WHATEVER IT TAKES…
A confrontation is brewing among Greece’s international creditors over who will provide the financing needed to keep the country afloat.
A report by international inspectors, due in October, will state how big the funding shortfall is in Greece’s bailout program, but European officials say the deficit is far too big for Greece to close on its own.
That means the International Monetary Fund, the European Central Bank, and euro-zone governments such as Germany will have to negotiate over which of them will make painful concessions to ease Greece’s debt-service burden. (…)
Northern creditor countries, led by Germany, the Netherlands and Finland are adamant that Greece won’t get more loans from them. Such loans would require the approval of Germany’s parliament, where Chancellor Angela Merkel fears many of her center-right allies would revolt, causing a government crisis.(…)
(…) In a sign that the effects of the ECB’s pledge are allowing Spain to continue to access debt markets, the country’s treasury sold €4.8 billion ($6.26 billion) of bonds, above its €3.5 billion to €4.5 billion target. The offer received €8.577 billion in bids.
The ECB’s pledge to buy bonds with a maturity of up to three years encouraged Spain’s treasury to launch a new three-year bond, maturing in October 2015 and carrying a coupon, or scheduled interest payment, of 3.75%. This bond accounted for the bulk of the funds raised at Thursday’s auction, with the rest coming from the sale of an existing 10-year bond. (…)
Data from before Thursday’s auction show Spain had borrowed funds at an average cost of 3.87% so far this month, down from 5.75% on average in July, according to Jean François Robin, strategist at Natixis. Mr. Robin said ECB President Mario Draghi’s June 26 pledge to do whatever is needed to safeguard the euro “has clearly brought about a complete sea change as regards Spain’s funding costs.”
Spain has completed about 82% of its annual gross fundraising target of €86 billion for 2012, but some investors believe the country could soon need financial support from the European Union as Madrid faces a worsening recession, high borrowing costs and looming debt repayments, including about €30 billion in October. Spain has requested a euro-zone rescue loan of as much as €100 billion to overhaul its ailing banks, which are still reeling from a 2008 property-market crash.
On Thursday, International Monetary Fund Managing Director Christine Lagarde said a report on Spain’s banking sector due this month will show that recapitalization needs are lower than many feared, and close to projections of around €40 billion made by the IMF in June. (…)
The rift between Catalonia and Spain is expected to escalate, and analysts say that the drop in Spain’s financing costs may be short-lived, particularly if Moody’s Investors Service were to cut Spain’s debt rating to below investment grade, making it the first of the three major ratings firms to lower Spain to junk level.
A decision by Moody’s is likely by the end of the month. Such a move would further damp demand for Spanish debt.
That said, it sure looks like Spain is lining itself up for the big request:
Brussels is helping Madrid draft new economic reform policy
EU authorities are working behind the scenes to pave the way for a new Spanish rescue programme and unlimited bond buying by the European Central Bank, by helping Madrid craft an economic reform programme that will be unveiled next week.
According to officials involved in the discussions, talks between the Spanish government and the European Commission are focusing on measures that would be demanded by international lenders as part of a new rescue programme, ensuring they are in place before a bailout is formally requested.
Spain is considering freezing pensions and speeding up a planned rise in the retirement age as it races to cut spending and meet conditions of an expected international sovereign aid package, sources with knowledge of the matter said.
(…) Sources with knowledge of the government’s thinking said Rajoy’s comments were a sign that his stance was shifting.
“He just said that he would not cut the pensions. But did you hear anything else? We both know that there are several ways of cutting. One is to simply leave them steady against inflation,” said one of the sources. (…)
Europe’s permanent bailout mechanism is almost certain to start its life next month without the two leverage vehicles that were agreed for its temporary predecessor because of renewed Finnish concerns about its exposure to the funds, several people familiar with the situation said.
The leverage options were designed to allow the euro zone to mobilize far more than the EUR500 billion ($649 billion) lending capacity ceiling on the new bailout fund, the European Stability Mechanism, by offering extra protection to investors. (…)
Finance ministers from the euro zone discussed transferring the leverage vehicles to the ESM at a meeting in Cyprus last Friday. According to officials, there was broad support for the idea but objections from Finland blocked agreement.
One EU official said he believes Finland’s objections could be worked out. However, with the ESM due to be launched Oct. 8, the leverage vehicles now won’t be included in the ESM guidelines that will detail the tools available to the new rescue fund and the conditions for using them, two officials said.
That means the leverage vehicles aren’t likely to be available for use if a broader Spanish request for a bailout from the ESM were to come soon. (…)
Rome expects 2.4% contraction, twice as deep as it previously estimated
Rome also revised sharply upwards its predicted public deficit for this year from 1.7 per cent of gross domestic product to 2.6 per cent, and from 0.5 per cent to 1.8 per cent in 2013, underlining how tough austerity measures have made fiscal consolidation more difficult to achieve.
It predicted the economy would continue to shrink next year, by 0.2 per cent, rather than grow by a modest 0.5 per cent.
Initial unemployment claims fell 3,000 to a seasonally adjusted 382,000 last week but remain high, showing the labor market is struggling to sustain improvement, while leading indicators dropped 0.1% in August.
The four-week moving average of claims-—which smooths out weekly data—increased by 2,000 to 377,750. That is the highest level since the week ended June 30.
WEAK PHILLY FED
Yesterday’s Philly Fed Survey results were quite weak. Hopefuls jumped on the 6-m forecast to which I give little attention. Doug Short’s 3-months moving average plot smooths out the Index monthly volatility.
And Scott Barber displays the details:
See anything to cheer about there?
KB Home posted a fiscal-third-quarter profit as the builder delivered more houses at higher prices.
Orders were up 3.4% to 1,900 homes, and backlog—an indication of future business—climbed 33%.
China Slowdown Seen Longer Than in Crisis by State Economist China’s economic slowdown may last longer than during the global financial crisis because of worsening external demand and limited lending to smaller companies, a state researcher said.
“The slowdown will definitely extend into the first quarter of next year,” said Yuan, 58, who advises the government without being directly involved in policy making. “That will provide a good starting point for the new generation of leadership to make a turnaround, because things can’t get worse.”
(…) “China’s medium and small-sized businesses are finding it increasingly hard to borrow money from banks — the most fundamental part of the economy is suffering,” Yuan said.
China Money Rate Sees Biggest Weekly Increase Since February China’s overnight money-market rate had the biggest weekly advance in seven months on speculation banks are hoarding cash to meet quarter-end requirements.
Energy watchdog’s comments come as crude hits six-week low
Maria van der Hoeven, executive director of the Paris-based IEA, told an energy conference on Thursday that the oil market was “sufficiently supplied” with Saudi Arabia, the US and Canada delivering more crude to the market. (…)
“The Saudis remain the key factor in dictating the eventual price of crude,” said Mark Thomas, head of European energy at Marex Spectron, the commodities broker. He added that investors ultimately needed to “listen to and watch carefully Saudi price guidance”.
Fittingly, gold has experienced a “golden cross” today, which is a technical signal that occurs when the 50-day moving average crosses above the 200-day moving average as both moving averages are rising. Market technicians use the “golden cross” as a bullish indicator, but has it historically been bullish for gold?
MasterCard warns at an investor meeting that second-half revenue growth will come in lower than the pace it saw in Q2. The core of the problem could be that it sees worldwide processed transaction growth falling to 24.9%, down from its previous pace of 29.3%. The company also cites foreign exchange as a headwind, forecasting a 5-6 ppt negative effect in Q3 and 3-4 ppt in Q4. (webcast, slides) (SA)
Mantega says Fed could restart ‘currency wars’
Guido Mantega, Brazil’s finance minister, has warned that the US Federal Reserve’s “protectionist” move to roll out more quantitative easing will reignite the currency wars with potentially drastic consequences for the rest of the world. (…)
He cited Japan’s decision this week to expand its own QE programme, coming on the heels of the Fed’s decision to launch further QE last week, as evidence of growing global tensions. “That’s a currency war,” he said. (…)
“I would say today the currency is at a reasonable value, still overvalued against a basket of Brazil’s trading partners, but at current levels [it is] helping make Brazilian companies more competitive.” (…)
“The US, Europe and the UK are more protectionist than Brazil,” he said.
Companies are in a rush to lock in as much long-term debt as they can
They have sold more than $100bn of 30-year investment-grade corporate debt in the US so far this year, on pace for an annual record. Average yields on long-term corporate bonds are at 4.5 per cent, according to a Barclays index. (…)
But even if the debt is issued by a rock-solid company, this is a risky bet on interest rates. Remember the bond maths. Novartis this week sold 30-year bonds that pay a fixed 3.7 per cent; they are trading at almost $102.
If interest rates on equivalent bonds rise just 2 percentage points in five years’ time – well within historical ranges – the bond price will fall to about $75. Want to get par back? See you in 2042. (…)
Underfunded pension managers who lock in low yields will struggle to boost returns and close the funding gap when rates rise. Paper losses will be crystallised for mutual fund investors if the funds’ shareholders get spooked and start selling, which would force the manager to sell bonds at a loss. (…)
With bond yields shrinking, many mutual funds have found a way to look better: Invest in riskier bonds but continue to measure the funds’ performance against benchmarks composed of safer investments.
Benchmarks are the main tool investors use to measure mutual funds’ performance. But bond funds are free to choose—and change—their benchmarks.
HIGH YIELD SPREADS VS CAPACITY UTILIZATION
Here’s Moody’s take on high yield spreads. I am not sure about the “positive outlook for capacity utilization” however.
During the previous recovery, capacity utilization peaked at 80.8% in April 2007 and corporate credit spreads bottomed soon thereafter. Similarly, in the 1990-2000 business cycle upturn, the capacity utilization rate peaked at the 84.9% of November 1997, which was close to September 1997’s cycle bottom for the high yield bond spread.
Given the positive outlook for capacity utilization, the recent 528 bp spread of high yield bonds seems wide. However, seemingly excessive caution is warranted by above average macro and political risks. In addition, some question the sustainability of a now record low 6.2% composite speculative grade bond yield if only because of its exceptionally low benchmark Treasury yield. Nevertheless, the expected containment of inflation and the likelihood of subpar economic growth weigh against sharply higher Treasury yields.
BTW, Markit on its recent U.S. PMI:
The US remained something of a bright spot, with the PMI unchanged on its August reading of 51.5. However, the PMI remains well below levels seen earlier in the year and the ongoing sluggish pace of expansion meant the manufacturing sector saw the worst performance for three years over the third quarter as a whole. Moreover, the output sub-index of the PMI fell to its lowest since September 2009 pointing to a near-stagnation of production.
THE FISCAL CLIFF DETAILED (Moody’s)
(…) The following important measures go into effect at the beginning of calendar 2013 under existing law. Because the fiscal year begins on 1 October, the changes will affect only three quarters of the 2013 fiscal year.
1. Individual income tax rates will rise for ordinary income, capital gains, and dividends. In addition, certain tax credits will shrink and the alternative minimum tax (AMT) will affect a larger number of taxpayers. The Congressional Budget Office (CBO) estimates that total revenue from individual income taxes will rise from 7.2% of GDP in fiscal 2012 (which ends 30 September) to 9.0% in 2013 and 9.4% in 2014, the first full fiscal year the new tax levels would be in effect.
2. The Social Security payroll tax paid by employees will rise from 4.2% of income to 6.2% (on income up to $110,100), resulting in total social insurance taxes (also including Medicare) going from 5.5% of GDP in 2012 to 6.0% in 2013 and 6.2% in 2014.
Primarily because of these two tax increases, but also due to a number of smaller measures, the CBO estimates that total government revenue will rise from 15.7% of GDP in 2012 to 18.4% in 2013 and 19.6% in 2014, a rise of about 4% of GDP in just two years.
3. An automatic reduction in discretionary spending in 2013 and a cap on spending growth thereafter that were included in the Budget Control Act of August 2011 will, together with other measures including a reduction in payments to physicians for Medicare and the expiry of extended unemployment benefits, result in total spending falling from 22.9% of GDP in 2012 to 22.4% in 2013 and 21.9% in 2014.
The steep increase in revenues and the spending reductions/caps, if actually implemented, would result in the budget deficit falling from 7.3% of GDP in fiscal 2012 to 4.0% in 2013 and only 2.4% in 2014. The 4.9% reduction in the deficit over two years would be unprecedented since the end of the Second World War and is what has been referred to as the “fiscal cliff.” It would result in government debt as a percentage of GDP peaking in 2014 and declining thereafter. The economic effect of this fiscal scenario would be a recession, with the CBO estimating a drop of 0.3% in real GDP during calendar 2013.
GOOD QUOTE via Raymond James’ Jeffery Saut:
“Everyone kept saying ‘a top is not in place yet.’ They persistently pointed to the ‘normally reached’ levels of this or that statistic that were not yet there to reinforce their desire to remain bullish. … Apart from statistical measures of increasing blindness, this unwillingness to acknowledge what they themselves were already feeling revealed a comfortableness, a confidence, a conviction that whatever was happening – short-term survivable dips – would continue … until ‘the top,’ like a strip tease artiste of our youth would with decorum appear on stage, bow, and then, accompanied by applause from all the bulls eager to cash in on their excitement, would begin to twirl its statistical tassels in front of everyone.
I’ve gotten so old I can’t remember the names of those ladies at the Old Howard, but I can remember that all you got was a flash of this or that, before they waltzed off. Stock market tops are like that. You know it’s there somewhere if you squint hard enough, but you never quite see it, so you keep waiting for more. And then, in the end, as the curtain comes down on the bull market you realize that the one rule about tops is not that they provide this or that signal, but that they come before anyone is ready.”
… Justin Mamis