After a few days where it was the main subject of discussion in financial markets we got the results of the Portuguese government debt auctions yesterday. If we move straight to the figures we saw the following. Portugal sold 599 million euros of 9 and a half-year bonds at an average yield of 6.716 percent, compared with a yield of 6.806 percent at the previous sale on Nov. 10. She also sold 650 million Euros of bonds expiring in October 2014 at an average yield of 5.396% which compares with 4.041% at the previous sale.
Was it a success?
Before I apply criteria to examine this I wish to make one point often ignored in the mainstream media and that is that it takes a few days after a bond auction to see how it has really gone as there can be indigestion or further demand. This is particularly true at a time like this when there is so much official intervention in markets.
The first criteria is a success because Portugal succeeded in issuing the bonds and now has the money. The next criteria is to examine the price she had to pay which is best represented by the interest-rate or yield she had to pay on the bonds. Here again,compared to the worst estimates there was some success as the longer bond was not only issued at rate significantly below 7% it was also lower than the yield paid at the previous auction of this bond,although care is needed because this was also at a time of raised yields due mostly at that moment to Ireland’s problems.
However there were also less positive developments in the auction. Whilst some may trumpet a yield of 6.7% as an outright success if you look at it and the previous one of 6.8% then you see a situation where if they are sustained then Portugal will not be able to service its debt because its primary fiscal deficit will continue to increase. In effect such yields point to insolvency for Portugal which is hardly a success. Also the shorter-dated bond was issued at a yield which was 1.35% higher than at the previous auction. This is an issue on two counts. The first is simple it is higher. The second is that one of the features of crises in the periphery is that government bond yields across the maturity spectrum become much more similar than is normal and we see that here as the shorter-dated bond yield has risen towards the longer. We saw this in both Ireland and Greece. There is a further oddity in it rising as the European Central Bank concentrates its buying at the shorter-end and we know it has been buying but then the same happened to the ECB in Ireland and Greece.
Official Intervention in markets
A theme I have developed is that central banks have intervened in markets in increasing scale over the period of the credit crunch. We have seen signs of this here where the ECB via its Securities Markets Programme has bought some 74 billion Euros of peripheral Euro zone government debt. It started buying Portuguese debt in substantial size at the end of last week and Nomura estimates that in the two days running up to the auction the ECB spent between one and one and a half billion Euros on Portuguese government debt. We will have to wait until Monday for the official figures but if true we are potentially in the zone of monetising government debt.
On a theoretical basis this makes me at times question some of the prices and yields given in such a situation. If we add the type of secret deal with China that I discussed earlier this week then one can only worry more about manipulation. At times many Portuguese bond yields are simply the ones at which the ECB is willing to buy and may bear no real relation to what anybody else would buy at. Indeed I gather that some fund managers are so concerned about what may happen in 2013 should the Euro zone start to apply haircuts that they do not wish to buy Portuguese bonds at any price or yield, so we may have something of a false market.
Just to add to the sense of unease the Bank of Portugal released figures which showed that the ECB has increased the funding/liquidity it is providng to the Portuguese banking system as it rose to 40.9 billion euros from 37.94 billion euros in November. The increase follows three straight monthly declines.
Some reflection from European Commissioner Oli Rehn
I notice that in an article in the Financial Times Mr.Rehn said this and the emphasis is mine.
In parallel, we must ensure that the financial support mechanisms put in place last May are fit for purpose. The effective lending capacity of the current European financial stability facility should be reinforced and the scope of its activity widened.
I point this out because Mr.Rehn was one of the champions of the plan which the Euro zone was calling a “shock and awe” plan of enormous size and that the markets or “wolf pack” should be afraid of it. Perhaps the blizzard of hyperbole has developed into hubris. Mind you looked at from the longer-term “shock and awe” was not a success in Bagdad either was it? Indeed if you feel it was a longer-term failure then you may feel Mr.Rehn was right first time…
At least he seems to realise that a change of policy is needed and we should credit him for that.
German economic growth
The Federal statistics office released news that the German economic locomotive has built up a head of steam in 2010 and had grown by 3.6% which erases much of the 4.7% decline of 2009. If we look at the numbers then 2.5% of the growth was due to rising domestic demand and 1.1% to net exports. So there was more good news as it would appear that the German consumer is spending which will help as we need “surplus” economies to spend some of it. However such good news for Germany also reminds us that we have a two-speed Europe and with Greece’s economy shrinking at an even faster rate than Germany’s is growing we have the fundamental problem of the Euro zone in a nutshell. How exactly does the same exchange rate and the same interest-rate accommodate such divergences?
The US “beige book”
For those unaware of what this is it is the document which publishes the various survey reports that the US central bank the Federal Reserve takes of the US economy and its latest version was published yesterday. What did it tell us?
Reports from the twelve Federal Reserve Districts suggest that economic activity continued to expand moderately from November through December……….High levels of existing home inventories continued to damp the pace of new home construction in most Districts reporting on construction………. Home prices generally declined or held steady…….. (whilst some districts) mentioned distressed properties placing downward pressure on prices.
So we have a recovery but problems with the housing sector so in a way with apologies to Bob Seger this report was “Still the same”.
The UK economy
UK Balance of Payments Figures
Britain’s overall trade deficit widened marginally to £4.1 billion in November, from an upwardly revised £4 billion in October. So we see that there was little good news on this front as exports had increased but so had imports. I am very cautious about monthly trade figures as they are often revised heavily so I tend to look at the figures on a longer term basis but here too one is left with the conclusion that our trade performance after the 2007/08 depreciation of the pound does not so far look markedly different to the period which preceded it.
There is some hope going forwards as UK manufacturers have been reporting on an improved situation recently and this has been followed by today’s report that UK manufacturing expanded by 0.6% in November which follows an October where it also expanded by 0.6%. Industrial production also increased by 0.4% in November. So the hope is that such an improved performance will begin to help our trade deficit as we sorely need it.
The UK Monetary Policy Committee
The MPC has a vote this lunchtime and it faces something of a quandary. UK inflation is well above its targeted level being at 3.3% compared to its target of 2%. Indeed on our previous and in my view more accurate measure of inflation the Retail Price Index the situation is even worse at 4.7% which is 2.2% over its old target of 2.5%. Manufacturing is doing well and economic growth has recently exceeded forecasts. If we look at the world situation we can see that there are inflationary pressures on the global scene. For example the Commodity Research Bureau Spot Index rose yesterday by 3.79 to 536.32. The acceleration in this came in early/mid July 2010 where it was around 420. So since then by this measure commodity prices have risen by 27%. I noticed a comment on this blog about the surge in scrap metal prices yesterday so I took a look at the metals sub-component of this index. It has risen since the week of July 12th 2010 from 711 to 1028 making a rise of 44% in six months.
The price of oil has been rising too and has risen by 27% since the end of September 2010 using West Texas Intermediate as a benchmark ( although the UK benchmark of Brent crude has risen faster and further….). This combined with rising taxes where both Value Added Tax and Excise Duty have recently risen has led to a surge in prices at the petrol/diesel pump.
If the MPC were Martians beamed down to Earth and they happened to have an interest in economics they would raise UK base rates today. I would be enquiring as to why they had not beamed down more than a year ago and helped us out as on the 14th of December 2009 I wrote.
This period has been one where our monetary authorities have lost much of the control they ordinarily have over monetary conditions. I believe that Keynes’ concept of a liquidity trap was and is true but is operating in a slightly different way to that which he envisioned. ……. Accordingly I remain of the view that raising interest rates to 1.5% will be a beginning in us negotiating our way out of our current difficulties.
As you can see the MPC has fallen way behind my timetable and look where it has got us on inflation which according to them is “temporary”. I would be considering whether further rise might help today but if we move away from my thoughts let us look at the position. We have an emergency interest-rate but we no longer have an emergency…
Accordingly I feel that the MPC has failed in what is its primary purpose of controlling inflation and that a fundamental change is required in it and repeat my call for MPC members to be elected.