Today will see some economic figures which will give us more information on the current state of the US economy as we will receive the first estimate of Gross Domestic Product in the 2nd quarter of 2010. Whilst there is always some interest in these figures it is heightened today by the fact that other US economic figures have established a softening trend in the economy over the past month. So investors and indeed economists are waiting to see if this number confirm or conflicts with this trend. Actually as I have written before to concentrate on one GDP update like this is overstating how accurate and reliable they are. But there are few like me who point out this inconvenient truth and many others who prefer not to think of it (or of course simply are not aware of it even if they should be).
US interest rates
US government bond interest rates are extremely low at this moment in time. Partly this is a function of the recent economic slowdown, partly it is a function of the fact that the United States is seen as a stable nation in an uncertain world, and partly that the US dollar remains the main reserve currency with many commodities priced in it. Just to remind you the rates across the spectrum are as follows, 2 year rates are 0.63%, 10 year 3% and 30 year 4.07%. This week the US Treasury auctioned 38 billion dollars worth of 2 year Treasury Notes at an average rate of 0.665%. So investors with 38 billion dollars in their pockets are willing to accept an annual yield of 0.665%, I like to think of what economic scenario they must be expecting and lets face it their scenario must be rather apocalyptic…
These sort of rates are impacting on what the US consumer pays. You may or may not be aware that US 30 year mortgage rates have been hitting lows recently and are now 4.54%. The Financial Times has published a chart which I think shows the impact of this and so here it is.
Portugal Ireland and Spain’s government bonds rally
There was quite a furore you may recall when interest rates ( as represented usually by 10 year government bond interest rates) rose in these three countries. For example those for Portugal briefly topped 7 % and it looked like that she was near to becoming a “pariah” in government bond markets like Greece. Even the announcement of the euro zone shock and awe rescue package of a nominal 500 billion Euros and up to another 25o billion Euros from the IMF only gave a rather brief respite. So bad were things that the European Central Bank began to buy the debt securities of these countries in what was badged as a way of stabilising markets which were is disequilibrium but was really a support operation.
Rather curiously just as the European Central Bank has been reducing the scale of its Securities Markets Programme the situation has improved. It has bought some 60.5 billion Euros but in the last week only bought some 500 million Euros. This compares with a purchase of 16.5 billion in the week following the May 10th announcement. It is possible that the stock of purchases has helped but this does not explain the Greek experience,where most purchases are likely to have been but performance after an initial improvement then got worse.
To put the improvement into numbers I will show the 10 year government bond yields for these countries with last weeks close followed by Wednesdays close (the peak of the improvement). Portugal 5.76% and 5.01%: Ireland 5.49% and 5.01%; and Spain 4.41% and 4.14%. These numbers deteriorated a little yesterday probably partly because of the article I quoted from the Financial Times saying it would be better if Spain recapitalised her banks and went to the IMF now.
I do not think there has been any great improvement in the financial situation of these countries. There have been one or two surveys indicating an economic improvement in the euro zone but examining the figures often indicates that much of this appears to come from Germany. News such as Italy’s passing of her austerity plans is a two-way sword currently for an improvement in her public finances is welcome but rather a lot of countries in the euro zone are commencing austerity packages at the same time for comfort. I notice also that the general news media have in the main ignored this improvement so we have a situation like the one I mentioned when I looked at exchange rates on the 16th July where they only represent one side of the story.
One quite plausible explanation for the change is a change in investment fashions. Hedge and other investment funds have been looking for yield and these nations have been offering this in a world where many countries such as the United States for example do not. They do have implied support from the euro zone package and have implemented austerity plans. Personally I think if true it is a risky strategy.
Greek government bonds and her economy
Whilst there has been an improvement also in the yield of 10 year Greek government bonds it has been relatively much smaller. At 10.35% her ten-year government bond yield is an outlier and even her three-year yield exceeds 11%. If you think about it the difference between the two yields indicates a near term risk of default. Indeed if you consider that she is only issuing very short-term debt because the EU/IMF aid package has taken care of other needs the persistence of these rates becomes even more troubling.
Currently there is a party from the EU/ECB/IMF in Greece reviewing her economic performance as part of the aid package. You would think that just one group of them would do but I suppose we are getting another insight into the mindset of bureaucrats. Rather inconveniently Greece’s truck drivers ( a vested interest in Greece where such a licence apparently can change hands for 200,000 Euros) have been on strike and have caused fuel shortages. These have developed to such a level the government has been forced to resort to emergency legislation to try to stop the strike.
There have been genuine reforms in Greece and ironically the attempt to reform the truck drivers is one of them. In addition some much-needed pension reform has passed the Greek Parliament. However as I wrote on the 15th July I am troubled by the way that it appears that expenditure reductions are being trumpeted when much of them are in fact gained by delaying paying bills. Should the expenditure reductions be true it is then curious to say the least that the Greek establishment is now predicting a shallower recession in 2010. One might also expect Greek tax revenues to be exceeding targets not below them if the economy was really performing better than expected.
There was a scare story doing the rounds that the current review would fail Greece and that she would default in August. Such stories to my mind do not understand the political pressure in Europe for Greece to succeed and if the numbers disappoint then I expect them to be fudged this time around. Too much has been put into this by the euro zone and her politicians to let Greece fail now. The problem they face is that once their aid package is exhausted Greece still does not look viable.
The Ukraine and the International Monetary Fund
The Ukraine received a further loan from the IMF this week. Initially she received some 1.45 billion Euros and over time (with conditions) she will receive some 11.5 billion Euros in loans. However she had been suspended from further loans back in 2009 as she had not been following the IMF terms. This reinforces what I believe are two significant trends.
1. There are a lot of demands on IMF help and IMF funds at this time. I have questioned before the nature of how the IMF gets its money as it look even more like a body which can create fiat money. This leads to my mind as to who elects it and who gave it this authority.
2. Countries such as Hungary and Ukraine which are in the process of implementing IMF inspired austerity plans have left them as internal opposition has mounted. So IMF plans are not the panacea they are often represented as. Now the Ukraine has returned and eventually so will Hungary but someday we have to face the possibility that a country will leave and not come back. Previously I have looked at the impact of IMF austerity plans on Latvia and Hungary and we have seen severe impacts on economic output. Well to this list we can add the Ukraine where GDP fell 15% last year. Now 2009 was a bad year for the world economy so plainly not all of this is due to the IMF plans, but it again makes me wonder how the Greek establishment can be predicting a shallower recession….