After the severe falls in worldwide stock markets which took place on Tuesday I was expecting something of a rally yesterday. What surprised me was how weak it turned out to be particularly after the news on the new 3 month Long Term Refinancing Operation from the European Central Bank. On this more later but a take-up of 132 billion Euros was in many respects better than expected. However equity markets struggled to rally as for example the UK FTSE 100 struggled to 50 points up but then closed only 2 points up. After European markets had closed came more bad news for Spain and this contributed to the Dow Jones Industrial Average closing down 96 points followed by the Nikkei index in Japan closing down 191. I often compare the two as these days they are similar price levels and I notice that during this period the Nikkei has relatively underperformed as at 9191 it is some 583 points lower than the Dow’s 9774. During the lifetime of this blog (since last November) they have “crossed over” and the relative change will have been spotted and noted in Tokyo. Also this equity drop is still something of a stealth fall as far as the wider UK media are concerned as there has been little mention of it, I guess Wimbledon tennis and the World Cup may well be factors in this.
Equities and Government Bonds
Something interesting has gone on in the relationship between these two instruments. By government bonds I mean those of the UK US, Japan, Germany and similar countries. I wrote earlier this week that in my view the yield levels for government bonds in these countries were in my view at such a level that they were predicting a double-dip in the respective economies of these countries and in fact were so low that they were in effect forecasting it. Since then in the United States the ten-year Treasury Note has fallen to a yield of 2.93% so the situation has continued and extended. However even after the falls of the last few days equity markets are much more hopeful with the S&P index at 1030. To put this into context when these yields last fell below 3% the S&P was at 857 (thank you to the FT for the numbers). I hope that this makes the point clear, since then either equities are much more optimistic or bonds much less so.
Are they expecting more Quantitative Easing?
This is a thought that has occurred to me looking at the ten-year government bond yields of the countries I have mentioned. If you look at the UK the initial impact of Quantitative Easing (QE) took our such yields to 3.1% initially and now (without it) we are at 3.35%. If one considers that markets are forward-looking then one must therefore conclude that they may well be discounting QE mark 2. The situation in the United States is similar and so we may well expect a QE Type 2 there. As to Japan hers are now 1.09% and so we cannot rule it out there either although with her persistent disinflation the situation is somewhat different.
I notice some forecasters are now pencilling in new versions of QE and are expecting falls in government bond yields from here. I have two main thoughts on this. Such yields present a frightening view for the world economy and whilst I am nervous of a slowdown I still hope we can avoid the worst which in such a scenario would be heading towards Depression levels. Secondly as a taxpayer I have a thought for all the taxpayers reading this, we will be buying our own bonds at what are extraordinary levels in recent experience. To my mind it is likely to make QE mark 2 even more risky and dangerous for the future than the first. I return to a point I have made many times if it is such a wonderful idea why do we not issue all our debt to ourselves and stop bothering to sell it?
I notice on this subject that US Senators have approved the use of TARP funds for other purposes again, this is really profligate and shows I am afraid to say that if money is voted for a purpose then our current group of world politicians are in general unable even in these times to show some fiscal discipline. It is a problem of our times with elected politicians effectively still two years into a crisis being fiscally incontinent and does not bode well. If you think about it you end up with the view that on such projects you can only have an overrun because any shortfall will be spent.
In terms of detail a planned 19 billion US dollar bank levy was replaced with left-over TARP funds. Apart from the obvious irony of the use of the money it somewhat goes against the IMF’s review of the United States that feels it needs more fiscal discipline. Quite.
The European Central Bank and the expiry of its 12 month Long Term Refinancing Operation
After yesterday’s news that of the expiring 442 billion Euros from the ECB’ 12 month LTRO some 132 billion had gone into its new 3 month version i posed the question what about the remaining 310 billion Euros? I was asked on here as to the effect of the ECB’s Main Refinancing Operations which have grown to 163 billion Euros. To this I reply whilst this has grown from around 54 billion in January it has only grown by around 11 billion Euros over the last week so some funds may have gone into it from the 12 month LTRO but it is likely to have been a relatively small player.
On this front the ECB has become an enormous player in the money markets. If you add up all its various schemes and operations they come to around 900 billion Euros so I think the debate may go on. We will get another clue this morning as the ECB is operating a 6 day tender and some feel that funds may have gone into it. Much more of this and we may have to call in Sherlock Holmes! More seriously the forensic nature of the investigation shows the level of concern about this issue. There is some fear I think.
Looking at the ECB it has in effect taken over much of the role of interbank markets in the euro zone. We now have two types of bank those who can fund themselves normally and those who cannot and have to rely on the ECB. For those who do not follow this area then let me apologise for the acronyms I have used ( which can be complicated and confusing) and just simply let me say the issue is the scale and nature of its operations. At a time when emergency measures were supposed to be withdrawn it would appear that the ECB is in fact expanding its role. This is not a success.
Spain gets threatened with a downgrade
At the moment Spain is not getting much luck. Apparent good news is rapidly being dashed. For example news that her two biggest banks BBVA and Santander had done well in the euro zone bank stress tests was undone when it was leaked that these tests did not reflect sovereign risk. This leak was received with derision by financial markets and yet again showed how out of touch euro zone officials and ministers are. Then yesterdays good news on the LTRO was followed by Moody’s Ratings agency announcing that it was putting Spain on what it calls negative watch. Its statement referred to some issues I have raised on this blog before.
In the short-term, the government’s accelerated fiscal consolidation combined with the higher borrowing costs currently facing the government, consumers, and businesses will likely depress growth. From a longer-term perspective, it will take several years for the economy to adjust to the fallout from the collapse of the real-estate boom, to reduce the high level of private sector indebtedness to levels more in line with other EU countries, and to find new, internal sources of economic growth.
So it is worried about the impact of the austerity programme on an economy which so far has not fully dealt with the consequences of its housing boom on its property and banking sectors. It also has a view on the optimism ( I am being polite…) of Spain’s official forecasts.
Moody’s own forecasts for Spain’s fiscal deficits are higher than the government’s targets
I notice that in an interview with the FT that Moody’s makes what I feel is a crucial point.
They’re trying to do a lot in a relatively short period of time, after having postponed some of these measures until now
Whilst there are many issues concerning the ratings agencies and Spain as regards the differences between them I feel that Moody’s analysis is quite accurate. On a day when the weaknesses of politicians seems to be popping up more than once Spain’s government does I feel have questions to answer about her dithering and hoping for the best through much of the recent crisis. I wrote on this general subject on the 2nd April when I was comparing Ireland with Greece and discussing if there would be a reward for Ireland being prompt and pro-active, many of these themes apply in reverse to Spain.
As to today Spain has issued some five-year government bonds and on an initial look it has not gone too badly as the yield has only risen from 3.53% at the time of her last issue to 3.66%. As of last night her ten-year government bond yield was 4.7% which if you take out the period of her recent government bond auction has been a reasonably consistent level. However this month involves quite a bit of government bond issuance for Spain so this subject will return.
A More General Theme
This week to my mind has an underlying theme which is occurring more and more and it is expressed best as a question, did the extraordinary measures taken by monetary authorities defeat the credit crunch or merely kick the can down the road? If they merely kicked it down the road then next time around we will be weaker as some many resources have already been used…