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 5/10/10: Irish bonds - ECB propping Leni up, for now

Irish bonds have been performing quite strongly in the last few days, following last Thursday desperate news on banks recapitalizations. What gives, one might ask? Was the certainty of Ireland posting a historical record-breaking 32% budget deficit this year better than the uncertainty of previous estimates? Or was it something else.

Given the opacity of the sovereign bond markets - especially for countries like Ireland (note the farce here - Government own securities exist in a world of much more restricted newsflows than ordinary equities, and yet everyone today expects Governments to lead in a charge for greater transparency and regulation) - one finds it difficult to explain what has been happening here.

Two possible contributing factors emerged in recent days to at leats partially account for strong performance:

1. ECB buying Irish bonds; and
2. Short positions being rolled up in profit taking

Now, we have some confirmation to (1). FT Deutschland reports today that last week ECB has dramatically increased purchases of Greek, Spanish and Irish bonds, having bough ca €1.384 billion worth of stuff in one week, and bringing its total holdings to €63.5bn. The weekly ramp up was some ten-fold on €134 million of same bonds purchased in the last week of September. ECB now holds some 14% of the entire sovereign debt market in Greek, Spanish and Irish bonds. This implies that market valuations in these bonds are entirely bogus.

FT Alphaville has a few charts on both Irish & Portuguese markets (here).

Which brings us to the shorts closures. Holding an open and backdated short position in the paper artificially propped up by the ECB is like taking a proverbial p**ss into the gale force wind storm. Given that most shorts against Irish debt were written around mid- to late-August, this was clearly the time to book some profits. Which, of course, further pushed up demand for these bonds and thus prices. Yields compressed down.

But the question next is: where does the freed up cash flow now? Most likely, the markets will pause to see whether the ECB latest purchasing is going to continue. If so, expect another rise in prices and a waiting game, as markets participants would rationally expect the ECB to start unwinding new purchases in a couple of weeks time. Once that move is seen on the horizon, new shorts will be taken, once again.

Economics 4/10/10: Exchequer deficit

Lastly, it's time to put the sums together.

Despite the heroic efforts of the Government and the Public Sector Unions, Exchequer deficit continues to trace out the exactly same path as 2008. And this is ex-banks:
As I pointed out in the previous post, we are 'saving' €1,562 million January 2010-September 2010 of which €1,406 million came from the capital budget cuts (the so-called investment (dis-)stimulus that Brian & Brian have promised to deliver in Budget 2009, then Budget 2010 and in all of their 'growth strategies' since the beginning of the crisis). Only miserly €156 million of savings came out of the public sector current spending, less than 1/10 of the total cuts.

More worrying is the fact that much of the capital cuts came in at the beginning of the year, and since July, these cuts are getting smaller and smaller as a share of overall capital budget allocation. Meanwhile, current spending cuts are becoming virtually invisible with time as well.

In June this year, capital budget was down 36% yoy. Today this decline stands at 32.1%. In January, we posted an impressive 11.9% cut, yoy, in current spending. This has steadily declined to 1.6% by August 2010 and finally to 0.5% in September 2010. Let's take a look at the latter number: current spending by the Government €30,088 mln through September, which is 1/2 of 1 percent lower than it was in the first 9 months of the disastrous 2009! Does anyone still wonder why the capital markets don't buy the story that Irish Government is capable of controlling its spending habits?

Let's cut to the chase. Despite all the rosy, warmly glowing reports about "yet another month of improved fiscal performance" it looks like we are turning yet another corner - the corner of rapidly evaporating savings. Next intersection: Disaster Avenue?

Economics 4/10/10: Exchequer Expenditure for September

Exchequer expenditure in details.

Starting from the top, the same picture as in August remains true - capital spending cuts drive overall performance on expenditure side, while current spending cuts are extremely shallow:
Notice also that both cuts are getting shallower as the year progresses. In months ahead, delayed payments to contractors will have to be settled, implying that it is likely that current spending is going to break the contraction cycle by the year end, while capital side savings are going to get shallower. It is, therefore, highly unlikely that overall year on year performance in terms of Exchequer spending will post a decline greater than 2% of overall spending in the end.

Detailed expenditure by department, year on year:
So where's the money being spent?
And how does it compare to the DofF targets?
Again, let's exclude capital spending and focus on current spending:

So for all the hoopla about draconian cuts and great courage of our public sector (remember, the Croke Park agreement claimed that €3 billion has been cut out of public sector wages alone), we have saved (January-September 2010) a miserly €1,562 million. Oh, about 5 weeks worth of our state borrowing so far or 3 weeks of our borrowing year to date. But even that number conceals the truth. Year on year, just €156mln - miserly number indeed - was cut out of current expenditure. That's right, folks, for the state that borrowed €16 billion this year so far, we managed to save less than 1/2 a week worth of what we issued in fresh bonds since January 1.

Put this into Croke Numbers perspective, at the rate things go, it will take 19.2 years for us to reach the magic 3 billion in savings number cited by the Bearded Ones.

Economics 4/10/10: Tax receipts & burden

Second installment of analysis of tax receipts. Starting from the top:
As I noted in the first post - there's no evidence of any recovery when it comes to total tax receipts. There is, of course, a significant lag to any recovery translating into tax revenue, especially across the income tax receipts. But the same is not true for capital taxes (investment recovery usually predates employment recovery), VAT (consumption pick up shows up also earlier in the recovery cycle) and a host of other smaller tax heads (excise etc).

Year on year dynamics are also quite depressing:
Not a single core tax head is in positive growth territory, although excise is getting closer to hitting an upside.
In smaller categories, customs duties are posting positive growth - helped by car sales and imports by MNCs. Stamps show the extent of sell-off of shares in August on the back of renewed weaknesses in financials, plus some accountancy moves.

Now to the worrisome picture: tax burden distribution.
Back in the dark ages of the 1980s, PAYE taxpayers carried some 70% of the tax burden. Guess what, we are back to that territory now - all consumption and income tax heads are now accounting for roughly 79% of the total tax take. The Government policy of making taxpayers pay for everything - from banks to Croke Park agreement - is really starting to show.

Illustrated differently:

Lastly, receipts performance against DofF target.
Customs and Corpo are showing significant improvement. Income tax and Vat are poor cousins. Overall, total tax take is getting closer to target, but still runs below the DofF projections. Again, Q4 will be the crucial quarter here.

Economics 4/10/10: Exchequer receipts

High level view of Exchequer receipts paints a continuation to the depressing picture. If there is any stabilization in the economy, this stabilization is yet to be seen on the tax receipts side of things.
Income tax above is tracing neatly below the returns for the last year. Good news, September 2009 slight slowdown was avoided so far. But the real direction of tax receipts on income side is in going to be revealed in the current Q4. Same is true for VAT:
September 2010 VAT receipts are even more disappointing given all the noises about the pick up in retail sales. Going back to school, while yielding a small uptick in volume of sales, clearly was erased in terms of value of sales as deflation in core retail sectors continues.

Corporation tax is struggling to stay above 2008 - a clear sign that economy is still sick:
Core months here are however ahead of us.

Excise and Stamps taxes are almost bang on with 2009, which isn't much of an achievement.

Capital taxes clearly showing no improvement in investment in this economy:

Customs duties moving upside - in part clearly on the back of exporters robust performance so far, plus car imports mini-boom (well, relative to previous years)
Total tax receipts are therefore running well below their levels in 2009:
I never was a fan of the "receipts to target" metrics, primarily because real numbers/levels speak to me much more than imaginary numbers DofF produces our of its excel spreadsheet forecasts. However, to keep up with the fashionable 'economists' from our banks and brokerages - stay tuned for that analysis to follow.

Economics 3/10/10: Construction sector - destruction continues

Nothing exemplifies the collapse of the Celtic Tiger than the fate of our indigenous 'flagship' sectors: Banking and Construction. The two fates, linked at the hip, got some very different treatment in the media this week. Banks received all the attention, yet Construction suffered a total neglect. Yet, last week CSO published Q2 2010 data for Construction sector.

Undoing any damage to the Construction sector's reputation as the 'leading newsflow' sector of Ireland Inc, let's update the data. Here are the charts, most of which, as often is the case, speak for themselves.

First volume and value in all sectors ex-Civil Engineering:
Next: Civil Engineering:
Interestingly, if you recall, since Budget 2009, this Government has consistently claimed that Ireland is getting a significant stimulus in the form of public investment - which, of course, in Government's parlance always means 'building stuff'. In fact, even after the imposition of the latest cuts in the Budget 2010, Civil Engineering spend (ok, investment) declined at the rates greater than the Government has planned for.

Residential and Non-Residential:
To see the real extent of our crisis in the Construction and Building sector, compare ourselves to the European counterparts:
And what about our previous claims that we don't belong to PIIGS?
What's amazing, of course is that despite this massive contraction, our housing and property markets continue to free-fall while employment in the sector continues to contract.

Economics 3/10/10: The real stress in Euro area banks

"A picture's worth a 1,000 words" an old proverb goes. So here's a couple of pictures from the latest GFSR analytical papers issued by the IMF last week:

Remember the favourite EU leadership myth: "The Americans caused this crisis". Ok, if so, one would assume that EU banks are in a better position through the crisis than their US counterparts.
If the assertion above was correct, why would the demand for CB financing be so much greater in the EU both in terms of banks demand for liquidity prior to the crisis and after the crisis?

Charts above are confirmed by the even more dramatically divergent case of the banking sectors exposure to the repo operations:
The magnitude of European banks internal sickness in structuring funding - from their chronic dependence on CB funding even at the times of plentiful liquidity, to their massive exposures to repo operations in general is stunning.

If you want to see the really frightening summary of this analysis, here it is, courtesy of the GFSR:
Notice the disproportional over-reliance of Euro area banks on short-term funding (the infamous maturity mismatch) and non-deposits-based long-term funding (the infamous liquidity and counterparty risk-linked bit). Now, check out the healthy US side of deposits finance - you'd think that the picture should be inverted, given Europe's demographics, but no - heading into the massive explosion of retirement age population in EU, our savings play so much smaller of a role in funding our banks, one must wonder: What happens when German consumers start drawing down their deposits to finance their retirement consumption? Will there be anything else left for the future of the continent other than sales of Mercs and BMWs to China?

Economics 2/10/10: Brian Lucey's comment on Minister Lenihan's statement

In rare occasions, I re-print here some comments made available to me by other economists and analysts. This is the full text of Professor Brian Lucey's comment in yesterday's Irish Examiner (not available on the newspaper website):

"THE Government yesterday engaged in a series of interventions, announcements, and actions which in my opinion have brought the prospect of an intervention from the IMF or the European Union significantly closer.

The major announcements were threefold: the announcement of the losses of Anglo, the bombshell in relation to Allied Irish Banks, and the startling admission that the Government was voluntarily withdrawing from international markets. Let us examine all three of these.

In relation to Anglo Irish Bank, we finally begin to see clarity and reality from the Government; for the first time in two and a half years estimates begin to overlap. The worst-case scenario that the Government has put forward is that Anglo will lose €35 billion. This is the average estimate. We must take this government figure with a very large pinch of salt. The Government over the last two years has given us at least four “final” figures for the total cost of Anglo. God be with the days when it was only €4.8bn. It remains highly likely in my view and in the view of independent analysis external and internal to the country, that the Anglo losses could stretch towards €40bn.

That is an eye-watering amount of money, equivalent to nine months’ total government expenditure. While this on its own is bearable, what is unbearable, and should not be borne, is that once again bondholders take precedence over citizens.

The only rationale for having such an extensive guarantee in 2008 was that over the period of time the banks would be cleaned of their bad loans, the banks would be cleaned of their bad management, and the bondholders would be dealt with. Subordinated bondholders should get nothing, senior debt holders should have been faced with a stark choice; either take an offer of perhaps 30 cent on the euro or take their chances on the market place. A debt-for-equity swap should also have been considered.

On all three of these issues the Government has failed. We are told that instead of NAMA taking loans in excess of €5 million, it will only take loans in excess of €20m; this leaves a large amount of impaired and toxic loans on the balance sheet of the banks. It is these very toxic loans that imperilled the banks in the first place and which will make it next to impossible for the banks to engage in any meaningful credit creation.

As if Anglo were not enough, we are also told that AIB will require an additional €3bn. The state will end up with 70%+ ownership of AIB; this will rise as AIB will find it difficult to raise the required funds from the markets or from asset disposals and will consequently have to ask the taxpayer to invest further. The ludicrous situation is that the taxpayer will be taking ownership of a much weaker bank than had this been done two years ago. AIB has sold the jewel in its crown, the Polish operation, and is actively selling its US and British operations. We will own a bank which has sold off its profit-making arms and will be left with a carcass.

Finally, it appears, in so far as one can glean from the gnomic and somewhat confused utterances of Eamon Ryan, that the Government were told that the National Treasury Management Agency (NTMA) did not feel they could raise funds in the markets. The Government has therefore locked itself out of the markets until early 2011. Presumably, the hope is that by 2011 a miraculous change in Irish and world economic conditions will have occurred.

What remains absolutely unclear is what plans, if any, the Government has for a situation where in 2011 the NTMA finds it either impossible to raise funds or finds that those funds are prohibitively expensive. There are in excess of 5bn of Irish government bonds maturing in 2011, these will have to be rolled over or repaid. What if we cannot raise these funds?

In that case the Irish Government will have to raise funds from the International Monetary Fund or from European funds, and this of course ignores the tens of billions of debt which the banks have to roll over on a regular basis. In my view we have moved closer to the end game of losing national economic sovereignty.

Brian Lucey is associate professor in finance at Trinity College Dublin. "

Irish Examiner 1/10/2010

Economics 2/10/10: EU Commission official view of Minister Lenihan's plans

Much debate has been thrown around about the EU Commission position on the latest Government announcements concerning banks recapitalizations. Here is the fact (linked here) - note comments and emphasis are mine:

Full quote: MEMO/10/465, Brussels, 30 September 2010 "Statement by Competition Commissioner Almunia on Irish banks"

"European Competition Commissioner Joaquin Almunia welcomes the comprehensive statement issued by the Irish Finance Minister on banking. Commissioner Almunia said:

"I welcome the statement on banking which brings clarity with regard to the remaining transfer of assets to NAMA and the capital needs of some banks and building societies. [Note there is no finality assertion here on the estimates]. Regarding NAMA, the announced changes to the way it manages loans are in line with the Commission's approval of the NAMA scheme.

"Concerning Anglo-Irish Bank, from a competition point of view, it is clear that the foreseen restructuring and resolution of the bank addresses competition distortions created by the large amounts of aid at stake. Once the Commission receives the details of the plan, it will proceed rapidly towards taking a final decision. [The gombeens haven't yet supplied the Anglo Plan to the Commission, despite the claims made today on RTE Radio by Minister Hanafin to the contrary]

"I also welcome the announcement that subordinated debt holders will make a significant contribution towards meeting the costs of Anglo. This is in line with the Commission's principles on burden sharing since it both addresses moral hazard and limits the amount of aid, with benefits to the taxpayers. [So Commission operates under the direct assumption that subbies will be soaked. And that this will correspond to the spirit of the European common markets.]

"I note that Allied Irish Bank will need to receive further capital in the form of State aid, which will have to be notified to the Commission for approval. I will of course follow this process very closely. I have no doubt that, as in all previous cases, the collaboration between the Irish authorities and the European Commission will be satisfactory. [No blanket endorsement of new AIB capital injections]

"I note positively that Bank of Ireland will be able to continue the restructuring process without further recourse to State resources. The Commission in July 2010 approved the aid and the restructuring plan of Bank of Ireland, and is monitoring its implementation."

"With regard to building societies INBS and EBS, the Commission remains in close contact with the Irish authorities. For INBS, the Commission will await the notification of the additional capital as well as the details on the institution's future, and will assess them thoroughly and swiftly. For EBS, the Commission is in the process of finalising its initial assessment of the restructuring plan submitted end May 2010. "

So let's recap Commission's official opinion:

• Anglo subs must be haircut;
• No Anglo plan delivered to the Commission;
• No Anglo recapitalization additions endorsed;
• No AIB recapitalizations (announced by Minister Lenihan) are endorsed
• No INBS and EBS measures endorsed
  

Economics 1/10/10: External Debt

Yesterday, CSO published Q2 2010 data on our International Investment Position.

Here are some highlights:

"At 30 June 2010, the gross external debt of all resident sectors (i.e. general government, the monetary authority, financial and non-financial corporations and households) amounted to €1,737bn." So Irish total gross external debt rose €63bn qoq.

Our total foreign liabilities stood at €2,643bn and are offset by €2,500bn of foreign assets.

The liabilities also include €1,218bn of equity and derivative liabilities that do not form part of external debt.

Liabilities of the Monetary Authority (to ECB) that consist almost entirely of short term loans and deposits, amounted to €66bn, an increase of €28bn on Q1 2010, but down €38bn on Q2 2009.

General government foreign borrowing decreased by over €3bn to €80bn between end-March and end-June 2010.

The liabilities of other sectors (financial intermediaries and non-financial corporates) increased by €17bn from Q1 and at €657bn represented 38% of the total debt, a similar share to the
previous quarter.

Direct investment liabilities increased by €17bn to €262bn in Q2

Liabilities of monetary financial institutions (credit institutions and money market funds) consisting mostly of loans and debt securities were €672bn, an increase of over €5bn on Q1, but down €18bn on Q2 2009.

Few charts. Starting with levels of assets and liabilities:
Next, balance:
Notice declining surplus in Other Sectors.

Combining assets and liabilities:
Lastly, removing Government from the equation:
Clearly, a sign of expanding liabilities and rising assets, with net balance on the negative side slightly worse than in Q1.

Summarizing these in tables:

Economics 1/10/10: Retail sales data

Oh, let's cut the bull, folks. The retail sales data is making rounds the banks 'economists' notes with all the hoopla of the 'positive news' arguments. So things are turning corners?.. Actually, not really.

With motors:

• Value of sales rose 1.3% mom in August and a re down 1.7% yoy;
• Volume of sales was up 1.1% mom and 1.3% yoy

Conclusion, with motors included, we are still selling more stuff at ever-lower prices, though this time around declines in prices did not outpace increases in volume. Which means that no jobs are being created. If we take on board the fact that Euro remains relatively weak compared to last year vis-a-vis our main trading partners outside the Euro zone, implying we are buying imports at a higher price, the margins in retail sector gotta be shrinking even more than the volume/value gap above suggests. Which, in turn, implies that there aren't any new jobs being created in the retail sector on the back of the latest 'turnaround'. The whole thing about 'great news on retail sales front' is a damp squib.


And if you want to see even deeper into the official spin, take a look at ex-motors retailing:

• Value of core sales was flat mom in August and is down 3.6% yoy;
• Volume of core sales was up 0.2% mom and 1.4% yoy

So declines outpacing volume increases is clearly operative here.

Dig deeper and take a look at the breakdown of sales across main business lines.

• The largest increases in value took place in Books, Newspapers & Stationary (+4.7%). Given all the great news we've heard about Ireland in August, this is hardly surprising.
  
• Second largest value increase (ex-motors) mom took place in... errr... Fuel (+4.5%). That wouldn't be an indicator of our consumer confidence in the future, but the price increases in the sector where prices are controlled by the Government.
• Durables continued to tank: Electrical goods (-3.2% value and -2.5% volume mom), Furniture and Lighting (-1.% and -0.7% respectively) - again, not a great sign.

The worst part of this data is that it continues to show that there is no restart to household investment in sight. Before the households begin investing, they will usually start consuming more durable goods. This is clearly not happening.