperation and Development said. Europe should deploy all of its instruments “but mostly the ECB,” OECD Secretary General Angel Gurria said in a Bloomberg Television interview in London yesterday. “There is the bazooka.”
After what happened to Hank Paulson and his famed 'bazooka' in 2008, bureaucrats and politicians should be really careful about employing the term. It tends to invite burst bazooka barrels and bad Karma. However, with so many experts pushing the ECB to print, how much longer can it resist? There is a ton of 'political capital' crying out to be saved after all.
Italy's two year yield at 5.16% is not terribly reassuring, even though it remains well below the (euro era) record high of November.
Spain's two year yield has moved well beyond the 'not very reassuring' level. Note the swiftness of the recent move higher. This may well be seen as an 'oversold' condition that will soon correct ('oversold' because the yield moves inversely to the bond price), but one cannot really state that with certainty. We have seen on previous occasions that these moves can easily become worse once a definitive breakout occurs.
Addendum: Whining Down Under
The Australian housing industry, which has up until recently profited handsomely from one of the biggest housing bubbles yet to grace the planet, is now crying for a government bailout as well – in strident tones as it were. You couldn't make this up:
“Australia's Housing Industry Association lobby Tuesday called for an immediate rescue package from the government and longer-term structural reform, lest the sector–one of the economy's major drivers – continues to languish in recession.
"Economic conditions in the housing industry are the worst in decades," Shane Goodwin, the association's managing director, told reporters, adding that new dwelling starts this year will fall by around 12% year-on-year to an estimated 130,000–the lowest number in four decades–and well below the long-term annual demand average of 165,000. "At best there is only a very modest recovery in the pipeline and even then, that could be 12 to 18 months away," he said.
Mr. Goodwin was commenting after convening a roundtable meeting of industry and government officials, including Housing Minister Brendan O'Connor, and representatives of the government's Treasury Department, Reserve Bank of Australia, Westpac Banking Corp. (WBC.AU) and national building supply companies including CSR Ltd. (CSR.AU), Boral Ltd. (BLD.AU) and Brickworks Ltd. (BWK.AU)
Manufacturers and all businesses in the supply chain are shedding staff and moth-balling plants, and the industry–which is worth an estimated A$70 billion a year to the economy, or almost 5% of gross domestic product–is seeing disinvestment and is contracting, he said.
Any industry rescue package would include further stamp-duty reductions by state governments, which have an immediate impact, but longer-term structural issues need fixing, he said.”
Weren't people ranging from Australian bankers to house flippers to politicians all telling us a short while ago that Australia's housing bubble was completely impervious, because it was based on such sound fundamentals as the malinvestment orgy in China continuing at its customary frenetic pace?
Just asking …
Charts by: BigCharts, Markit
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|04/03/2013||Fallen French ‘Tax Czar’ Embroiled in Tax Evasion Scandal||story|
|04/01/2013||Bizarre Updates from the John Law School of Economics||story|
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