Economics 22/10/10: Bailout that is losing steam by an hour

The immediate fallout from the Irish bailout package is:

• short sales closing on Irish sovereign markets means profit booking, yields down (although surprisingly slightly -0.323%)
• Germany gets relief (Irish-German spread is actually up 0.503%) and
  
• short seller moving on to new targets: the rest of the PIIGS:

Makes you wonder if Portugal, Italy and Spain bonds brokers have been pushing their clients into losses as hard as our own did...

Contagion is clearly far from over, which simply exposes the fact that EU's EFSF and IMF short-ending for the insolvent sovereigns is not a solution to the PIIGS problems and that the EU has no plan B.

Economics 6/11/10: Two charts - IRL & Spain

Two interesting charts on 5 year bonds for Ireland and Spain, courtesy of CMA:
What's clear from these charts is the extent of inter-links between banks and sovereign credit default swaps. In Spain at least three core banks - La Caixa, BBVA and Banco Santander act as relative diversifiers away from the sovereign risk since late October. In Ireland - all of the banks carry higher risk than sovereign. Another interesting feature is a significant counter-move in the Anglo CDS since late September. This, undoubtedly underpinned by the large-scale bonds redemption undertaken by Anglo at the end of September. Thirdly, an interesting feature of the Irish data is that CDS contracts on Anglo, IL&P and AIB are now trading at virtually identical implied probability of default.

Lastly, Irish sovereign debt is now trading at probability of default higher than that of the Spanish banks!

Economics 6/10/10: Irish spreads in the need of a new catalyst

Updated below

A quick post on foot of last morning call (here) on ECB propping up Irish Government bonds

Yesterday, absent visible ECB interference in the markets, Ireland’s 10-year yield rose 6 bps relative to benchmark German bund. The gap now stands at above 408 bps, still below a record 454 bps posted on September 29.

The Portuguese-German spread rose by 1/3 of Irish-German spread - up 2 bps to 385 bps, while the Spanish-German spread stayed put at 180. Greece-Germany spread is at 777, but it is largely academic, as the country does not borrow from the open markets anymore.

The spreads are moving up on Moody’s latest threat to Ireland's sovereign ratings. Moody's downgraded Ireland to Aa2 in July. The agency now says that it will complete a new review of country position within three months. Accoridng to Moody's: “Ireland is on a trajectory toward lower debt affordability over the next three to five years.” Which of course means the probability of Ireland having to restructure its debts is rising, primarily on the back of deteriorating economic conditions.

S&P’s cut Ireland’s credit rating one step to AA- on August 24, while Fitch has a AA- rating.

So in the nutshell, the 'honeymoon' post-Lenihan's announcement last Thursday seems to be over - we are back into the markets-determined volatility and there's a desperate need for a catalyst to shift yields either way.

Update:
Oh, and of course, since hitting the 'Publish Post' button, this is just in: Fitch downgraded Irish credit rating to A+ from AA- and put it on a negative outlook. Causes: bigger-than-expected cost of cleaning up the country's banks and uncertainty over economic recovery.

Irish-German spreads moved up to 421.4 bps

Economics 24/9/10: Still deep in denial?

Updated

In the real of bizarre, we have two fresh statements from Irish officials.

First, NTMA issued a statement claiming that Irish authorities - aka Irish taxpayers - will make up any shortfall on the banks capital side. One wonders if the NTMA has acquired new powers from the State - this time around, to determine our budgetary policy. You see, per European authorities, capital support for the banks is a matter of national deficits. National deficits are a matter of fiscal policy. Fiscal policy is firmly a matter for the Exchequer (i.e the Government). NTMA is neither the Exchequer, nor the Government. What business does it have in making promisory statements to the markets concerning the matters of fiscal policy?

Second, per Reuters report: "An Irish official told The Daily Telegraph that Dublin will "explore the appropriate burden-sharing arrangements" over coming weeks as it fleshes out its plan to break up the nationalised bank. Anglo Irish may ultimately cost Irish taxpayers as much as €25bn". So let's quickly summarize the statement:

1. After the economy posted a double dip (GDP side), having lost some €13,000 per every working person in income since the beginning of this Great Recession,
2. After all independent analysis has pointed, for some 21 months now to the need to cut loose the subordinated (and senior) debt holders in Anglo, plus subordinated debt holders in other state-supported banks,
3. After the above calls by independents was echoed in recent weeks in the international analysts opinions (e.g. RBS),
   
4. After independent analysts have correctly estimated Ireland's exposure to Anglo to be in the region of €33-39 billion, the estimate once again echoed in international analysts estimates (S&P),
5. After international bond markets have shown total disapproval for the Government handling of the recession, bidding both bond yields and CDS spreads to historic highs
   

our officials remain in a deep denial about both the extent of the problems and the required course of action.

Economics 21/9/10: This Little PIIGSy Went to the Market

So here we go again: NTMA went to the market, ECB came along, the results are suspiciously identical (save for obviously increased costs of borrowing) to those achieved in August.

We sold €500 million of 4 year debt due in 2014 at an average yield of 4.767%, compared with 3.627 percent at the previous auction on August 17. Cover on 4 year paper was We also sold €1 billion wort of 8 year paper due in 2018 a yield of 6.023%, up from 5.088% in a June sale.

Short term stuff first:
Cover support is clearly running well above average/trend, indicating potential engagement by the ECB. Price spread is down, suggesting that the yields achieved are reflective in the perceptions compression on behalf of bidders, which in turn might mean that the markets are getting more comfortable with higher risk pricing of Irish bonds.

Next up: yields and prices achieved:
The dynamics are crystal clear - we are heading for a new territory in terms of elevated yields and lower prices. Actually, setting historical record in both, despite likely ECB interventions.

Weighted average accepted price:
Boom! The curve is getting curvier.

On to longer term stuff:
Yield spread down as well - same reason - higher yields are now a 'normal' for the markets as average accepted yield shot up.
Cover slightly up, perhaps being pushed by the bidders flowing from the shorter term paper - crowded out by Jean Claude Trichet's boys. Price spread is down (see yield spread discussion above).

Predictably, longer-term accepted average price is testing historical lows:
Boom, redux!

And the maturity profile of debt is getting steeper for the folks who'll take over the Government in the next round, and our teenagers (that'll teach'em a lesson, for those, of course who'll stay on these shores):

Economics 18/9/10: It's not just IMF

As argued in my earlier post (here), based on the IMF analysis, our sovereign bonds yields are still some distance away from those justified by fundamentals.

It turns out the IMF paper cited in the earlier post is not alone in the gloomy assessment of our realities. Another August 2010 study from German CESIfo (CESIfo Working Paper 3155), titled "Long-run Determinants of Sovereign Yields" and authored by António Afonso Christophe Rault throws some interesting light on the same topic, while using distinct econometric methodology and data from that deployed in IMF paper.

Here are some insights from the paper (available for free at SSRN-id1660368). "For the period 1973-2008 [the study] consider the following countries: Austria, Belgium, Denmark, Finland, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Portugal, Sweden, Spain, UK, Canada, Japan, and U.S."

Take a look at table 2 of results from the paper estimation across listed countries. The model is based on 3 variables here - Inflation (P), Current Account (CA) and Debt Ratio (DR). All have predictable effect on the variable being explained. Per study authors: "Results in Table 2 show that real sovereign yields are statistically and positively affected by changes in the debt ratio in 12 countries. Inflation has a statistically significant negative effect on real long-term interest rates in ten cases. Since improvements in the external balance reduce real sovereign yields in ten countries, the deterioration of current account balances may signal a widening gap between savings and investment, pushing long-term interest rates upwards."

Ok, here are those results:
Ireland clearly shows relatively weak sensitivity in interest rates to debt.

But take a look on our sensitivity to deficits. Per study: "Moreover, when the budget balance ratio is used (Table 3) a better fiscal balance reduces the real sovereign yields in almost all countries"
Clearly, Ireland shows 3rd highest sensitivity of interest rates to Government deficits. We are in the PIIGS group, folks, based on 1973-2008 data!

Now, this firmly falls alongside the IMF results - further confirming my guesstimate in the post earlier.

Economics 18/9/10: IMF data on bond yields

With all the debate, recently fueled by the Governor of our Central Bank and Minister for Finance, concerning the level of Irish bond yields, it is always insightful to look at the historic evidence as the source of better understanding of the underlying bond markets realities.

Fortunately, courtesy of the IMF, there is some new evidence on this issue available. IMF working paper, WP/10/184, titled "Fiscal Deficits, Public Debt, and Sovereign Bond Yields" by Emanuele Baldacci and Manmohan S. Kumar (August 2010) does superb analysis "of the impact of fiscal deficits and public debt on long-term interest rates during 1980–2008, taking into account a wide range of country-specific factors, for a panel of 31 advanced and emerging market economies."

In a summary, the paper "finds that higher deficits and public debt lead to a significant increase in long-term interest rates, with the precise magnitude dependent on initial fiscal, institutional and other structural conditions, as well as spillovers from global financial markets. Taking into account these factors suggests that large fiscal deficits and public debts are likely to put substantial upward pressures on sovereign bond yields in many advanced economies over the medium term."

But the detailed reading is required to see the following: "the impact of fiscal balances on real yields provided results that were quite similar to the baseline, although the size of the estimated coefficients was larger: an increase in the fiscal deficit of 1 percent of GDP was seen to raise real yields by about 30–34 basis points." (Emphasis is mine). Table below provides estimates:
By the above numbers, Irish bonds currently should be yielding over 7.54%. Not 6.5% we've seen so far, but 7.54%. This puts into perspective the statements about 'ridiculously high' yields being observed today.

If we toss into this relationship the effect of change in our public debt position, plus a risk premium over Germany (note that the estimates refer to the average for countries that include not just Ireland, but 29 other developed economies, including US, Germany, Japan and so on), the expected historically-justified yield on our 10 year bonds will rise to

• deficit-induced 7.54% +
  
• country risk premium driven by deterioration in economic growth adjusting for ECB rates) of 1.46%+
• change from initial public debt position 0.30%

So the total, fundamentals-justified Irish 10 year bond yield should be around 9.30%.

Don't believe me? Well here's a historic plot that reflects not a wishful thinking of our policymakers, but the reality of what has transpired in the markets over almost 30 years.
Ooops... looks like our ex-banks deficits warrant the yields well above 10% and on average closer to 15%, nominal (remember the above yields computed based on model results are real). Alternatively, for our bond yields to be justified at 6.5% we need to cut our deficit back to around 5.2% mark and hold our debt to GDP ratio steady.

Someone, quick, show this stuff to our bonds 'gurus' in the Government.

Economics 23/8/10: ECB & IRL bonds

Per report today: "FRANKFURT, Aug 23 (Reuters) - The ECB said on Monday it bought and settled €338mln worth of bonds last week, the highest amount since early July and bolstering recent market talk it had ramped up purchases of Irish bonds. The amount is well above €10mln of purchases settled the previous week... It follows recent comments by market participants that the ECB bought 60 million euros of 2012 Irish government bonds just over a week ago, after spreads over German Bunds ballooned. The ECB has not given any details of its bond buying."

I speculated after last auction results were announced by the NTMA that extraordinary level of cover (x5.4) on 4 year bonds issue looked strange and that ECB buying might be the case. To remind you - NTMA sold €500mln of 4-year bonds. It now appears that the ECB did indeed engage in potentially substantial buying of Irish bonds. If so, such buying cold have

1. pushed other purchasers out of the shorter term paper into 10 year bonds; and/or
2. pushed yields on both shorter and longer term paper down.

€338mln figure includes trades executed between August 12 and August 14 - the auction of shorter term paper that is known to have involved ECB buying.

All in, we are clearly now in the yields zone where the markets are happy to watch us lean on ECB, the ECB is happy to watch us skip one-legged across budgetary deficit that keeps opening up wider and wider. Clearly, such an equilibrium is unlikely to be stable. Expect some fireworks once markets come back to full swing a week from now.

Economics 18/8/10: NTMA's foray into bond markets wilderness

As promised - a more in-depth analysis of today's data from NTMA auction.

"The Gruffalo said that no gruffalo should
Ever set foot
In the deep dark wood"

Clearly, bent on saving nation's face, the NTMA could not pass on going to the markets today.

First, let us take a look at the changes in averages from April 2009 first auction through today, against the same averages for the period excluding today's auction.
So today’s auctions have led to:

• a small increase in overall maturity profile of Irish debt (good news)
• a small increase in average coupon paid for all maturities (true future liabilities on debt)
• a modest rise in average cover (potentially due to massive overbidding by ECB, but this is a speculative remark at this moment in time)
• a drop in average price paid and a corresponding rise in the weighted average yield.

These effects were most discernible in the benchmark 10 year bonds issue, where:

• Average coupon rose by ca ½ basis point;
• Average cover dropped
• Weighted average price declined and weighted average yield rose (the latter by almost 0.7%)
• Average allocation amount rose.
  

Even more interesting stats are in the price and yield spreads:
Again, for across all issues averages spreads in prices rose significantly – by 8.3% and spreads in yields rose 7.85%. This is on the back of 10 year paper alone, suggesting the following two things:

1. Whatever was happening in the shorter term paper market (cover and lower yields) appears to be disconnected from what was going on in longer term paper markets (perhaps the rumoured ECB intervention on the shorter side was after all true?);
2. Since the prices and yields reflect bids by market makers – the widening of the spreads between max and min bids might be indicative of the markets inability to tightly price Irish sovereign risk. In other words, this might signal general markets uneasiness about the bonds.
   

Some charts illustrate more general trends.

Short term paper auctions first (5 years and less):
Average yield is still on the rising trend despite a clearly 'extraordinary' move down in today's auction. Even steeper upward trend for November 2009-present is still present. Yield spreads are on the upward move again once more signaling potential rise in overall market skepticism.
Price spread trends up predictably in line with yield spread trend. To see it in absolute terms:
Weighted average price achieved in the auctions:
Again, if ECB speculations play out to be true, the small uptick in price in last auction can be written off completely.

Now to longer maturity (10 years and above).
Average yield down, but still above long term trend. Yield spreads up, quite significantly. As I mentioned in the earlier post, latest auction produced yield spreads of 9.9bps - third highest spread since April 2009.
Price spreads are 75bps - second highest spread since April 2009. Cover down - lowest since February 2009 and is down year on year. Again, to highlight spreads in real terms:
Next, look at the price achieved:
This hardly constitutes any sort of 'success'. May be, just may be - some sort of a stabilization, with mean reversion still incomplete.

Now to the maturity profile of our debt:
We keep on loading the 2014 end of the spectrum - bang on for the year when we are supposed to reach 3% deficit. Of course, with already close to €5 billion in rollovers due in 2014, it's hard to imagine how this is going to help our fiscal position.

Economics 17/8/10: Another 'success' marks NTMA's foray into bond markets wilderness

Wall Street Journal blogs have beat me to the analysis of our NTMA results. Four reasons can explain this blogs tardiness:

1. I was doing Drivetime commentary on the results at 5:15pm today;
2. I was finishing my article on the topic for the Irish Examiner tomorrow;
3. Call of work duty had shifted me firmly for a few hours into a beautiful world of international macro data (oh, the place where there are no Anglos and INBSs... at least not after FDIC gone through their equivalents with a sledge hammer);
4. Last, but not least, my son gave me an even more important task of playing with him Garda and Helicopter rescue of a Big Black Spider.

To atone for this, this post precludes my deeper analysis of today' NTMA results. This post is a verbatim reply to Wall Street Journal blog post (linked here).

"Dear Richard,

I appreciate the short-term analysis span you deployed in your article on the latest Irish bonds auction.

However, several points worth raising in relation to the claimed 'success' of today's
NTMA placement.

1. the auction achieved price bid spreads of 75bps - 2nd highest in the last 2 years, suggesting that 'success' was based on a rather less consensus-driven pricing with market makers (traditionally most stable pricing players in the market) having shown significant differences in their ability to price Irish sovereign risk;
2. the weighted average yield achieved was the 3rd highest over the entire 2009-2010 period of issuance of 10 year bonds; and
3. cover achieved in 10 year paper auction was lower than a year ago (down to 2.4 from 2.7)
   

However, it is the longer term issues, that are certainly worth highlighting.

These involve the fact that even under Government own projections, factoring in expected Nama losses forecast by independent analysts, such as myself, Peter Mathews, Prof Brian Lucey and Prof Karl Whelan, by 2012 Ireland will be carrying over 210 billion worth of state (sovereign and quasi-sovereign) debt on its books. At 5.386% yield, this translates into ca €11.31 billion in interest payments alone or more than 1/3 of the entire tax revenue collected by the Irish Government in 2009.

It is naive to believe that 2010 gargantuan deficit in excess of 20% of GDP is a 'one-off' reflection of banks recapitalizations demand.

Again, based on balance sheet analysis, I expect 6 banks covered by the State Guarantee to incur loans losses of ca €50 billion between 2008 and 2012. Current provisions announced by the Irish Government and the banks cover roughly a half of these. The rest will have to be financed out of taxpayers funds in years to come.

In a taste of things ahead, earlier today Governor of the Central Bank has stated that next stage
recapitalization of Irish Nationwide and EBS building societies will cost taxpayers not €3.5 billion earlier factored in by the Minister for Finance, but €4 billion. €500 mln discrepancy within 5 months is a pittance for the Exchequer burning deficits at 20% of GDP (or roughly a quarter of the real domestic economy), but... Independent estimates put the final figure at €7 billion.

So much for the 'one-off measures'.

Perhaps the most telling sign of what is really happening in the markets NTMA tapped today is the fact that having dropped 20bps, Irish bonds spreads over German 10-year bund have risen once again to within a hair of 300bps.

Some success, then..."

In addition, one can only speculate whether the 'spectacularly' large cover of 5.4 for shorter term 4 year paper is due to the much speculated about, but yet to be confirmed or denied, direct buying by the ECB. If so, then we might have a situation where ECB gross over-bidding in the shorter maturity paper placement drove buyers into longer term paper. this, in turn would imply that neither the 3.627% weighted average yield achieved in 4 year bonds nor the 5.386% average yield priced in 10 year bonds are to be trusted as market benchmarks.


A more detailed analysis of the bonds issuance follows in the next post, so stay tuned.

Economics 22/7/10: Irish bonds auctions - a Pyrrhic victory?

“Despite Moody’s downgrade on Ireland’s credit rating on Monday, the NTMA successfully borrowed €1.5bn yesterday. Yesterday’s auction showed increased demand from investors for Irish debt and now means that the NTMA has completed 90% of its 2010 long-term borrowing programme.”

That was the swan song from one of Irish stock brokerages.

Lex column in the FT was far less upbeat, saying Ireland “offers a not terribly encouraging example of how difficult it is to overcome a massive debt binge.”

NTMA might have pre-borrowed 90% of this year’s €20bn borrowing target . But two things are coming to mind when one hears this ‘bullish’ statement.

Firstly, the €20bn is a target, not the hard requirement. If banks come for more cash, Brian Lenihan will have to get more bonds printed.

Secondly, Irish spread over German bunds is now higher than it was at the peak of the crisis in early 2009.

Want see some pictures illustrating Irish borrowing ‘success story’?

Let us start on the shorter end of maturity spectrum – 5 years and under:

Chart 1Average yields are trending up over the entire crisis term and are soudly above their entire crisis trend line since June. More significantly, the trend is now broken. As yields declined in 2009, hitting bottom in October, since then, they have posted a firm reversion up and once again, June and July auctions came at yields above those for this dramatic sub-trend.

Worse than that – in complete refutation of ‘improved demand’ claim by the brokers – yield spreads are now elevated. This spread – the difference between highest yield allocated and lowest yield allocated – suggests that markets are having trouble calmly pricing Irish bonds issues. Success or psychosis?

Chart 2 below illustrates the same happening in terms of price spreads.

Chart 2Auctions cover for shorter term paper is still below the long term trend line, although the line is positively sloped.

Chart 3Chart 3 above shows just how dramatic was the price decline and yields rise in Q2 2010 and how this is continued to be the case in July.

Chart 4Chart 4 gives a snapshot on pricing.

Next, move on to longer term bonds (10 years and over). There has been only one issue of 15 year bonds, so it is clear that the NTMA is simply unwilling to currently issue anything above 10 year horizon because of prohibitive yields.

Chart 5Chart 5 above shows upward trend in yields and July relative underperformance compared to longer term trends. It also shows yield spreads – again posting some pretty impressive volatility in June and bang-on long-term average (or crisis-average) performance in July. If that’s the ‘good news’ I should join a circus.

Chart 6Weighted average price is not changing much over the crisis period, so no improvement is happening here. In fact, since May it is trending down below the long term trend line, suggesting significant and persistent deterioration. Cover is on the up-trending line, but came in below the trend in June and July.

Chart 7 below shows more details on max and min prices and yields.

Chart 7Chart 8Chart 8 above clearly shows how average price is now in the new sub0trend pattern since November 09 price peak. May-July prices achieved are clearly below long term trend line and even more importantly – below the sub-trend line.

Finally, chart 9 shows the maturity profile of auctioned bonds:

Chart 9Notice how before the 2014 deadline, the Exchequer is facing the need to roll over €6,381 million in bonds issued during the 2009-present auctions. If Ireland Inc were to issue more 3-year bonds, that number will rise. That should put some nasty spanners into Irish deficits-reduction machine. But hey, what’s to worry about – our kids will have to roll over some €21,264 million worth of our debts (and rising), assuming the Bearded Ones of Siptu/Ictu & Co don’t get their way into borrowing even more.

Let us summarize the ‘success story’ that our brokerage houses are keen on repeating:

Table 1In other words, we are now worse off in terms of the cost of borrowing than in January 2010 – despite the ‘target’ for new issuance remaining the same throughout the period. We are even worse off now than at the peak of the crisis in March-April 2009 in short-term borrowing costs, although, courtesy of the German bund performance since then, we are only slightly better off in terms of longer maturity borrowings.

The compression in yield term structure delivered in June-July this year is worrisome as well. It suggests that the markets are not willing to assume that Irish Government longer term position is that much different from its shorter term prospects.

So on the net, then, what 'success' are our stock brokers talking about then? The success, of course is that NTMA was able to get someone pick up the phone and place an order, at pretty much any price? Next time, they should try selling pizzas alongside the bonds - the cover might rise again and they might convince the Eurostat that pizza delivery services are not part of the public deficit...

Ecoinomics 19/7/10: Moody's downgrade Redux

As Brian Cowen has been telling the world that Ireland has turned the corner, the country got some rude awakening.

First, Moody’s – aka the lagging indicator – pushed Irish bond ratings one notch down to aa2. Second - and I will be covering this in a separate blog post - Nama has completed transfer of the second tranche of loans.

With it, Moody’s also downgraded to aa2 that ‘not our problem, says Lenihan’ debt called Nama bonds. Irony has it, for all the SPV accounting tricks deployed by the Government, Nama bonds are rated on par with sovereign bonds and Moody’s statement justified both downgrades as being primarily driven by “the government’s gradual but significant loss of financial strength, as reflected by its deteriorating debt affordability”.

Per Moody’s, the third key factor driving rating cut is “the crystallization of contingent liabilities from the banking system... Overall, the recapitalization measures announced to date could reach almost €25bn …and Moody's expects that Anglo Irish Bank may need further support. … While we do not expect the government -- not even in a moderately stressed scenario -- to incur permanent losses in excess of 25% of the country's 2009 GDP as a result of [Nama] obligations, we believe that the uncertainty surrounding final [Nama] losses would exert additional pressure on the government's financial strength.”

Oh, mighty. So Moody’s believes that Nama will generate final losses. May be not as bad as €41bn (1/4 of GDP), but certainly losses. And notice that losses below 25% of GDP are expected by Moody’s explicitly in the scenarios that are better than or equivalent to their ‘moderately stressed scenario’… Of course, Nama’s Business Plan Redux envisions losses only in the ‘worst case scenario’ and even then, the modest €800mln.

“Moody's notes that the country could experience downward rating pressure in the event of (i) a failure of the economy to rebound in a meaningful way; and/or (ii) a severe deterioration in the country's debt metrics triggered by a further crystallization of bank contingent liabilities beyond Moody's current expectations.”

Err… let me see…

Bank recapitalizations that Moody’s have factored in – at €25bn to date – have already been exceeded, with current running estimate at €32bn committed, plus last week’s open-ended offer to give AIB anything it needs from Brian Cowen. These are likely to rise once again after today’s announcement from Nama on tranche II transfers. So condition (ii) is already satisfied.

Per economy’s likelihood of a rebound – well, give it a thought. Government policy over the last two years was characterized by increased taxes, retained waste, lack of reforms in public sector, lack of reforms in state-controlled private economy, lack of reforms in bankruptcy laws, massive waste of funds on poorly structured banks supports, and laissez fare in relation to banks and semi-state companies ripping off consumers and businesses. None of it is likely to change in 2011-2012. Which part of this litany of economic policies misfires can contribute to an increasing likelihood of a robust economic rebound?


Ireland is clearly not out of the woods when it comes to bonds ratings and this persistent problem of continued deterioration of public debt ratings will be a costly one.

Mark my words – as Ireland’s public finances continue to deteriorate, our debt will become more costly to finance. Should the Government opt for any tax increases in order to raise 2011 revenue, it will face continued fall off in income and transactions taxes collected, as people engage more actively in tax liability minimization. This will trigger widening of our deficits in excess of international forecasts (no one pays attention to our own ‘rosy’ forecasts anymore), leading to further debt downgrades. In particular, I would expect Fitch to move first once again to put two notches between itself, Moody’s and S&P.

One more point before we conclude. Irish banks are heavily dependent for capital and collateral on Irish sovereign and Nama bonds. The latest downgrade must have an adverse longer term impact on the quality of the banks balance sheets. Regardless whether AIB and BofI pass their EU-administered stress tests or not, I would expect the Moody's downgrade to have potentially significant adverse effect on Irish banks ability to tap private markets for funding in the near future. This, of course, might trigger another run on the Exchequer and customers by our leading banks.

Economics 05.03.2010: Greeks are paying the price

So you've heard by now that Greece 'escaped' the wrath of the market yesterday by placing €5bn worth of 10-year bonds. But don't be fooled - Greek's escape was nothing more than a respite: Greek taxpayers are now on the hook for paying a 6.3% yield on the 10-year paper - in line with near junk status of the bonds. This marks the highest spread for Greek debt since 2001.

Despite the issue being covered at 3x, there is a possibility for prices to tumble in the secondary markets (as happened with their 5-year paper last month) and there is an added concern that demand was underpinned by speculative investors with short-term horizons, as 'hold-to-maturity' types of investors (e.g insurance companies and pension funds) are cutting back on their holdings of PIIGS bonds. If the latter is true, then we can expect a serious pressure on yields to emerge in the next few days, with subsequent noises from the EU authorities about 'speculators' profiteering.

Big - albeit artificial - test for the euro will be March 16th when the EU Commission will rule on Greek fiscal consolidation plans. Expect approval, enthused speeches, and backroom talks on how to proceed forward with the country that

• plans to cut 2% of its GDP-worth off the deficit this year, but
  
• is unlikely to deliver on this target, whilst
• needing to cut a whooping double the planned amount just to stay afloat toward the 3% deficit goal for 2014-2015.
  

Meanwhile, Jean Claude Trichet went out of his way yesterday to tell the Greeks not to invite the IMF. During his press conference, Trichet repeatedly stressed that Europe has its own safety net for defaulting states (well, not quite in these terms) so no need to call in the big boys from the IMF. One wonders, what is Mr Trichet talking about. Papers quote Trichet saying that it is absurd to envisage scenarios of Greek exit from the euro.

All of this resembles the debates in the Afghan government in 1979 - to invite the Soviets or not... And the really, really, really funny thing is - IMF is EU-led organization (of the two supernationals: the World Bank is traditionally reserved as the leadership game for the Americans, while the IMF leadership goes to the EU appointees). While the Greek taxpayers are now set to pay over ten years €184.22 per each €100 borrowed last night - a steep price for not calling in 'Your Own Bad Guys' from Washington.

Now, put the Greek pricing into a perspective. On 14 January 2010 the NTMA issued €5 billion of a new bond, the 5% Treasury Bond 2020. If Irish debt was priced at Greek yields, the total cost to Irish taxpayer from this deficit financing would have risen €21.33 from €62.89 per €100 borrowed. In other words, our expected annual deficit for 2010 alone would be some €4,050 million more expensive over 10 years.

Economics 31/12/2009: Bond markets

Food for thought: rummaging through backlogged papers, I cam across 3 notes from our heroic stockbrokers' bonds desks singing songs about the right timings for investment in bonds. These trace back to June and October 2009.

So I asked myself the following question: should I have listened to your brokers' advice to buy Irish or US bonds in 2009?

Well, here are two tables giving a breakdown on bond price sensitivities to changes in interest rates. The US table:And the Irish table is here:Now, in darker blue I marked the cells corresponding to the reasonably plausible scenario for yields for 2010. In lighter blue - the next best predictions. So go figures - should you have listened to anyone pushing Irish or US bonds onto you?

Think of the following numbers - I don't have the same for the Irish markets - in the US, cash inflows into bond funds markets amounted to some USD313 billion in 2009, as yields kept on dropping to artificially low levels on the back of the US Fed buying up Federal paper. At the same time, as stock markets rallied, just USD2 billion net was added to stocks funds. (Numbers are to November 1, 2009). Some has been fooled.

So a Happy New Year for all and best wishes for the new decade!

My next post will be already in 2010 and will show comparative performance for Irish banking sector relative to other EU states - the latest data - for 2008.

Economics 12/06/2009: NTMA gamble

My apologies for staying off the blog posts for some time now - travel and compressed number of commitments this week have kept me with no time for blogging. Hopefully, this brief interlude is now over.

Per NTMA release:
"Irish Government Bond Auction on Tuesday 16 June 2009
The Irish National Treasury Management Agency (NTMA) announces that it will hold an auction of Irish Government bonds on Tuesday next 16 June, closing at 10.00 a.m.
Two bonds will be offered in the auction –
3.9% Treasury Bond 2012
4.6% Treasury Bond 2016
The overall total amount of the two bonds to be auctioned will be in the range of €750 million to €1 billion."

This is clearly a gamble on the 2016 bond and another tranche of medium term borrowing for 2012 issues.

Two problems continue to plague NTMA in my view:

Problem 1: issuance of bonds maturing prior to the magic 2013 deadline is threatening to derail the fiscal adjustments promised to the EU Commission, as these bonds will have to be rolled over into new issues and, potentially, at a higher yield. This also relates to the problem faced by the buyers of these bonds, as prices are likely to be depressed further should interest rates environment change.

Problem 2: signaling via maturity suggests that we are in trouble. If the state cannot issue credible 10+ year bonds, what does this say about the markets perception of the quality of our finances?

The bet NTMA are entering with the 7-year bond is that healthy results in the latest US Treasuries auction for 30-year paper yesterday will translate into a general bond markets demand improving.

Here are the combined results for the entire H1 2009 to date in issuance of bonds... not that NTMA would bother to put these in an Excel file for all to use...

First long-term:
Telling us that longer term bonds cover is at risk of being thin again (2.7 in March, down to 1.1 in April and up to 1.8 in May). Effective yields are rising: March issue at 4.5 coupon yields 5.81%, then down to April issue at 4.5 coupon yielding 5.08%, and up to May issue at 4.40 coupon and 5.19% yield. Next one will have 4.60 coupon and at what effective yield?

Plus notice how, with exception of one bond placement, all issues have gone past 2013. This means that offering another 2012 maturity bond next week is a sign of growing concerns for NTMA.

Short-term: a sea of borrowings here:
Covers are getting healthier, spreads on yields are shrinking and maximum allocated yields are starting to notch up again. What does it mean? Short-term money is relatively abundant and so covers should not be a problem for any non-junk paper, but the markets pricing spreads are getting tighter, more compressed to the higher yield range.
One more comment - both OECD and IMF have warned the governments not to succumb to a temptation to issue short term paper as refinancing it will bear a risk of higher yields. Guess what - based on the evidence above - is our Exchequer doing? H1 2009 issues to date:

• paper maturing in or before 2013: €12,157mln
• paper maturing after 2013: €2,978mln

Nothing more to say...

The cost of Ministerial chatter: Irish credit ratings

After a week of incomprehensible gibberish coming out of the Government statements on:

• borrowing restraints (here);
• receipts shortfalls (here and here);
• 'painful' solutions (aka destruction of private sector economy via fiscal policy - here);

and months of policy wobbles, two things came to their logical conclusion today.

The first one - reported (for now in very oblique terms - I will put more flesh on it when the embargo on the documents I received expires) here.

The second one - the S&P downgrade of Irish sovereign credit ratings.

Now, S&P is not known for being the quickest or the sharpest analysis provider on the block (I wrote about the need for a downgrade for some three months now), but at last they have moved, if only a notch, lowering Ireland's ratings from AAA to AA+ and retaining negative watch outlook (meaning more downgrades await).

I was neither surprised nor impressed by the S&P statement:

"March 30 - Standard & Poor's Ratings Services today said it had lowered its long-term sovereign credit rating on the Republic of Ireland to 'AA+' from 'AAA.' At the same time, the 'A-1+' short-term rating on the Republic was affirmed. The rating outlook is negative"

So far so good. Except in my view, a combination of the depth of our crisis, the severity of our economic policy failures and the lack of realism on behalf of this Government, pooled together with Cowen's unwavering determination to 'soak the rich' (middle and upper classes) to protect his cronies in the public sector - all warrant at the very least a downgrade to an A level. Given the structural nature of our deficits and Cowen's willingness to flip-flop on policy - an A- rating will be also justifiable.

Ok, back to S&P statement: "The downgrade reflects our view that the deterioration of Ireland's public finances will likely require a number of years of sustained effort to repair, on a scale greater than factored into the government's current plans," Standard & Poor's credit analyst David Beers said. As I said - lack of realism on behalf of the Government is costly. I have mentioned some recent evidence I got from the Partnership Talks (here). Telling... But what is also telling is the shade of realism that is being brought to the policy discussion table by the S&P, which is completely missed by the quasi-state ESRI (see here) who expect swift (2-3 year time horizon) action on closing structural deficits by increasing taxes.

The S&P is also referencing their belief that there will be further need for additional support for banking sector. I agree. And the Government has been boasting to the Partnership folks that it has resolved the banking crisis...

But here is a really good piece - bang on in line with what I've been warning about for a long time now. Despite our Government's senile belief that soon - a year or two from now - we are going to return to strong growth, S&P clearly states: "We expect that the Irish economy will materially under perform the Eurozone economy as a whole over the next five years, recording minimal growth in real and nominal GDP, on average, during the period. As a result, we believe that Ireland's net general government debt burden could peak at over 70% of GDP by 2013, a level we view as inconsistent with the prospective debt burdens of other small Eurozone sovereigns in the 'AAA' category."For comparison, here is the table from the DofF Junior Nostradamus's' January 2009 Update (below). This shows that our boffins are thinking we will be churning out 2.3% GDP growth in 2011, with 3.4% in 2012 and 3.0% in 2013...

Yeah, may be if we get Michael O'Leary to run this country...

"The medium-term prospects for the Irish economy are constrained by three interrelated factors: first, the impact on domestic demand as the private sector reduces its high debt burden, which stood at 280% of GDP in 2008; second, the scale of the deterioration of asset quality in the banking sector and possible need for additional capital; and, third, the support from external demand Ireland can expect as global economic conditions improve."

Ont the first point, I am again delighted that S&P decided to look beyond their naive insistence on focusing on public debt alone. Private debt mountains choking Ireland Inc (and soon to be added public taxation concrete weighing the economy down as we sink deeper into a recession) have been something I warned about for some time now.

On the second point, it is important to recognise that this Government has done virtually nothing to help repair the banks balance sheets and is not forcing households deeper into financial mess. Banking sector and real economy are linked.

• When a bank gets capital injection, but sees more mortgage holders defaulting because the Government has sucked their cash dry, what happens to banks assets?
  
• When a bank gets a deposits guarantee scheme at a cost to the system of €226mln since inception, but it costs the Exchequer twice as much due to higher cost of borrowing, what happens to the financial system's ability to provide credit finance?
  
• When a bank gets a promise to be rescued in some time in the future, but sees corporate deposits dry out today because the Government actually taxes companies (and sole traders) in advance of their receiving payments on overdue invoices, what happens to bank's capital?

Has Mr Lenihan bothered to take Level I CFA exams, he would have probably understood these brutal A-B-Cs of macrofinance. Alas, he didn't.

Now, next, the S&P avoids falling back into its comfort zone: "The government has already taken steps to contain the budgetary impact of these pressures, and further adjustments in taxation and spending, amounting to 2%-2.5% of GDP, are expected to be announced in next month's supplementary budget. At best, however, these measures will contain this year's general budget deficit to around 10% of GDP and lay the basis for a slow reduction in nominal budget deficits in future years. We are concerned, however, that a credible multi-year fiscal consolidation strategy will not emerge until after the next general elections, due by 2012. Accordingly, on current trends, we believe Irish net general government debt will likely exceed 70% of GDP by 2013 before beginning to trend downwards."

True that, as they say in the USofA. True that. Can you close your eyes and imagine Brian Cowen telling public sector unions that he is going to cut numbers of paper pushers employed in the public sector? or to trim their pay? or to eliminate our overseas aid budget? or to cut our defense spending by half to reflect the real might of our armed forces? or to privatize health care delivery (not access to services - delivery)? or to introduce efficient system of education fees? or that he will switch all public sector employees of age 45 and less into defined contribution private pension schemes? or that he will no longer automatically index pensions to already retired public sector workers to future wage increases in the sector? or that the corporatist model of centralized wage bargaining is done and over for ever? or that he will impose restrictions on striking activities in the public sector and will end job-for-life conditions of employment in the sector?

No? Neither do I. And neither does the S&P - at last.

'Happy Times' at NTMA: Updated

Remember that unrivaled shot of Borat sun-bathing on the banks of the river? Green unitard thong and brownish sand of post-Apocalypse industrial wasteland of a landscape? This is probably the scenery at NTMA today. The guys, and my heart goes to them for their effort (honestly - they did as good of a job as was possible under the circumstances), have gone away with loading into the markets a €700mln worth of 10-year Irish bonds. They wanted to upload €1bn, but stopped selling 30% short of the target. Why, you might ask? Well, it all comes down to terms. There is no actual information on bid spreads, but the average was 5.80%, lowest price of 89.6, average price 89.527. Yikes.

Some time ago I predicted that we might see 6.5-7% yields on Irish Government paper by the year end. Well, that was before the latest 50bps drop in the ECB rate (March 11), implying that at 5.80% today we are in the territory of 6.00-6.10% already if compared with the situation before March 11th.

What is even more telling is that I was right on March 10 when I priced 10-year bonds in the range of 5.7%-5.9% (here).

Lastly, it is worth looking at the volume of issue - €700mln... sunflower seeds for the public sector - at current rate of spending, Brian^2+Mary are going to get through this amount in less than 4 days and 1 hour 30 minutes. NTMA is better start issuing new paper weekly at that rate of spend! Or maybe they should pick up a phone and dial Leinster House, asking to stop the madness of bleeding the taxpayers and companies to feed the beast of our public sector and start cutting fat. Showing the markets that Ireland's Government is not just a public sector unions' crony and is capable of getting its fiscal policy under control just might bring down the cost of borrowing.

Happy Times?


Update: the media is singing praise for yesterday's issue, but hold on: they say we raised €1bn, in reality, we raised only €700mln in 10-year paper and €300mln in 3-year paper. You don't have to be genius to see that the 3-year stuff is going to mature before the expiration of the 2013 deadline for putting our finances in order. So in effect, we kicked €300mln worth of a problem into the scoring zone... This is equivalent to a drug addict's miraculous 'recovery' reports when the chap simply stashed some powder for a quick hit in a couple of hours time. Some success.

More details from NTMA itself: for the 10-year bond, lowest price 89.46 at yield of 5.818%, weighted average yield 5.808%. Pricey stuff this is and wait until the mini-budget shows the rest of the world that Cowen has no intention of seriously tackling the deficit - where will we be next time we shove pile of debt into pre-2013 maturity?

And you don't have to be a genius to recognize that if the state completes one 'successful' auction like the one yesterday per month, NTMA will have, by the end of 2009:

• raised maximum of €10bn, while we need €15bn just to stay afloat this year;
• pushed some €7bn (€3bn in monthly auctions, plus €4bn in February sale) in new debt into 2011;
• reached €63.5bn national debt level (up from €52.5bn as of the end of February); and
• forced Ireland Inc even further away from meeting its commitment to the European Commission of getting under 3% budget deficit limit by 2013.

Yesterday's success is starting to look more like a Pyrrhic victory to me.

Irish credit III

NTMA is brewing up a plan again (here). This time around, reportedly for a 5-year bond to be launched next Tuesday at 4.5%. Which would be a wishful thinking - the current bid yield is 60bps above that - if not for the possible caveat.

Oh no, the caveat is not about launching the bonds into the outter space from Baikonur Launching Station in Kazakhstan (although potentially only Martians would willingly take Irish paper on these terms and only Borat-land would underwrite such a launch). The caveat - speculative at this junction - is that the 'launch' will aim to place the bond in Irish banks and some into the eurozone CBs. The banks will then go to the ECB and get, ugh, 85c on a euro. A helicopter drop of money with Mr Trichet in the driving seat.

Now, don't take me wrong - NTMA has done some seriously competent job to date and, in my view, represents pretty much the second half of the two functioning financial organizations in this state (the Revenue Commissioners being another). But they are facing an increasingly impossible task of feeding the Brian-Brian-Mary T-Rex of fiscal excesses.

Last time around (see here) only 21% of the bond issue has gone to the willing private buyers. That issue was priced to the market median. This time, 4.50% implies only a 75bps premium over German 10-year bund placed earlier this week. Today's YTM on 10 Plus Bond Index was at 5.90% and no outstanding bond with maturity beyond 2014 was priced at YTM below 5%. So where does it leave the newest issue? My guess - at the ECB via a primary orbit of the Irish banks.

So let's speculate together:

Take 4.5% at 15% ECB discount on, say 79% of bonds placed via banks (and with CBs), 2018 10-year bond and March 16th closing (clean) price of 91.35. You have YTM of 4.64-4.89% - darn close to 4.5% NTMA dangling about, except it is priced off the February issue (extending the maturity horizon).

Now, move forward to 2019-2020 and take the same 4.5% bond at 15% discount, 85% placement with ECB and get 5.6% YTM at today's opening price. What is the YTM consistent with 100% placement at ECB? 6.4%, which in March 16th market corresponds to 11.5 cents discount on a Euro. Also nicely close to today's 15 cents discount at ECB window.

It all adds up iff we are setting up a sale to ECB. At ECB's discounts on near-junk paper (here)...

Housekeeping and S&P

You can see a quick snippet of my contribution to the Bloomberg report on Ireland today here.


But for now, the main piece of news of the week so far is the S&P downgrade of Irish Banks.

The downgrade is the second in just 4 months - took Ireland's Banking Industry Country Risk Assessment from Group 1 (prior to December), to Group 2 in December and now to Group 3. We are now in the sick puppies crate with Portugal, Austria and Japan. The first (December 2008) downgrade was based on S&P's negative assessment of banks loan books exposures to housing and construction. The latest downgrade is based on an all-but-silly argument that Anglo Irish Bank loans scandal has undermined reputation of Irish Banking, as if a litany of bad loans did nothing of the sort, or as if unethical manipulation of the banks books via cross deposits between IL&P and Anglo did nothing of the sorts.

More importantly, S&P has also threatened a further downgrade due shortly - this time on the back of "significantly weaker long-term prospects for the Irish economy". Such a downgrade will place us in a banking ICU with Greece, Israel, the Czech Republic, Slovakia and Slovenia in the neighboring beds.

But the real unspoken issue remain unaddressed.

• The Irish taxpayers have guaranteed the banking system's liabilities, nationalized one of the big 3 banks and committed to injecting capital into other.
  
• Yet, the ability of the Exchequer to cover these commitments has been deteriorating at a speed that would make Einstein's theory of relativity go bonkers.
  
• In the mean time, not-too-often remembered smaller banks, building societies and credit unions are getting their closets opened up by scandal-seeking media. And rich pickings these parish-pump financial institutions present under the inspecting lens of public attention.
• All along, housing markets are still falling, commercial property is heading South like a flock of geese sensing a winter chill and the economy is shrinking like ceran wrap on a fireplace mantle.

So here is a question that S&P is trying to avoid so desperately and our Government is bent on denying with the trustworthiness and passion of the banker telling the markets "Our books are sound and we need no new capital": Given Irish Exchequer decision to blend public debt with banks' liabilities and capital exposures, why should Ireland's General Government bonds be rated AAA?


Rome or Reykjavik?
In the mean time, economic silliness (I am avoiding here a much stronger word) continues to grip the Government, as the latest statements by Minister for Finance (see here), attest.

“A lot of political pundits say the choice next time for Ireland will be Rome or Reykjavik,” Lenihan said on Bloomberg TV today. “Most people will vote for Rome."

Yes, Minister, we get the historical pun. But do you actually mean what you are saying?

Ireland is already in the company of Rome in many senses. Being a part of the APIIGS countries we are in a club of the sickliest countries in Europe (and OECD) alongside Italy. We have surpassed Italian levels of unemployment and, should we adopt Minister Lenihan's suggestion and chose Rome, we will be settling into a trend (long-term) growth rate of 0.5% annually over the next 30 odd years. But then again, we have already surpassed Italy as a more corrupt society (according to the World Bank) and as our economy shrinks by 7+% this year and 16% between 2008-2010, we are well on track to be the Mezzogiorno of the North Atlantic (minus weather, food, wine and beaches of Sicily). And, of course we are heading for the glorious 100%+ public debt to GDP ratio should Brian Cowen, have his way with the economy. So, Mr Lenihan, is Irish Government really bent on getting Ireland to join Rome? Is this what you will be telling the international investors?

In reality, what this comment illustrates is that Mr Lenihan is much better fit to be a Minister for Justice than a Minister for Finance, for even his European references set is so limited to the legalities of European treaties that he forgets that the brief he has is in finance!

But there was more to Lenihan's comments than Rome v Reykjavik blunder. “The ECB stands behind the entire Irish banking system, just as the Bank of England will stand behind the banks in the U.K.,” said Lenihan. “So there’s no default issue in relation to the banking system.”

Irony has it, I predicted after the last issue of Government bonds in February that in effect Ireland is already being rescued by the ECB. Now, we have a confirmation. Mr Lenihan's reckless actions on Irish banks have been preconditioned upon his belief that the ECB is going to back him up!

Here are two follow up questions to this statement:
1) If this is true, when did you negotiate with the ECB actual arrangements for emergency financing for Irish banks?
2) Do Germans and French know about this ECB commitment to Ireland?

Lenihan said nothing on this, other than claim that Ireland will be "in a position to fund ourselves as a state this year and the European Central Bank stands behind our banking system... So we’re a solvent state and we’re well able to do our business.” This is eerily reminiscent of Eugene Sheehy's infamous battle cry that AIB will not take any public money last Autumn. We know how that one turned out in the end...

Setting aside the arguments as to whether or not Mr Lenihan can actually finance our Exchequer deficit this year, can we please see the actual contract that commits the ECB to underpinning the Irish Government guarantees to the Irish banks and provide capital to these banks?