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“Euro advances as debt concern eases before summit” alongside “Treasuries gain as Spanish rating cut spurs demand for safety”: two apparently contradictory headlines from the same news source (Bloomberg) reflect the market’s parallel hopes and fears about the euro rescue process. Rarely has opinion been so divided between those who see the euro’s future as bright, and those who see it as total failure. |
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From the beginning, our own view has been moderately optimistic that a euro solution will be found, even though it is taking longer than we imagined. Our faith is based on the political will to save the euro, even if European politicians presently lack the energy to drive the process to its logical, and to us inevitable, conclusion of a degree of federalisation, lead, albeit reluctantly, by Germany. |
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The new euro zone “federal” structure is still undefined, although some elements are appearing. The most significant is that Germany is begrudgingly accepting the need to bail out peripherals via some sort of centralised institution, but only if the final say remains with the German parliament. Paradoxically this puts Germany even more firmly in the driver’s seat. |
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Other components of the plan include: |
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- a 5-fold increase to over EUR 2 trillion of the size of the EFSF, with its role being closer to that of an insurer, rather than of a lender
- a haircut for holders of Greek sovereign debt of about 50%, hopefully recognised as “voluntary restructuring” rather than a default event
- recapitalisation of banks to absorb the said haircut
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We are convinced that the European leaders wish to delay Greek restructuring until the banks have the capacity to absorb the losses (we would estimate by around mid-2012). Market pressures may however make such a delay impossible. Much depends on the weekend meeting of G20 finance ministers in Brussels, and of the G20 summit in Cannes in the first week of November. |
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European banks are far from happy about being forced to recapitalise. Deutsche Bank was first to voice opposition, followed by Santander and Banco Popular (Spain). The best they will achieve in negotiation with political leaders is some differentiation amongst banks as a function of their exposure to the forthcoming losses. Botin of Santander calls the recapitalisation request nonsense, saying that the euro sovereign debt crisis has to be solved first. He fails to recognise that the euro crisis has become a banking crisis, and that the solution lies in dealing with both issues simultaneously. |
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Mervyn King’s speech (BoE) this week had nothing in it that has not already been written in this Weekly, except possibly the hope that UK inflation was now peaking at over 5%. He emphasised the need for surplus countries to expand their domestic demand, and that the four-year old crisis was more about insolvency than illiquidity. He nevertheless defended quantitative easing as a means to gain time while addressing the underlying problem of excessive spending in the developed world, and insufficient spending in China. |
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Our own clients are continuing to seek yield with limited risk by focusing on the lower end of investment grade corporate bonds. Interestingly, there appears to be little appetite for sovereigns. |
Market Focus |
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- USA: wholesale prices rose more than forecast in September, the producer price index climbed 0.80%, the most in five months. Industrial output increased 0.20%. Job openings fell in August for the first time in four months, the number of positions waiting to be filled dropped by 157k to 3.06 million. However, consumer confidence remained near a record low, the Bloomberg index fell to -50.8 in the week ended 9th October from -50.2 for the prior period
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- Euro zone: apparent Franco-German agreement to expand EFSF to over EUR 2 trillion
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- Germany: investor confidence (ZEW) fell to the lowest level in nearly three years from minus -43.3 in September to - 48.3 in October. Inflation accelerated from 2.50% in August to 2.90% in September, the fastest pace in three years
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- Portugal: the EC called Portugal’s 2012 budget-cut plan a “bold” step which should help the country meet deficit targets and help restore economic growth in the country
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- Spain: the country’s credit rating was cut for the third time in three years by S&P and Moody’s on concerns of slowing growth and potential rising defaults. S&P reduced by one level to AA- keeping a negative outlook, while Moody’s were more severe, downgrading two notches to A1, also with a negative outlook
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- UK: the unemployment rate rose to a 15 year high in the three months through August, increasing from 7.90% to 8.10% in the three months through July. Inflation as measured by CPI and RPI rose 5.20% and 5.60% respectively YoY in September. Ernst & Young’s ITEM Club cut its U.K. growth forecast. The GDP forecast for 2011 was lowered from 1.40% in July to 0.90%, and the 2012 forecast from 2.20% to 1.50%. It suggested the Bank of England should lower rates, arguing that the new round of asset purchases is unlikely to be enough to revive growth
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- Switzerland: producer and import prices fell for a fifth month in September, prices for products from factory to farm goods as well as imports dropped 0.10% from August, when they fell 1.20%
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- Ireland: led by the USA, foreign companies are investing in the Republic. This is lowering unemployment, helping make Ireland the only euro zone peripheral country to see its ten-year sovereign yields move down, albeit modestly
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