After a day yesterday where global stock markets had a quiet day so far this morning the “Santa Rally” has regained its momentum. In the Far East the Chinese Shanghai Composite equity index rose 1.79% to 2904 and the Japanese Nikkei 225 equity index rallied 154 points to 10,370. This trend has continued into European trading as the UK FTSE 100 is currently up 40 points at 5931 and the German Dax has rallied a similar amount to 7057. Should anything like these trends continue then 2010 will have been a good year for equities and let’s face it after the previous decade they needed it! As she rarely gets good news let me point out that Ireland’s ISEQ equity index is up by 0.7% so far today and let the one year performance slip my mind.
The Japanese Economy and the Bank of Japan
Today saw a statement by the Bank of Japan and some further economic data. It has not been reported a lot in the mainstream media but Japan is undertaking its own version of Quantitative Easing. This easing is innovative certainly as the Bank of Japan is in the process of spending some 5 trillion Yen or around US $60 billion on such assets as real-estate investment trusts and exchange traded funds. So whilst there has been discussion of whether other central banks asset purchases or QE has supported equity prices there is no doubt at all about the Bank of Japan’s actions. I have discussed such matters often in my section on Quantitative Easing. I have also chosen the word innovative quite carefully as use of the word in Ireland for example often metamorphosed into a poisoned chalice. Let me ask a question which proponents of QE virtually never have an answer to, how do you plan to reverse this? Or more formally what is your exit strategy?
Falling Prices or disinflation in Japan
This trend continued in Japan in October as the Bank of Japan’s chosen inflation measure which is consumer prices excluding food prices fell by 0.6% on an annual basis. Those not familiar with Japan may be shocked that this is the 20th month in a row of price falls. Just to add further detail to this the highest recording for this measure in the past 5 years has been 0.5% back in September 2008. So for once my argument that QE leads to higher inflation is not a criticism of this policy as in fact a nudge higher has been the objective of the BoJ for quite some time. It is aiming for 1% inflation.
For those who regularly follow Japan the -0.6% may seem an improvement but there was an increase in the tax on cigarettes recently ( a 33% rise) which will have contributed to this.
Moving back to the Bank of Japan its Governor promised today to “steadily” buy assets and continue its programme. Furthermore he said this
Volatile long-term rates can affect the economy, prices and financial conditions by influencing borrowing costs for households and companies.
For those expecting a situation like that happening in Europe you may need to sit down as in Japan worries about ten-year government bond yields have arisen with a yield of 1.18%. and no that is not a misprint. It is a rise of 25% in more recent times but is also an interest rate that would have even agnostics in many debt management agencies falling to their knees and thanking God! The US ten-year Treasury Bond yield rose by nearly this amount recently (before retracing a little) and at its recent peak was treble the Japanese yield stated here.
For those who have followed regularly my updates on Japan little has really changed. She remains mired in disinflation which her central bank seems unable to do much about. On this subject there is an irony in that the inflationary commodity price trends evident in the world may help the Bank of Japan which may well be wishing it did not exclude food prices from its favourite consumer price index.
Some help is coming internationally. In the United States the tax cut/stimulus programme combined with the Federal Reserve’s asset purchases at a rate of US $75 billion a month have led to upwards revisions to growth which will benefit Japan’s exporters. Also the exchange rate of the US dollar has improved so there has been some relief for the Bank of Japan as the Yen has weakened to 83.66 rather than continually rallying. If this were to carry on the Bank of Japan would welcome some imported price inflation which is a sign of how different things are there to elsewhere. Combining this with the actions of the Bank of Japan and the Japanese government’s fiscal plans has probably led to the recent improvement in Japanese equities but as ever looking forward fundamental problems remain.
Switzerland and Hungary: Swiss Franc borrowing
The Swiss Franc exchange rate has been rallying recently and it has struck a new high against the Euro at 1.2636 today. There have been events this year which favour Switzerland as it has safe haven status and it has a long-term association with gold in an era where the gold price is off its highs but still very strong. However there are more implications to this. You see the Swiss National Bank has been trying to resist this move all year. Let me quote from my update on this subject on the 31 st of August.
The implications of this are bad enough for Switzerland who finds herself saddled with an uncompetitive exchange rate. They are even worse for the Swiss National Bank which has spent much of this year intervening to try to stop this rise. Before this recent further rally the SNB was estimated to be sitting on losses of 7.5 billion Euros because of this failed intervention and these are mounting as I type
Now this situation is even worse as the exchange rate back then was moving thorough 1.30 versus the Euro and it is higher now. Not much of a Christmas present for Switzerland or her National Bank. But there is a problem with this for much of Eastern Europe.
Many countries in Eastern Europe borrowed in Swiss Francs and I wrote about the problems caused by this on the 10th June and the 19th July . They did so because the interest rate cost was lower in many cases much lower, but the risk is that the currency you borrowed then rises. To look at the numbers and concentrating on Hungary where this was and is a big factor some 1.7 million mortgages were taken out in Swiss Francs and the total sum borrowed is estimated at around half of her GDP.
So the recent rise in the Swiss Franc will be a problem for many debtors in Eastern Europe as the value of their debt will be rising if they earn their income in anything related to the Euro. If we look at the Hungarian Forint the exchange rate against the Swiss Franc is not at the highs for this year but at just under 217 it is up just under 16% over the past year and up nearly 35% over the past 3 years. So it is likely that for most borrowers the value of their debt will have risen over the past 3 years swamping any likely monthly repayments.
Unfortunately Hungary has other problems. It raised its official interest-rate this week to 5.75% in response to its consumer price inflation rising to 4.2%. However in an echo of a situation that I expect to be repeated in many other places in 2011 the story I have recounted above also illustrates deflationary forces at work in Hungary. Her central bank is worried about inflationary expectations building and has responded in a conventional manner but if I was on it I would be just as quick to reverse course if necessary.
Just to link this theme with events elsewhere these loans were often given by Euro zone banks with those in Austria to the fore. So yet again a problem is associated with the banking sector and this reality is probably behind Austria’s temporary unwillingness to join in with Euro zone rescue plans.
After remarking on Friday that Moodys seemed to be working its way across Europe with its threatened downgrades well today it reached Portugal. Its reasons for expressing fears of a downgrade can be summarised thus.
Concerns about Portugal’s ability to access the capital markets at a sustainable price; and concerns about the possible impact on the government’s debt metrics of further support for the banking sector, which may be needed for the banks to regain access to the private capital markets.
You may think that there is something self-fulfilling about this and in my opinion you would be right. In terms of timing it definitely feels that Moodys is going through a list here as the trends evident in the Portuguese economy have been apparent for quite some time. However linking this story to my update on the Swiss Franc above makes me think that some investors may like the Swiss Franc even more which of course could make this something of a self-fulfilling prophecy by Moodys. We have something here which is the reverse of the saying, ” there is nothing to fear but fear itself.”
UK Public-sector borrowing
The UK has been fortunate to find itself in something of an economic oasis recently which its tendency to inflation apart has been much more benign than many of its neighbours. However the issue of its public borrowing is starting to raise concerns.
We as a nation borrowed some £22.8 billion in November which comes on the back of poor figures in October too. If we compare this to a year ago then in November 2009 we borrowed some £16.7 billion so today’s number was up by £6.1 billion. Remember since then recorded economic growth and indeed inflation which should help these numbers have both been fairly strong so the figures are in fact even worse than they initially seem. As tax income rose then there is plainly a problem with public expenditure and most of it seems to be in the section unhelpfully labelled other current expenditure.
If we look for some perspective then we can look at the figures for this fiscal year so far and make a comparison with the same period in 2009. So far in 2010 we have borrowed some £99.9 billion which is only just below the £101.4 billion for the same period in 2009.
Something which may begin to trouble markets as time passes is our national debt which at the end of November 2010 was £971.0 billion (equivalent to 65.2 per cent of GDP). This compares to £843.6 billion (59.5 per cent) as at the end of November 2009. One impact of this rapidly expanding debt was that our payments on our debt interest rose by 50% from £3 billion in November 2009 to £4.5 billion in November 2010.
These are very troubling figures as they seem to be forming a trend and I have worries on three counts.
1. The UK government is supposed to be committed to austerity and yet public expenditure has risen more than expected.
2. Economic growth has recently been strong and should have helped the numbers.
3. Inflation has been strong too and this also helps the numbers via the impact of it on Value Added Tax and fiscal drag on income taxes.
As we stand George Osbourne has claimed to be a man of austerity and yet the figures do more than hint at a stimulus or at least of a lack of control. To borrow 6.7% of your economic output in the period April to November is some way away from his previous claims.