27/7/15: IMF Euro Area Report: The Darker Skies of Risks

The IMF today released its Article IV assessment of the Euro area, so as usual, I will be blogging on the issues raised in the latest report throughout the day. The first post looked at debt overhang, while the second post presented IMF views and data on the euro area banking sector woes. The third post covered IMF projections for growth.

So let's take a look at the risks to the IMF's 'growth returns to Euro zone' scenario.


Per IMF: "Risks are now more balanced than in recent years when vulnerabilities dominated. On the upside, low oil prices, QE, a weaker euro, and rising confidence could bring larger than anticipated benefits. Downside risks include lingering weakness and low inflation, a potential
slowdown in emerging markets, geopolitical tensions, and financial market volatility, whether due to asymmetric monetary policies or contagion from events in Greece."

Now, let me translate this into human language:

1) Eurozone has no real drivers for current growth uptick (which is weak to begin with). Instead, all it got to brag about are: QE (extraordinary monetary policies); QE-induced weaker euro (beggar thy neighbours trade policies), some rising confidence (hopping mad global asset markets bidding everything up on foot of global QEs - extraordinary policies); and lastly - lower oil prices (that sign of global economy on a downward slide). Congratulations to all - hard work and enterprising are not required for this sort of growth.

2) Eurozone's abysmal growth is at a risk from:

• 'lingering weakness' (aka structural non-reforms that Europe worked so hard to achieve since 2008, we are all in tears… so lots of sweat, not much of gain here) and 
• 'low inflation' (a euphemism for consumers and investors on strike in this promised Land of Plenty); and 
• 'potential slowdown in emerging markets' (that thingy that makes oil cheaper - take you pick, Euro area: get crushed by higher oil prices in presence of EMs growth or get squeezed by lack of EMs growth in presence of low oil prices), 
• 'geopolitical tensions' (aka: Russkies not playing the ball with Good Europeans by refusing to buy their apples), and 
• 'financial market volatility' (wait: what on earth have we been doing since 2007 other than fight the said financial markets volatility? Looks like lots of successes here, if the said volatility is still a risk), 'whether due to asymmetric monetary policies' (in other words, if the Fed hikes rates too early too fast) or 'contagion from events in Greece' (would that be the same Greece that has been ring fenced and repaired? most recently this month?).

You have to wonder: IMF effectively says all risks that were in the euro area in ca 2011 are still in the euro area in ca 2015…

Now, recall that some time ago I said that the next step for Europe will be a fiscal / political union with less democracy for all and more technocracy for the few? (link here). And IMF does not disappoint on this too.

"Beyond the near term, there should be a concerted effort to accelerate steps to strengthen the monetary union and European firewalls. Fully severing bank-sovereign links would require a common deposit insurance scheme with a fiscal backstop, a larger and fully funded Single Resolution Fund, and easier access to direct bank recapitalization from the ESM. The greater risk-sharing implied by these measures should be underpinned by a strengthened fiscal and structural governance framework which could require possible Treaty changes. These reforms are desirable in any case, but accelerated progress could help bolster market confidence in the face of recent events."

What have we learned from the above? Why, of course that the frequent claims by the EU officials that Europe now has fully severed contagion links between banks and taxpayers are… err… a lie. And that common claims by the European officials that we now have a genuine monetary union infrastructure is also a lie. And that to make these two claims not to be a lie we will need something/rather that requires 'possible Treaty changes'… which is of course a political and fiscal union. So kiss that national sovereignty and self-determination bye-bye… assuming you still believe such exist in the Euro Land.

Here is full IMF risks assessment matrix:

Now, do some counting: out of 7 key risks, four have either high probability of occurring or bear high impact if they should occur or both.

Now, all of the above still generates a positive outlook under the IMF forecasts - positive, meaning GDP growth over 1.2-1.4 percent, never mind GDP growth anywhere near that of the U.S.

But then the IMF goes slightly gloomier and paints a "Downside Scenario of Stagnation in the Euro Area". Here we are getting some traction with highly probable reality by the highly diplomatic Fund.

"Subdued medium-term prospects leave the euro area susceptible to negative shocks. A modest shock to confidence—for example, from lower expected future growth, or heightened geopolitical tensions—that lowers private investment could affect households via labor income and wealth. Expectations of lower inflation at the zero lower bound would keep real interest rates high. For countries with high public debt, risk premia could rise, amplifying the shock and raising the risk of a debt-deflation spiral. Policy space would be limited with short-term interest rates at the zero lower bound and public debt high in countries with large output gaps (Bullard, 2013)."

What the above really means is that, given we are already in the environment of zero policy rates and unprecedented money printing by the ECB, any further shocks will have nothing offsetting them on policy side as

• Monetary policy has fired almost all its bullets already, and
• Fiscal policy has no bullets because of already high levels of debt, whilst
• Currency devaluation policy is not an option in the monetary union dominated by Germany.

Welcome to Hope Street where things can only go as smoothly as today, forever.

"An illustrative downside scenario, assuming lower investment for all euro area countries and increased risk premia for high debt countries, suggests that euro area output could be nearly 2 percent lower by 2020." Guess what: 2020 forecast growth is 1.5% (link here) which means that IMF is saying it will be -0.5% aka another recession.

"The main channels would be through higher real interest rates depressing investment and consumption as well as lower inflation and wage growth constraining adjustment within the euro area." Which means IMF is now fully buying into the Secular Stagnation (Demand Side) scenario I wrote about here.

"The impact would vary across countries with real interest rates higher in countries with weaker balance sheets. Fragmentation progress would reverse and public debt would increase more in high debt countries due to lower fiscal balances and nominal output. “Bad” internal rebalancing would follow, as current accounts in high debt countries would rise due to import compression. Lower inflation would worsen external imbalances, by forcing countries with large output gaps and imbalances to adjust through lower prices and employment."

Yeeeks!

So projections:

Double Yeeeeks!

20/1/2013: Euromoney Credit Risk Data: Q4 2012

All of the G10 countries, with the notable exception of Sweden, saw their risks rise in 2012, according to the latest results from Euromoney’s Country Risk Survey – and not just because of the problems affecting the debt-ridden euro zone sovereigns.

ECR (Euromoney Country Risk survey data for Q4 2012 is out and the results are quite interesting. Broadly they confirm the risk dynamics traced by the survey through the entire 2012, suggesting that qualitatively little has changed over 12 months to signal the improvements in the global economic environment.  Here are some top-line results:

• Of G10 countries, all but one (Sweden) saw further deterioration in ratings.
• G10 ratings deteriorations were not only driven by the continued euro area crisis, but are also present in the case of Japan, the US, and the UK own dynamics.
• Japan and the US continued "on a downward trend, as various economic and political problems continued to raise alarm bells among economists and country-risk experts regarding their medium-to-long term fiscal viability…"
• "Japan’s crippling debt problems, stunted growth and deflation have seen its score fall to 65.5 out of 100 and to 32nd out of 185 countries surveyed – a new record low, when 20 years ago Asia’s former powerhouse was ranked the world’s safest sovereign."
• US scores were down 1.6 points over 2012 to 74.7. 
• "…The US is far from a substantial risk – it is, after all, the 15th safest sovereign in the world, according to the survey. However, US politics has had a decidedly negative influence on its risk profile – all six of the political risk indicators were downgraded in 2012".
• On December 'deal' reached by the US Congress and the White House: "The two sides in the debate must still find common ground to negotiate $110 billion of spending cuts (the “sequester”) without bringing the US economy to a grinding halt. A budget must be agreed, while raising the $16.4 trillion debt ceiling even further presents another, even more perplexing, question of how to ensure medium-to-long term fiscal sustainability in light of adverse demographics – the weakest of the country’s structural factors, according to the survey."

Realting to two major themes I have been highlighting for some time now:

1. The fallout of the euro area from the global growth & growth environment clusters; and
2. The relative rise in risk quality in the 'Southern' growth clusters, leading to relative convergence in risks between the deteriorating 'North' (advanced economies of the West) and the improving 'South' (the middle income and some emerging economies of Asia-Pacific and Latin America)

we have this:

• "Risk differentials between the G10 and the emerging market regions narrowed by between two and three points in 2012, to 25 points for the Middle East and to 30 points each for Asia and Latin America." This is a notable result, coincident with one major theme in global risk changes that I have highlighted for some time now.
• "Differentials between the eurozone and emerging markets saw even larger shrinkage, highlighting that, although traditional markets are still safer, their comparative advantages have diminished."
• "Some of the emerging markets became safer in 2012: those that were largely decoupled from Europe’s debt problems – growing rapidly in many cases – and with fewer domestic issues." 
• "Latin America saw three distinct patterns emerging. Brazil, Chile and Colombia continued their long-term ascent in the global rankings, despite having their economic scores shaved by a slowdown in China paring back commodity demand. Argentina and Venezuela struggled with their domestic crises, which caused both countries to slide further down the rankings. Mexico, Peru, Uruguay and Bolivia all emerged on the radar, benefiting from strong policy management, good growth and other factors."

A special place in the risk rankings 'hell', however is reserved for the euro area:

• "Eurozone countries, …saw shrinking levels of confidence as Slovenia, Cyprus, Spain and Italy endured the largest falls in country risk scores of any of the countries surveyed worldwide, weighed down by creaking banks, rising debts, contracting economies, and the political and structural dimensions to the crisis."
• "The eurozone score fell by 3.1 points, the largest drop of any of the main geographical or economic regions."
• In the case of largest downgrades within the euro area: "All four saw their risks continue to rise during the fourth quarter, despite some progress in tackling their fiscal problems. Bond yields fell and credit default swap (CDS) spreads tightened, suggesting the risks had eased, but ECR has had reason to doubt CDS signalling." Which is the theme consistent with my analysis of CDS in the past.
• Of the peripherals: "Italy, down 14 places in the global rankings this year (to 51st place), Spain (an 18-place faller to 58th), Cyprus (down 11 to 42) and Slovenia (plunging 15 places to 37th) all failed to convince country-risk experts that the worst of the crisis was over."
• The crisis is now perceived to have spread from purely financial and fiscal dimensions to political and structural: "The systemic banking sector and sovereign debt problems stretching across the single currency area have invariably influenced economic risk assessments. However, the political and structural elements to the crisis have resulted in broadly equivalent falls in scores for each of the three measures of risk, on a euro-wide basis."

• On ECB actions: "...in the absence of growth and amid justifiable concerns about the political commitment to budget consolidation and reform – highlighting the risks of policy execution failure – fiscal projections have proved wildly optimistic, deferring the prospect of outright debt reduction for many countries." In other words, while ECB can talk as much as it wants (OMT, the inevitability of the euro etc), end-game is set by real actions. And these are now increasingly in question.
• "Peripheral country risk remains high, even in Greece, which has seen its ECR score stabilize this year, yet on a score of just 34 points and languishing in 110th place on the ECR scoreboard, the country’s problems are far from over… All of Greece’s economic and political factors, 11 in all, score less than five out of 10 as another future debt rescheduling looms. The much-feared Grexit is still not out of the question either, although the markets have been calmed by the progress achieved to date."
• "Debt resolution programmes in Spain, France and other countries are all being questioned."

You can see (subscribers only) the data and play with interactive charts and maps here and the overall site for the data is www.euromoneycountryrisk.com.

8/2/2012: A more pleasant Sovereign arithmetic

And for a rather more pleasant sovereign arithmetic, here's an interesting table from the Global Macro Monitor (link here) summarizing yoy movements in 5 year CDS:

Frankly speaking, all of this suggest some severe overshooting in CDS and bonds markets on upward yield adjustments over time followed by repricing toward longer term equilibrium. What this doesn't tell us whether we have overshot equilibrium or not... Time will tell.

7/2/2012: An unpleasant risk arithmetic

Here's the guys Irish authorities trust so much on risk assessment, they contracted them to do banks stress tests - PCARs - back in 2010-2011. Note: this is a statement of fact, not an endorsement by me. The Blackrock folks produce quarterly report on sovereign risks and this the summary chart from the latest one - Q1 2012. Negative numbers refer to higher risks:

So Greece leads, Portugal follows, Egypt and Venezuela are in 3rd and 4th place worldwide of the riskiest nations league and then, in the fifth place is Ireland, followed by Italy. And here's the summary of the euro area ratings:

Yes, bond yields have been improving significantly, including due to both fundamentals and banks liquidity steroids, which is a good news. The bad news, yields have been declining for other countries as well and investors' relative sentiment is not improving as much as the absolute levels of yields declines suggest.

Today, one of the Irish Stuffbrokerages claimed in a note that: "The country’s success in meeting its targets under an EU/IMF bailout without social or political unrest and its export-focused economy has enabled it to dodge the recent Eurozone downgrades by S&P and Fitch and distance itself from fellow bailout recipients Greece and Portugal. " Distancing we might be, but the neighborhood we are lumped into is not changing as the result of this distancing. At least not for now.

Please note, the assessments above are consistent with CMA analysis based on CDS spreads, covered here.