Are "organised and orderly" sovereign defaults a good solution?

- "More and more voices are calling for "orderly defaults" for over-indebted euro-zone countries."
- "The advantage of a (partial) default for the sovereign debt is clear: reducing the country’s debt ratio to the level where it is sustainable (a stabilisation of the public debt ratio at this level is feasible without an excessive primary budget surplus). After an "orderly" default, the risk of a new default can be ruled out, and the interest rate on the country’s debt ought to decline."
- "What are the drawbacks or the risks?
• perhaps unbearable losses for banks and institutional investors that hold the country’s debt, and need - if that is the case - to recapitalise them, which may increase other fiscal deficits;
• investor expectations that an "orderly" default may affect other countries, leading to a contagion of the rise in interest rates;
• moral hazard for countries posting excessive fiscal deficits;
• rejection of other solutions: monetisation by the central bank, restructuring of the debt without any actuarial loss for its holders;
• funding problems for the defaulting country, at least for a while."
Natixis Flash Economics 348 20100705

Challenging navigation to calmer waters

- FI Strategizer: "Yields at all-time lows make risk/reward for AAA govies unfavorable. Fiscal tightening in the EMU, lower demand for ECB liquidity and stress tests results should lead to moderately higher yields in core countries. The key risk is a significant loss of growth momentum."
- Macroeconomic focus: "In 3Q10 the debate on the possibility of a renewed recession will heat up. However we believe that the slowdown in EMU growth appears in line with standard business cycles and fiscal tightening should be manageable given currency depreciation. We see odds for a double dip recession in the eurozone at around 10%."
- EU Portfolio Strategy: "During 3Q10, the country allocation should be of exceptional importance again. After 2Q10 widening we are moderately constructive on periphery. We keep the duration slightly long."
- Money Market: "Recent ECB refinancing operations suggest MM tensions are not extreme. The reduction in maturity of ECB liquidity should increase volatility of MM rates. The end of September will be a critical date: about EUR 90bn of 6M and 12M liquidity will mature and, barring new announcements, the ECB will hold its last 3M LTRO."
- Inflation: "ILBs have underperformed nominal bonds YTD. Inflation will remain moderate in 3Q10 and so will inflation expectations. However, as the EMU 10Y BE trades at a very cheap level, we see a good buying opportunity. On the contrary, US and UK BE do not look attractive."
- Supply Corner: "3Q10 will be the most liquid quarter of the year in the EMU, with EUR 175bn of redemptions and EUR 60bn of coupons. We expect EUR 195bn of gross supply (EUR 20bn net), with risks on the upside. Even so, net supply should be much lower than in 1Q and 2Q10."
- FX Strategizer: "Swings between risk appetite and risk aversion will keep trading jerky on FX majors. Yet, CHF and JPY should outperform again."
- EUR: "EUR-USD may approach the 1.28-1.30 area in the very near term, but the global risk picture and creeping EMU budget fears still favor a weaker EUR-USD back towards 1.24-1.22 after the summer."
- JPY: "As the JPY will stay sensitive to persisting global uncertainty, EUR-JPY should also remain skewed to the downside and would hardly develop significant correction potential beyond 113 in the rest of 3Q10."
- CHF: "The recent EUR-CHF bounce appears far from convincing and we still consider a temporary test below 1.30 as a very likely scenario."
- GBP: "The bold UK emergency budget should keep sterling firm: cable should head towards 1.60, while EUR-GBP should still break below 0.80."
- Commodity Currencies: "Trading should stay choppy on AUD, NZD and CAD, reflecting global risks and a tighter monetary policy at home."
- Nordics: "Market uncertainty and prudence on rates at home will make a further EUR-SEK and EUR-NOK drop bumpier."
- FX Special: "China’s decision to allow the yuan greater flexibility should not be overstated. We doubt USD-CNY will fall well below 6.70 by 4Q10."
Unicredit Curves & Crosses 20100709

France: decision time on public finances

- "The deterioration in French public finances since the end of 2008 will result in a general
government deficit amounting to around 8% of gross domestic product this year. While the impact of the 2009 recession should not be denied, this unprecedented situation also reflects the already weak budgetary position with which France started the crisis."
- "Although sovereign debt markets remain under pressure and the economic recovery is still very fragile, the euro zone countries most affected by debt refinancing problems (Greece, Ireland, Portugal and Spain) have lost no time in implementing severe budgetary consolidation programmes. France is going to have to follow suit next year, albeit in a less brutal fashion, if only because the credibility of the European stabilisation mechanism launched in the spring partly depends on sound finances among the euro zone’s major countries. And that means Germany and France, first and foremost."
- "Continually postponed when the economic situation was more favourable, the consolidation of French public finances will be all the more difficult for the fact that it will have to be achieved, for the most part, in a context of sluggish growth."
BNPParibas_Conjoncture_20100630

The two problems that must be solved by the euro zone

- "To avoid deflation, the euro zone must solve two major problems:
• the high and rising level of household savings, which depresses demand;
• the low level of nominal growth, in the short and medium term, which makes it very hard to stabilise debt ratios."
- "Could economic policies be imagined that would both lower the household savings rate and increase long-term nominal growth?
• a redistribution of unearned income to wages, which could be done via fiscal policy or via income sharing rules. In that case there would be both faster wage growth, less incentive to save due to the fall in the expected return on equity, and higher nominal growth;
• an attenuation of all the persistent uncertainties (concerning pensions, social welfare and the means used to trim fiscal deficits), in order to stimulate both consumption (fall in recautionary savings) and corporate investment;
• a depreciation of the euro exchange rate could be used only if wages were inflation-indexed; otherwise it would reduce wage-earners' purchasing power and increase the savings rate."
Natixis Flash Economics 347 20100705

Quality Ideas with a Catalyst: Stock Specific Names for the Current Market

- "With last week’s strong market rally coming on the heels of the prior weeks’ strong re-entrenchment, we believe there is much investor scepticism over the future
direction of the market. Macro economic data remains weak: business and consumer confidence are soft, the manufacturing recovery has stalled and labor market growth is anaemic. On the other hand, valuations are potentially attractive in many stocks and sectors. Heading into earnings season, there is a potential for upside surprises in a number of stocks which makes a defensive positioning a risky scenario for investors."
- "We are recommending a combination approach for investors: going long highquality stocks that are attractive valued on a free-cash-flow basis that have also been experiencing significant upwards earnings revisions. We believe this combination of attractively valued high-quality names that are experiencing a “catalyst” in the form of upwards earnings revisions positions investors well for the current market. These are defensive stocks that could deliver better than expected earnings this quarter."
Barclays Equity Research 20100712

Readings

Bank Profits Depend on Debt-Writedown `Abomination'- Bloomberg
The feckless Fed - Paul Krugman
Euro Gains Damp Break-Up Talk on Germany's Strength - Bloomberg
Japan ruling party reels after vote - Reuters
Wall St. Hiring in Anticipation of an Economic Recovery - New York Times
Fidelity reopens four money-market funds - Reuters
Crisis Awaits World’s Banks as Trillions Come Due - New York Times
BIS gold swap best news to hit gold in 30 years - Mineweb

Cutting public deficits in France: between ambition and political will

- "On 30 June, the French government presented a preparatory report in the run-up to the forthcoming public finance policy debate."
- "The report sets out the main measures that need to be taken to cut public deficits in 2011-2013 from 8% in 2010 to 3% of GDP in 2013. A full, detailed, three-year budget for 2011-2013 will be presented in the autumn."
- "The reduction of 5 points of GDP in deficit ratios over three years is extremely ambitious. Four of the five percentage point would come from structural measures, and notably a very marked slowdown in public spending of 0.6% per year by volume in 2011-2013 compared with an average increase of 2.2% per year in 1998- 2008. The remaining percentage point would be achieved through the cyclical growth, with forecast volume growth of 2.5% a year."
- "This scenario clearly seems too optimistic. Based on our own forecast of growth returning very gradually to its potential rate, the ratio of deficit to GDP should come out at 4.5% in 2013. Additional measures are thus likely to be necessary to counter these cyclical effects and achieve the announced target."
CreditAgricole Eco News 20100708

European bank stress test as catalyst for a new medium-term uptrend? No!

- "In the short term, the hopes being pinned on a successful bank stress test will improve the chances on an improvement in the sector’s relative performance. The positive medium-term impact on overall market is, however, likely to remain slight, since it can neither change the pending deterioration in the growth dynamic nor defuse the causes of the tensions in the euro zone."
- "The dependence of some national banking systems on funding via the euro system remains high. This points to further potential risks for the equity market because of tensions in EMU."
- "By the end of July, roughly 65% of the S&P 500 companies will report on the development of business in 2Q (Euro STOXX 50: 50%). The earnings estimates for 2010 will likely remain supported; the estimates for 2011 will come under pressure from expected weaker macro data."
- Outlook: "In the coming months, we think weaker macro data will, on balance, result in new lows for the year. Within this picture, however, there is the chance in the coming weeks of a temporarily friendlier trend because of the concentration of (positive) corporate reports on 2Q."
- STOXX Europe 600 sectors: "Financials are stabilizing; ahead of the stress tests we are upgrading Banks and Financial Services from underweight to neutral. At the same time, we are downgrading Travel & Leisure from overweight to neutral, and Construction & Materials from neutral to underweight."
Unicredit Market Outlook 20100708

The sentiment pendulum swings positive

- The sentiment pendulum swings positive "The past week was marked by a positive reversal in market sentiment, as expectations on the global outlook firmed, with upward growth revisions by the IMF adding to optimism. Central bank rate hikes in the region also indicated policymakers’ confidence in their economic growth prospects."
- Strong growth outturns continue, despite weakening external demand… "The region again posted strong growth indicators, including for Australia (falling unemployment), and Malaysia (industrial production), although economic weakness in Japan persists (machinery orders). The inflation picture remains benign, with the Philippines releasing a lower-than-expected figure for June, and Taiwan posting a higher-than-expected, albeit still tame reading of 1.2% yoy. Over the last weekend, China posted a surprisingly exports outturn for June of 43.9% yoy, showing that external demand is not cooling as much as previously expected."
- …causing central banks to resume monetary tightening "Interest rate hikes in Korea and Malaysia showed that the region’s policymakers are growing more confident in their economies’ growth outlooks. Monetary stances nevertheless remain accommodative,
given risks to the global outlook."
- In the coming week… "China will release a batch of new data for June including inflation and industrial production, and Q2 GDP. Elsewhere in the region, Thailand, the Philippines and Japan will hold monetary policy meetings. We expect the Philippines, Japan, and Thailand to remain on hold, although the latter is signaling rate hikes in the near future."
BBVA Asia Weekly Watch 20100712

The Return of Sovereign Risk in the Industrialised World

- "The severe deterioration of asset quality in the Western world’s banking system in late 2007 marked the opening act of the financial crisis. The second act of the crisis was the eye-watering drop in global economic activity during 2008 and early 2009, marking the start of the Great Recession. Yawning output gaps combined with falling asset prices and shrinking financial sector profits started to take their toll on public finances. Fiscal positions took a further hit when governments decided to embark on the biggest Keynesian experiment in living memory to prevent the repeat of the Great Depression 2.0. The “Great Rescue” paid off as the world economy has been tiptoeing back from the precipice since mid-2009. But now another danger seems to be lurking on the horizon – a wave of sovereign defaults in the industrialised world. The fear amongst many market participants is that this will mark the third act of this unforgiving crisis."
- "The fact that policymakers continue to remain divided about the timing of exit from loose fiscal policies only adds to investors’ concerns. It seems that we have learnt nothing from the rich history of financial crises. In one camp, policymakers claim that exiting now is necessary to calm market nerves lest interest rates will jump and turn the already bad situation into something far uglier. In the other camp, however, the opponents argue that synchronous exit of governments will do nothing more than strangle the incipient recovery at birth, which may weaken public finances even more."
- "The division between the two camps stems largely from their assumption of private sector recovery going forward. The “exit now” camp expects households and firms to step in as the government leaves the stage while the “exit later” camp believes that such assumption is grossly optimistic. Only time will tell which camp is right. But one thing is for sure, governments are navigating in unchartered waters. Relying too much on private sector strength can ultimately turn into an economic disaster if it proves to be incorrect (much higher unemployment and a paralysed banking system) while remaining complacent might push many sovereigns towards the brink of bankruptcy."
- "Given the amount of uncertainties surrounding both views, we decided to identify the industrialised countries that are most vulnerable to a sovereign debt crisis. In doing so, we look at a number of early warning indicators that have performed reasonably well in the past in predicting impending liquidity and solvency crises. Based on our Sovereign Vulnerability Index (SVI), Italy is the most vulnerable to a debt crisis after Greece mainly because of its strong reliance on foreign investors, relatively high level of corruption and high interest payments. The next countries in line are Portugal, Japan and the US. At the opposite end of the spectrum, the Scandinavian and current account surplus countries seem to be the least vulnerable."
Rabobank Economics Special July2010

Seven Reasons to Sell Sterling

- "Over the summer the pound has bounced against the dollar. But we believe the risks are to the downside for our end year 1.35 forecast."
- "There are seven reasons to sell sterling. First, the rest of the BOE Monetary Policy Committee is unlikely to join Andrew Sentance in voting for rate hikes. Second, the beneficial impact of last month’s Budget has now been priced into sterling. Third, the scale of the budget cuts forecast for the next four years will undermine growth. Fourth, exports can’t be relied upon to take up the slack. Fifth, the MPC remains willing to resume quantitative easing if the economy weakens. Sixth, tighter fiscal policy and looser monetary policy can result in a much weaker pound as occurred after the 1981 austerity budget. Seventh, other major currencies like the yen have also experienced prolonged weakness when fiscal policy has been tightened during times of economic weakness."
UBS Foreign Exchange Note 20100712

Under what conditions can quantitative easing (QE) help pull out of deflation?

- "When the economy becomes very weak, short-term interest rates draw close to zero, and monetary policy has to change its instruments and method of action, since interest rates can no longer be cut. Economic literature suggests several approaches:
• a (depreciated) exchange rate target and currency interventions,
• a target of price level, not price growth,
• reduction in long-term interest rates (via central bank purchases of bonds),
• central bank purchases of private-sector securities (quantitative easing or credit easing),
• quantitative easing (increasing the monetary base and banks’ excess reserves)."
- "Some central banks have used foreign exchange interventions (Switzerland); others bond purchases to lower long-term interest rates (United States, United Kingdom, and now the ECB); some qualitative easing (United States, ECB); and all have - explicitly or implicitly - used quantitative easing. But it seems almost inefficient (lack of upturn in credit or in demand via asset prices). This results from the fact that banks are not using their excess reserves, for several reasons."
Natixis Flash Economics 346 20100705

Should OECD countries deleverage or should their growth be stimulated?

- "There were two opposing opinions during the G20 in Toronto at the end of June 2010:
• that of countries which want the stimulation of the global economy to be extended (United States, China):
• that of countries which favour deleveraging and a reduction in fiscal deficits (Europe)."
- "First of all, we understand the differences of opinion: the United States and China can stimulate their economies without any difficulty (purchases of Treasuries by non-residents in the United States, efficiency of monetary policy in China, and high potential growth in both cases). This is far more difficult in Europe (low potential growth making it difficult to reduce
indebtedness, sovereign debt crisis) and pressure from financial markets. Fundamentally, we cannot imagine that the economies’ growth will be permanently linked to the rise in the total debt, public (in Europe) and private."
- "At a given moment, the issue of long-term growth (productivity, innovation) must be dealt with, and it should no longer be believed that debt can be the solution if potential growth is insufficient, which makes Europe’s situation very different from that of United States or China."
Natixis Flash Economics 345 20100705

Japan: Recovery of corporate capex has been lagging

- Recovery of corporate capex has been lagging
• One of the major disappointments on the macroeconomic data front in recent weeks has been the sluggish fixed business investment
• Although many companies have upgraded their profit forecasts amid the improved business conditions, they remain cautious about revising up their investment plans
• The June BOJ Tankan survey revealed only a 0.5% increase in planned capex on an all-firms basis for FY2010; weak sentiment amongst non-manufacturers along with cautiousness on the part of the materials sector appears mainly responsible
- Machinery orders: disappointing
• Core machinery orders decreased for the first time in three month by a large 9.1% mom in May. Orders seem to have bottomed out, but the pace of recovery remains very moderate
• The current account surplus decreased for the first time in four month, by 8.1% yoy in May. While the goods and service surplus continued to expand, the income surplus shrunk in the lower global interest rate environment
- Demand for funds remains weak
• The year-on-year growth in M2 in June slowed down for the first time in three months.
• The year-on-year decline in the balance of bank loans by city banks expanded further in June.
CreditSuisse Japan Economics Weekly 20100708

China: Rising wage concern

- "Rising wage pressure is a growing concern for China. Major foreign invested enterprises (FIEs) such as Foxconn and Honda reportedly increased wage by an average of 30%. These numbers are seemingly alarming and will generate some spill-over effects to a certain degree."
- "From a historical perspective, total wages as a share of GDP has persistently fallen from 56% in the early 80s to around 35% in 08. Profit as a share of GDP, on the other hand, shot up rapidly from 20% in mid-90s to 31% in 08. Considering the fact that labor does not share as much as economic prosperity as entrepreneurs during the booming years amidst rising inflationary pressure, a one-off hike of 30% this year seems more like compensating their lost years."
DBS Economics 20100707

EcoWeek

- Overview "Testing for stress"
- Pensions: Doubts about the long-term sustainability of public pension schemes "This week, the European Commission has unveiled a Green Paper on pension reform. It should start a debate on ensuring the long-term sustainability of the pension systems. In the European Union, age-related government spending (as percentage of GDP) is expected to increase by 5.1 percentage points between 2010 and 2060. The countries most at risk are those that have earnings related schemes as part of the public pension systems. In particular citizens in these countries fear that their pension entitlement will be negatively affected by economic and financial events."
- US housing market: a long tunnel "Now that the tax credit scheme has come to an end, the residential real estate market is not showing signs of a solid recovery. In May new homes sales were at an all-time low, with sales of existing homes at a level similar to that in September 2009. Although the strong downward trend in real estate prices that prevailed until the beginning of 2009 is over, no real recovery is under way. However, there are some positive signs. Household real estate purchasing power is quite strong, due to the sharp correction that has already taken place in prices and the very low level of interest rates. And despite weak sales, stocks of new homes have continued to shrink over recent months."
BNPParibas_EcoWeek_20100709

Infrastructure investment of pension funds in an international context

- "Infrastructure investments by the private sector have reached a high growth rate in recent decades. Multiple Public-Private Partnerships (PPPs) models have emerged as the key tool to this development."
- "The fact that infrastructure investment projects are of a long term nature, and that there remains a good relationship between profitability/risk observed in many of them, has attracted the attention of pension fund administrators in many countries who have been increasing the weight of this type of investment in their portfolios."
- "However, not all the results have been successful. This type of project is highly complex and requires specialized multidisciplinary teams to study each project after individually, which has made accurate evaluation difficult in some cases. At the same time, there can be numerous limitations in some countries that make pension fund participation difficult. Among other notable problems, there exists the lack of coverage in the face of specific and diverse risks for each project, bureaucratic and regulatory issues."
- "Conversely, in other countries, institutional changes have been made to favour infrastructure private financing, modifying regulation, offering diverse types of warranties and making the processes of awarding of bids more transparent and effective."
- "The private pension funds participation in develop countries has had different kind of funds schemes and cotized and non-cotized companies in the market. However, the basic model is in each one."
- "In this pension watch we will describe the model of private investment in countries outside of Latin America where a greater participation from the private sector has developed in recent years. Specifically, we will review the cases of Australia, the United Kingdom, Canada, the USA and Continental Europe."
BBVA Pension Watch July2010

Readings

The dollar question: Where are we? - VoxEU
European Bank’s Economist Is Optimistic on Sovereign Debt - New York Times
U.S. Says No Country Manipulates Currency, Yuan `Undervalued'- Bloomberg
What is the Threshold For More Fed Action? - Economist's View
What can the Fed do now? - Macro and other Market Musings
What is the current stance of monetary policy? - Macro and other Market Musings
Staring into the abyss - Economist
The Vanishing American Consumer and the Coming Trade War - Robert Reich
Exports Hit Record in China as Trade Gap Surges - New York Times
Pending Homes Sales Crash in a Record Fall to a Record Low - Housing Story
Goldman's Silent Board - Bloomberg
How To Exit Liquidity Traps - Real Clear Markets
Ahead of a Busy Week - Tim Duy
Germans Deaf to U.S.`Nonsense' as Exports Power Growth - Bloomberg

FX Strategy Weekly

- "Stronger than forecast employment data from Australia and Canada along with short
covering in risk assets boosted the AUD, CAD, NZD and NOK, but doubts over momentum
have not disappeared as markets square up to the first reports of US Q2 company earnings. With market positioning still overwhelmingly short EUR, we look for bearish EURtrends eventually to be reasserted on profit taking ahead of July 23, release date of the bank stress tests. Correlation with risk assets remains elevated for higher yield and commodities currencies, but with the balance tipping in favour of a second rate hike by the Bank of Canada later this month, the CAD looks well placed to resume its upward move vs the AUD. The prospect of a 7th drop in the UK claimant count rate in June may neutralise this month’s rally in EUR/GBP. Greece will tap the capital markets on Tuesday."
- "A rally in global equities propelled the AUD to the top of the G10 ranking, helping the
currency to log a 4.7% gain vs the JPY, a 4.4% gain vs GBP and a 4% profit vs the USD. GBP
fell against all G10 peers, but losses were limited to 1.3% vs the EUR and 0.7% vs the USD.
The weakness in sterling was partially attributed to the compression in UK/G10 yields.
UK/EU 2y benchmark yields fell into negative territory for the first time since February. The
unwinding of safe haven flows put the JPY at the bottom of the G10 table, with losses
ranging between 5% vs the AUD to 0.4% vs GBP, despite the report of record JGB buying
by China in May and a 0.5% upward revision by the IMF to Japan’s 2010 growth outlook."
- "UK economic data came up short of expectations this week for most of the releases,
except for the bullish report by the NIESR on Q2 GDP. The NIESR estimates that the
economy expanded by 0.7% q/q in Q2, down from an upward revised 0.9% in Q1. The BoE left Bank rate and the APF unchanged at 0.50% and £200bln, respectively. The services PMI slipped to 54.4 in June from 55.4 in May, marking a 3rd drop in 4 months. The global trade deficit widened to £8.0bln in May, a 3-month high as imports rose 2.4% to £29.5bln, the highest since Jul-08. Industrial output rose a stronger than forecast 0.7% m/m in May, and PPI output price inflation slowed to 5.1% in June vs 5.7% in May (core up to 4.8%)."
- "A mixed week for UK rates but overall yields stayed within the tight recent ranges and
close to the cycle lows observed since mid-May. 5y swaps finished the week at 2.44% and
10y yields dropped back to 3.32% following a very solid session on Friday post weaker PPI
and trade data. The prospect of lower June CPI data next week could bring the prospect of new lows and a bull flattening of the 2y/10y curve. The 3mth Libor/Ois spread narrowed a fraction to 22.5bp. EUR libor/Ois also tightened to 27bp (-5bp). The 2020 gilt sale drew very solid demand and was covered 2.45 times (0.2bp tail)."
LloydsTSB FX Strategy Weekly 20100709

Motion sickness

- "2H growth forecast lowered for US and Japan; EM Asia likely to follow"
- "Reduction in risk appetite tempering recovery in final demand"
- "Asia slowing in response to China tightening and waning inventory cycle"
- "Expecting increased bank funding stress to damp activity in Europe"
JPMorgan Global Data Watch