Wednesday, August 17, 2011

Today's links

1--German Stocks Drop After Merkel, Sarkozy Meet; Infineon Falls, Bloomberg

Excerpt: German stocks dropped after Chancellor Angela Merkel and French President Nicolas Sarkozy rejected a broadening of Europe’s rescue fund and calls for joint euro borrowing.

Deutsche Boerse AG (DB1) led declines, falling 6.8 percent as the leaders resurrected plans for a financial transaction tax rejected by the European Union in 2010. Deutsche Bank AG (DBK), Germany’s biggest lender, fell 2.3 percent. Infineon Technologies AG (IFX) slid after Morgan Stanley lowered its recommendation on the industry and Dell Inc. cut a forecast.
“Most market participants weren’t expecting the meeting to yield any significant progress on the debt crisis but they also weren’t expecting the idea of a financial transaction tax to resurface either,” Jonathan Sudaria, a dealer at London Capital Group, wrote. “The punitive measure is only likely further to hurt the financial sector.”...

Harmonized Tax Rates
Merkel and Sarkozy agreed to press for closer euro-area cooperation, tougher deficit rules and a harmonization of their corporate tax rates. A plan to resubmit a financial-transaction tax, which the European Union rejected in 2010, sent stocks lower in New York trading.

2--More Student Loans Are Past Due, Wall Street Journal

Excerpt: On Monday Real Time Economics noted that since the depths of the recession the only type of credit to notch growth was student loans. Credit to students also stands out when looking at delinquency rates.

In the second quarter, 11.2% of student loans were more than 90 days past due and the rate was steadily rising, according to data from the Federal Reserve Bank of New York. Only credit cards had a higher rate of delinquency — 12.2% — but those numbers have been on a steady decline for the past four quarters.

Younger workers have continued to face the most difficult conditions in the labor market. Workers between 20 and 24 years old have a 14.6% unemployment rate, compared to the national average of 9.1% recorded in July. That comes even as the share of 20- to 24-year-olds that are working or looking for a job is at the lowest level since the 1970s, before women entered the labor force en masse.

3--August 2011 World Bank Report Shows Food Price Index Up 33% Over a Year Ago, Big Picture Agriculture

Excerpt: The World Bank came out with an updated report on global food prices and stocks. The following is taken from their August 2011 Food Price Watch report:

Food Price Trends

Global food prices in July 2011 remain significantly higher than their levels in July 2010. On average, the World Bank Food Price Index remains 33 percent above its level a year ago. Similarly, price levels of a number of major commodities are higher than their levels in July last year, for example, maize (84 percent), sugar (62 percent), wheat (55 percent), and soybean oil (47 percent). Crude oil prices remain 45 percent higher than a year ago and the price of fertilizers increased by 67 percent over the same period.

4--Hoover reversed the Depression, until hit by bad luck from Europe, The Money Illusion

Excerpt: Herbert Hoover succeeded in reversing the Depression during early 1931. During the first 4 months of 1931, industrial production in the US rose slightly, after plunging sharply throughout 1930. Then bad luck hit. The German-Austrian agreement of late March poisoned relations with France. Then the Austrian bank Kreditanstalt failed in May. Then German banks came under pressure, then the German currency. Then the British currency. The crisis kept moving from one country to another. People sought gold as a safe haven, and the value (or purchasing power) of gold increased. More deflation set in. The severe recession of 1930 turned into the Great Contraction.

Here’s Obama yesterday:

At a town hall meeting on his campaign-style tour of the Midwest, President Obama claimed that his economic program “reversed the recession” until recovery was frustrated by events overseas.

Hoover wasn’t able to print gold, but can be blamed for supporting the Fed’s tight money policies. Obama can’t print dollars, but can be blamed for not moving aggressively to put people at the Fed who understand the need for more dollars.

5--Credit Market Indicators Suggest Darker Days Ahead, Wall Street Journal

Excerpt: Hate to follow up one downbeat post with another, but I have to mention a note from Mike Darda at MKM Partners today pointing out that the credit market is still singing a very different tune than the cheery stock market.

First, a note about Mr. Darda. He is not a perma-bear. Going back to the crisis, he has consistently done a good job in sussing out the direction of the market and economy, both higher and lower, by following credit-market indicators.

He warned ahead of the crash in 2008 that things were about to get ugly, and he pivoted with near-perfect timing to bullishness in March 2009.

He maintained that bullishness throughout 2009 and much of 2010, but warned that 2011 would be a tougher year.

Sure enough, it has indeed been a tough year, and unfortunately, according to the indicators Mr. Darda is watching, it could get tougher still:

Although some recent data releases have come in better than expected (jobless claims, retail sales), we believe these could be misleading, given the abrupt tightening in financial conditions and the associated spike in equity volatility.

Here are the indicators on his dashboard flashing red:

The Bloomberg Financial Conditions Index has fallen sharply in recent weeks and remains at levels consistent with soft economic conditions going forward.

High yield spreads, which have risen to 438 bps from 151 bps in February, lead year-ahead earnings estimates for the S&P 500 by three to six months and now suggest more than 30% downside to analysts’ earnings expectations for the next year.

And the large spike in volatility this year suggests this spread-widening may not have run its course, meaning the magnitude of the appropriate downward adjustment to forward earnings estimates may be a moving or,perhaps more appropriately, falling target. Thus, we would continue to sell any rally in cyclical equity sectors and focus long positions on areas better able to weather a slow growth/recessionary storm, such as utilities and consumer staples.

The FRA/OIS spread, which is based on forward expectations for LIBOR/OIS settings, has worked its way up to 40+ bps from about 15 bps in early April. This spread (along with the VIX Index) tends to lead corporate bond spreads.

At the same time, the 2yr/10yr term spread has collapsed to 209 bps from a 289 bps peak in February (the spread briefly fell to 192 bps this week before recovering some ground yesterday). … The collapse in the spread from February onward suggests deep pessimism about future growth prospects. Remember, Japan slipped into recession in 1997 when its 2yr/10yr spread fell to 175 bps. Flatter term structures and wider credit spreads point to slower, not faster, growth.

While many of the clients we interact with appear to believe that the equity and credit market environment resembles 2010, we believe the outlook is much more precarious now.

6--MONEY MARKETS-No quick fix seen to money market stress, Reuters

Excerpt: Latest bout of funding worries to keep interbank lending low

- The stress affecting the interbank lending market looks set to remain high in the medium term, analysts said on Tuesday, with the rapid deterioration in funding conditions seen in recent weeks set to hamper markets for months to come.

As worries over the health of euro zone sovereigns have spiralled, stress indicators in the vital short-term lending markets increasingly point to a dwindling appetite to lend between banks, creating the extra effect of spooking overseas lenders.

Markets show stress has edged back from its worst levels but the impact on sentiment and effects of increased dependence on long-term emergency loans from the European Central Bank mean a return to freer lending between banks will be slow in coming.

n response to a rapid worsening of the sovereign debt crisis which threatened to envelop Italy and Spain, the ECB backtracked on attempts to withdraw banking sector support and offered an unlimited amount of six-month loans.

"Without the ECB liquidity facilities I think we would have had a situation similar to that before Lehman Brothers collapsed -- no trust between banks and no interbank lending," said Barclays Capital strategist Giuseppe Maraffino.

The ECB's emergency six-month buffer attracted 50 billion euros of bids from banks struggling to find long-term funding elsewhere, helping to prevent a full-scale funding squeeze while artificially lowering interbank rates and distorting money markets....

"I expect several more months of still abundant liquidity and money market operation to remain far from normal... Now, the starting point for a normalisation has to be a solution to the sovereign crisis," Maraffino said.

Despite lower outright interbank rates, indicators such as the euro Libor/OIS spread, which shows the market valuation of counterparty risk, have more than doubled since late July. On Tuesday the spread eased to a still-elevated 58 basis points from a peak of above 60 bps.

Analysts said a long-term solution to the sovereign crisis, which hits trust between banks because of their large holdings of government bonds, ultimately relied on solid economic growth -- something unlikely to materialise in the near term.

"If it does end up looking like we're heading for a recession in the developed indebted markets -- the U.S., the UK and the more core euro zone markets -- then that's something that would be pretty dire for the money market situation," said Simon Smith, chief economist at FXPro in London.


While ECB cash insulated the impact of reduced access to euros on the interbank market, signs that U.S. money market funds were cutting short-term lending to euro zone banks have pushed up the cost of raising dollars using cross-currency basis swaps.

7--Credit taps run dry for European banks, International Finance Review

Excerpt: Options are rapidly running out for Europe’s ailing mid-tier banks as nervous creditors pull the plug on once-vital sources of funding in response to growing sovereign contagion worries, sowing the seeds of an imminent liquidity crisis at the heart of the eurozone.

With bond markets shut and investors unwilling to buy asset-backed securities, the repo market – for some banks the sole remaining source of private funding – has become the most recent tap to run dry, with some investment banks pulling credit lines worth tens of billions of euros in recent weeks.

Bankers who once ran the now-defunct repo facilities for medium-sized European banks say the credit lines were withdrawn after risk managers became concerned about their own exposure to the unfolding sovereign debt crisis, leaving some clients now solely reliant on central banks for cash.

“Given what’s going on in the markets, there are big question marks surrounding some of these clients,” said one banker who has closed such lines. “The appetite from investment banks is fading. There is a great deal of concern about financing wrong-way collateral.”...

“Many of the wholesale banks are starting to rethink these credit lines,” added the global markets chief of one European investment bank heavily present in the repo markets. “Things can turn pretty nasty if you get these things wrong.”

The funding drought is all the more dramatic given that it’s only a few weeks since most European lenders were comfortably able to raise funds in markets. Covered bond issuance has been particularly popular, with Italian banks selling €11.9bn of the securities so far this year and Spanish banks €18.2bn.

Markets closed

However, there has not been a single publicly announced European covered bond deal since June, and other parts of the bond markets also remain closed to most. That could create a strain on the finances of banks that need to raise cash to pay maturing debts.

According to the European Banking Authority, the region’s banks have €4.8trn of wholesale and interbank funding expiring this year and next.

The closure of traditional credit lines is a clear sign that concern about European sovereign debt has infected the region’s banks. Many in the region are big holders of the debt of their respective governments. According to the EBA stress tests published in July, the 90 banks it surveyed held a total of €326bn in Italian government debt, €287bn of Spanish public debt, and €215bn of French debt.

“Everyone has been cutting their exposure,” said the head of another European investment bank. “It started with Greece, then Spain and now Italy. People don’t want to do business with these banks. Many of them have good underlying businesses, but they are stuffed.”

Before recent developments, repo markets were steadily gaining importance for banks. The facilities, financial market equivalents of pawn shops, which allow banks to borrow against collateral for specific periods, helped many firms to generate cash out of assets sitting on banks’ balance sheets....

Financial detritus

For many, the European Central Bank is now the last remaining source of liquidity. Under its open market operations – brought in during the depths of the crisis to pump liquidity into the region’s banks – its member central banks provide unlimited repo financing against certain eligible assets.

Demand for that money has been picking up of late, as banks feel the squeeze of dry private credit lines. Earlier this week, the Italian central bank said lenders asked for €80.5bn of liquidity during July, almost double what it had provided only a month earlier, in a sign of banks’ deteriorating finances.

Total use of the ECB’s main refinancing and long-term refinancing facilities – both part of the open market operations – are now close to €500bn, up from about €400bn in the spring...

If ECB eligible collateral runs out, banks will have little option but to sell off assets in a final fire sale, say bankers. That will depend on whether there are willing buyers for such assets, much of which were accumulated pre-2007 as retail, commercial and wholesale loans.

“The financial wreckage at many of these banks is along the lines of World War Two,” added the global markets chief. “There is so much detritus. But a lot of them don’t want to sell at these current prices: they know there will be a capital hit if things are properly priced.”

8--President Weighs Asking Panel for Stimulus Measures, Wall Street Journal

Excerpt: President Barack Obama is considering recommending that lawmakers on a deficit committee back new measures to stimulate the lagging economy, people familiar with White House discussions said Tuesday.

The plan Mr. Obama is considering also would recommend the congressional committee come up with a package that reduces the federal budget deficit by much more that its mandate of $1.5 trillion over the next decade, a senior administration official said, through changes in the tax code and social safety-net programs.

"There's no reason to stop at $1.5 trillion," the official said.

Mr. Obama hasn't agreed to a set of proposals, people familiar with the discussions said, but the White House will begin to decide on elements of the plan in coming days. Mr. Obama is expected to make some decisions by Thursday.

Mr. Obama said in Iowa that when Congress returns from recess in September he will put forward "a very specific plan to boost the economy, to create jobs, and to control our deficit." He will unveil his plan before the Joint Select Committee on Deficit Reduction's first meeting on Sept. 16.

The White House is looking for ways to boost the sluggish economy and bring down unemployment that is now stuck above 9%. Mr. Obama, facing re-election next year, has been pushing Congress for months to adopt a variety of stimulus measures, some of which he could urge the committee to embrace. These include extending unemployment-insurance benefits and a payroll-tax cut for employees, which expire at year end and together cost more than $160 billion a year, and an infrastructure bank that could cost as much as $30 billion. The White House is also looking at a payroll-tax cut for employers, worth perhaps as much as roughly $110 billion, and other tax breaks for businesses of as much as $55 billion.

Mr. Obama's recommendations could complicate the committee's task because the stimulus measures, by increasing government spending and reducing revenue, would worsen the deficit in the short term. But Mr. Obama would recommend ways to offset those effects, and the whole package would still reduce the deficit over 10 years.

9--El-Erian: What to make of the Franco-German Summit, FT. Alphaville

Excerpt: Judging from the press conference, France has now aligned itself with a Germany that is increasingly, and effectively, asserting itself on the Eurozone. Assuming full implementation of this joint agreement, and that is far from certain, the Eurozone that emerges down the road will be better integrated, more fiscally disciplined and, possibly, smaller in size.

The message from Germany and France is clear: progress towards budget balance and better economic governance must come before additional cheque writings, Eurobonds and other financial engineering aimed at bailing out profligate peripheral economies.

It is not surprising that Germany is pushing this line. The fact that France is endorsing it so strongly is much more of a surprise. I suspect it reflects the loud alarm bells associated with last week’s market debacle.

Peripheral economies will not be thrilled with this outcome. They must now press ahead even more forcefully with fiscal austerity, and they will be asked to adhere to a “golden rule” that would hardwire stronger fiscal discipline.

With so many markets having priced in more German cheque writing, equity markets will likely come under immediate pressure, German and US bonds will likely rally initially, and peripheral credit spreads will likely widen.

10--How Federal Spending Affects Aggregate Demand for Goods and Services, CBO

Excerpt: As the recent severe recession and slow recovery are showing, economic activity
can deviate for substantial periods from its potential level in response to changes
in aggregate demand (the total purchases of a country’s output of goods and
services by consumers, businesses, governments, and foreigners). When demand
for goods and services falls short of the economy’s ability to produce them, as is
the case currently, increasing government spending can increase aggregate
demand and thereby narrow the gap between the economy’s actual and potential
levels of output....

changes in government purchases and transfers create demand-side
effects that are usually only temporary: They raise or lower output relative to
what it would be otherwise only for a while because, over time, stabilizing forces
in the economy (such as the responses of prices and interest rates and actions by
the Federal Reserve) tend to move output back toward its potential.
A recent analysis by the Congressional Budget Office (CBO) of an illustrative
deficit reduction plan (without any particular changes in spending or revenues
specified) provides a very rough indication of the magnitude of the economic
effects of cuts in government spending under current economic conditions.

In that analysis, CBO estimated the short-term and longer-term effects of reducing
the primary deficit (the budget deficit excluding net interest) by $100 billion in
2012 and by amounts increasing gradually to $300 billion by 2021. CBO
estimated that the illustrative plan would decrease real (inflation-adjusted) gross
national product (GNP) in 2012, 2013, and 2014 by amounts ranging from
roughly 0.1 percent to 0.6 percent depending on the year and the assumptions

How Federal Spending Affects the Nation’s Potential Output
Over the long run, the nation’s potential to produce goods and services depends
on the size and quality of its labor force, on the stock of productive capital (such
as factories, vehicles, and computers), and on the efficiency with which labor and
capital are used to produce goods and services...

the federal government’s budgetary policies affect potential output
primarily by affecting the amount of national saving and the incentives for
individuals and businesses to work, save, and invest. The nation’s capital stock
depends both on public saving (the surpluses, if any, of state and local
governments and the federal government) and on private saving (by households
and businesses). A federal deficit represents a reduction in public saving and,
therefore, in national saving. An overall decline in national saving reduces the
capital stock owned by U.S. citizens over time through a decrease in domestic
investment, an increase in net borrowing from abroad, or both....

Specific spending policies can also influence the economy’s potential output in
other ways. Some types of spending, such as funding for improvements to roads
and highways, may add to the economy’s potential output in much the same way
that private capital investment does. Other policies, such as funding for grants to
increase access to college education, may raise long-term productivity by
enhancing people’s skills. The positive longer-term impact of deficit reduction on
GNP would be smaller if the policies that reduced deficits included cuts in
productive government investment...

On a more fundamental level, the government provides a crucial role in
maintaining the legal and institutional framework within which the economy

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