8/2/15: BRIC Manufacturing PMIs: one cold January for growth

BRIC PMIs for January are continuing to show divergence in growth dynamics across the four economies, across the two key sectors, and a broad slowdown in growth across majority of the BRIC parameters. Here are some details:

Starting with Manufacturing PMIs:

• Brazil Manufacturing PMI improved marginally to 50.7 from 50.2 in December. Current 3mo average is at 49.9 and this compares as a weak improvement on 49.4 3mo average through October 2014. January 2014 3mo average was 50.3. Across the board - weak growth returned to Brazil's manufacturing, but both m/m and 3mo on 3mo growth improvements were poor.
• Russian Manufacturing PMI dropped significantly from already contractionary 48.9 in December to strongly contractionary 47.6 in January. 3mo average through January 2015 is at 49.4 and this compares unfavourably to 3mo average through October 2014 at 50.7. However, 3mo average through January 2014 was even worse - at 48.7. Overall, substantial decline in Manufacturing activity as signalled by the PMI reading and second consecutive month of sub-50 readings.
• China Manufacturing PMI stayed virtually flat at 49.7 in January as compared to 49.6 in December. 3mo average through January is at 49.8, down on 50.6 3mo average reading through October 2014 and on 50.3 3mo average through January 2014. Just as in the case of Russia, Chinese Manufacturing activity posted second consecutive month of sub-50 readings.
• India Manufacturing PMI slipped from 54.5 in December to 52.9 in January, with 3mo average through January still reading at 53.6 - ahead of 3mo average through October 2014 (52.0), and ahead of 3mo average through January 2014 (51.1).
• Overall, India (-1.6 points), and Russia (-1.3 points) posted declines in Manufacturing PMIs in January compared to December 2014, while Brazil (+0.5 points) and China (+0.1 points) posted increases. Declines outstripped increases by a wide margin and two economies (China and Russia) posted sub-50 readings. 
• Conclusion: BRIC manufacturing sectors are still suffering from weak growth conditions, with Russia being the weakest, followed by China, and with very anaemic growth in Brazil and slowing growth in India.

Chart and summary table below:

Services PMIs covered in the next post.

8/2/15: Carry Trades Returns: More Pressure for Ruble & CBR

Carry trades involve borrowing in one currency at lower interest rates (say in Euro or Japanese Yen) and 'carrying' borrowed funds into investment or lending in another currency, bearing higher interest rates (e.g. into Australia or New Zealand, or Russia or Brazil). The risk involved in such trades is that while you hold carry asset (loan to, say, an Australian company), the currency underlying this asset (in this case AUD) devalues against the currency you borrowed in (e.g. Yen). In this case, your returns in AUD converted into Yen (funds available for the repayment of the loan) become smaller.

With this in mind, carry trades represent significant risks for the recipient economies: if exchange rates move in the direction of devaluing host economy currency, there can be fast unwinding of the carry trades and capital outflow from the host economy.

Now, let's define, per BIS, the Carry-to-Risk Ratio as "the attractiveness of carry trades" measured by "the ...risk-adjusted profitability of a carry trade position [e.g. the one-month interest rate differential]... divided by the implied volatility of one-month at-the-money exchange rate options".  In simple terms, this ratio measures risk-adjusted returns to carry trades - the higher the ratio, the higher the implied risk-adjusted returns.

Here is a BIS chart mapping the risk-adjusted ratios for carry trades for six major carry trade targets:

Massive devaluation of the Russian Ruble means that carry trades into Russia (borrowing, say in low interest rate euros and buying Russian assets) have fallen off the cliff in terms of expected risk-adjusted returns. There are couple of things this chart suggests:

1. Dramatically higher interest rates in Russia under the CBR policy are not enough to compensate for the decline in Ruble valuations;
2. Forward expectations are consistent with two things: Ruble devaluing further and Russian interest rates declining from their current levels.

Still, three countries with massive asset bubbles: New Zealand, Australia and Mexico are all suffering from far worse risk-adjusted carry trade performance expectations than Russia.

The Russian performance above pretty much confirms my expectations for continued weakness in Ruble and more accommodative gradual re-positioning of the CBR.

8/2/15: Reformed Euro Area Banks... Getting Worse Than 2007 Vintage?..

For all the ECB and EU talk about the need to increase deposits share of banks funding and strengthening the banks balance sheets, the reality is that Euro area banks are

1. Still more reliant on non-deposits finding than their US counterparts; 
2. This reliance on non-deposits funding in Euro area is actually getting bigger, not smaller compared to the pre-crisis levels; and
3. This reliance is facilitated by two factors: slower deleveraging in the banking system in the Euro area, and ECB policy on funding the banks, despite the fact that Euro area banks are operating in demographic environment of older population (with higher share of deposits in their portfolios) than the US system. Note that Japanese system reflects this demographic difference in the 'correct' direction, implying older demographic consistent with lower loans/deposits ratio.

Here's the BIS chart on Banking sector loan-to-deposit and non-core liabilities ratios  showing loan-deposit ratios:

Note: 1)  Weighted average by deposits. 2)  Bank liabilities (excluding equity) minus customer deposits divided by total liabilities. 3) The United States, Japan and Europe (the euro area, the United Kingdom and Switzerland). This ratio measures the degree to which banks finance their assets using non-deposit funding sources.

Source for the chart: http://www.bis.org/statistics/gli/gli_feb15.pdf.

7/2/15: Euro Area's Debt Addiction

Europe's debt addiction in one chart: the following chart plots total domestic and cross-border credit to non-banks, at constant end-Q2 2014 exchange rates, in per cent of GDP:

Source: BIS: http://www.bis.org/statistics/gli/gli_feb15.pdf

In the above:

• The solid lines are actual outcomes, 
• The vertical lines indicate the 2007 beginning of the global financial crisis and the 2008 collapse of Lehman Brothers. 
• Figures include government. 
• The dashed lines reflect long term trend, calculated as for the countercyclical capital buffer in Basel III using a one-sided HP-filter.

Two obvious conclusions emerge from the above:

1. Since the start of the Global Financial Crisis, debt addiction expanded both in the US and the Euro area, with US addiction rising faster than the Euro area's.
2. The gap between Euro area and US dependency on debt at the end of 2014 stood at a similar level as at the start of the Global Financial Crisis and above the pre-crisis level. That is despite the fact that in the US, most recent manifestation of the debt addiction has been associated with much higher economic growth and jobs recovery than in Europe.

6/2/15: Two Tax Inversions Islands

Remember Tax Inversions Islands? Ireland ≠ Bermuda?

Bloomberg have a neat reminder:

Source: http://www.bloomberg.com/infographics/2014-09-18/tax-runaways-tracking-inversions.html

6/2/15: Cyprus AWOL on Troika 'Reforms'

Yes, at some point, Troika won't be able to handle all the bad news flying its way... for now, however, a new alarm at the barbwire fence of European Reformism: Cyprus is heading off the Troika Reservation:

Whatever might have made Cyprus rush for the AWOL, I'll let you discover, but judging by the foreclosure and insolvency framework reforms approved by the Troika in Ireland, one can't be too much surprised if any country would have much of faith in Troika expectations on that front. Then again, Cypriots would probably remember how EU regulators first encouraged accumulation of Greek sovereign debt in Cypriot banks, then haircut that debt, causing instant insolvency crisis across the Cypriot banks. Why would anyone listen to the same people giving advice on 'structural' reforms next, puzzles me.

5/2/15: IMF and Ukraine: 'Scaling Back' Risk Is Real

Generally, I rarely comment directly on Ukrainian economy as was explained before on this blog. But the latest set of news is certainly falling into the category of 'big time news'.

As I noted before, IMF were in Kiev since mid-January and were going over the Ukrainian Government request for switching lending to Ukraine into a different facility (see http://trueeconomics.blogspot.ie/2015/01/2112015-ukraine-requests-extended-fund.html). In January, IMF head, Christine Lagarde gave an interview to Le Monde, saying that no partner of the IMF can participate in a funding programme when some 20% of the Ukrainian economy remains impacted by the conflict in the East.

So far, under stand by arrangements, IMF committed USD17 billion in funding for Ukraine, of which Kiev already received disbursements of USD3.2 billion in May 2014 and USD1.4 billion in September. Under stand-by arrangements, funding is provided for up to two years, so in 2015, Ukraine must redeem USD1.42 billion in IMF funding and some USD9.6 billion more in maturing government debt. Of this, more than USD4 billion is due in Q1 2015. Meanwhile, currency and gold reserves of Ukraine are down to USD7.5 billion - below debt maturity levels for 2015.

Now, IMF is reportedly (see here: http://www.bloomberg.com/news/articles/2015-02-05/ukraine-allows-hryvnia-free-float-raises-key-rate-to-19-5-) "is seeking to limit its share of the aid burden in discussions on an expanded bailout for Ukraine, according to two people with knowledge of the institution’s stance, as a military conflict pushes the sovereign closer to default."

Note: IMF limiting new funding share to 2/3rds will mean that of USD15 billion that Ukraine wants to get over the next 2 years, USD5 billion will have to come from 'other' sources. If IMF were to restrict its total share to 2/3rds of all bailout money, then in the new funding, the non-IMF share will be USD4 billion. One might think that the funds can be provided by the EU - keen on partnership with Kiev. But EU talks a lot, yet delivers little. In 2014, EU Commission President, Barroso stated that the EU is willing to commit EUR11 billion to fund Ukraine over 2 years. So far, EU delivered only EUR1.4 billion in 2014 and committed to provide EUR1.8 billion in 2015. EBRD and EIB promised Ukraine EUR6.5-8 billion in funding, but delivered only EUR2.2 billion so far. Germany promised and delivered EUR1.6 billion to Ukraine in 2014 and in January this year committed to provide further EUR500 million.

The point is that absent IMF funding an entirely new programme, it is impossible to see how Ukraine can continue servicing and redeeming existent debts and cover current deficit that is expected to hit double digits in 2015. On the other hand, IMF is aware of this reality as well as of the lack of will in Europe and the US to fund Ukraine. Worse, stung by the 'partnership' with EU in funding euro area crisis-hit countries, the IMF is itching to cut back its engagements with difficult partners. Meanwhile, Ukraine has - completely understandable - difficulties pushing through IMF-mandated reforms. And to add to the complexity of the situation, the EU and US are nursing major differences in their respective objectives when it comes to what the two players want to see emerging from the current crisis.

In my view, Ukraine is now being played in the game of geopolitical chess by all sides, with the IMF struggling to remain independent (even pro-forma). The tragedy of all of this is that Ukraine is being prevented, by a combination of poor funders cooperation and ongoing conflict in the East, from actually engaging in reforming its economy, politics and society. My sympathies on this mess are with Ukraine and President Poroshenko - they got the short ends of all sticks.

Note: In my opinion, Ukraine needs a much more structured package of supports, including larger loans, on more benign terms, and grants, and over a longer horizon. In effect, it needs a Marshall Plan.

5/2/15: Maan... it's like... Structural Reforms, like... maaan!

You know that slightly odd person who sits on a park bench repeating to anyone who bothers to ask him the same story over and over again? Well, now try imagining one that is doing so unburdened by a request.

And you have ECB...

At least Frankfurt did not mention its (and IMF's) favourite made up dream: the labour market reforms... presumably because in China, labour markets are already 'efficient' enough, why with all the factory dorms and campuses and the rest.

H/T for the ECB blurb to @LorcanRK.

5/2/15: Where the Models Are Wanting: Banks Networks, Risks & Modern Investment Theory

My post for Learn Signal blog: "Where the Models Are Wanting Part 2: Banks Networks, Risks and Modern Investment Theory" covering networks effects on risk propagation in the financial services sector and the impact of these networks on equity pricing models is now available here: http://blog.learnsignal.com/?p=153.

5/2/15: Gazprom's Nord and South Streams: Lessons Learned, Strategy Changed

I just published a long note on the trials and tribulations of the ill-fated South Stream gas pipeline project that was designed to deliver Russian gas to Bulgaria and Southern Europe. Here is the link: http://trueeconomicslr.blogspot.ie/2015/02/5215-gazproms-nord-and-south-streams.html

4/2/15: Debt Overhang and Sluggish Growth

Debt overhang and its impact on growth has been a rather controversial topic over the recent years. One of the key contributors to the debate is Kenneth Rogoff. Rogoff has a new paper out on the topic, together with Stephanie Lo, titled "Secular stagnation, debt overhang and other rationales for sluggish growth, six years on" published by the Bank for International Settlements (http://www.bis.org/publ/work482.pdf).

In the paper, Rogoff and Lo state that "there is considerable controversy over why sluggish economic growth persists across many advanced economies six years after the onset of the financial crisis. Theories include a secular deficiency in aggregate demand, slowing innovation, adverse demographics, lingering policy uncertainty, post-crisis political fractionalisation, debt overhang, insufficient fiscal stimulus, excessive financial regulation, and some mix of all of the above." Rogoff and Lo survey "the alternative viewpoints" on the causes of slow growth. The authors argue that "until significant pockets of private, external and public debt overhang further abate, the potential role of other headwinds to economic growth will be difficult to quantify."

Rogoff and Lo focus strongly on the effects of debt overhang on growth. "In our view, the leading candidate as an explanation for why growth has taken so long to normalise is that pockets of the global economy are still experiencing the typical sluggish aftermath of a financial crisis… The experience in advanced countries is certainly consistent with a great deal of evidence on leverage cycles, for example the empirical work of Schularick and Taylor (2012), who examine data for a cross-section of advanced countries going back to the late 1800s and find that the last half-century has brought an unprecedented era of financial vulnerability and potentially destabilising leverage cycles. Moreover, focusing on more recent events, Mian and Sufi’s (2014) estimates suggest that the effects of US household leverage might be large enough to explain the entire decline in both house prices and durable consumption."

Still, their conclusion is very cautious. Instead of assigning direct causality from debt to growth, they suggest increased indeterminacy of the relationship between other variables and growth in the presence of high debt overhangs. They do reinforce the point that the argument about debt overhang relates to the total real economic debt (governments, households and non-financial corporations), not solely to government debt alone.

4/2/15: Russian Services & Composite PMIs: January

Russian manufacturing PMI slipped deeper into contractionary territory posting 47.6 in January compared to 48.9 in December, as covered here: http://trueeconomics.blogspot.ie/2015/02/2215-irish-manufacturing-pmi-january.html

Today's release of the Services PMI adds to the gloom. Services PMI posted its fourth consecutive monthly reading below 50.0, coming in at abysmal 43.9 in January, down from an already disastrous 45.8 in December. 3mo MA through January is now at 44.7 - a deep contraction, deepest since 2009 recession. This compares to the already contractionary 49.4 3mo MA through October 2014. 3mo average through January 2014 was benign 52.2. So we have a full swing of 7.5 points year on year on a 3mo MA basis.

Things are bad over both sectors of the economy, implying that the Composite PMI should be performing poorly as well. No surprise there, hence, with Composite PMI falling to 45.6 the lowest monthly reading since May 2009 and the fourth consecutive monthly reading sub-50. 3mo average through January 2015 is at 46.8, marking significant contraction that accelerated from October 2014 through January 2015. This compares to 3mo average of 50.4 for the 3 months period through October 2014 and with 51.5 3mo average through January 2014. Year on year, 3mo average reading is now down 4.7 points.

In summary, January m/m decline in PMIs was second steepest over 12 months period for Manufacturing, fourth steepest for Services and third steepest for Composite PMI.

The downward trend across all series is being reinforced since Q3 2014.