Spain – Everything Suddenly Stops
Retail Sales in Spain Plunge
Economic data releases from Spain have one thing in common lately: they are all 'worse than expected'. Even data that were in fact expected to be atrocious surprise by being more atrocious than previously imagined. The latest example is the reported decline in retail sales of 9.8% year-on-year, a new record. In fact, this was the 'seasonally adjusted' decline. In real terms, retail sales plummeted by 11.3% year-on-year. This follows on the heels of a 3.8% (s.a.), resp. 4% (real) decline last month, which was already quite bad, but not really alarming just yet.
A friend remarked to us that when looking over Spain's economic data releases during April and May, one had the impression that everything had 'suddenly stopped'. This was buttressed by a table depicting said releases:
A selection of important economic data releases from Spain for April and May (mortgage loan growth is for March) – click chart for better resolution.
We remarked to this point that the phenomenon is one we have observed several times in the past. Yes, recessions are always foreshadowed by leading indicators, which range from yield curve inversions to weakening PMI data to falling stock markets. However, the moment when it becomes unequivocally clear to everyone that the recession is here and that it is of the full-blown variety is invariably described as akin to 'someone throwing a light switch'. Suddenly sales shrink rapidly, order books dry up, tight credit becomes even tighter. The economy often seems to stumble from mild weakness into full-blown recession from one month to the next.
We suspect that this has probably psychological reasons: it is akin to a 'third wave' decline in a financial market – also known as the 'recognition point' – the time when the majority of actors in the economy (or market participants in the case of a financial market) realizes that the weakness that up to that point could still be hoped to be temporary is probably far worse than thought and that they better batten down the hatches. This could be triggered by a confluence of events, or simply by the fact that those who either fear a dramatic worsening of the situation or experience it already personally reach a critical mass.
There is of course nothing inherently 'bad' about that. A credit expansion-led boom like the one Spain went through produces the bulk of the losses that will later be realized already while the good times appear to still be rolling.
One must remember here that artificially loose credit will lead to capital malinvestment and ultimately capital consumption, which can for a long time be masked by what will later turn out to have been entirely illusory accounting profits.
So the 'recognition phase' is actually the period when all and sundry become aware of this reality. The time when recession actually strikes is coincident with the beginning of the economy's healing process, if only it is left to its own devices that is. The only way to hasten the process is to remove all obstacles that stand in the way of the necessary adjustments and hinder recovery. There is – and this is an important point that can not be stressed often enough – no way to 'avert' the losses commonly associated with the downturn. One can delay, extend and pretend, engender fresh capital malinvestment and so forth, all measures that will on the surface appear to ease the pain, but ultimately malinvested capital has to be liquidated or where this is possible repriced and transferred to new uses that are profitable. This takes time and is accompanied by the usual recessionary backdrop of rising unemployment, falling prices and wages, contracting sales, and so forth.
Of course we observe what is now happening in Spain's economy with a sense of foreboding, not least because the data suggest that all the deficit projections and targets issued by the government and the EU will have to be revised considerably and that this is a process that may still be in its infancy. Retail sales are an important datum in this context, due to the value added tax representing a large component of the government's revenues (indirect taxes are about 35% of tax revenue in Spain). As an aside, Spain increased its VAT from 16% to 18% in 2010 and had planned to increase it by a further 2% in 2013 (there is talk that it will bring the increase forward into 2012).
Obviously, with the bond market in panic over the bottomless pit that the Spanish banking system is threatening to become, any reduction in tax revenues is apt to further exacerbate the situation – not least because markets that are already extremely nervous will tend to react badly to any fresh negative evidence that emerges. Also, Spain had to revise it deficit estimate for 2011 for a second time on May 20, from 8.5% to 8.9% – the 8.5% estimate was already a revision from the original 6% estimate. These successive revisions have hit the government's credibility, as they are suspiciously reminiscent of how the Greek crisis began.
Once the revisions of this year's target trickle in, things will be seen in a worse light yet again, not least because the government insisted it would meet them on occasion of publishing the latest 2011 revision. This was of course before the size of the Bankia bailout became known.
Fleecing of Retail Investors Puts Government on the Hook
Speaking of Bankia, Bloomberg reports that Bankia sold over €22 billion in preferred stock (i.e., glorified debt) to its retail customers, a practice that banks pursue all over Europe as their normal funding sources dry up. Retail investors often don't realize what they are getting into, as the banks are not exactly forthcoming regarding the risks involved.
We know via friends that Spain's banks are especially egregious violators of their retail customers' trust, an assertion that the preferred stock sales by Bankia clearly confirm.
In fact, Bankia apparently marketed its preferred shares by falsely stating they were 'as safe as deposits':
“The instruments were marketed as very liquid and as safe as a deposit,” said Herrero, who described issuing the risky securities to individual investors as an “original sin.”
Bankia Chairman Jose Ignacio Goirigolzarri said May 26 that the lender is working on a “solution” to the problem of the preferred shares that may be ready before a shareholder meeting scheduled for June 29.“
This kind of restricts the government's flexibility in dealing with the bank's insolvency, as any attempt to 'bail in' unsecured creditors would have to include the retail holders of Bankia securities. Apparently this is considered politically unpalatable.
„The sale of preferred stock to depositors means that almost the only option for the government now is injecting capital,” said Arturo Bris, a professor of finance at IMD business school in Laussanne, Switzerland. “A writedown of preferred shares placed with depositors would cause a social problem. It’s not really a feasible alternative.”
The government nationalized Bankia on May 9, leading the lender with the biggest Spanish asset base to request 19 billion euros of state backing to clean up bad loans to borrowers such as property developers. That’s on top of the 4.5 billion euros of Bankia preference shares the government has already bought. Spain’s also considering guaranteeing joint regional bond issues with tax revenue, three people familiar with the plans said.
The burden all this puts on Spain pushed the extra yield that investors demand to hold the nation’s 10-year notes instead of benchmark German bunds to a record 5.16 percentage points. Bankia lost 12.5 percent of its value today, bringing its decline this month to 54 percent.
A taxpayer-funded bailout of Bankia would foist losses on a wider portion of society than making individual bondholders, many of them depositors, lose money.”
What a fine mess. Other governments in the euro area should pay attention, as banks are doing similar retail deals everywhere. Whether Spain's government can actually swing this bailout without outside help becomes ever more questionable considering the ongoing surge in its bond yields.
Credit Market Charts
Below is our customary update of credit market charts, including the usual suspects: CDS on various sovereign debtors and banks, bond yields, euro basis swaps and a few other charts. Charts and price scales are color coded (readers should keep the different price scales in mind when assessing 4-in-1 charts). Where necessary we have provided a legend for the color coding below the charts. Prices are as of Wednesday's close.
We decided to bring a complete update as there have been big moves in all these markets. It should be noted that CDS have become quite overbought, bonds and stocks look very oversold and lastly there is a record net speculative short position in euro futures. These facts would all argue for an imminent pause in the panic, with some sort of corrective retracement triggered soon (what might provide the trigger is unknowable at this time). However, one must always keep in mind at such junctures that 'oversold conditions' occur also just prior to outright crashes. This possibility, although it usually has a very low probability of eventuating, must be kept in mind whenever a budding panic is underway.
5 year CDS on Portugal, Italy, Greece and Spain – Spain at a new record high of 586 basis points, Italy at 550 basis points very close to its 2011 panic high - click chart for better resolution.
5 year CDS on France, Belgium, Ireland and Japan - click chart for better resolution.
5 year CDS on Bulgaria, Croatia, Hungary and Austria - click chart for better resolution.
5 year CDS on Latvia, Lithuania, Slovenia and Slovakia - click chart for better resolution.
5 year CDS on Romania, Poland, the Ukraine and Estonia - click chart for better resolution.
5 year CDS on Germany (white) , the US (orange) and the Markit SovX index of CDS on 19 Western European sovereigns (yellow) - click chart for better resolution.
5 year CDS on Bahrain, Saudi Arabia, Morocco and Turkey - click chart for better resolution.
Three month, one year, three year and five year euro basis swaps – the bounce is taken back again - click chart for better resolution.
Our proprietary unweighted index of 5 year CDS on eight major European banks (BBVA, Banca Monte dei Paschi di Siena, Societe Generale, BNP Paribas, Deutsche Bank, UBS, Intesa Sanpaolo and Unicredito) -higher, but not yet a new breakout - click chart for better resolution.
5 year CDS on Bankia's senior debt. Although the market is probably certain it will be bailed out, the bid has come back - click chart for better resolution.
10 year government bond yields of Italy, Greece, Portugal and Spain – an interesting equal opportunity massacre with Portugal a notable exception - click chart for better resolution.
Austria's 10 year government bond yield (green), Ireland's 9 year yield (white), UK gilts (yellow) – [ignore the orange line, this is an incorrect quote – we still have been unable to exorcise this particular Gremlin] – the perceived 'safe havens' get all the money that is fleeing from the periphery. Compared to November, Austria is now uncommonly lucky. However, both Austrian and German CDS spreads tell us that all is not OK - click chart for better resolution.
Addendum 1: CDS versus Bond Yields
Alphaville discusses a recent Nomura research report on German Bund yields and why they could go much lower than anyone thinks possible. The decisive passage is this one:
“In essence, as fears of a EUR break-up grow, we think Bunds would essentially have an embedded FX option that diminishes the relevance of yield levels to domestic (and international) investors.”
So the expectation of a post-euro new Deutsche Mark's strength is what partly makes investors ignore extremely low and even negative yields at the short end of the curve. This is not an unreasonable idea. As to why CDS spreads on German debt have risen anyway, they do not contain the embedded foreign exchange appreciation option and are thus a pure play on creditworthiness:
“In essence, because a euro break-up would likely see an appreciating Deutschmark, assets in other countries own by Germans would decrease in value. It works the other way around for foreigners wanting to store their assets in Germany.
Although when you think about it (particularly the part about costly German bank rescues…) it’s a mixed message for German credit. As Nomura write, ‘if Germany leaves the EUR we think Bunds are a sell – but the embedded FX option allows time.’
So it’s interesting that Nomura suggests hedging by buying German CDS, as a purer play on German creditworthiness, because it doesn’t incorporate the FX option, home bias, collateral issues, or the risks (we’ll get to those in a minute). Indeed, while yields have fallen, CDS spreads have increased throughout.
But there’s still what Nomura call ‘the greatest risk to Bunds’, ECB announcement of quantitative easing or mass asset purchases to fix the crisis. ”
Whether such an ECB announcement will ever come remains to be seen of course. Not if Germany has anything to say about it. In fact, we doubt 'QE' could be done without altering the ECB's statutes.
A similar effect (falling yields versus rising CDS) may be at work in Japan as it were. It will be interesting to see what happens if the BoJ ever becomes serious about inflating all out.
Addendum 2: Greek Banks Get Their €18 billion in Recap Funding
The largest Greek banks can now return to the ECB's trough until their latest collateral injection is used up too; readers may recall that this was announced last week already, but in the meantime it has actually been effected:
“Greece handed 18 billion euros (14.39 billion pounds) to its four biggest banks on Monday, the finance ministry said, allowing the stricken lenders to regain access to European Central Bank funding.
The long-awaited injection – via bonds from the European Financial Stability Facility rescue fund – will boost the nearly depleted capital base of National Bank, Alpha, Eurobank and Piraeus Bank.
"The bridge recapitalization of the four largest Greek banks was completed today with the transfer of funds of 18 billion Euros from the Hellenic Financial Stability Fund (HFSF)," the finance ministry said in a statement.
"This capital injection restores the capital adequacy level of these banks and ensures their access to the provision of liquidity funding from the European Central Bank and the Eurosystem. The banks have now sufficient financial resources in support of the real economy."
The finance ministry statement confirmed what an official at the HFSF had earlier told Reuters. The HFSF was set up to funnel funds from Greece's bailout programme to recapitalise its tottering banks. The HFSF allocated 6.9 billion euros to National Bank, 1.9 billion to Alpha, 4.2 billion to Eurobank and 5 billion to Piraeus. All four are scheduled to report first-quarter earnings this week.
The news came as two government officials told Reuters that near-bankrupt Greece could access 3 billion euros, left from its first bailout programme, to cover basic state payments if efforts to revive falling tax revenue fail.”
Prediction (an easy one…): not a single cent will reach Greece's 'real economy'. Otherwise, consider the can kicked down the road a little further – until June 17th or thereabouts (the date of the next election).
Regarding Spain's latest retail sales number, we have been apprised that it may be especially bad due to a seasonality quirk, namely the timing of the Easter holidays last year and this year. Even so, it is an especially weak number (seasonal distortions can probably only explain part of the outsized move). However, next month's sales data will likely provide a more reliable figure.
Charts by: Bloomberg
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