Tuesday, November 29, 2011

Today's links

1--Another Asian Wake-Up Call, Stephen S. Roach, Project Syndicate

Excerpt: Never before has America, the world’s biggest consumer, been so weak for so long. Until US households make greater progress in reducing excessive debt loads and rebuilding personal savings – a process that could take many more years if it continues at its recent snail-like pace – a balance-sheet-constrained US economy will remain hobbled by exceedingly slow growth.

A comparable outcome is likely in Europe. Even under the now seemingly heroic assumption that the eurozone will survive, the outlook for the European economy is bleak. The crisis-torn peripheral economies – Greece, Ireland, Portugal, Italy, and even Spain – are already in recession. And economic growth is threatened in the once-solid core of Germany and France, with leading indicators – especially sharply declining German orders data – flashing ominous signs of incipient weakness.

Moreover, with fiscal austerity likely to restrain aggregate demand in the years ahead, and with capital-short banks likely to curtail lending – a serious problem for Europe’s bank-centric system of credit intermediation – a pan-European recession seems inevitable. The European Commission recently slashed its 2012 GDP growth forecast to 0.5% – teetering on the brink of outright recession. The risks of further cuts to the official outlook are high and rising.

It is difficult to see how Asia can remain an oasis of prosperity in such a tough global climate. Yet denial is deep, and momentum is seductive. After all, Asia has been on such a roll in recent years that far too many believe that the region can shrug off almost anything that the rest of the world dishes out....

China – long the engine of the all-powerful Asian growth machine – typifies Asia’s potential vulnerability to such shocks from the developed economies. Indeed, Europe and the US, combined, accounted for fully 38% of total Chinese exports in 2010 – easily its two largest foreign markets.

The recent data leave little doubt that Asia is now starting to feel the impact of the latest global shock. As was the case three years ago, China is leading the way, with annual export growth plummeting in October 2011, to 16%, from 31% in October 2010 – and likely to slow further in coming months.

In Hong Kong, exports actually contracted by 3% in September – the first year-on-year decline in 23 months. Similar trends are evident in sharply decelerating exports in Korea and Taiwan. Even in India – long thought to be among Asia’s most shock-resistant economies – annual export growth plunged from 44% in August 2011 to just 11% in October.

2--Europe’s grand bargain, FT Alphaville

Excerpt: Published in September, the authors of this Occasional Paper, who include Jurgen Stark, spell out their ideas for the future of widely abused Stability and Growth Pact.....

1. All planned deficits in excess of 3 per cent of GDP should require unanimous approval across euro area governments. All planned deficits in excess of a country’s medium term objective (but less than 3 per cent of GDP) have to be approved by qualified majority.

2. A commitment to correct past fiscal slippages with essentially no room for discretion: countries to adopt national “debt brake” rules.

3. A country requiring assistance under the ESM is placed in financial receivership if its adjustment programme fails to remain on track, with the planning and execution of budgets requiring the agreement of the appointed financial receiver. This is necessary “where countries have no political consensus in support of reforms” to mitigate risks of countries failing to comply or defaulting.

4. Automatic fines and sanctions upon breach of the 3 per cent deficit limit.

5. All national countries introduce an independent budget office to produce budgetary forecasts, create an independent entity at European level to monitor national policies and administer ESM programmes.

3--European banks' asset sales face disastrous failure, IFR

Excerpt: European banks are being forced to abandon their efforts to sell off trillions of euros worth of loans, mortgages and real estate after a series of talks with potential investors broke down, leaving many already struggling firms with piles of assets they can barely support.

Lenders have instead turned their attention to reducing the burden of carrying such assets over months and years, with many looking at popular pre-crisis “capital alchemy” arrangements to minimise capital requirements and boost their ability to use the assets to tap central banks for cash.

Deadlocked talks with potential buyers – a mix of private equity firms, hedge funds, foreign banks and insurers – show little sign of making breakthroughs, say bankers taking part in those negotiations, with the stalemate threatening to block the industry’s ability to save itself from collapse through a mass deleveraging.

“European banks have spent far too long saying everything is fine, when it really isn’t,” said one banker at a US bank who has been advising European clients on their options. “They are slowly realising that they just won’t be able to do what the market is expecting. We are edging slowly closer to the depths of the crisis.”

Some of Europe’s largest banks, including BNP Paribas and Societe Generale, have in recent weeks pledged to sell assets. Together, firms are expected to shrink their balance sheets by as much as €5trn over the next three years – equivalent to about 20% of the region’s total annual economic output – through a combination of sales, asset run-off and recapitalisations.

Draconian measures

A funding squeeze has prompted the Draconian measures. Since the summer, most banks have been unable to tap traditional sources such as unsecured bond markets. As old debts come due – some €1.7trn will roll over in the next three years alone – banks need to find cash to avoid bankruptcy.

“Banks are feeling pain on both sides of the balance sheet,” said Alberto Gallo, head of European credit strategy at RBS. “On the one side you have a funding squeeze with banks unable to raise cash in the capital markets. At the same time, many of the assets they hold are deteriorating in quality.”

“Banks need to reduce their balance sheets as much as €5trn in assets over the next three years or so,” he added. “The problem is that there just aren’t enough buyers. Most banks will be forced to hold on to much of this stuff to maturity, which will affect their ability to lend and impact on the real economy.”

People involved in asset sale talks say price is the major sticking point. Lenders want only to sell higher-quality assets near to par value so as to avoid huge write-downs, which would erode capital further. By contrast, potential buyers want high-yielding investments and are offering only knock-down prices.

“There is a huge amount of liquidity among investors right now, but they only want to buy at distressed prices,” said Stefano Marsaglia, a chairman within the financial institutions group at Barclays Capital. “Lots of discussions are taking place but there is a gulf in terms of pricing.”...

There is also a vast overhang of unsold assets from the initial part of the crisis. Many banks such as Commerzbank, RBS, WestLB and even the Irish government set up legacy units – or bad banks – that were charged with winding down and selling those assets. That process is still ongoing.

Without the cash that would have been generated through outright asset sales, struggling European banks are now looking at alternative levers. The problem is that traditional options such as issuing equity, increasing deposits or consolidation just aren’t feasible.

That has prompted banks to turn to more creative solutions, with some now looking at what one banker termed as pre-crisis “capital alchemy” arrangements to reduce capital needs. Such methods can also in some cases make assets which banks hold to maturity eligible for ECB repo operations.

Securitisation is at the heart of such arrangements. Assets with low ratings are pooled together into diversified portfolios in order to attain a higher rating. The resulting asset requires less cash and as a result of the higher rating can be more readily pledged to the ECB or to other banks to borrow against...

Still, the practice is not a panacea to banks’ asset and liability problems. Although it can open the door to using ECB repo facilities by making collateral meet strict eligibility criteria, assets pledged are still subject to a haircut, meaning banks cannot borrow enough to fund the asset in question.

Use of the facility is surging, nevertheless. ECB lending to banks spiralled this week, with 178 lenders requesting €247bn in one-week loans, the highest in two years. Bankers warn that if banks are unable to sell assets, the ECB will have to play a much bigger role in funding banks.

“Natural deleveraging through not renewing loans is one of the few options remaining to banks to shrink their balance sheets, but the timetable for implementing this kind of strategy can be very protracted,” said Ryan O’Grady, head of fixed income syndicate for EMEA at JP Morgan.

4--A Minsky moment in the eurozone?, FT Alphaville

Excerpt: Named after the economist Hyman Minsky, the phrase describes a situation where investors who have borrowed too much are forced to sell even good assets to pay back their loans.....

Financial institutions sometimes have to sell their stronger assets rather than their lower-quality assets since these can provide greater liquidity and may enable the booking of a profit. This partly explains why Bunds have encountered recent selling pressure which has limited their value as a safehaven asset. Similarly, the European AAA supras market has seen a notable blow-out in spreads and decline in market liquidity as investors look to exit positions and as banks have limited ability to warehouse risk...

Hence the question is: are Bunds experiencing downwards price pressure because they are now perceived as more risky?... Or, are they experiencing price pressure because some investors are selling them in order to bolster their cash holdings, given the very high price that can be obtained?...

Unable to tackle the numerator of the capital ratio, banks are by necessity taking aim at the denominator and shrinking assets....

And of course, one of the most natural forms of delevaging is to not extend new loans in the first place.

In this febrile environment, beware the looming presence of a potential tipping point in bond auctions, Nomura says:

A few failed bond auctions away from region-wide dual equilibrium?

Given the combination of an asymmetry of risk and bank deleveraging, forthcoming semi-core bond auctions comprise event risks. One can easily build a scenario whereby an adverse series of events results in a marked increase in the risks of a euro break-up: a failed bond auction or sequence of failed bond auctions in a semi-core country could result in banks residing in that country facing a withdrawal of liquidity and deterioration in counterparty relationships. This dynamic is critical to understand, since governments rarely choose to break currency pegs or FX arrangements, but rather they tend to be forced to do so through market pressure and runs on liquidity. Under this scenario, the risk asymmetry would be magnified, and the runs on liquidity would risk broadening to other markets and countries. It would be difficult to predict the nature of any such break-up or the composition of any slimmed-down-euro” since it would be highly unlikely that one country would face these pressures in isolation.

5--Retail sales fall at fastest pace since March - CBI, Telegraph

Excerpt: High street sales have fallen at their fastest rate in almost three years as the household squeeze continued to take its toll on retailers, raising fresh fears about the recovery, according to research by the CBI.

The scale of decline in annual sales growth for November was far more severe than expected, at minus 19, and far worse than the minus 11 recorded in October, the CBI’s Distributive Trades Survey showed. It was the lowest recording since March 2009. ...

The latest survey follows other bleak data. This month, the Nationwide Building Society revealed that consumer confidence had fallen to a record low in October.

6--Should the Fed save Europe from disaster?, Telegraph

Excerpt: The dam is breaking in Europe. Interbank lending has seized up. Much of the financial system is paralysed, setting off a credit crunch just as Euroland slides back into slump

The Euribor/OIS spread or`fear gauge’ is flashing red warning signals. Dollar funding costs in Europe have spiked to Lehman-crisis levels, leaving lenders struggling frantically to cover their $2 trillion (£1.3 trillion) funding gap.

America’s money markets are no longer willing to lend to over-leveraged Euroland banks, or only on drastically short maturities below seven days. Exposure to French banks has been slashed by 69pc since May.

Italy faces a “sudden stop” in funding, forced to pay 6.5pc on Friday for six-month money, despite the technocrat take-over in Rome....

Unless Germany agrees to the full mobilization of the European Central Bank very fast, the eurozone will spiral out of control. As The Economist put it, “The risk that the currency disintegrates within weeks is alarmingly high.”...

If break-up occurs in a disorderly fashion, with Club Med states and Ireland spun into oblivion one by one, the chain reaction will cause an implosion of Europe’s €31 trillion banking nexus (S&P estimate), the world’s biggest and most leveraged. This in turn risks an almighty global crash – first class passengers included.

7--Fed will buy more mortgage securities, Housingwire

Excerpt: A third round of economic stimulus based on the Fed's consumption of mortgage securities could be right around the corner. In its 2012 Securitized Products Outlook report, JPMorgan (JPM: 28.48 0.00%) suggested there is a wild card on the table—namely "QE3 in mortgages."

That prediction was backed up by two bond dealers interviewed by BusinessWeek over the weekend. According to the BusinessWeek article, the dealers expect the Federal Reserve to begin a new round of economic stimulus by buying up mortgage securities instead of Treasuries.

French investment bank Société Générale believes a third round of quantitative easing from the Federal Reserve will be announced in January. The buying, they expect, will begin soon after in March....

When looking at just non-agency residential mortgage-backed securities, the report says "market volatility, lack of liquidity and stagnant fundamentals" will remain drags on the entire segment in 2012. In non-agency residential mortgage-backed securities, the authors also noted slowing activity on the modification front. "We continue to recommend fixed-rates and select seasoned hybrids," the report said.

8--The recovery in the OECD area has now slowed to a crawl, Pragmatic Capitalism

Excerpt: The OECD’s latest economic outlook provides a very nice summary of global events:

“The recovery in the OECD area has now slowed to a crawl, notwithstanding a short-lived rebound from the restoration of global supply chains disrupted by the Japanese earthquake and its aftermath. Emerging market output growth has also continued to soften, reflecting the impact of past domestic monetary policy tightening, sluggish external demand and high inflation. Against this background, the protracted fiscal-policy discussions in the United States and the deepening euro area crisis have highlighted the role of destabilising events and policies as well as the reduced political and economic scope for macroeconomic policies to cushion economies against further adverse shocks. In turn, this has heightened risk awareness and uncertainty, with a corresponding drop in confidence, both in financial markets and in the non-financial private sector. Lower confidence will weigh on the global economy in the coming quarters....

Decisive policies must be urgently put in place to stop the euro area sovereign debt crisis from spreading and to put weakening global activity back on track, says the OECD’s latest Economic Outlook.

The euro area crisis remains the key risk to the world economy, the Outlook says. Concerns about sovereign debt sustainability are becoming increasingly widespread. If not addressed, recent contagion to countries thought to have relatively solid public finances could massively escalate economic disruption. Pressures on bank funding and balance sheets increase the risk of a credit crunch.

Another serious downside risk is that no action would be agreed to offset the large degree of fiscal tightening implied by current law in the United States. This could tip the economy into a recession that monetary policy could do little to counter.

“Prospects only improve if decisive action is taken quickly,” said OECD Chief Economist Pier Carlo Padoan. “In the euro area, the risk of contagion needs to be stemmed through a substantial increase in the capacity of the European Financial Stability Fund, together with a greater ability to call on the European Central Bank’s balance sheet. Much greater firepower must be accompanied by governance reforms to offset the risk of moral hazard,” he said.

9--Dollar Funding Costs Rise to 3-Year High in Euro Money Markets, Bloomberg

Excerpt: The cost for European banks to fund in dollars rose to the highest levels in three years, according to money-market indicators.

The three-month cross-currency basis swap, the rate banks pay to convert euro payments into dollars, was 148 basis points below the euro interbank offered rate at 11:53 a.m. in London, from minus 146 Nov. 25. The measure is the most expensive on a closing basis since October 2008.

The one-year basis swap was little changed at 100 basis points under Euribor, data compiled by Bloomberg show. A basis point is 0.01 percentage point.

A measure of banks’ reluctance to lend to one another in Europe was little changed. The Euribor-OIS spread, the difference between the borrowing benchmark and overnight index swaps, held at 93 basis points. The difference was 98 basis points on Nov. 3, the widest since March 2009.

Lenders increased overnight deposits at the European Central Bank, placing 256 billion euros ($342 billion) with the Frankfurt-based ECB on Nov. 25, up from 237 billion euros the previous day. That compares with a year-to-date average of 78 billion euros.

Three-month Euribor, the rate banks say they pay for three- month loans in euros, rose to 1.477 percent from 1.475 percent on Nov. 25. One-week Euribor fell to 0.909 percent from 0.911 percent on Nov. 25.

The dollar London interbank offered rate, or Libor, for three-month dollar loans rose to 0.523 percent from 0.518 on Nov. 25, data from the British Bankers’ Association showed. That’s the highest level since July 15, 2010.

No comments:

Post a Comment