Deep economic collapses are dangerous – Martin Wolf of the FT

Bloomberg reports that officials are in the process of drawing up plans which would result in shareholders and junior bondholders in Spanish banks facing losses, prior to any bail out. Not before time. At least the EU is finally (partially) getting it, though senior bond holders look as if they will be made whole – why?. There are certain issues, I accept, but senior bondholders were not investing in guaranteed bonds;

Spain is expected to make a formal request to the EU for funds to bail out its banks on Monday. The IMF (indeed in non diplomatic language), supported by many in the EZ, want the funds injected directly into the banks, rather than through the FROB, (Spain’s bank restructuring agency) as it will not increase Spanish debt to GDP – to approximately 90% by end 2012. Furthermore, EZ finance ministers failed to agree whether the E100bn of loans would rank senior to existing privately held debt, a key issue. Germany has refused to concede, though there are (some?) signs that Mrs Merkel will do so at the heads of state meeting on 28/29th June, in return for EZ countries agreeing to measures to enforce strict fiscal discipline. Interestingly, Spanish 10 year yields fell 97bps from the previous weeks highs to close at 6.34% on Friday;

Portugal’s budget deficit rose by 35% in the 1st 5 months of the year, to E2.72bn (E2.02bn previously). Revenues declined by -2.3% to E14.82bn, whilst spending rose to E17.54bn. The data casts doubt on Portugal’s ability to reach their targeted budget deficit of 4.5% this year, especially as May’s revenues came in significantly below expectations and the decline in revenues continues into June. Last years budget deficit was achieved by a one-off transfer of bank pension funds. In spite of repeated denials, Portugal will need another bail out in the next couple of months. Having said that Portuguese 10 year bond yields declined by around 100bps last week;

EU finance ministers failed to agree an EU wide financial tax. Some countries, including proponents of the tax such as Germany, Austria and France will attempt to reach agreement with at least 9 EU countries to introduce such a tax, essentially some form of stamp duty, though set at less than the 0.5% currently applicable in the UK. The EU reports than 11 (out of 27) EU countries would support such a tax;

Germany (Mrs Merkel) agreed to a E130bn plan to stimulate growth, which has been pressed by Italy, France and Spain – no significant development. Her opposition parties supported the move. No other material agreements were achieved at the meeting in Rome yesterday, which by all accounts pitted the 3 leaders of France, Italy and Spain against Mrs Merkel;

A recent poll (Infratest survey for ARD public TV) suggests that 55% of Germans want the Deutschmark back, up 9% on the previous month. This is getting serious, but the real problem is that German politicians have not explained the consequences of such a move (the DM would become a supercharged Swissy) to their public. 62% of Germans supported Mrs Merkel’s insistence on imposing austerity measures. Support for Greece was ebbing fast. (Source FT);

Questions are being raised as to whether the ESM can raise the full amount of E500bn. Portugal, Ireland, Spain and Greece (and Cyprus soon) are due to contribute just above 19% of the E500bn, which must be considered uncertain. If Italy faces a problem, another 18% would disappear. It does not look as if the EZ leaders will agree to granting the ESM a banking licence at the 28/29th meeting, in part due to the recent German Constitutional court issues. However, as the size will prove insufficient, it is a near certainty that the ESM will have to be granted a banking licence in due course.
There is, of course, the EFSF (which continues till July 2013) and which, to date, has lent just under E250bn of its E440bn lending capacity. Given existing commitments, the total future lending capacity of the EFSF/ESM is estimated (optimistically) at approximately E400bn (following the E100bn to be provided to recap Spanish banks), insufficient for the likely needs, suggesting, once again, that the ESM will have to be granted a banking licence – the maths simply does not work otherwise. As a backstop, the ECB could buy peripheral debt in the secondary markets, but the ECB (quite rightly) remains reluctant;

Martin Wolf of the FT responds to a letter from a senior official in the German finance Ministry, Mr Ludger Schknecht, who replied to an op ed written by Mr Wolf. You really should read it. However, I will just focus on one point, namely that the rise of Adolf Hitler in Germany was not due to high inflation in Germany – indeed, it was due to the depression/deflationary environment, following the austerity programme introduced by Mr Heinrich Brunning. This issue is widely misunderstood in Germany – time to suggest that its critical to “do your homework?” do you think. Mr Wolf concludes that “Deep economic collapses are dangerous”. Absolutely right. There are mounting (extremist) political challenges in the EZ – in France, Greece, Holland, etc, etc. Time to understand the issues Mr Schknecht;

US 30 year mortgage rates hit a record low of 3.66%, down from 4.5% the same time last year. A number of mortgage holders will refi given the much lower rates, increasing disposable income. The FHFA house price index rose by +0.8% in April MoM and +3.0% YoY;

Goldman’s suggest that the FED will have to push forward guidance for its 1st rate increase further into the future and, in addition, do another QE programme, as unemployment remains a problem and inflation declines. Sounds right to me;

Brazil’s Petrobras has been granted permission to raise petrol prices for the 1st time in 9 years. Petrobras should be amongst the best performing energy companies worldwide, though government policy (actually massive interference) has neutered the business. Is this the beginning of a change – well, history suggests that investors should remain cautious for a while at least;

Really on hold and awaiting developments arising from the EU heads of state meeting. At present, it looks pretty bleak, I must admit. A failure will be disastrous for markets. Need to watch this one carefully. I will be trying to read the tea leaves next week.

Have a great weekend.

Kiron Sarkar

23rd June 2012