For a while yesterday events took investors minds off what was happening in Ireland and the other peripheral members of the Euro zone. Unfortunately for them it was the seriousness of North Korean artillery firing on South Korea with South Korea then replying in kind that refocused minds rather than any resolution to Europe’s problems. World equity markets took this badly with the US Dow Jones Industrial Average falling 142 points to 11036 and the UK Ftse 100 falling by 99 points. Also we saw the return of what I call the military dollar as the crisis led to it surging with the US (trade-weighted) dollar index rising to 79.73. The announcement of the artillery fire had the dollar index rallying from 78.6 to 79.5 in very short order. A safe haven US dollar often has US government bond yields falling too and indeed they did with the yield on the ten-year falling to 2.76% and the thirty-year to 4.17%.
One interesting feature of this was the performance of Japan’s financial markets. On the day her equity markets were closed but today the Nikkei 225 equity index has only fallen by 85 points to 10,030. This means that the spread between it and the Dow is now down to 1006 points from the 2000 or so it got too pre the most recent Federal Reserve meeting. I have been asked in the comments section to what use I put this spread and would like to make two points. It is a broad sweep to my mind rather than an inch by inch calculation where a move from equality to 2000 points matters as does the move from 2000 to 1000 but a move of 20 points may mean little or nothing. Also I tend to think of it just as a spread and would consider the currency effect separately, that probably comes from my time in derivative/futures markets as it would appear that you can take the boy out of those markets but you cannot entirely remove their effect on the boy! Added to the outperformance of the Nikkei we have seen a rally in the Yen in foreign exchange markets. In these times an improvement against the Euro may be unsurprising but an improvement against a safe have military US dollar to 83.02 is.
The Euro zone: The European Central Bank
I did in the end receive the news about the ECB’s announced purchases of peripheral Euro zone debt from the previous week. It had bought an extra 713 million Euros worth of what was probably mostly Irish and Portuguese paper makings its total purchases now some 66 billion Euros. Apart from the fact that these purchases are bring little relief to these markets I have some questions about the SMP overall.
The Securities Markets Programme: Is it a success or is it a failure?
1. For the countries concerned the situation in terms of their government bond yields is deteriorating and not improving with Greek ten-year yields near 12%, Irish above 8% and Portuguese over 7%.
2. Accordingly the SMP must have accumulated some fairly substantial losses on a market to market basis. How much? We are not told.
3. The effect of accumulating all this loss making paper must be to accumulate sovereign paper which nobody else wants and must damage the credit-rating of the ECB itself. Remember this is the same ECB whose repo operations led it to accept lower-rated paper. So I believe an audit of what the ECB is currently holding would be concerning for Euro zone taxpayers who in effect are backing it. This is before we even discuss what private debt it may have bought too.
4. What is the exit strategy here? A realise that we are in a crisis situation but if one steps back and thinks it is still hard to see how this can be reversed. As the ECB often buys short-dated paper some of these will mature perhaps over the next year or two but the country concerned will have to issue new debt and who will buy that?
5. The policy has split the ECB with the President of the German Bundesbank Axel Weber being against the scheme.
6. The SMP was supposed to be an answer to “disequilibrium” in markets. However does anybody actually believe that the Irish government bond market is in disequilibrium? Yields are rising but in many respects this seems logical, are all inconvenient yield rises to be badged as example of disequilibrium?
So in conclusion is the SMP part of a solution or is its increasing size making it part of the problem? As time passes I believe it is become more of the latter. Just like my criticism of Quantitative Easing there should have bene a planned exit strategy before it started and yet I see no sign of one at all.
Ireland in distress
The building political crisis in Ireland meant that yesterday even purchases by the ECB under the programme discussed above were unable to stop government bond yields rising. For example her ten-year yield rose to 8.36% and the index for her overall government bond market fell by 1.21 to 83.37. When you consider all the aid she is likely to get this is not a good result. This time markets have moved straight to the solvency question and they do not appear to like the answer.
It is also true that we have very little detail and this leads to further criticisms to my mind. For example the EU/IMF/ECB must know how much they are willing to lend and at what interest- rate yet the area remains shrouded in a type of fog. If you wished to make yourself appear hesitant and uncertain this is exactly the way to do it. Some things we can figure out for ourselves because the IMF has standard terms but for the EU’s programmes I can only say that I believe my calculations were/are correct but it would appear that so far the EU is uncertain of its own calculations. We will have to see.
The rating agencies have begun to downgrade Ireland with Standard and Poors first up but the truth is that a new long-term rating of A is probably still behind the curve. So the concept of ratings and ratings agencies takes another knock, if their credibility was a boxing match the referee would have stepped in to stop the fight long ago. But still they remain so to add to all the other zombie institutions we have we also have zombie ratings agencies.
Today Portugal’s unions set out on a general strike as a response to her planned austerity programme. Unfortunately as I explained yesterday this planned austerity has so far in 2010 led to an increase in public expenditure when compared to 2009! Ooops. The financial markets are not in a mood to be forgiving and her ten-year government bond yield rose to 7.02% as of last nights close.
Contagion and Spain
This subject gets raised from time to time and problems for her Iberian neighbour must have an influence on Spain. If we look at her economy we see a large housing boom followed by something of a bust. We have also seen her economic statistics questioned and debated leading to a drift down in their credibility. For example her statistics agency recently reported that unemployment had fallen to below 20% when in fact the underlying statistics pointed to a rise. Anyway an unemployment rate of 20% is a serious issue in itself as is the feeling that the real falls in Spanish property prices are yet to come as her banks have shifted loss-making property investments into all sorts of special purpose vehicles leading to an inventory “overhang” for her property market.
With the problems elsewhere gathering one is forced to the conclusion that should Spain hit trouble then there is not enough money in the Euro zone;s rescue vehicles to successfully rescue her. This assumes that they will successfully rescue anyone, a concept subject to increasing doubt. Of course these doubts do not help either and Spain would not have welcomed the fact that she had to issue some Treasury Bills yesterday. Not good timing and poor luck. For example the yield she had to offer on some 6 month Treasury Bills rose to 2.11% from the previous 1.29%.
Her longer-dated yields are coming under attack. For example in late summer of this year her ten-year government bond yield fell back to 4% but since then as tensions have risen so has the yield and it is now at 4.93%. So a concerning rise and in something of a danger zone. Added to this in an example of fiscal recklessness the Spanish government redid its fiscal calculations when yields on its debt fell and spent the expected gains (there was a particular announcement of 750 million Euros worth of spending). Now of course the gains have disappeared but the extra spending remains. If we look at her ten-year yields with comparison to Germany then they now exceed hers by some 2.36%.
I see as I look around a lot of talk of rescues in the Euro zone but as I have written today I see no sign of anyone actually being rescued so far. Perhaps delaying action might be a better term as if we look at Greece we see that the EU/ECB/IMF troika is calling for yet more austerity in return for more tranches of aid. Her ten-year bond yield is at nearly 12% and her economy is shrinking and will carry on shrinking in 2011. If you look beyond the hyperbole there are real concerns that rather than getting better things may be getting worse. Back in the spring when these matters were being debated I argued that Greek debt needed a restructuring where private-sector bond-holders took a haircut and the lack of this to my mind looks ever more like a fatal error. Yet we find ourselves six months forwards in time unable to address this matter and if we look at the various schemes in place we see that private sector bond-holders are likely to have been able to offload much of their holdings onto the ECB and other Euro zone bodies. In that respect we have gone backwards rather than forwards. Is the Euro zone rescuing banks or sovereign nations?
US Economic Figures
We did receive some updates yesterday on the state of the US economy and also the minutes of the latest Federal Reserve meeting when the new Quantitative Easing programme or QE2 was announced. Economic growth in the third quarter was marginally better than expected at an annualised rate of 2.5% rather than the previously reported 2.4%. So there is some growth in the US but not enough to reduce unemployment. The news on prices was also confirmed as according to the BEA.
The price index for gross domestic purchases, which measures prices paid by U.S. residents, increased 0.8 percent in the third quarter, the same increase as in the advance estimate; this index increased 0.1 percent in the second quarter.
I raise this because we are often told how low inflation is in the US and the Federal Reserve has indicated that it wishes to raise it. One’s perspective changes when you see that it appears to be rising on its own! The minutes from the actual FOMC meeting added little value except to maker it clear that there was some dispute and dissent. If we look at where the markets are now one has to conclude that so far QE2 is off course. Equity markets are down.Some government bond yields are higher and so is the US dollar.
US existing home sales
As we go forwards one influence will be the state of the US housing market and the figures released yesterday were concerning. There were two main issues here. Firstly the number of sales fell on a seasonally adjusted basis by 2.2% between September and October meaning that October 2010 had 25.9% fewer sales than October 2009. Secondly the inventory of unsold houses is now at 10.5 months worth which is considered very high by those who follow this market as sales tend to slow down at this time of year.
So not a collapse but troubling with implications for the wider economy over the next few months.