8/7/20: On a Long-Enough Timeline, This Is Not Sustainable

Something will have to give, and on an increasingly more proximate timeline, although we have no idea when that timeline runs its course...

In basic terms, U.S. Bonds yields are only sustainable as long as:

1. There remains a market-wide faith that the U.S. Government will not deflate itself out of the fiscal mess it has managed to run, virtually un-interrupted, since at least 1980 on; 
2. There remains a regulatory coercion into the U.S. Government bonds being 'risk-free' capital 'instruments'; and
3. There remains vast appetite for the U.S. dollar as the store of value instrument for everyone - from migrants and legitimate business people in the politically questionable jurisdictions to drug dealers.

Which puts a serious question mark over how long can the U.S. Treasury afford to escalate weaponization of the dollar.

16/10/19: Ireland and the Global Trade Wars

My first column for The Currency covering "Ireland, global trade wars and economic growth: Why Ireland’s economic future needs to be re-imagined": https://www.thecurrency.news/articles/1151/ireland-global-trade-wars-and-economic-growth-why-irelands-economic-future-needs-to-be-re-imagined.

Synopsis: “Trade conflicts sweeping across the globe today are making these types of narrower bilateral agreements the new reality for our producers and policymakers.”

13/3/15: Emerging Markets Corporate Debt Maturity Squeeze

H/T to @RobinWigg for the following chart summing up Emerging Markets exposure to the USD-denominated corporate debt redemptions calls over 2015-2025. The peak at 2017 and 2018 and relatively high levels for exemptions coming up in 2016, 2019-2020 signal sizeable pressure on the EM corporates that coincides with expected tightening in the US interest rates cycle - a twin shock that is likely to have adverse impact on EMs' capex in years to come. With rolling over 2017-on debt becoming a more expensive proposition, given the USD FX rates and interest rates outlook, the EMs-based corporate sector will come under severe pressure to use organic revenue generation to redeem maturing debt. Which means less investment, less hiring and less growth.

The impossible monetary policy trilemma that I have been warning about for some years now is starting to play out, with delay on my expectations, but just as expected - in the weaker and more vulnerable markets first.

16/1/2015: S&P Capital IQ Global Sovereign Debt Report: Q4 2014

S&P Capital IQ’s Global Sovereign Debt Report is out for Q4 2014, with some interesting, albeit already known trends. Still, a good summary.

Per S&P Capital IQ: "The dramatic fall in oil prices dominated the news in Q4 2014, affecting the credit default swaps (CDS) and bond spreads of major oil producing sovereigns which have a dependence on oil revenues. Venezuela, Russia, Ukraine, Kazakhstan and Nigeria all widened as the price of oil plummeted over 40%. Separately, Greece also saw a major deterioration in CDS levels as it faces a possible early election."

And "Globally, CDS spreads widened 16%."

No surprises, as I said, but the 16% rise globally is quite telling, especially given CDS and bond swaps for the advanced economies have been largely on a downward trend. The result is: commodities slump and dollar appreciation are hitting emerging markets hard. Not just Russia and Ukraine, but across the board.

Some big moves on the upside of risks:

• "Venezuela remains at the top of the table of the most risky sovereign credits following Argentina’s default in Q3 2014, resulting in its removal from the report, with spreads widening 169% and the 5Y CDS implied cumulative default probability (CPD) moving from 66% to 89%." 
• The only major risk source, unrelated to commodities prices is Greece where CDS spreads "widened to 1281bps - an election as early as January could see a change of government and fears over a possible exit from the Eurozone have affected CDS prices." 
• "Russia enters the top 10 most risky table as CDS spreads widened around 90% following the fall in oil price which is adding more pressure to an economy already subject to continued economic sanctions." 
• "Ukraine CDS spreads also widened by 90%." 
• "CDS quoting for Nigeria remained extremely low throughout the last quarter of 2014. Bond Z-Spreads widened 150bps for the Bonds maturing in January 2021 and July 2023 but remained very active." 

Venezuela and Ukraine are clear 'leaders' in terms of risks - two candidates for default next.

Other top-10 are charted over time below:

Again, per S&P Capital IQ:

• "The CDS market now implies an 11% probability (down from 34% in Q3 2014) that Venezuela will meet all its debt obligations over the next 5 years, as oil prices dropped 40% in Q4 2014." 
• "Russia and Ukraine CDS spreads widened 90% during Q4 2014. The Russia CDS curve also inverted this quarter with the 1Y CDS level higher than the 5Y. Curve inversion occurs when investors become concerned about a potential ‘jump to default’ and buy short dated as opposed to 5Y protection." This, of course, is tied to the risks relating to bonds redemptions due in H1 2015, which are peaking in the first 6 months of the year, followed by still substantial call on redemptions in H2 (some details here: http://trueeconomics.blogspot.ie/2014/11/24112014-external-debt-maturity-profile.html). As readers of the blog know, I have been tracking Russian and Ukrainian CDS for some time, especially during the peak of the Ruble crisis last month - you can see some comparatives in a more dynamic setting here: http://trueeconomics.blogspot.ie/2014/12/16122014-surreal-takes-hold-of-kiev-and.html and in precedent links, by searching the blog for "CDS".
• "Greece, which restructured debt in March 2012, returned to the debt markets this year. CDS spreads widened to 1281bps and the 4.75Y April 2019 Bonds, which were issued with a yield of 4.95%, now trade with a yield of over 10%, according to S&P Capital IQ Bond Quotes." 

By percentage widening, the picture is much the same:

So all together - a rather unhappy picture in the emerging markets - a knock on effect of oil prices collapse, decline across all major commodities prices, dollar appreciation and the risk of higher US interest rates (the last two factors weighing heavily on the risk of USD carry trades unwinding) - all are having significant adverse effect across all EMs. Russia is facing added pressures from the sanctions, but even absent these things would be pretty tough.


Note 1: latest pressure on Ukraine is from the risk of Russia potentially calling in USD3 billion loan extended in December 2013. Kiev has now breached loan covenants and as it expects to receive EUR1.8 billion worth of EU loans next, Moscow can call in the loans. The added driver here (in addition to Moscow actually needing all cash it can get) is the risk that George Soros is trying to get his own holdings of Ukrainian debt prioritised for repayment. These holdings have been a persistent rumour in the media as Soros engaged in a massive, active and quite open campaign to convince Western governments of the need to pump billions into the Ukrainian economy. Still, all major media outlets are providing Soros with a ready platform to advance his views, without questioning or reporting his potential conflicts of interest. 

Note 2: Not being George Soros, I should probably disclose that I hold zero exposures (short or long) to either Ukrainian or Russian debt. My currency exposure to Hrivna is nil, to Ruble is RUB3,550 (to cover taxi fare from airport to the city centre on my next trip). Despite all these differences with Mr Soros, I agree that Ukraine needs much more significant aid for rebuilding and investment. Only I would restrict its terms of use not to repay billionaires' and oligarchs' debts but to provide real investment in competitive and non-corrupt enterprises.

18/2/2013: G20 & Currency Wars

Amidst continued rapid devaluation of the Yen, predictably, and per usual, the G20 summit in Moscow has ended with a useless and unenforceable statement. This time around, as was signalled in the days ahead of the meeting, the 'focus' of transnational vacuousness was on the topic de jour: the Currency Wars.

But the background to it was much less economic than political. G20's sole obsession is to drive forward the idea that to survive, the world needs more coordination of top-level policies. This invariably requires (a) finding a convenient newsflow-worthy boggy, (b) making a statement to the effect that greater coordination is needed and that cooperation can cure all ills, and © proceeding to do absolutely nothing about it post-statement. The latests communique went on to conclude that “ambitious reforms and coordinated policies” were the key to achieving strong sustainable growth. Just like that: coordinate and magic shall happen.

Thus, the meeting of G20 has issued a statement rallying against competitive currency devaluations - or in more common parlance, a “currency war”.

In reality, G20 has no power to abate, let alone reverse, the process of currencies debasement. Quantitative easing - in its now fully evolved multitude of forms will go on, with central banks and governments across the OECD continuing to print their ways out of the slump. If G20 communique were to achieve anything, it will be just to push the whole affair under the proverbial rug, with devaluations not explicitly targeted in public pronouncements.

The communique states that G20 states "will refrain from competitive devaluation. [and] will not target our exchange rates for competitive purposes, will resist all forms of protectionism and keep our markets open.” The devil, of course, is in the slight turn of phrase. The G20 committed to not drive down their currencies values for 'competitive purposes'. But as long as money printing is 'necessary' to sustain domestic financial stability or deliver a monetary stimulus or both - then all is ok.

Just how feeble the whole statement is was illustrated immediately, with the worst offender - the Japanese Yen, down 7% in value already in 2013 - posting a slide against major currencies. In many ways, the communique makes it even more likely that sustained devaluation of the yen will be even more damaging now. Prior to G20 statement, the Japanese Government could have simply continued pushing down yen values by focusing on aggressive statements about the need for monetary stimulus and forex rate targeting. Now, it will have to print hard cash silently.

And the Fed is still sitting on a massive bonds purchasing programme that so far has been running at ca USD80bn per month. At G20 meeting this programme has been squarely defended by Bernanke.

Senior Bank of England, Martin Weale went on, during the G20 summit, to praise Sterling debasement, saying that a 25% devaluation of the pound over 2007-2008 period was not enough to boost exports and that more devaluation should be targeted.

In short, the entire G20 summit was a joke. It neither signaled any real policy shift, nor mapped a single tangible policy response to the crises still impacting advanced economies. If anything, via reducing potential rhetorical impact of monetary policy stance, it pushed the G7 countries into a more aggressive real monetary policies responses space. This promises to accelerate the currencies wars, while reducing overall ability of the monetary authorities to quickly unwind the decisions taken in years to come.

04/08/2011: Safe Haven within a small open economy

Some interesting news flow on the Swiss Franc side today with the Swiss National Bank announcing that it will intervene in the markets across not just one instrument, but three, simultaneously. CHF had seen dramatic appreciation against the Euro and the USD in recent months (see charts below), with current valuations of CHF, according to SNB: "threatening the development of the economy and increasing the downside risks to price stability in Switzerland."

In line with this, SNB announced that it will (1) move target 3-mo Libor rates closer to the range of between 0% and 0.25%, down from the current range of 0% to 0.75%, (2) will "very significantly increase" the supply of CHF, and (3) will hike required deposits for Swiss banks from CHF30 billion to CHF80 billion.

Funny thing, folks, shortly after the announcement, CHF fell against the Euro by 1.8% to CHF1.1061/Euro, and against the dollar +1.4% to CHF0.7761/USD. Yet, with the latest rumors from the US - about QE3 - the USD promptly fell back against the CHF to 0.7701/USD and erased most of the euro gains to CHF1.1054/Euro.

The problem, of course, is that for all the firepower deployed, SNB has little power to shift the prevalent investor sentiment that, at the time of expected QE3 and continued uncertainty about the Euro area sovereigns, CHF - alongside other small currencies - represents, in the minds of investors, a safe haven. This, of course, is the dilemma of the Swiss franc - a safe haven within an small and open economy: too well-run to join the basket cases across its borders, too small to defend...

And so to end with some good background on what's going on with CHF recently - read this.

Economics 07/03/2010: A long term view of the currency markets

With the euro unsteady against the dollar (post-10%+ drop in recent months from its highs over 1.50 in December 2009 to 1.35) there is a question to be asked - can dollar and euro act as reasonable hedges for each other. In other words, should euro-overweight Europeans hold dollars, while dollar-overweight Americans, Asians and Latin American hold euros? In my view – neither.

This view is formed by my belief that both currencies will continue to fluctuate along a short-term weakening of the euro rend, followed by an equally volatile, but flat trend in the medium term, moving into a dollar appreciation trend in the long run.

Why? Because two economies fundamentals are currently very similar, and only the long term view affords a potential for the US to pull away from the structurally sicker European partners.

In absolute terms, the EU27 is the largest ‘economy’ in the world – some 16.2% greater in terms of PPP-adjusted GDP than the US ($14.2 trillion) economy. But the eurozone itself is equivalent to just 74% of the US total output, despite being 10 million ahead of the US in population terms. Taken as such, one can argue that on average, the euro currency and the US dollar cores are roughly the same.

Both had pretty tough time through the downturn. 2009 US GDP was down 2.7% outperforming Eurozone where GDP fell 4.2%. Unemployment is running pretty much in line, but US unemployment is usually more willing to subside once recovery begins. On financial sector side, euro area has taken roughly 40% of the required corrections of the banks balancesheets as of Q4 2009, while the US banks have taken 60%.

Inflation in the US has been running ahead of the EU16 (2.7% as opposed to 0.6% in 2009). But this inflation differential means two things – it reflects differences in the timing and the size of fiscal and monetary interventions and it reflects the effects of devaluation of the dollar. US recovery has begun, while EU16 is still languishing at around 0% growth and there are growing signs of a possible double dip hitting Berlin, Paris, Rome and Madrid, not to mention the peripherals.

Greeks are the star performers when it comes to the circus of fiscal recklessness in the Northern Hemisphere: 12.2% deficit (more likely closer to 13%). Last week’s plan to trim 2% off that number is, assuming it actually comes into being, equivalent to being 5.875% short of the cost of financing the Greek debt annually. In other words, Greek debt is priced at 6.3% per annum. It stands at 125% of GDP, which means that 7.875% of the GDP is spent every year by the Greeks on interest payments on the debt alone. It will take Greece 4 years of consecutive 2% cuts to just cancel out the existent interest on the debt.

For Ireland, the figures are hardly more pleasant. 11.6% deficit planned for in 2010 Budget (a net cut of just 0.1% on 2009 figure) and with our debt (ex-Nama) heading for €90 billion (over €100 billion with recapitalization factored in) or 56% of expected 2010 GDP, at the latest yield of 5%, means that our debt burden is currently taking up 2.8-3.2% of GDP annually. At the current rates of budgetary adjustments (per Budget 2010), it will take Ireland Inc over 30 years to bring the budget into offsetting the interest costs on the current debt.

Ok, I hear your protests, the actual cut was closer to €3.3 billion or 2.04% of GDP, but further deterioration in expenditure due to social welfare and unemployment increases has scaled this back to 0.1%. Fine – at 2.04% cuts, it will take Ireland 1.5 years to offset the interest bill. Factoring in Nama and expected deficits in 2010-2014, 3 years of consecutive cuts of the same magnitude as Budget 2010 would do the job.

The important thing here, of course, is to remember that in both cases (Greece and Ireland) these cuts will not be denting the deficit at all, just offsetting the rising interest rate bill. And we made no assumptions about the direction of the bonds yields.

But Greece, Ireland and the rest of APIIGS aside, the EU and euro area are fiscally marginally better than the US. The EU16 average deficit will be 6.9% of GDP in 2010 – some 3.7 percentage points below that of the US. Similarly for the debt levels: euro area is currently at 84% of GDP, rising to 88% in 2011 and over 100% by 2014. In the US, current debt is already at 87% of GDP and will rise to 100% by 2012.

Of course, there are three things worth mentioning. EU forecasts are done by the EU Commission with historic accuracy record of tea leafs readers. US forecasts are done by the US Budget Office, with rather decent forecasting powers. The US is more willing to deflate out of its debt problems than the EU16.

Finally, the numbers above do not reflect the fact that there is a higher risk of a double dip in the euro area. Nor do they reflect the fact that EU16 banks are still facing severe liquidity and capital shortages amidst untaken writedowns.

In other words, expect euro area deficit and debt to go up erasing the difference between the US and EU in fiscal terms.

So what really perpetuates US dollar vastly more powerful position in the reserve vaults of the banks worldwide is the legacy. Central banks simply cannot unwind their massive holdings of the dollar without destroying their own balancesheets. This process will have to be stretched over time.

The thing is – with the latest revelations concerning Greek financial mechanics in the past and the EU’s inability to face the reality, majority of the central banks around the world which might have started reducing their dollar exposure in the recent past are now reversing that strategy. Going into dollar became fashionable once again.

But the dollar is not a safe heaven in the medium term. And neither is, per above, the euro. One analyst recently described the current shift back into the dollar as “exchanging your ticket on the Titanic for a ride on the Hindenburg”.

So really, folks, last time this happened – parallel inflation in the euro and the dollar and economic weakening of both, with public finances coming under pressure – back in 2007, the markets response was an age-old one. Gold and commodities went up, debt went down, stocks went out of the window. It looks like we are in 2006 once again, sans economic boom, but with a new rebalancing. I would expect gold to continue firming up, commodities to lag behind on the same trend and stocks and FX bouncing violently at the bottom.