Economics 16/06/2009: Oil & Gas and NTMA's auction

For a longer post with my thoughts on oil and gas prices, scroll down.


NTMA's gamble... per NTMA release today:

On Tuesday 16 June, NTMA offered two bonds in the auction,

• the 3.9% Treasury Bond 2012 and
  
• the 4.6% Treasury Bond 2016.

Actual results are below:
"Total bids were received for €2.397 billion and it was decided to issue a total of €1 billion [as planned]. An amount of €500 million of the 4.6% Treasury Bond 2016 was issued where the total bids received were 2.5 times the amount allocated, while €500 million of the 3.9% Treasury Bond 2012 was also issued where the total bids received were 2.2 times the amount allocated. The 2016 bond was sold at an average yield of 4.755% while the 2012 bond was sold at an average yield of 3.056%."

If you look at the table above, NTMA always preferred issuing €300mln in shorter maturity bonds and €700mln in longer maturity bonds - a 30:70 split. This time around, it appears it had to borrow heavier in shorter maturity range, hence 50:50 split. And this is for 2016 bond as opposed to 2019 bond earlier. Ouch...

Price spreads min-max were also relatively heavy on shorter maturity. Compare the following two screen shots:
June 16th auction: spreads of 19bps on 2016 bond (2.375 pa ) and 16bps on 2012 bond (5.33 pa)
May 119th auction: spreads of 37bps on 2019 bond (3.7 pa) and 5bps on 2014 bond (1 pa).

Again, NTMA are doing excellent work here, but it is a tough job...



Natural Gas - upward?

Natural-gas prices have been lagging oil prices over the recent months despite the fact that gas drilling and production are on decline worldwide. This has been noted by some Irish analysts, most notably – Davy, whose June 15 quick daily note must be credited for spotting the trend first in the Irish market.

Per Davy note (Caren Crowley): “The ratio of the US oil price to gas price is reaching record highs. A reversion to more normal levels requires the oil price to pull back or the gas price to rally. With the oil price looking unstoppable, it is all up to the gas price, but it is an uphill battle.” There is not much of a real in-depth analysis in the Davy note, so here are some of my thoughts on the issue.

First some short-term facts:

US gas prices have fallen 34% in 6 months to June 2009 and 72% off 2008 peak. In part, this is driven by demand declines. But, as Davy note states, supply capacity has been catching up on downward trajectory: “the number of rigs exploring for, and producing, gas has fallen 56% since September 2008 when it peaked at 1,606, and is at its lowest level since 2002.” This is yet to translate into actual supply cuts as “US gas inventories are abnormally high and are 22% above their five-year average.”

In early April, US natural gas inventories stood at 1,650bn cubic feet in the week ended and steady, equivalent to 300 bn cf above 5 year average and 400bn above year before. Chart 1 below (courtesy of Energy Information Administration) shows that this abnormal situation has gone worse since then with gas inventories breaching the 5-year min-max range for the first time since May 2007.
Now, 25%-30% of US gas production comes from relatively young wells (drilled in the last 12 months). A significant cull of drilling rigs operating today will, therefore, translate into higher demand for imports in winter 2009-2010. The number of running (producing) rigs was down to 1,039 in the week of April 1, 2009, according to Baker Hughes (BHI) - down 49% from the 2,031 level seen in mid-September 2008 -- the highest since 1980.

Chart 2 shows the same over the longer period, with clear signs of seasonality and a rising trend in inventories over time.
One noticeable feature here is that volatility below the trend has been declining throughout the April 2003-April 2006. Afterward, the maximal depletions of gas reserves have steadily increased through April 2008, before once again starting to decline in late 2008 through April 2009. The rate of the later decline has been so far consistent with the rate of decline in 2003-2006 period. This is exactly identical to the 4 years falling, 3 years rising and 1 year falling cycle in 1996-2002.

Another feature is the lack of similar cyclicality at the maximum surplus inventories level, in other words – in peaks above the trend (dashed line). In fact, the trend here is identical (in slope) to the average trend line. Furthermore, when it comes to surplus inventories deviations, current historically high levels (for November 2008) are actually below the maximal inventories trend.

The two facts together suggest that high inventories are not being driven by excessively high supply of gas (which would be consistent with abnormally low minimal inventories in around April trough and abnormally high maximal inventories in and around late Autumn).

Yet another interesting feature of the data is captured in Chart 3, which clearly shows that in recent months, weekly growth rate in inventories has not fallen substantially for positive growth rates, while the rate of natural gas inventories depletion (the negative range) has declined.


Given that this already accounts for seasonality and the weather effects have not been dramatically out of line, what’s going on? The answer is: twin effects of demand changes and equity markets trends are driving prices of oil, while only demand changes have been instrumental in determining the price of natural gas to date. And this is about to change...

On the demand side, power gen accounts for 58% of all US gas demand and this has been falling – 6-8% down so far in 2009. It is also important to note that gas-based electricity generation in the US is concentrated in the Western Pacific states and Northern Atlantic Board states – all of which have seen serious economic pressures on demand side.

But these fundamentals do not really explain the historic trend in gas prices. Futures prices for natural gas have now hit their lowest levels since 2002. Recent pricing below $4 per million British-thermal-unit on the NYMEX, down from $9 mbtu in Q1 2008.

Again, supply-demand analysis does not explain this. Fundamentals analysis focuses on abnormally cold weather in early 2008, which pushed spot prices up and resulted in higher levels of exploration activity. Production capacity increased, but demand collapsed. Fine theory, except, recall prices are down more than 50%, although US Energy Department expects natural-gas consumption to decline by only 1.3% in 2009.

And US gas prices are linked to global gas prices – which are facing significant pressure on the Russian supply side. How? In two ways:

Short-term pressure is rising due to delays in pumping annual storage reserves in Ukraine – a technical issue that can derail gas supplies to Europe. Basically, the principle here is a simple one. To run gas pipe between Russia and Western Europe (the pipe transiting Ukraine), Soviets built a pressure maintenance system that requires intermediate storage facilities (positioned on Ukraine’s territory out of the Soviets’ consideration for ‘balanced regional development’ and owned by Ukraine) to be filled to capacity. This ensures that if Ukraine’s own gas purchases start depleting the pipe flow, the flow can be topped up with reserves of gas. Ukraine is broke and has no cash to pay for this gas – which it will own once it is pumped into storage. Russians are telling Ukrainians that they can’t give them a $2bn loan for gas and are offering to split the loan between Russia and the EU. EU is refusing. So we have stalemate. Now things are getting even more complicated because Ukraine also owes Russians further $3bn worth of cash for gas supplied to the Ukrainian consumers. In short – if gas is not pumped into storage tanks within the next 2 months, there will be serious risk of disruption of gas supplies to Europe in fall/winter 2009-2010. This in turn will lead to price increases for gas globally.

Long-term pressure is also rising due to Russian gas production now shifting to the Eastern Siberian plains. Completion of the new pipeline to service China and Japan is a sign of this. The problem here is that unlike Western Siberian plains, Eastern Siberian plains have smaller gas fields, fewer developed fields and geology that is much more challenging (shale, smaller reservoirs, more complex folds and more broken folds) that the near-perfect sands of Western Siberia. Again, this signals an upside to gas prices in the longer term (I will write about this in few days in more details).

So in the nutshell, future supply constraints are daunting. And these should be working in both short term and long term in the future... Again, supply is not the main driver for the abnormal situation of falling gas prices and rising inventories.


So what is? One word answer is ‘oil and gas price correlations with equity markets’. In my view, it is a speculative buying of oil as a hedge against inflation and the ‘blue chip’ low risk commodity that is driving a wedge between oil prices and gas prices and simultaneously driving closer oil prices and equity prices.

A series of charts below illustrate this point.



Chart above shows relatively coincident long-run trends in DJIA and Oil prices that are not replicated in gas prices. This is confirmed in the scatter plot below. Here, strong correlations in oil and gas prices against DJIA occur over significantly different slope relations. If 100 points increase in DJIA index leads to a $1.4 increase in the price of oil, the same change in DJIA index is associated with a $0.16 rise in the price of gas. While at parity this appears to be a movement in favour of oil, given current conditions in the market (the extremely high negative correlation between price of oil and price of gas and extremely low price of natural gas) any changes in the stock markets valuations should, based on fundamentals, drive prices of gas closer to the price of oil. Expressed in current price percentage terms, table 1 below the chart shows these historically-justified price responses.

Chart below illustrates what I mean by extreme correlations
Notice that current correlation is:
(a) within the range of -0.75-1;
(b) the change in correlation between peak of June 2008 (+99.3) to today (-88.1) is the highest on record for downward adjustment.
Chart above shows the replay of the oil and gas prices correlation in line with the broad equity markets. Here, while correlation between DJIA and oil prices stands at +0.78 and remains in the positive territory since September 2008, the correlation between DJIA and gas prices is at -0.57 and has moved into negative territory in May 2009.

This is interesting, because the structure of gas prices to date contrasts the findings of the recent research on links between oil and gas prices. Jose A. Villar (Energy Information Administration) and Frederick L. Joutz (Department of Economics, The George Washington University) paper The Relationship Between Crude Oil and Natural Gas Prices, prepared for Energy Information Administration, Office of Oil and Gas in October 2006, shows that there exist “a cointegrating relationship relating [natural gas] prices [and] the WTI and trend capturing the relative demand and supply effects over the 1989-through-2005 period. The dynamics of the relationship suggest a 1-month temporary shock to the WTI of 20 percent has a 5-percent contemporaneous impact on natural gas prices, but is dissipated to 2 percent in 2 months. A permanent shock of 20 percent in the WTI leads to a 16 percent increase in the [gas] price 1 year out all else equal.”

So the lags structure implies that a temporary shock to oil price should be followed by a delayed shock to gas prices 12 months after and that the magnitude of changes in gas prices is roughly 80% of the magnitude of shock to oil price.

Clearly, as table above and charts illustrate, this relationship is currently being reversed, suggesting two emerging short- and medium-term trends:

1. fundamentals (firming demand/falling supply) trends indicating significant room for gas prices increases in the range closely linked, but shallower (at 70-80%) than those in oil prices. This implies trend price for gas of ca $8-8.25 per thousand cubic feet of gas;
2. short-run dynamics trends, indicating a ca 6% upside to gas price relative to oil price in the next 3-6 months, implying a price range of $6.8-6.9 per thousand cubic feet.

Short of a W-shaped global recession risk, there is little downside pressure on gas prices in the medium term in my view.

Economics 15/06/2009: policies for growth

For those of you who missed my Sunday Times article, here it is in an unedited version (scroll below).

Here is a link to my Friday's quote in WSJ editorial.


Our Government keeps droning on about Ireland not having a toxic derivatives problem in the banks… Hmmm… unless you count the banks themselves as derivative instruments. Take a look at our loan-to-deposit ratios (LDRs):

AIB: 153% at end-June 2008; 140% in March 2009;
BOI: 174% in September 2007, 157% March 2008, September 2008: at 160.3%,
ILP: 245% in November 2008, 277.4% in September 2008.
Anglo: 124.2% in September 2008
Nationwide: 154% in April 2009 down from 170% in 2007

Now, according to a UBS survey of bank balance sheets of September 2008, Ireland's average loan-to-deposit ratio was 163.1%.

US average: 51% LDR for pre-1960, rising to 85% between 1960 and 1980; breaching 100% in 1997, then 113% in 2007 at its peak, down to 97% May 2009.

Yes, we don’t need securitized packages of MBS tranches to get ourselves thoroughly poisoned…


On to my Sunday Times article:

Over the last two weeks, just as Brian Cowen was exulting over the prospects for Ireland’s return to economic growth thanks to his visionary policies, Russian Government, also facing a major economic crisis, unveiled a new set of economic programmes aimed at getting the state back on track. The package included a tough realistic Budget for 2009-2010, some tax breaks, a commitment to fiscal conservativism, an ambitious set of policies directed at reducing public sector waste, corruption and improving management practices, measures aimed at stimulating private sector investment and demand, and significant new initiatives in R&D and business and technology innovation.

To-date, Irish government sole responses to the crisis have been to raise taxes on businesses, consumers and income earners, and to cut capital investment. All to preserve excessively high level of current public expenditure. Moscow’s response was to cut wasteful spending, lower some business and personal tax rates and rationalise new investment programmes to focus on future growth priorities.

Hence, an ordinary working person in Ireland is now facing an effective tax rate of over 22% - up from 19% a year ago. Her counterpart in Russia is facing a flat rate income tax of 13%, the same as in 2008. An average Irish self-employed person is looking at surrendering over 32% of her income in income tax, up from 29% a year ago. Russian self-employed workers enjoy a new 6% income tax, down from 13%. In terms of incentives, it is clear that Irish Government’s priority is to skin the small entrepreneurs, while the Russians are taking an approach of encouraging individual risk-taking in business.

While Ireland is facing a double-digit fiscal deficit, our current expenditure continues to rise unchecked since July 2008 Government promise to get it under control. The Government is yet to produce a single forecast that actually projects a decrease in current expenditure at any time between now and 2013. This unambiguously signals that Irish leadership envisions fiscal policies adjustments to be fully financed out of increasing tax burden on the ordinary households and businesses.

In contrast, Moscow is cutting spending outside priority areas and temporarily shifting funding from longer-term investment projects. In effect, the Russians retain ring-fenced commitments to invest significant funds in new technologies and SMEs – areas earmarked for future growth, but the Government is borrowing short-term some of the already allocated funds to finance more immediate crisis-related spending.

For example, a year ago, Russian state allocated some €2.3bn for investment in nanotechnologies to cover its programmes over the period of 2009-2015. Last week, the Government wrote Rusnano – semi-state investment company in charge of the funding – an IOU for almost €500mln of these funds, temporarily withdrawing cash without sacrificing any of its investment programmes.

This reveals a more sustainable funding model for state investment in Russia that is based on pre-funding and ring-fencing long-term investment, than the one we have in Ireland, where current revenue is used to finance public investment irrespective of the length of investment horizon.

Other measures enacted by the Russian government in combating this crisis, such as export credits supports, aid to SMEs and state financing of some enterprises (either via equity stake purchases or preferential loans) would fit well in our own policy arsenal, were we more prudent with our expenditures in the years of economic boom. In just 7 years between 2002 and 2008, Russian fiscal authorities built a war chest of funds to sustain necessary public spending and investment. Even after almost a year of financing growing primary imbalances, Russian reserves currently stand at approximately 21% of 2008 GDP. Ireland’s NPRF never exceeded 12% of Ireland’s 2008 GDP – hardly an impressive record of state ‘savings’ over 17 years of robust growth.

History aside, Russian experience shows that forward policy planning and fiscally conservative approach to current spending are the necessary ingredients in dealing with a crisis. Which brings us to the scope for long-range reforms that present a feasible alternative to the present Government plans.

First and foremost, long-term changes are required in our taxation. This much is admitted even by our policy cheerleaders in the Department of Finance and the ESRI. However, to date, there is no indication that the taxation commission is guided in its decisions by the future growth considerations, rather than by the immediate objective of raising new tax revenue.

If Ireland were to seriously pursue high value-added growth development model, our taxation policy has to be altered dramatically. The burden of financing the Exchequer spending, currently disproportionately falling on the shoulders of the above-average income earners (majority of whom represent the same knowledge economy we are trying to expand) must be shifted away from personal income to less mobile physical capital. This will incentivise investments in education, labour productivity-enhancing R&D, training and other forms of human capital, and reduce the wage-costs pressures on companies that operate in the knowledge-intensive sectors. One of the means for delivering such a change would be to levy a significant tax on land offset by reductions in the upper marginal income tax rate.

Another aspect of the tax reform that can stimulate creation of sustainable long-term economic activity in Ireland is an idea of dramatically reducing self-employment and proprietary income tax in line with the Russian experience. Self-employed individuals assume all the risk of running their own business without gaining any of the tax benefits that accrue to corporations. Lowering personal income tax on self-employment to a flat rate of, say, one half of the effective rate of tax applying to an employee earning €60,000 pa (currently standing at 32%) will go a long way in encouraging shift from unemployment into small entrepreneurship.

A different issue is now resting in the hands of yet another Government commission. Current public sector pay, financing systems, and managerial and work practices are simply out of line with the rest of our economy. Across all sectors of Ireland Inc, public sectors sport the lowest value added per unit of labour inputs. Ditto for comparing Irish public sectors productivity against other small open economies within the OECD. Yet, the cost of financing these services is accelerating even during the current downturn, just as the sector overall output is falling. This is hardly news: since the mid 1990s, the range of services and products supplied by the state has been narrowing, yet the staff levels, especially at the top of the pay scale, remuneration costs and non-pay benefits grew.

Reforms must address this exceptionally poor performance, as well as restore pay and benefits to reflect low levels of productivity and value-added delivered by the public sectors.

However, even more important for the long-term growth is to enact systematic principle of separating service provider from the payee. In effect, Irish public sectors are quasi-regulated near-monopolies in their respective industries. Modern services in a small economy cannot function efficiently if the State employees responsible for these services provision are also responsible for pricing and rationing access to the services, regulating services supply and restricting external competition. Irish public sectors price inflation shows conclusively the overall lack of efficiency in our public services provision (see chart).
The Government should elect to provide payment for public access to services, without any prejudice in the choice of service provider. Thus, for example, in health, once standards for quality and safety are adhered to, any approved and properly regulated provider should be allowed to supply medical services to patients. The Exchequer should ensure that those without sufficient income are given state funds to access necessary services. But the Government should exit the business of actually supplying medical services.

Such reforms promise delivering on several key objectives. Experience in other countries, where services provision and access were effectively separated in the 1990s shows that existent service providers do engage in cost-reducing competition, thereby drawing down the cost to the Exchequer. Second, the range and quality of services supplied are improved. Third, granted critical access to the market, new enterprises and thus new employment grow, with some supporting export of such traditionally domestic-only services abroad. Fourth, services consumers do welcome greater choice of service providers and better quality of services. Separation of service provider and payee is a basic concept of organizing modern public services that is yet to dawn on our allegedly highly enlightened politicians and civil servants.

After some 11 months since the current Government has first acknowledged the existence of the economic and financial crises, it is both surprising and disheartening to observe continued lack of policy responses from our leadership. Yet now is not the time to sit on our hands and wait for the US and global economy upturn to rescue Ireland Inc. Instead, it is time we start putting in place few policies that can underpin the recovery in the short run, but can provide support for future long-term growth as well. Tax reforms and public sector revamp certainly top the priorities list.

Economics 14/06/2009: Housekeeping & DofF

Per housekeeping: there is a new post on my Long Run Economics blog with a full copy of DofF's latest ludicrously used-car-salesman-like presentation on Irish economy. Check it out here.


As a companion to the presentation, DofF also released a 3-page document: Ireland: Key messages Department of Finance May 2009. Below are my comments on some of the DofF views on Irish economy.

“Domestic pressures in the Irish economy, in particular the ongoing contraction
in the construction sector and its effect on the wider economy, are compounding the deterioration in international economic conditions.”

Conveniently, DofF fails to list any other challenges, suggesting that all would be fine in Ireland Inc were it not for building sites slowdown. No banking crisis to worry about when it comes to real growth, no fiscal crisis (made largely of DofF’s disastrous past policy choices).

“Ireland has a track record of adjusting and showing its flexibility; asset prices, wage levels and price levels are all adjusting rapidly to the new circumstances improving Ireland’s competitiveness.”

Ireland has a historical record of staying in recessions for decades, not ‘adjusting’ or ‘showing its flexibility’ but getting stuck in vicious past fiscal spending quagmires. This is exactly where we find ourselves today – perpetuation of unsustainable public spending spree that we entered in 2001.

Furthermore, per DofF assertion on wages, asset prices and prices:
• Declines in wages have been concentrated in the productive economy whilst unproductive public sector-dominated activities continue to post wage increases;
• Ditto for price falls (see below);
• Asset price declines – it amazes me that DofF can call the destruction of wealth we have experienced as an ‘improvement in Ireland’s competitiveness’, but the most bizarre twist of DofF’s logic comes when one considers the fact that these assets also include property prices. If property price falls are restoring our competitiveness, the same price declines are also responsible for the collapse of the property markets, including building activity, which per DofF earlier point is the cause of our problems. So per DofF – asset price falls are both good and bad for Ireland Inc…

The latest CPI data released last Thursday clearly shows continued trend of public sector-controlled inflation. In percentage terms, state-set prices for alcohol and tobacco rose 0.4% month on month in May 2009, while health continues to post 3.5% inflation when measured in annual terms. As do communications services – up 0.8% year on year. Recreation and culture – a category also largely influenced by state pricing policies posted a 0.2% rise in prices in May. While utilities and local charges have fallen 6.5% in monthly terms, this category of services remains in a positive inflationary territory in annual terms, up 4% year on year. One category of services highlights the differences between private sector and public sector controlled inflationary pressures: housing, water, electricity, gas and other fuels. Here, 12-months change to the end of May 2009 in mortgage interest costs was -42.4% (posting a -4.2% additional loss in may itself). This was exactly the same as the rate of price decline for largely private sector-distributed liquid fuels. In contrast, Electricity and Natural gas – two largely state-monopolized sectors posted price increases of 4.7% and 6.5% year on year respectively despite the last month’s price reductions of 10.4% and 11.3%. Similarly in health: state-priced hospital services costs are up 9.1% year on year in May, more privately supplied outpatient services up 1.9%. Consumers rip-off by public sector is well alive in our age of deflation and DofF has absolutely nothing to say on this.

“Ireland has made significant strides in the development of modern 21st Century infrastructure while positioning itself for its next stage of development as a knowledge economy. While there are obvious difficulties, it is important to state that keyfactors which facilitated Ireland economic success in recent years still remain. These include:
• stable political system; part of the EU and the eurozone; access to the Internal Market,
• young, highly educated, English speaking, flexible, mobile workforce,
• export orientated, open economy,
• relatively low corporation tax rate,
• pro-enterprise focus.”
Cringing yet? Me too…

“The Government has been clear in its strategy to address the difficulties in the public finances and has already taken a number of very significant steps in this regard:
• In July 2008, expenditure adjustments were introduced to save €440 million in 2008 and up to €1billion in 2009 [of course, they can’t tell us the exact number for 2009 savings arising from July 2008 measures, because there were no measures of any sort introduced in July 2008 – just promises. As per €440mln savings for 2008 – well these ended up with an overrun, not savings];
• Last October in Budget 2009, expenditure for 2009 was strictly contained and significant tax measures were brought forward to secure close to €2 billion in additional revenue in 2009 [not really - €2bn is the figure that does not include second order effects of proposed measures, so the real value of these tax measures was less than €1bn];
• In early January, the Government set a five year framework to 2013, with ambitious targets, to restore order to the public finances over the five years; In February, in line with the framework, a series of measures were announced to secure further savings of up to €2 billion on a full year basis primarily through the introduction of a pension levy for public servants [again, this is the case of powdering over the scars – the pensions levy will not generate claimed returns due to secondary tax effects and clawbacks, implying that the net effect on the revenue is expected at around €1.4bn, before we subtract a massive cost of the early retirement scheme];
• On 7 April, the Government introduced a supplementary Budget for 2009 which sets out further taxation and spending measures for this year amounting to some €3.3billion in 2009 and over €5billion in a full year. Government also signalled that there will be additional spending adjustments of €2.25 billion in 2010 and €2.5billion in 2011 with taxation increases of €1.75 billion in 2010 and €1.5 billion in 2011 [in case you’ve missed the point – yes, they will tax us all into economic oblivion to save their pals in public sector unions. Per claimed 'savings' and 'revenue enhancements' - I already did this analysis before (here)];
• Ireland will need to borrow some €25 billion in 2009 which it is well on the road to achieving but Ireland has a relatively low debt level to begin with. [ok, to date, we have borrowed €1.532bn in short-term paper maturing after 2009 and €4.9bn in longer term paper (see here). This is less than 26% of the total borrowing requirement for 2009! ‘Well on the road’, then? And that is before NAMA borrowings are factored in.];

“A greater integration of the Central Bank responsibilities with the regulatory and supervisory functions of the Financial Regulator is being considered.
• The objective is to deliver robust standards of banking and financial regulation and corporate governance;
• This will help restore the reputation of Ireland’s regulatory regime and rebuild confidence;
• It will ensure that best EU and international practice is applied to Ireland’s regulatory system and it is appropriately aligned with new developments in international supervisory architecture.”

Actually – already close links between the DofF, CB and FR are the main source of the problem with lax regulatory enforcement and lack of risk pricing capabilities at the Regulator level. Further integration is the worst form of response to the existent structure challenges. A truly independent regulatory office for financial services separate from the consumer agency would offer much stronger potential for enhancing enforcement and preventive powers.

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...

Economics 05/06/2009: PMI, Live Register & Why Brian Cowen is simply wrong on economy

So things are getting better, say Comrade ‘Surreal Economist’ Cowen. Translated into human language (any human language short of North Korean) this really means that we have a terrible crisis that is getting worse at a decreasing (for now) rate. What do I mean?

Exchequer returns were bad, but they were not worse than in April. Hmmm – it only took thousands of families drowned in fresh taxes to get us this far. And add to it a ‘slowdown’ in the rate of growth in expenditure. Mr Cowen calls this ‘the right policy that is supported by the majority of economists and the ESRI’. About the only part of this assessment that I would agree with is the one which separates ESRI from economists – being a nearly purely state-paid ‘group-think tank’, ESRI is not about economics, it is about kissing the… you know what.

Back to the ‘greening’ shoots of this week… Irish PMI figures came in with a slowdown in the rate of decline… same as with the Exchequer results… again – things are not getting better, they are getting worse, but worse at a slower pace. Now, services sectors in Ireland, per PMI, shrank for the consecutive 16^th month in May, as NCB’s PMI rose from 32.2 in April to 39.5 in May. If this is a glimmer of hope, it is a smile from the bottom of the ocean. Future expectations are up to 50.8 in May, which is good news, when compared to the reading of 46.6 in April, but what this means exactly, given that we are heading into summer doldrums is highly unclear. One brighter star at the bottom of the barrel was Technology, Media & Telecos (TMT) – most upbeat of all sectors. Apparently, contraction is over in the sector, per May data. I am sceptical here, since this sector just got a boost from political advertising spend, and it has contracted at an extremely fast pace in December 2008-February 2009. Furthermore, most of the spend for the TMT sector for 2009 has already been allocated, so the contraction might have overshot the target before, with a slight bounce to the low flat trend expected about now.

Manufacturing PMI came virtually with the same results as services PMI, delivering a rise to 39.4 in May from 36.1. In other words – still no expansion, or 16 straight months of contraction. Export component of PMI rose, but remains below expansion reading. “With the domestic economy so weak, look for the new export orders component of the PMI to breach the 50 mark before the headline PMI will follow suit”, NCB’s Brian Devine told The Guardian. I agree. So where does this leaves Mr Cowen’s ‘right’ policies? Oh, not far from the proverbial ‘hole’. If Mr Cowen’s policies were right, we should not be expecting our economy to be rescued by exports or in other words, if our policies were to work, they would have positive effect on domestic economy. Instead, Mr Cowen is now positioning himself to claim completely undue credit for any upturn in the global economy… after having spent last 10 months blaming the world for Irish economic troubles.

Going forward, my expectation is for a flat trend for both PMI reports with some volatility in months to come. Autumn 2009 can potentially yield another round of relatively shallow (compared to 2008) contractions, especially in services.

The real issue from now on will be what can we do with an army of unemployed, bankrupt families that is amassing in the country and how can we get out of the hole that Mr Cowen and his predecessor have forced us into.

Today’s Live Register data does not provide much of hope that the task will be easy. In May there was another 13,500 increase in numbers claiming benefits in May. It might have been the lowest monthly rise since September 2008, but we now have 402,100 on the Live Reg and we are still on track for reaching 500,000 before we can toast the New Year.

Dynamics are tough to gauge. May’s monthly rate of increase was 3.5%, down for the fourth consecutive month and the slowest pace of growth since May 2008. But there is no indication that we are not going to see another bout of accelerating growth in unemployment comes June and then September-October. One reason to note – males are still dominating the firing line (65% of all new additions to the LR in May), so at some point in time, there will be new entry by women. How do I know? Simple – since December, layoffs have been moving off the construction sector into other, more ‘gender balanced’ sectors. I many cases, employers there offered voluntary redundancies with rather generous pay-offs. Women were the most likely to take such for a number of reasons:

· Women are more willing to switch into part-time employment;

· Women are more likely to go into continued education than men;

· Women are more likely to undertake family work than men etc

So this means that there a many ‘hidden’ layoffs working their way through redundancy packages that will surface once money becomes extremely tight.

Just in case you still believe in Mr Cowen’s economic assessment, give the following fact a thought. It comes courtesy of the Ulster Bank economics team and I agree with them wholly:

“The Live Register estimate of the unemployment rate increased from 11.4% in April to 11.8% in May, a rate last seen in May 1996. Our unemployment rate forecast of 14% by the end of this year therefore continues to look realistic. While today’s figures were certainly a welcome improvement on preceding months, the numbers signing on will continue to rise in coming months, as job losses in the services sector, most notably in wholesale and retail and hotels and restaurants, in addition to layoffs in construction, are ongoing. We therefore continue to forecast that the unemployment rate will peak at 16% by the end of 2010, before falling back gradually when the economy starts to recover.”

So Brian’s policies are working, then… too bad he can’t even tell us which policies he has in mind…

Economics 04/06/2009: Exchequer returns for May

First order of business today is to say "Happy Birthday, Jen" to my (much) better half - "I miss you here in Moscow!"

Second order of business is the Exchequer release from yesterday. As my access to data and software is somewhat more restricted here, it is a short analysis:

January-May 2009 tax receipts are in and they are down €3.6bn y-o-y – 21%, slightly better than –24% decline in January-April. Uncork that vintage Dom, Brian? Not yet…

Budget expectations are for 15.6% decline in the entire 2009. Not likely at the current rate. So far we have: 5 months receipts accounting for 39% of the total of projected annual intake of €34.4bn. Annual projection from here suggests that we are going to see around €32-33bn assuming all goes as planned.

Good news, in 2007 we also had 39% collected by the end of May. Bad news is – we had a very robust flow of business for SMEs and self-employed – all of whom force tax payments into the end of the year. Now, recall that we are going to see two things around October-November: (1) tax returns reconciled for 2008, (2) tax returns estimates for 2009. On (1) we can assume that estimates made, say in October 2008 did not fully take in the carnage of November-December, so estimated payments back in October 2008 will be erring on higher side, implying that the actual returns filed in autumn 2009 might be much weaker. On (2), given the current tax measures in place, businesses and self-employed will do everything possible to reduce and delay payments, so estimates will be erring on a lower side and tax deductions will be used to the max. I am not sure that a combination of (1) and (2) will not provide for relatively poor showing in autumn returns.

Current moderating is most likely reflective of the fact that the first half of 2008 was relatively buoyant, so the corresponding period in 2009 is going to register steeper declines. This will moderate into the second half of 2009, naturally, but it will mean preciously little, because any decline on the debacle that we witnessed in H2 2009 is going to be a disaster reinforced.

Another issue to keep in mind: current figures include two rounds of tax increases – Budget 2009 and, partially, Supplementary Budget 2009 – some €230mln added in 5 months. So one can expect further push on tax receipts side. The fact that it is not very impressive is telling me that tax measures are not working and tax substitution and minimization are now working their way through the economy.

To see how bad the new tax measures are at raising revenue – consider the fact that tax receipts in April were 1.7% below the tax profile published on April 28. In other words, within days, the receipts have already slowed down 1.7% relative to what DofF expected. May figures were 1.9% ahead of the profile: Corpo Taxes came in €155mln ahead of profile, Excise and Income taxes were ahead by €48mln and €39mln, respectively. VAT was down €139 million on profile in the month. So, ok – we are now bang on the target when it comes to profile.
Note: the source for the above table is Ulster Bank, with minor adjsutments by me.

But Income tax receipts were driven by new taxes, as are Excise duties, and the two will see some new pressure per optimising households and businesses. Corpo tax can surprise on the upside, assuming the US MNCs continue to book profits here – that is the big unknown in my view. CGT is also a candidate for downgrades as investors are shifting out of Ireland, booking losses here. In general, apart from income tax, other revenues were down 27% in May – a moderation of sorts on 32% decline in April, but the flattening out of the tax decreases curve is not anything to cheer about – it is simply the nature of any asymptotic dynamics: the closer you get to absolute zero, the slower the pace.

So back to income tax measures: €48mln monthly gains in May suggest that the income tax measures to date are yielding: 48mln*5/0.39=615mln in revenue, assuming that income tax follows the same path over the year as total tax receipts. A far cry from €1.5-2bn envisioned and very much close to what myself and other observers were expecting back in April.

In the mean time, spending races ahead: current expenditure was up 4.3% (in April it was up 4.5% but the latest ‘moderation’ is still placing current spending at an insolvency levels and the decrease was due to factors other than demand for social welfare and public sector wages). Capital spend continues to fall - down 6.3% year-on-year. Some suggested that there are timing issues delaying capital spending boost, but we are now 5 months into the year and this leaves me wondering – what sort of timing are we talking about?

On the net, therefore, May figures are no real improvement: receipts are flattening at a very slow rate, we might be closer to target here than before, but this only means a difference of €1-2bn on revenue side – a chop-change for our public sector wasters. On expenditure side, we are now 10 months past the July 2008 promises by the Government to introduce real savings, and… zilch, nada, none, nyet, can’t find any no matter how hard I am looking… If a rapidly decaying alcoholic were to be the allegory for the Exchequer balance sheet, we are past the gulp stage and into a burp moment. The hand with a bottle is rising once again, drawing closer and closer to the mouth. How long can this last? Your guess is as good as mine, but a friend today suggested that 6 weeks from now the Government will say, “Whoops, due to international economic conditions (WHICH HAVE NOTHING TO DO WITH THE LAST 12 YEARS OF FIANNA FAIL RULE) our readiness for rebound which was most certainly there when we said so has now disappeared. Not our fault, mate.”

Sounds about right…