Tuesday, February 14, 2012

Today's links

1--Japan economy shrinks more than expected in Q4, weak, Reuters

Excerpt: Japan's economy shrank a bigger-than-expected 0.6 percent in October-December, hurt by slowing global growth, Thai floods and a strong yen, casting doubt about expectations that growth will resume this quarter as Europe's debt crisis clouds the outlook.

Domestic demand also weakened in a worrying sign that the economic boost from rebuilding the country's earthquake-devastated northeast coast is slow to materialize.

Japan's fourth contraction in five quarters pushed economic output for the whole of 2011 down 0.9 percent, marking the first calendar year contraction since the global financial crisis in 2009.

The weak reading could add to mounting political pressures on the Bank of Japan to ease policy further to shore up the world's third-largest economy with policymakers grappling with persistent deflation and a strong yen....

The contraction was largely caused by a slump in exports, and the economy is likely to remain in a soft patch through the first half of this year as exports struggle, capital spending slows and implementation of public works is delayed," said Yoshiki Shinke, senior economist at Dai-Ichi Life Research Institute.

2-- The morning after, Athens News

Excerpt: Athenians swept rocks and broken glass from the streets of their city on Monday after a night of violence that gave MPs a taste of the challenge they face in implementing a deeply unpopular austerity bill demanded by the troika.

Firefighters doused the smouldering remains of several buildings, set ablaze by hooded youths during protests against the package of pay, pension and job cuts adopted by parliament just after midnight, on Monday morning, after 10 hours of debate.

The bill was the price of a 130bn euro EU/IMF bailout to save Greece from a chaotic default next month.

Prime Minister Lucas Papademos’s government must come up with a further 325m euros in budget savings to satisfy eurozone finance ministers, scheduled to meet on Wednesday, and political leaders must commit to implementing the measures even after an election pencilled in for April.

The government saw 43 deputies rebel in what may be an indication of the difficulties in ensuring politicians stick to the programme, which include a 22 percent cut in the minimum wage – a package critics say condemns the economy to an ever-deeper downward spiral.

Police said 150 shops were looted in the capital and 48 buildings set ablaze. Some 100 people – including 68 police – were wounded and 130 detained, a police official said on Monday.

There was also violence in cities across the country, including Thessaloniki and the islands of Corfu and Crete.

Athenians were shocked at the burnt buildings that included the neoclassical home to the Attikon cinema dating from 1870.

"We are all very angry with these measures but this is not the way out," said Dimitris Hatzichristos, 30, a public sector worker surveying the debris.

3--Moody's Downgrades Italy, Spain, Portugal And Others; Puts UK, France On Outlook Negative - Full Statement, zero hedge

Excerpt: You know there is a reason why Europe just came crawling with an advance handout looking for US assistance: Moody's just went apeshit on Europe.

Austria: outlook on Aaa rating changed to negative

France: outlook on Aaa rating changed to negative

Italy: downgraded to A3 from A2, negative outlook

Malta: downgraded to A3 from A2, negative outlook

Portugal: downgraded to Ba3 from Ba2, negative outlook

Slovakia: downgraded to A2 from A1, negative outlook

Slovenia: downgraded to A2 from A1, negative outlook

Spain: downgraded to A3 from A1, negative outlook

United Kingdom: outlook on Aaa rating changed to negative

4--Use of lower-rated debt in repos has returned to pre-crisis levels, credit writedowns

Excerpt: Looks like there’s a storm brewing in the U.S. repo markets.

It figures: profit-center banks have every motivation to stay one step ahead of the regs and the pols. Since the gamekeepers have now gotten around to looking at proprietary trading and bringing derivatives onto exchanges, you can almost bet your first-born that the next crisis will be in neither one of these areas but someplace else entirely different.

As Walter Kurtz describes so well on his Sober Look blog (emphasis added):

Tremendous leverage is in fact available via repo, a market far larger than CDS. The media often misses the fact that MF Global failed because of repo based leverage. And by the way so did Lehman and Bear Stearns and Merrill Lynch – all failed because they could not roll their repo loans. That’s why repo markets are of critical importance to the financial system and need to be well understood by policy makers. It’s amazing that a typical US politician knows more about the Kandahar Province in Afghanistan than what a repo transaction is.

On the most basic terms, a repo is a short-term collateralized loan. The borrowers are the big banks and broker dealers: JPMorgan Chase, Bank of America, Citigroup and others. They’ve got fixed income securities on hand (some theirs, some belonging to their clients.) They post these bonds to the lenders, who are usually mutual or money market funds, other asset managers and custodial banks.

The lenders provide cash in varying proportions to the collateral posted. If it’s a super-safe, super-dull bond like a U.S. Treasury then they’ll get close to one dollar in cash for every dollar’s worth of bonds that they offer up. If it’s a riskier bond then they’ll get far less. And if the bond goes down in value or gets downgraded by a ratings agency while the loan is still outstanding, then the lender will usually make the borrower post more collateral to reflect that increased risk. At the end of the agreed-upon term the lender gets its cash back, the borrower gets its securities back and all’s square.

If the collateral underlying a repo deteriorates, the lender calls for more security, and the borrower can’t provide it, then you could be looking at the start of a Lehman death spiral. These borrowers do everything in size, so it’s likely that they would have been using that same type of collateral all over town. They wouldn’t have just one lender hounding them to post more collateral, they’d have several. Even other kinds of counterparties who’ve got nothing to do with these trades might hear about it and start pulling back credit. And then the repo lenders themselves may become unable to honor their own obligations because of their exposure to the deadbeat borrowers. And so on, like a domino trail. Cue the apocalypse.

Now the lending funds who this brush with death were understandably gun-shy in the immediate aftermath of the crisis and, for a while, resolved to forego juicier returns and to stick to accepting only the safest, most highly rated stuff as collateral. But that’s now starting to change.

A report by Fitch Ratings says that the use of lower-rated debt in repos has returned to “pre-crisis” levels. And, by the way, they’re back to using bonds backed by subprime and low-quality residential mortgages. The U.S. repo market is worth around $1.6 trillion; Fitch looked at data from 10 of the biggest money market funds engaged in repos and found that 20% of the underpinning collateral consisted of structured finance, or repackaged loans, and that almost half of this is made up of repackaged subprime and subprime-like mortgages.

The ratings agencies have admitted their earlier “mistakes” of rating these risky mortgage-backed bonds too highly. And since the crisis, they’ve adjusted their models, rerun their analyses and let the downgrades fly. All the negatives are already priced in, right?

Not quite. Naked Capitalism hipped us to a face-palm-inducing report from R&R Capital from just a few weeks ago:

Realized losses declared on private residential mortgage-backed securities (RMBS), already much higher than original rating agency and investor estimates, are projected to rise substantially in the coming months [...].

On the securities performing at December 2011, a universe of approximately $1.42 trillion, R&R estimate the amount of additional losses likely to materialize is $300 billion, with one-third concentrated in ten arranger names, including Countrywide, Morgan Stanley and JP Morgan. About 17,000 tranches, or 34% of the universe analyzed by R&R, may lose up to 83% of their remaining principal.

In addition, R&R estimates that approximately $175 billion of losses already incurred on the loans have not yet been allocated to the bonds in the related transactions. Failure to allocate realized loan losses could distort the valuation of related RMBS tranches.

This is not to mention the fact that the features of the Obama administration’s ever-changing homeownership help programs are getting closer and closer to inflicting pain on RMBS investors. As Yves Smith says (emphasis mine):

[RMBS] investors have sat on the sidelines during the mortgage settlement and “fix the housing market” debates, even as becomes clearer and clearer that the solution envisaged is to take from investors to make the banks whole.

What happens when the eventual losses start being reflected as lower valuations and dropped ratings for the RMBS collateral being used in the repo market? Who’s going to get hosed here? And where will this latest domino trail lead?

5--SPIEGEL Interview with George Soros--'Merkel Is Leading Europe in the Wrong Direction', Der Speigel

Excerpt: Soros: I admire Chancellor Merkel for her leadership qualities, but she is leading Europe in the wrong direction. To solve the euro crisis, I advocate a two-phase policy -- which is first austerity and structural reforms as Germany implemented them in 2005, but then also a stimulus program. If you do not provide more stimulus in Europe, you will push many European countries into a deflationary debt spiral. And that would be extremely dangerous.

SPIEGEL: Are the new austerity guidelines for countries like Spain, Italy or Greece too tough?

Soros: They create a vicious circle. The deficit countries have to improve their competitive position vis-a-vis Germany, so they will have to cut their budget deficits and reduce wages. In a weak economy, profit margins will also be under pressure. This will reduce tax revenues and require further austerity measures, creating a vicious circle. Markets do not correct their own excesses. Either there is too much demand or too little. This is what the economist John Maynard Keynes explained to the world, except that he is not listened to by some people in Germany. But Keynes explained it very well -- when there is a deficiency of demand, you have to use public policy to stimulate the economy....

Germany has mishandled the rescue operation by providing the bailout at penal interest rates, which then led to an increase in the indebtedness of Greece. That is why today Greece is beyond rescue.

6--America Inc. Faces Margin Stall, WSJ

Excerpt: After three years of profit-margin expansion, U.S. companies have begun to see rising costs eat into the bottom line. And for now, there is little that they can do about it.

After the 2008 financial crisis, companies cleared the decks. With demand falling sharply and credit availability uncertain, they shed millions of workers and cut deeply into their spending on capital equipment. When the economy clawed its way back, they were slow to hire and slow to spend.

The result: Profits swelled. Last year, sales generated by S&P 500 companies were about 14% higher than they were in 2007, according to S&P Capital IQ's latest estimates. Operating earnings were up 21%.

But in the fourth quarter, there appears to have been a shift, with earnings growing a bit slower than sales. And analysts' estimates suggest that is something that will continue in the quarters to come.

The same dynamic shows up in the Labor Department's productivity statistics. After surging as the recession ended, productivity, as measured by output per hour, was up just 0.5% above its year-ago level in the fourth quarter. Outside of economic downturns, it has rarely been so weak.

The message: Companies have reached the point where it is very hard for them to get more work out of their existing employees. So as business continues to expand, they have to hire: There is a reason job-market figures have taken a turn for the better. That layers on labor costs.

Normally, when margins and productivity look like they could get squeezed, companies buy labor-saving equipment and software. So far, they have been slow to do that.

Companies cut capital spending during the downturn to the point where they weren't even replacing equipment that had became worn out and obsolete. As a result, America's capital stock—the inflation-adjusted value of all business equipment and software in place in the country—fell for the first time since World War II.

So while capital spending has lately been growing at a faster clip than the overall economy, much of it has been directed at replacing old equipment. Macroeconomic Advisers economist Ben Herzon says capital stock appears still to be in the process of catching up to where it should be, given the economy's size.

One takeaway from that is that the prospects for companies that benefit from increased capital spending—from the likes of engine maker Cummins to software group SAP—look good. On top of already strong catch-up sales, they are likely to see an increase in orders from companies desperate to boost productivity.

Of course, stepped-up spending won't boost productivity right away; it takes time to install, figure out and integrate new capital equipment into operations. So companies will need to hire more people to meet demand. The downside of that is margins could get hurt. The upside is that it will be good news for the economy.

7--Oil demand and forecasts: getting it wrong again in 2012, Reuters

Excerpt: Trying to forecast world oil demand growth is a tricky job at the best of times. This year abnormal levels of uncertainty about the global economy are making the job even more difficult.

Leading energy demand forecasting agencies last week were divided on whether the prospects for demand growth are improving or deteriorating.

The three - the International Energy Agency (IEA) for consumer nations, the Organization of the Petroleum Exporting Counties (OPEC) and the U.S. government's Energy Information Administration (EIA) - have long struggled to accurately predict global oil demand changes.

Last week, the IEA cut its 2012 forecast for a sixth consecutive month to growth of less than 1 percent, or 0.8 million barrels per day. OPEC also painted a grim picture with a reduced growth estimate of 0.94 million bpd .

But the EIA raised its forecast to 1.32 million bpd.

Some analysts question whether some of the estimates have been cut too deep, too fast and say 2012 may yet surprise on the upside should the economy pick up.

"There is general confusion at the moment about what is happening to demand," said Will Riley, co-manager of the Guinness Atkinson Global Energy Fund.

"There does seem to be a discrepancy between dropping oil inventories and the demand picture, which the IEA are presenting."

Two years ago, a steep recovery in demand in 2010 after a global financial crisis caught everyone by surprise, and what at first looked like a more predictable 2011 proved no less challenging.

A year ago the three agencies were all forecasting 2011 demand to grow by more than 1.5 percent, or 1.4 million barrels per day, after a stunning 2.75 million bpd of growth triggered by global stimulus spending in 2010.

But growth for 2011 came in at only a half that level, and the onset of yet another wave of economic uncertainty and a debt crisis from the middle of last year prompted all three forecasters to start slashing growth estimates for 2012 from initial levels in August of 1.6 million bpd for the IEA and EIA and 1.3 million for OPEC.

Given that all forecasters estimate that OPEC is pumping way above the current market need, it would be logical to predict the world might be heading for a large crude oversupply and potentially an oil price crash.

Oil prices, however, show stubborn resistance and are holding at historical highs on an annualized basis, which analysts say is partly due to fears about supply losses from Iran and a new influx of cheap money into commodities but equally to a less bearish view about future demand growth.

James Zhang from Standard Bank said he believed the IEA's forecast was too focused on the developed countries and that it underestimated growth from emerging economies.

"While the current price level for Brent is overstretched in our view, driven by a fresh wave of investment into the oil market, it is likely to prove to be a mistake to take IEA's demand forecast as a bearish signal for the medium term," he added.

On the downside, the fact that oil prices are stubbornly holding at record highs cannot be good for global demand.

"Consumers are adjusting their behavior, it is clear to everyone, but it is very difficult to observe in forecasts," said Wech, who is among the biggest pessimists for this year's demand growth, foreseeing 0.6 million bpd.

"The U.S. economy looks a bit better recently, but I would still be cautious about it," he said. "But things that are not included in the forecasts are usually much more often on the upside."

Wech added that most forecasts are a reflection of global economic predictions by the International Monetary Fund (IMF) and are therefore slow to realize the economy might be turning a corner.

"The IEA has to use the IMF forecasts, and they came out all bearish, and it doesn't reflect the fact that things seem materially better," agreed Seth Kleinman from Citi.

"It seems like the IEA is the laggard and that they will revise their forecasts up rather than down. It doesn't feel like we're in a massive supply glut," he said.

8--IEA Cuts 2012 Oil Demand Forecast on ‘Darkening’ Growth, Businessweek

Excerpt: -- The International Energy Agency cut its 2012 global oil demand forecast for a sixth month as a “darkening” economic outlook reduced prospects for growth amid supply concern following sanctions on Iranian crude.

Worldwide crude consumption will increase by 800,000 barrels a day to 89.9 million barrels, from 89.1 million last year, the IEA predicted in its monthly oil market report today. That’s 300,000 less than its previous estimate. The agency cut its forecast after a “sharp deterioration” of economic growth projections by the International Monetary Fund last month to 3.3 percent from a September forecast of 4 percent.

“It’s a pretty remorseless picture of decline for oil demand throughout the OECD,” David Fyfe, head of the agency’s market and industry division, said in a telephone interview from Paris. “These are mature markets, in which industry recovery is stuttering, and moving into recession in the case of Europe.”

Consumption will drop in member nations of the Organization of Economic Cooperation and Development this year as Europe’s sovereign debt crisis slows growth, according to the IEA. Brent crude, which advanced 9.3 percent this year, dropped 1 percent following the IEA demand revision to $117.38 a barrel. Prices were lifted by a European Union ban on Iranian crude imports, which will take effect in the summer and concern that Iran will retaliate against the embargo.

‘Uneasy Balance’

“An uneasy balance characterized oil markets in January, with tensions surrounding Iran counteracting a weaker economic outlook,” the Paris-based adviser to consumer nations said. “Sanctions targeting Iran’s oil exports do not take effect until 1 July, but several European customers have already curtailed imports of Iranian crude and Asian buyers are also moving to line-up alternative supplies.”

Global oil demand will rise by 0.9 percent, the IEA estimates. The outlook is split into “robust” consumption in emerging countries, while in most advanced economies fuel use will drop, the IEA said. In developing nations, demand will increase by 2.8 percent next year, offsetting a decline of 0.8 percent in OECD members.

China’s purchases may be spurred if it decides to fill storage tanks at two strategic petroleum reserve sites, which will be completed in the first quarter, the IEA said.

9--Estimating trade elasticities: Demand composition and the trade collapse of 2008–09, VOX

Excerpt:  To summarise, according to our investigation, there is no major ‘puzzle’ in the magnitude of the fall in world trade observed during the recent financial crisis. Trade fell mostly because demand crashed globally and did so particularly in its most import-intensive component – investment. Moreover, the strong relationship between exports and imports in each country, due to the increased internationalisation of production and the strong dependence of the tradable sector on imported inputs, contributed to the simultaneity and unprecedented severity of the trade collapse.

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