Yesterday was a relatively quiet day in equity markets with the Dow Jones Industrial Average closing down some 22 points to 10835. However other markets were not so quiet as the currency markets continue to test the resolution of the Bank of Japan’s efforts to weaken the Yen, or to put it another way they are looking to find out what the Japanese government meant by “appropriate action”. As I typed my update yesterday it was at 83.64 and this morning it has strengthened further to 83.32, so we are getting very near to the level where the Bank of Japan first intervened and above the level it is rumoured to have intervened at last Friday. So help has come from a recently strong Euro such that the Yen has been weakened against it and now stands at 113.44.however the Euro is now weakening a little as there has been poor news for both Ireland and Spain today which I will discuss later in this article.
The US dollar has continued to weaken overall and its dollar weighted index is now at 78.8 which represents a considerable depreciation since its highs of around 88 in early June. This reminds me of part of my criticism of Adam Posen’s speech as I feel that some of this fall has been caused by expected further monetary stimulus measures in the United States but he only records exchange rate movements after an announcement is made in his speech thus ignoring expectations completely. There was a development on the political front yesterday as a bill to get countries with overvalued exchange rates to weaken them was passed by the House of Representatives by 384 to 79 which is quite a margin. The bill gives the authority to put import duties on such countries. Quite what they would do if China passed a similar bill and accused the US of manipulating the dollar down I do not know. But I am sure that such moves are likely to bring a trade war nearer and the no-doubt pre-election manoeuvering of the House of Representatives could very easily backfire on not only their constituents but the whole world. Again this reminds me of a flaw in Adam Posen’s speech.
Japan’s economy and equity market
On Wednesday we got a generally favourable Tankan report in Japan,where the Bank of Japan looks at general economic conditions, but some were worried that the expectations measured in it were turning down again. This morning saw disappointing industrial production figures which were expected to rise and in fact fell by 0.3% if we compare August to July. This set a gloomy mood which an increase in retail sales of 4.3% was unable to offset,mostly because the retail sales figures represented the last month of Japan’s equivalent of a “cash for clunkers” car support programme.
If we add to this the way the Yen has strengthened against the dollar, and falls in banking stocks as euro zone fears rise we get a mix which led to a substantial fall in the Nikkei 225 equity index of 190 points to 9369. This means that the spread between it and the Dow Jones has widened to 1463 points or 15.6%,indicating quite a discrepancy in relative performance.
Ireland tries (again) to fix her banking system
The last couple of weeks has seen concerns rise about the state of the Irish banking system which because of its relative size has led to concerns about the creditworthiness of Ireland as a nation. In a 2008 report I was reading recently Irish banking liabilities were represented at nearly 400% of Gross Domestic Product and therefore even higher against Gross National Product which is lower. The reason I make this distinction is that GNP represents Ireland’s tax base more accurately. So as you can see there have been fears that a weakening banking sector could in the worst type of scenario drag Ireland down with it. This possibility has not been helped by the way that many of Ireland’s banks and in particular Anglo-Irish Bank have continually under-estimated the scale of their problems giving investors the impression of a deteriorating situation.
As I have reported one way of measuring the scale of the problems has been to look at Irish government bond yields. If we look at last night’s close we see that her ten-year yield is now 6.73% which is the highest I have spotted during this crisis ( for FT readers only the yield in their tables is incorrect they are quoting for a 2025 bond not a 2020 one). As the equivalent German bund yield fell yesterday to 2.25% we can see that the difference or spread is now 4.48%. Another way of looking at the situation is to look at what interest rate Ireland could access emergency funds from the Euro zone which is just over 5% and compare this with Ireland’s government bonds yields. As of last night the barrier is now at her bond which expires in April 2013 which gives her little room to breathe. All further out maturities have higher yields. Now this is particularly disappointing when one factors in that the European Central Bank has again been buying Irish government bonds.
Why is this crisis hitting now?
As part of her response to the credit crunch Ireland gave a two-year blanket guarantee for bank liabilities at its six domestic lenders in September 2008 to prevent a run on Anglo-Irish. If you add two years to this you can see that as of tomorrow it expires and this has led to fears in spite of Ireland introducing some additional measures. Unfortunately two years on there are again fears for Anglo-Irish so it was at best a partial success and if it delayed outright reform historians may yet judge it an outright failure.
What happened today?
A report has been issued by the Governor of the Irish Central Bank on what further measures will be required to support Ireland’s banks. He has recommended the following.
The base case capital requirement for the Asset Recovery Bank is € 29 billion.
The base case capital requirement for the Funding Bank is €250 million.
Note that €23 billion has already been injected by the Government into Anglo in 2009 and up to end-August 2010.
Taking into account all these stress elements, the Central Bank estimates that an additional €5 billion of losses, above the €29.3 billion base estimate, are possible under a severe hypothetical stress scenario. These estimates do not include any burden sharing with subordinated debt holders.
So we see that he feels that a further 6.3 billion Euros will be required and that an additional 5 billion Euros may also be required to draw a line under the Anglo-Irish debacle.
Allied Irish Bank
To his credit the Governor has chosen to try to sort out AIB as well. The Irish regulator has announced that it will need another 3 billion Euros of capital by the end of this year.I notice that this morning AIB has announced plans to raise some 5.4 billion Euros of equity capital. Here things are slightly uncertain for the sovereign as the Irish National Pensions Reserve Fund Commission is underwriting the issue and until it actually takes place we do not know how much of the bank it will own, although it is hard to escape the suspicion that it may end up owning AIB. This has implications again for the sovereign nation in spite of it being badged under the national pension fund.
I think that the Governor deserves some credit for his efforts here which are much more realistic that what has been published in the past. There ia a welcome contrast with past efforts which have turned out to be efforts at “kicking the can down the road” hoping for better times. It may help to settle the situation a little but there are still risks. Whilst his stress scenario is more prudent than the recent EU banking stress tests the situation in Ireland’s property market is currently very bad and there are a lot of concerns about the quality of assets that the Irish bad-bank NAMA has taken on.Indeed there remain some questions about NAMA’s methodology and operations but the Governor can do little about that at this time.
The effect on Ireland as a nation
Whilst I think the report by the Governor will be well received in general it does pose some problems for the Irish government. For example the Irish Finance Minister Brian Lenihan was very critical and indeed scathing of Standard and Poors when it suggested only a month ago that total aid to Anglo-Irish Bank might reach some 35 billion Euros. In a fairer world Mr.Lenihan should now apologise. however in reality we are left in a situation where Ireland’s government has reduced its own credibility just at the moment it most needs it. It is very hard to see now how Ireland can credibly claim to be able to reduce her fiscal deficit to 3% of GDP by 2014. Mr.Lenihan has issued a statement this morning which gives some idea of the scale of the problems as he sees them.
There will be a very substantial spike in Ireland’s General Government Deficit in 2010 as a result of the capital support that we are providing to our banking system, totalling almost 20% of GDP. On a purely headline basis our General Government Deficit for 2010 will be around 32% of GDP. Were it not for this once off spike we would have broadly met our budget target for 2010. I want to stress today to all, including our European partners, that Ireland remains fully committed to reducing our deficit below 3% of GDP by 2014 as agreed. It is important that we have a credible path to show how we propose to meet this commitment. Accordingly, a four-year budgetary plan, incorporating the annual measures will be published in early November……………..The full amount of the costs for Anglo and INBS is added to Ireland’s General Government Debt which raises the ratio to 98.6 per cent this year.
I notice that he uses the more favourable GDP comparison rather than a more realistic GNP one. I explained the distinction and the importance of it to Ireland in my article on the 24th of September. Also to my mind the commitment to reduce the deficit to 3% by 2014 now looks like political hyperbole, after all he hasn’t done his new budgetary plan yet! We also get an indication that Ireland’s authorities are beginning to realise the seriousness of their position.
I am advised by the NTMA as the Exchequer is fully funded until late June 2011 the Agency has decided not to proceed with the bond auctions scheduled for October and November. The NTMA will return to the bond markets in the normal way in early 2011.
This begs the question of why the auctions were thought necessary in the first place as the National Treasury Management Agency hardly schedules them because it feels like it. Indeed the situation is of course now worse than what it expected when it scheduled them. The answer to this conundrum is that Ireland had around 20 billion Euros of cash reserves some or all of which will now be used to try to plug the fiscal gap. In the end of course it leaves her weaker than she was however the politicians try to hide this.
I have enjoyed the trips I have made to Ireland for both business and pleasure and report these problems with a sense of sorrow. She is far from the only country that needs a new political class,however. And I am reminded that Ireland does a lot of trade with the UK so there are clear implications from this much nearer to home.
Spanish economic problems and downgrades
The ratings agency Moodys has downgraded Spain’s credit rating this morning from AAA to Aa1. This is not as significant as it might otherwise be for two reasons, the first is that the other ratings agencies had already done this and the second is that ratings agencies do not have the credibility they had and lost it mainly by giving instruments AAA ratings they did not deserve.
I have written previous articles on here about Spain and some misrepresentation in her fiscal statistics. The debate on Spanish statistics has moved on this morning as according to the Financial Times an email has been doing the rounds suggesting that Spanish GDP has been overstated by some 14.2%. As you can imagine this has created something of a stir. In its favour is that it is quite detailed although there are one or two questionable issues,and against it is the fact that it is anonymous. The FT did to its credit prove that it can keep a sense of humour in a difficult situation.
We’ve contacted the INE to discuss.While we’re still waiting to speak to their economists — since they too were on austerity strike on Wednesday……
I will take a look at the numbers and report back as they require some reading and some analysis but one cannot help but think of Greece and that in a way speaks for the credibility of Euro zone statistics rather eloquently.