Euro zone moves put Portugal in a new crisis and are UK government bond yields too low?

After the confusion that has existed this week over the state of US economy and specifically the likelihood of an improvement in employment and hence hopefully unemployment we received further information yesterday. The weekly statistics from the US Department of Labor were as follows.

In the week ending Jan. 1, the advance figure for seasonally adjusted initial claims was 409,000, an increase of 18,000 from the previous week’s revised figure of 391,000. The 4-week moving average was 410,750, a decrease of 3,500 from the previous week’s revised average of 414,200.

By initial claims they mean initial claims for unemployment assistance. If we look at the seasonally adjusted figures that they produce the headline number is higher than the previous week but as this number is rather volatile I also like to look at the four-week average. This has been falling over the past 3 months or so and this week it has continued that trend. In essence this sums up the report as being positive.

A More Troubling Perspective: non-seasonally adjusted figures

If we look at the underlying figures without seasonal adjustment the trend is not so hopeful as this week they were 577,279 which was some 52,038 higher than the previous week’s number of  525,241 which was some 29,693 higher than the previous week’s 495,548. So we had better hope that the seasonal adjustment is working properly! There is some comfort in the fact that in the equivalent week last year the figures were 645,446 but even so it is worth watching.


So we see that assuming the seasonal adjustment process is working we received a number which tends to indicate an improvement in the US employment situation and this does continue a trend. This is by no means as positive as the ADP employment numbers I reported on yesterday but is perhaps more reliable. Of course the ISM numbers were somewhat weaker. Just in case the waters were not already muddy enough the polling organisation Gallup has released a survey suggesting that by its measure unemployment is rising and in fact rose by 0.2% over the last month and that there has been an increase in part and short-term working leading to its measure of underemployment which relates to the U-6 measure rising to 19%. Tucked away in the report was also something of a criticism of the official US figures and the emphasis is mine.

Because the Gallup unemployment measure is not seasonally adjusted, it tends to more accurately reflect what is actually taking place in the U.S. job market — and may not agree with the government’s estimate that is seasonally adjusted. Further, Gallup’s data tend to be more up-to-date than the government’s because Gallup polls on the unemployment situation continuously.

Ouch. So we have something of a problem as we approach today’s figures for non-farm payrolls (employment) and unemployment in the United States. The figures from ADP have led markets to be more optimistic and to raise their forecasts for job creation. Others feel that the recorded level of unemployment may drop back slightly partly due to concerns over seasonal adjustment. In a nutshell you can sum events up thus, if you trust the seasonal adjustment they seem to be improving, if you have concerns about it then it may not be. Roll on one thirty UK time and please remember that non-farm payrolls is a volatile series and is accordingly unreliable on a monthly basis.

The US dollar exchange rate: Dollar Strength or Euro Weakness?

After referring to the way the recent raised hopes for the US economy had led to an improvement in the US dollar I was left wondering how far it would go. Against the Euro it has pushed through the 1.30 barrier and is now at 1.298. However I believe that whilst the dollar is strong we have also to realise that the Euro is going through something of a weak phase. Worries are again gathering over the Euro zones plans for the peripheral nations and in particular Portugal and unlike the Sunday Times the markets do not appear to feel that the worries for Portugal have passed. Also there has been signs of more political instability in Belgium. If we look at the Euros exchange rate against the pound we can see that the pound has risen from 1.16 to 1.19 which expresses the Euro’s weak performance.

But the Dollar is strong and has reached 83.48 against the Yen which will provide some relief for the Bank of Japan and the trade-weighted dollar index has risen to 80.98 up from yesterday’s 80.3.  With commodity prices currently so high there is a danger that a stronger US dollar will be an inflationary influence on countries which do not have it as a currency as most commodities are priced in it. Just what we need you might think but then many did not like a falling dollar either!

Another New Plan for Bondholders in the Euro zone

Regular readers will be aware that there have been quite a few proposals on this front in recent times by Euro zone officials and ministers. This, in my view, shows indecision at a time of crisis which is one of the things you must not do. Accordingly it has been one of the main contributors to the fact that the crisis is appearing to widen and deepen rather than reduce. Undaunted by such failure the European Commission has come up with a new plan that involves burdensharing for bondholders should a bank be in danger of insolvency or default, so in essence exactly the opposite of what has happened so far! Here are the relevant excerpts from the press release and the emphasis is mine.

The Commission intends to come forward with a legislative proposal for a comprehensive framework for dealing with failing banks before the Summer of 2011…………… ensuring that authorities across the EU have the powers and tools to restructure or resolve (the process to allow for the managed failure of the financial institution) all types of financial institution in crisis, without taxpayers ultimately bearing the burden………Indeed, the objective is to ensure that the resolution tools can be used on all banks, irrespective of their size, complexity or systemic importance………..This might include possible mechanisms to write down appropriate classes of the debt of a failing bank to ensure that its creditors bear losses. Any such proposals would not apply to existing bank debt currently in issue.

Now let me start with the principle which I believe to be correct that bond holders should bear some of the risk. So I agree there but we may have a big problem with trying to introduce this in the middle of a crisis rather than when it began as I suggested. It would have been much better to have put such policies in place then as whilst markets may not have liked it they probably half expected it. I still feel that this crisis would have been ameliorated if a haircut had been put on Greek debt back in the spring of 2010. The problem of doing it now and excluding existing bondholders has several factors.

1. Weaker banks are in effect backed by implicit guarantees by their governments, this weakens this which is likely to weaken these banks.

2. New bank funding will plainly be more expensive than existing bank funding which will hardly make banks more liquid and willing to lend.

3. This structure rather casts Ireland adrift as her taxpayers are on the hook but bondholders in her banks are let off it by this.

4. The speed of this as in lack of is extraordinary. I have often argued that such policies should be considered and debated in secrecy and then applied immediately whereas this consultation does not end until mid 2011. Occasionally I read articles saying that the Euro zone is moving quickly which I have to say I read with bafflement.


Just to add to the potential problems raised above the issue of the political problems in Belgium has reared its head again. In essence there seems to be yet more confusion over whether a new government can be formed which has led to questions about economic policy. This in some ways poses a rather serious issue for the Euro zone as Belgium is something of a core country in the arrangement and accordingly not at the top of the list for rising bond yields caused by uncertainty. Be that as it may the ten-year government bond yield in Belgium has risen steadily since last summer and is now at 4.1%. The spread with the German equivalent is now at 1.2% which is widening but I feel that the most revealing comparison is with the UK where the ten-year gilt yield is 3.53%. So the first pause for thought comes with a relatively core Euro zone country having to pay higher yields and the second comes from the fact that the difference is now 0.57%.


Unfortunately for it on a day with the uncertainty described above Portugal was always likely to suffer. After her short-term bill issue of earlier this week minds were always likely to switch to when this year Portugal will choose to try to issue the around 20 billion Euros of new debt and refinancings that she needs to do. As this was digested then her government bonds were sold and prices fell and yields rose with her ten-year yield rising by 0.34% to 7.14%. So all the buying by the European Central Bank (which has been estimated to have bought some 20% of the entire Portuguese government bond market by Goldman Sachs) has been unable to prevent her looking soundly insolvent again. Just to rub it in price falls also raises questions about the size of the losses in this area at the ECB and reinforce the questions I have raised about its solvency.

I reported yesterday that the rescue schemes (even though they charge interest-rates which are too high in my view) offered by the Euro zone and the IMF must be starting to look attractive to Portugal. Well after the way her yields rose during the day and the way they are rising this morning the matter must be being debated in Lisbon. Is it time for her to call for help? Yes and a few months late.

Other nations in the Euro zone

Spain got a brief period of relief when China promised to buy some 6 billion Euros of her bonds earlier this week. Markets appeared to be willing to ignore the fact that China seems to be making a lot of such promises recently and accordingly one has to question how serous she is. However her ten-year yield is now approaching 5.5% again and whisper it quietly but the Italian equivalent rose by 0.11% yesterday to 4.82%. The scale of either of these two economies would mean that the so-called shock and awe package would run out of money if either of these two hit trouble and as I type this I think of the boasts of May 2010 by Elena Salgado and other Euro zone ministers and hubris comes to mind.

The UK and our gilt yields

After reviewing the government bond yields of other countries it would appear that the UK government bond market (gilts) is being perceived as something of a safe haven. However if you look at our economic fundamentals I feel that you cannot avoid the view that if you applied the same criteria on the UK as others are suffering then prices look too high and yields too low. Just to confirm this is an opinion and not an investment recommendation!


13 thoughts on “Euro zone moves put Portugal in a new crisis and are UK government bond yields too low?

  1. Hi Shaun, I am slightly confused –

    “the European Commission has come up with a new plan that involves burdensharing for bondholders should a sovereign nation be in danger of insolvency or default”

    did you really mean to say sovereign nation there? or did you mean bank?

    I thought the new plan for a “comprehensive framework for dealing with failing banks” was just to tackle bank failures in general – did they actually mention bank failures caused by sovereign defaults? I had a suspicion (which I thought was a bit paranoid and crazy) that this is what they are maneuvering to do, but I would’ve thought this policy would be a complete disaster. The banks were operating under the assumption that sovereign € debts were safe – it’s not really senior debt holders’ fault that the architects of the Euro have been rather malfeasant about this. Also, as you say, introducing this over a time scale of years is just mind-boggling. Do they actually want a run on Eurozone banks?! (maybe that’s it – maybe they want nice leisurely bank runs so that they can see where the problems are – maybe they don’t trust their own stress tests??)

      • OK – I thought that would have been a bit of a brazen thing for them to do – but do you think this could be part of their aim at the end of the day? i.e. prepare the banks to deal with losses from sovereign restructuring.

  2. Hi Shaun,

    Thanks for continuing to write this blog! It’s an essential daily read for me!

    Regarding your comment:

    “Occasionally I read articles saying that the Euro zone is moving quickly which I have to say I read with bafflement.”

    I guess everything is relative!

    Perhaps they were comparing the Euro zone response time to this crisis to something *really* speedy like, for example, continental drift…

    • Hi Michael and welcome to my blog

      I do not know about other peoples measurement of time and as I have mentioned before do not wish to be involved in the game of criticising other particular commentators etc. However as a generic point I read from time to time views expressed that the Euro Zone is indeed moving quickly and to my mind that immediately identifies them as being out of touch with events. This is not a political game peoples livelihoods and economic futures are at stake and my view is that the response should match this. I do not expect politicians to respond at the speed that markets respond to events but I do expect them to build a plan and strategy. It is the job at times of a central bank to respond more quickly if necessary.

      I feel that this is most illustrated by the Securities Markets Programme at the ECB which has gone on for 8 months now. You see something like this should hold the line for a couple of months at the most whilst a strategic plan is put in place and yet we arrive at a time 8 months later where there is still no concerted plan.

      However as you point out all time is relative and compared to continental drift then they are indeed Mr and Mrs Speedy…… But BBC 4 broadcast an interesting documentary on the subject of time recently and it concluded that there was a possibility that we inflict it on ourselves and I shall leave you with that more philosophical point to ponder.

  3. Graham B said he was slightly confused. Me? I’m totally confused. To me a 5% to a 7% interest rate doesn’t sound excessive in view of the fact that a lot of nations, not just the porcine ones, have been living beyond their means for years. To compound my problems even more it seems to me to be foolhardy for nations in debt to be looking for more debt at any price. We all castigate those individuals who get a new credit card to pay off existing debt laden cards. What is the difference? I know that politicians don’t like immediate pain but for heaven’s sake.
    Instead of little letters being written between mates couldn’t we have something with teeth like if the government has to borrow more than 3 % of the GDP then it has to resign and go to the people. Maybe excessive debt would become a thing of the past. Fat chance do I hear murmured in the foreground.

    • Hi Robert
      It is hard to know from reading a message if you just chose 3% or are deliberately referring to the Euro Zones Stability and Growth Pact! For those unaware of it the targets were annual deficits of under 3% of Gross Domestic Product and a national debt of under 60% of GDP. The problem was nobody bothered with them and even Germany broke it. Somewhere tucked in there is the real problem, as far as I can see politicians imposing discipline on other politicians has a low credibility rating…

      The irony is that the nations which are joining the Euro these days have taken these matter much more seriously than the existing members.

  4. May I continue with my confusion? You say in this blog that there were 409K new claims by newly unemployed people. So when they say in the BBC web site that 103 K jobs were created do they mean that there were actually 512 K jobs created? In other words does the 103 K jobs represent a difference in jobs lost and jobs gained?

    • Hi Robert
      One of the problems at a time like this is that when you have a big issue like the employment/unemployment situation that the focus goes on every scrap of news and some of these are contradictory and some are unreliable! In this instance we have 3 different sets of what are official data even though they come from the same source aka the US government.
      1. My number of 409k was the seasonally adjusted number for new unemployment claims last week. The unadjusted number was 565k if I remember rightly so this was in fact the actual number of claims which then get seasonally adkusted for the headline figure.
      2. Next we get the non-farm payroll number or employment number which is over a month rather than a week so a different time period. This was the 103k.But this is a survey and not an actual count.
      3. We also get a different series for unemployment which dropped from 9.8% to 9.4%.This is done by a different survey though from non-farm payrolls but is also monthly.

      Hopefully this helps….

  5. First and foremost, many thanks Shaun for this outstanding blog.

    “This structure rather casts Ireland adrift as her taxpayers are on the hook but bondholders in her banks are let off it by this”

    Shaun.. when are the next Irish elections ? My concern is that the new Irish Gov’t might want to re-negotiate some of the terms of their indentured servitude..

  6. Mr. Kowalski,
    The election date here has not been set in stone but there are muted suggestions of late February or March. The are mumerings that the main opposition party, who will come to power, will look to share the burden in the form of debt restructuring. There is a groundswell of opinion here, rightly or wrongly, that we are being put on the hook for not only our own reckless borrowing and lending but also for the reckless lending of so many European banks here, especially British and German. The vast cuts which have been made here are really hitting home now which will only crystalise the growing negative public opinion.

    Personally, I can’t see how the country can move forward without debt restructuring. The amount of debt which has been nationalised from the banking sector here is simply amazing. The level of impairment still in the banking sector however, which I don’t think has been given the recognition it deserves, is massive. Only last week the government had to put another e3.7bn into AIB with more to come for both AIB and BOI, our two largest institutions.

  7. Happy new year everyone,

    Firstly season adjusted figures are there because the raw figures make people go ouch. Has their method adjusting been that far out in the past? I guess this begs the question-by the way I use this phrase in the original sense rather than your use before.

    “I feel that you cannot avoid the view that if you applied the same criteria on the UK as others are suffering then prices look too high and yields too low”

    Before I sensed you mainly referred to inflation making the UK yields look silly, now do you have concerns about our ability of the UK to pay off the debt?

    • Hi Fletch

      My previously expressed views on the subject of gilt yields have mostly concerned comparing them with UK inflation and most importantly expected UK inflation as it is only with an idea of that which allows you to calculate a real yield. In essence this is for domestic investors who will spend their money in the UK.

      The view I expressed here looks at the situation internationally. As some of our peers are seeing rising yields I ask the question, why not us? To which I feel that there is not a full answer and we may be liable to an upward yield shock. Markets do not always move smoothly. For example US 30 year yields moved above our equivalent recently and at the ten year level many countries who would argue that their situation is not that different to us now have higher yields.

      This does not mean that our yields have not risen recently it means perhaps that in relative terms they may not have moved enough. For now we have benefitted from several factors I think.
      1. International investors look often for an expected currency gain as much as they do yield (ideally both!) as the £ had a fall in 2007/08 they may expect us to be stable or maybe rise.
      2. Europe is in disarray in many respects and some investors may be waiting for a clearer strategy.
      3 In the US the advent of QE2 has unsettled the bond markets rather than boosted them.

      So at this stage my concern is that we may be benefitting from safe haven status which can be short-term and end quickly.

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