After a dull day in US and European equity trading we saw a rally in the Far East this morning. The Japanese Nikkei 225 index rose by 116 points to 9626 and equities in Australia and Hong Kong rose too. This has been followed by European equities this morning with the Ftse 100, Cac 40 and Dax rising by nearly 1% in their opening hour. The rally in the Nikkei means that the spread between it and the Dow Jones has now fallen to 968 points the first time it has fallen into three figures for a while. Much of the recent rally in the Nikkei has been caused by the currency intervention undertaken by the Bank of Japan and so far it is going fairly well with the exchange rate versus the US dollar at 85.80 and the exchange rate versus the Euro at 112.63 which if sustained will provide some relief for Japan’s exporters. Although looking at the recent history on a chart reminds me that we are only back to the levels of early August and that the rate versus the US dollar was above 90 for much of the late spring.
If we move on to see what is happening in the world of commodity prices the Commodity Research Bureau spot index has crossed the 470 barrier and is now at 471.4 with metal prices as the main component which rose yesterday. If we look back a year then over this period the CRB has risen by 87.58 or 18.6%. So a slowing world economy is facing commodity price pressures. Fortunately the oil price seems stuck in a range at the moment and a barrel of West Texas Intermediate crude is currently priced at 75 dollars,so it is not contributing to commodity price pressures.
The US dollar the Euro and the Yuan
Whilst the media focus is on the Yen at this time it is revealing to take a look at the world’s other main currencies. This week the US dollar has had its weakest week for over a year and on the dollar weighted index has fallen to 80.9 for a fall of 2% on the week. One needs to remember that for the latter part of the week it has been rallying against the Yen so it has been particularly weak against its other trading currencies. If one looks back the US dollar has been falling since the beginning of June when its dollar index value was 88.7 so we have had a 10% fall since then. Now if we apply this to the commodity price rally and add in that they are usually priced in US dollars we find that since June price rises for the rest of the world have in general been masked by rallies against the currency it has been priced in. Not quite the conventional view is it?
Whilst we are discussing falling currencies we need therefore to think of who has risen as it is a zero sum gain as they have to fall against something. We find accordingly that the much maligned Euro has been having a good run and has now risen to 1.3140 versus the US dollar. As it started the week below 1.28 this is a move of over 2.5% and a considerable rally since it dipped below 1.20 versus the US dollar in early June of this year. Another currency which is often ignored is the Chinese Yuan but it has been rallying too. Since China abandoned the peg for the Yuan which I wrote about on the 19th June it has rallied by 1.5% and is now at 6.7172 versus the US dollar. So as suspected at the time its rise has been slow but it has risen. This has not stopped US politicians from being very critical of the slow rate of progress and if one does the maths it must have fallen against the Euro and Yen.
Ireland looks as though she needs help
The situation concerning Ireland and her potential fiscal position has been deteriorating over the past couple of weeks. I wrote on the deterioration in her real-estate and banking sectors on the 1st,7th and 8th of this month. In essence the figures produced by her banks particularly Anglo-Irish have been too optimistic over time and in my view remain so.The size of the potential losses and the implications of this for Ireland as a sovereign nation which has stood behind her banking sector are mounting.There are now scenarios were these losses may overwhelm her ability to pay for them.
I have written previously that Ireland has in terms of its fiscal problems tried to do the right thing. For example she has announced cuts to her fiscal deficit of some 5.5% of Gross Domestic Product for 2010. However this severe dose of austerity has led to rising problems in a country where real GDP fell by 7.6 % in 2009 ,following a fall of 3.5 % in 2008. Because of the number of overseas companies based in Ireland it is useful to look as well at Gross National Product or GNP which fell by 10.7 % in 2009 in real terms, following on from a fall of 3.5 % during 2008. In addition there are rising fears that in spite of the haircuts it has imposed on the portfolios it has received the Irish national bad bank or NAMA may end up making a loss.It was originally projected to make a profit of around 2.5 billion Euros. Another example of the problem is that yesterday NAMA announced that the government will definitely be guaranteeing the 2.5 billion Euro Commercial Paper programme being used for short-term funding of NAMA projects. This adds another 2.5 billion Euros to the sovereign debt. To give some perspective to the numbers being quoted Ireland has a population of around four and a half million and according to her National Treasury Management Agency she had a National Debt of 87,236 million Euros at the end of August.
One irony of this situation is that up until the credit crunch Ireland had sound public finances. Here is a statement from the National Treasury Management Agency from 2005.
Interest payments on Ireland’s national debt are just one fifth of what they were 10 years ago, according to the National Treasury Management Agency.
In its latest annual report, which was published today, the NTMA said Ireland’s total national debt had also been reduced to the equivalent of around eight months’ tax revenue.
The General Government Debt/GDP ratio continued to fall – to 29.9 per cent at end 2004 (32.0 per cent at end 2003) and continues to be one of the lowest in the EU.
This contrasts with other nations and for example with my own country the UK where our government at that time was loosening the fiscal purse strings. You may ask where did it all go wrong? The answer is in a property boom mostly financed by the banks which turned to bust and a banking sector which dwarfed the size of the underlying economy. Even on the Irish government’s rather optimistic projections the Anglo-Irish bank will require some 25 billion Euros of support. Pretty much everyone else’s estimate is higher and sometimes much higher.
So a weaker economy after the declines of the past two years is facing ever higher losses from a banking sector which itself is very dependent on liquidity provided by the European Central Bank. There have been efforts recently to project a path forward for Ireland most notably by the Economist magazine and other have followed with this type of analysis.Even on optimistic assumptions such as a 3% economic growth rate it feels that Ireland will still have a fiscal deficit in 2015 and that her national debt which in her calculations correctly in my view includes an allowance for NAMA unlike the official numbers has it rising to 121% of GDP.
One can add something to this. As I pointed out earlier in some respects Gross National Product is a better guide for Ireland’s economy because of the number of overseas companies based there and as it is smaller than GDP for her then the numbers deteriorate further. Now all analyses of this type are only as good as their assumptions but such figures are troubling particularly if you factor in a world economy which is showing signs of slowing with obvious possible implications for Ireland’s growth rate.
Irish Government Bonds show the strain
Last night Irish government bond yields closed higher with the benchmark ten-year maturity closing above 6% again. Looking at this mornings prices a theoretical ten-year Irish government bond is now trading at approximately 6.15% (in case you are wondering why I say theoretical she actually has one a bit shorter and one a bit longer). One might reasonably wonder what plans the ECB has as last week it stepped in to buy Irish government bonds at lower yield levels than this. So it could step in again. But unless it is willing to keep buying such purchases do not solve the problem. Even if it does keep buying we are then left with the issue of an exit strategy which is a familiar theme, or rather perhaps I should say lack of exit strategy as has often turned out to be the case in 2010.
I took a look at Ireland’s yield curve last night to investigate the position. In case you are wondering why let me give you some figures, Greece was supported by the euro zone with funds which cost around 5% and the last time I looked at calculations for the European Financial Stability Facility or EFSF then funding from it was costing 5.23%.Now if we look at Ireland’s maturity spectrum we see that at last nights close her bond which expires on 18/4/2016 which yielded 5.11% is pretty much on the threshold. All longer bonds are more expensive. Indeed if we look at the fact that IMF funding is much cheaper and that she has recently relaxed the criteria for funding it must be very tempting for Ireland’s government to call her in.
One needs to be slightly careful as under her current projections Ireland has funded her borrowing needs for 2010.So we are discussing secondary rather than primary market prices and yields for now. However these do not allow for the deterioration in her banking sector particularly Anglo-Irish bank. As the focus turns to her then there is the danger just like Greece of events moving more quickly than politicians,officials and bureaucrats can cope with.Also markets can ebb and flow and today’s crisis may become tomorrows fish and chip wrapping but Ireland’s problems are unlikely to go away for any period of time.
As Ireland has strengths that Greece did not have for example she ran a much better fiscal policy before the credit crunch and took more decisive initial steps to respond she in my view could add to those strengths by again acting decisively and calling in the EU/IMF to help her. For once a country could get ahead of events rather than just respond to them. Also Portugal is weakening again,although this is much less talked about, and in such an instance there may be further advantages from acting first.