Economics, Banking & Capital Markets

Grexit wrap – lunchtime edition

25 May 2012 | Posted by Euromoney Skew

A focus on the key news and analysis surrounding the potential Greek exit from the eurozone [More]

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Asian currencies under fire

25 May 2012 | Posted by Kanika Saigal, Euromoney Skew

Driven by worsening sentiment regarding the Eurozone, Asian currencies are under pressure. The market has sharply increased its expectation that Greece will exit the Eurozone, and USD-Asia and regional volatility has surged. [More]

The effect of ‘Grexit’ on Asia via HSBC:

If the market was to suddenly anticipate that there was an even higher chance that a country could exit the single currency union, then USD-Asia would be under pressure to move even higher, and regional central banks could face a bigger challenge if they aimed to prevent local currency weakness

Yes: FX depreciation in Asia is gathering pace - quite a volte-face from the narrative earlier this year when Asian central banks were fighting appreciation amid a surge in capital flows.

Now, Asian currencies will likely remain vulnerable, especially versus the USD and the JPY, reckons HSBC:

In our view, the INR and IDR remain the most at risk, with authorities also increasingly limited in their potential responses We have long been cautious on these currencies but further weakness cannot be ruled out. Meanwhile, ongoing deterioration in market sentiment will also continue to work against the KRW, MYR and, to an extent, SGD, although these currencies do have greater potential to be bolstered by proactive policy flex. Should we not see the above three developments, then we believe the relative outperformers would be the lower beta, lower volatility TWD, THB and PHP.

Europe is not the only reason for the declining performance of Asian currencies. Weaker global growth outlooks will prove to be a menacing force:

Asian currencies retain a cyclical nature and the recently disappointing global data have no doubt contributed to a higher USD-Asia. With global growth expectations seemingly yet to bottom out, and PMIs also suggesting ongoing weakness, the impetus for Asia currencies to strengthen quickly may be impeded, even if Europe offers more clarity.

... the flaring up of Eurozone sovereign risk has not always led to Asian currency weakness. In mid-2011, sovereign risk was intensifying but Asian currencies held up. This, in our view, was a function of global growth being on a stronger platform than it is now. Furthermore, the market was not factoring in a high probability that a country could leave the EUR. Hence, sovereign risk mattered but it was expressed more in the bond market than being a dominant fear factor for Asian currencies.

HSBC highlights three essential developments in order for regional currencies to strengthen:

A stabilisation of stresses within the Eurozone; Global growth expectations to bottom out; and Proactive policy choices to reflate regional economies

While you wait for those flying currency pigs, here's a nice chart that highlights regional exchange rates will remain beholden to top-down macro calls as a binary risk-on/risk-off mentality remains cyclically entrenched in global portfolio allocation.

Source: HSBC

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China's economic slowdown - something else for Germany to worry about

25 May 2012 | Posted by Kanika Saigal

China's economic slowdown will exact a heavy economic toll on global demand. Although Beijing has many weapons it can mobilise, its slowdown comes at an inauspicious time for Germany [More]

While all eyes are on Greece, another global threat looms - China’s economy is slowing down. Economic data for April was disappointing and industrial production grew at a much weaker rate than predicted. Following this, the World Bank has revised its forecast for China’s GDP growth from 8.4% in 2012 to 8.2% and a slew of analysts have duly followed suit. Morgan Stanley, for example, recently changed its 2012 GDP growth outlook from 9% to a more modest 8.5% for China.

China is the gauge for the health of the emerging market growth thesis and, of course, integral to global commodity demand. Against this backdrop, fears are growing South East Asian trading partners Singapore, Indonesia and Malaysia will be hit hard while a fall in commodity prices will inevitably affect Australia, South Africa and Brazil. But here''s an under-appreciated monster in the closet: if the slowdown is not contained, Germany will have even more on its plate than just Grexit as high quality exports to China and the rest of Asia will hit the European heavy weight. Hard.

According to a report by the German Institute for Economic Research, DIW Berlin, China, before fears over a hard landing snowballed, was set to become Germany’s second-largest trade partner after France in 2013, with co-operation in the automotive sector, mechanical engineering, and the information and communications technology sector, in particular. In the first half of 2011, exports to China increased by 25.2% compared with the first half of 2010, while German exports grew by a total of 14.7%, a key driver in Germany’s economic outperformance.

But the recent softening in demand from China has already hit German exports and business confidence, say analysts.

Luckily, however, China still has a lot of fire-power to turn its economy around, even after its-growth-and-all-costs stimulus policies after the Lehman disaster, which sowed the seeds of a credit bubble. Still, most China watchers reckon the government has myriad fiscal tools at its disposal to boost demand.

“In the first four months of this year, China ran a Rmb 900 billion fiscal surplus,” says Li Wei, economist at Standard Chartered based in Hong Kong. “This is much larger than it was this time last year so Beijing has a lot of room to manoeuvre. The government can lower the surplus and even run a deficit to boost the economy.”

“China will recover, but the recovery will be volatile,” says Wei. “Beijing needs to act now.”

Credit for growth

“It’s important for the Chinese economy that credit growth stabilises and recovers,” explains Viktor Hjort, head of Asia fixed income research at Morgan Stanley.

“But, banks are stretched,” says Hjort. To generate a recovery in credit growth and stimulate economic recovery, small to medium sized banks will need to overcome these woes. This is one of the main challenges that policy makers face. “But the government has a lot of monetary and administrative ammunition at its disposal,” says Hjort.

Weapons of choice

Reminiscent of 2008, when the Chinese government pumped over Rmb4 trillion into its faltering economy to prevent the economy from cooling, China is yet again pulling out all the stops and a State Council meeting held on 23rd May is a clear sign that a fiscal stimulus is on its way. Here''s a brief overview:

1. Investing in infrastructure
Analysts at Morgan Stanley in Asia believe that “the government will likely release more government led infrastructure investment and SOE-led manufacturing investment projects, before gradually relaxing demand controls in the property market.
2. Cutting rates
According to Morgan Stanley, The People’s Bank of China (PBOC) will cut both lending and deposit benchmark interest rates twice this year, each by 25 bps which will ease the economy
3. Moderate the pace of CNY appreciation/depreciating the yuan
In addition, the Central Bank will suspend the CNY exchange rate appreciation against the USD. Together, points two and three “should help the economy by more than 100 basis points," say analysts at Morgan Stanley.
4. Corporate tax cuts
A recent Nomura report states that “a [cut in corporate tax] is very positive for growth,” and although no details were mentioned at the State Council meeting, “potential policies may include extending VAT taxes to more sectors (service sector in particular), and providing temporary tax cuts for SMEs.”

When it comes to stimulating growth, China has a lot of leverage. With policy measures taking shape, Morgan Stanley argues that China''s GDP growth has troughed and will accelerate in the third and fourth quarter this year. Indeed, analysts there raised their 2013 GDP forecast to 9.0% up from 8.6%. They are confident that the government has enough clout to boost growth this year that it will spill over into next year. Let’s hope so – for Germany’s sake.

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Grexit wrap – morning edition

25 May 2012 | Posted by Euromoney Skew

A focus on the key news and analysis surrounding the potential Greek exit from the eurozone [More]

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The perfect time for Germany to bail out Europe

24 May 2012 | Posted by Duncan Kerr

Market players are betting that German yields will sink further into negative territory - in theory, boosting its financing power to sign that blank cheque. [More]

A now-painfully well-known adage: financial repression - bad for savers; good for sovereign treasurers.

But the rally in Bunds this week is pretty dramatic. Fuelled by fears over the likelihood of Greece exiting the euro and the lack of a clear and actionable plan by Europe’s leaders to prevent that from happening, investors continued their flight to quality by pouring more money into Bunds on Wednesday, sending the 10-year and 30-year Bund yields down to record lows.

Ten-year yields fell to an all time low of 1.376% while 30-year yields closed below 2% for the first time ever at 1.992%. Investors’ demand for Germany wasn’t confined to the long-end of the curve either. At auction, Germany’s two-year bonds, known as Schatz, were 1.7 times oversubscribed by investors who were keen to snap up a zero percent coupon yielding as little as 0.02% – well below equivalent US and Japanese bonds.

Given the oversubscription for the two-year bonds and persistent fears over Greece, this in turn prompted questions around whether Germany would issue debt offering negative yields, in effect incurring a small capital loss for investors.

Jim Reid at Deutsche Bank, wrote in research report on Thursday: “Our favourite headline of the day was the one that suggested Germany won''t issue bonds with negative coupons...Imagine having to pay for the privilege of allowing a country to run up debts, especially one that might have to eventually backstop the whole of Europe.”

However, Steven Major of HSBC believes that it’s not outside the realms of possibility that German two-year bond yields could fall below the zero barrier. He told Dow Jones Newswire that yields of negative 50 basis points or even negative 100 basis points “is not impossible”, and particularly if a scenario emerges whereby the eurozone breaks-up and Germany is then forced to bring back its own currency.

Whether that is a scenario the market is willing to bet on or not, there has rarely been a better time for Germany to borrow/bailout Europe.

Source: Bloomberg

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In memoriam: Core eurozone sovereign creditworthiness

24 May 2012 | Posted by Andrew Mortimer, Sid Verma

As the euro tumbles, here are two charts from Euromoney's proprietary risk index that throw into sharp relief core Europe's fall from grace. [More]

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Grexit wrap – lunchtime edition

24 May 2012 | Posted by Euromoney Skew

A focus on the key news and analysis surrounding the potential Greek exit from the eurozone [More]

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Grexit wrap – morning edition

24 May 2012 | Posted by Euromoney Skew

A focus on the key news and analysis surrounding the potential Greek exit from the eurozone [More]

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Calm down dear! It’s only Grexit

23 May 2012 | Posted by Nathan Collins

As markets plummet, here are some trading tips from the sell-side. [More]

With markets on the decline again, Nomura is offering some perhaps surprising advice: relax a little - the sell-off is an unjustified over-reaction, remember, so short the fear industry:

It’s not exactly that we’re surprised by the volatility in global equity markets since the May 6 French and Greek elections: Even before this episode, the MSCI World Index suffered no fewer than twelve separate pullbacks of 7.5% or more since January 2009 over similarly compressed time horizons. Rather, it’s the sheer rashness of the thing that strikes us as remarkable...and ultimately, probably tradable. From the way markets have behaved, you’d think not only that Greece has already fallen out of the euro, but that European institutions, despite plenty of available firepower and advanced warning, had entirely failed to stanch the contagion -- and that a material interruption in global growth was now unavoidably inflicting itself upon the planet.

...

What’s worse, the financial kangaroo court that seems already to have decided for you that tiny Greece is an uncontrollable global growth disaster literally just waiting to happen may not even be doing your portfolio any good: By asking you to embrace its verdict and seek the safety of US Treasuries, for example, the fear industry is asking you to be content with a yield of just 1.7% in a world still expected to produce 5.0% nominal GDP growth in 2012 (and 5.5% in 2013).

SocGen is going so far as to predict a bounce in Asia, arguing that the nature of the shorts we’re seeing at the moment generally presages a sharp rise in the Hang Seng.

Shorts are crowded: Another way of measuring selling pressure on the markets right now is by looking at short positions. Chart 3 shows a ten day moving average of the short interest across the Hong Kong stock market, as a percentage of the day’s turnover. This measure is not quite as high as it was back in the trough of the bear market, in November 2010, but it is almost as high as it was during the 1998 Asian crisis.

And crowded shorts often lead to a market bounce: Now look at Chart 4, which shows the relationship between short positions and future performance of the stock market. The short positions (as in Chart 3) are shown in blue; the brown line shows the one month forward performance of the stock market. The correlation between the two lines since the start of this year has been almost 50%. Put another way, based on this trend, the current short interest of 10.3% of turnover implies a 5% rally in stocks in the coming month.

Goldman is a little less sanguine; accepting that while there are smart investments to be made in the medium-term – you just can’t trust European politicians to not ruin things for you...no matter what course of action you take.

“In the near term, however, we believe that the risks on the downside are still relatively big. This is less because equity markets are not reflecting the likely path for growth from here, but more because markets not fully discounting the scale and magnitude of things that can go wrong. Of course the risks of political errors that push markets much lower, particularly in Europe, may be equally matched by the risk that there are further aggressive policy interventions that push markets higher. It is the uncertainty over the balance between these forces that reduces our conviction levels in the short-term path but, at the same time, makes us believe that buying protection for equity investors makes good sense.”

Right now, investors are expressing their bearish views by snapping up the dollar and US Treasuries but hedging Grexit - and the second-order impact of a eurozone implosion - is a game-changer. The consensus among sell-side analysts is to embark on relative value and flight-to-quality trades rather than directional bets. But, as we have reported, some brave souls are arguing the fundamental credit strength of emerging market sovereigns and corporates suggest external market technicals won't derail emerging market fundamentals. We have heard that one before. [Hide]

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Eurozone divorce: sizing up deposit outflow risk

22 May 2012 | Posted by Sid Verma

Urgent steps are needed to craft an EU-deposit guarantee scheme that has teeth, analysts have said, as market attention turns to deposit outflow risk in peripheral Europe. [More]

As market rumours swirl over Greece’s exchange-rate prospects, fears are growing that deposit outflows from the weaker eurozone economies will soon gather pace. In short, if Greece converts euro deposits into its own currency, the European Central Bank (ECB) might be forced to abruptly guarantee all deposits in eurozone banks similar to the Fed action after the Lehman disaster.

If you think policy efforts to unfreeze wholesale funding markets have been less than desirable, buckle up: the long-term refinancing operation (LTRO) was the easy part. Analysts at Goldman Sachs sized up the risk of deposit outflows in a research report on Tuesday, concluding:

“Recent media reporting centres on potential customer deposit volatility at selected institutions on the periphery. The LTRO was not aimed – and would not be effective for – [at] potential volatility in customer deposit bases, in our view.

• The nine largest European banks – those under our coverage – report liquidity buffers of over €1 trillion, or some 28% of customer deposits (and 16% of their funded assets). Liquidity buffers are ample in our opinion.

• Still, liquidity buffers are effective when viability of a single institution is in question – they can serve to build confidence in the remaining “functioning” banks. If deposit loss occurs as a result of a systemic event, individual liquidity buffers would not prove effective in our view. Fears of a euro break-up (and fear of a corralito-type [the Argentinean-government deposit freeze in 2001]), for example, could give rise to loss of depositor confidence on a systemic level. This would call for a regulatory response.

• Typically, such a response would be at a government level. For the banks on the periphery where the stability of the sovereign is in doubt, it would need to be made at a multinational level. A pan-European deposit guarantee or a pan-European bank bailout facility would both work well for this purpose in our view."

So far, so sanguine.

As we have reported, the deposit outflow story in Greece is backed up by the official data, with a bleeding of the customer deposit base since end-2009. But elsewhere, volatility in customer deposit base is anecdotal – management at Bankia, Spain’s third-largest bank, for example, were forced to deny market reports that outflows have kicked in, although, according to ECB data, there was a marginal deposit loss in aggregate in the Spanish banking system in Q1 at 4.3% year-on-year. But a shift of deposits into money market products for some yield might account for a portion of this, according to Goldman. Italy, by contrast, has seen deposit inflows, Ireland and Portugal have held steady – while the Germanic banks have been the big winners, a symptom of intra-eurozone monetary imbalances.

However, the data available only relates to Q1 trends, and deposit outflow rumours might become self-fulfilling, cf. Northern Rock. Under the shadow of this risk, banks have a couple of beefy defences, according to Goldman Sachs:

“Were a loss of confidence, followed by a larger deposit outflow to begin to materialize, the largest European banks could sustain a substantial shock to their customer base. Depending on the entity, between 25% and 35% of deposits could be lost. By way of comparison, the Greek banks have lost c.30% of their deposit base since the start of the sovereign crisis in 2009 (ie cumulatively, over the past three years). In other words, we estimate that the largest banks currently have sufficient liquidity buffers to absorb the cumulative deposit flight experienced by Greek banks since 2009.

• Finally, it is clear that a deposit run of a system-wide magnitude could not be absorbed by banks themselves – external intervention would be needed. "

In short, on the optimistic side, there is scant evidence of deposit outflows from peripheral European banking systems save for Greece and the bigger banks have sufficient liquidity buffers. But the downside is that in the event of a systemic deposit outflow crisis, a pan-European response will be undermined by an EU deposit scheme that currently lacks teeth.

The deposit insurance scheme has two big drawbacks, according to Barclays Capital:

“The first is the local nature of the guarantee provider, which creates doubts about its ability to pay insurance claims; and the second is that this crisis is defined by emerging currency risk, which is something deposit insurance does not protect against. "

Go on:

“Historically, the deposit insurance landscape in the Europe Union reflected the varying degrees of strength and diverging priorities of individual member countries. The European Commission used to maintain a “minimum harmonisation” approach through its original Deposit Guarantee Scheme Directive (94/19/EC), but the financial crisis of 2008 highlighted some significant differences between the treatments of depositors within the 27 member states.

Specifically, deposit insurance limits diverged across Europe to the point that during 2008 and 2009, there was evidence that EU depositors were shifting their cash to member states that offered higher deposit protection and away from those offering less coverage. To offset this, the remodelled directive (2009/14/EC) was published in 2009. This sought to increase harmonisation and required member states to ensure a level of coverage that was fixed at €100,000 by the end of 2010. "

European policymakers, in other words, should take pay heed to the US’s powerful federal deposit guarantee scheme. The absence of clarity on this, of course, underscores the now-painfully obvious weaknesses in the eurozone’s political economy, including divergent bankruptcy codes across the monetary union and the stubborn lack of clarity over fiscal burden-sharing arrangements for bank bailouts.

Still, even if the bank deposit scheme is given EU-backed teeth, it presumably would fail to take into account currency redenomination risk. Expect this to be the elephant in the room at the Wednesday EU summit.

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Spain is the new Ireland, subordinated bank debt edition

17 May 2012 | Posted by Duncan Kerr

Investors trying to understand recent developments in the troubled Spanish banking sector could do a lot worse than looking to Ireland as a comparison, according to Barclays Capital. [More]

How do you say luck of the Irish in Espagnol? Analysts at Barclays Capital had a stab today with research that revealingly draws comparisons between the Spanish and Irish banking systems, and analogies between the two abound, in their view. Most notably, both countries are experiencing severe real estate market adjustments, as large imbalances accumulated over the decade prior to 2008 correct.

The main cause for concern, of course, is the negative impact of soaring Irish loan losses on subordinated bank bondholders, and in turn what this could mean for subordinated bondholders in Spanish banks.

“Loan losses soared in Ireland: It has been four years since the Irish lending boom came to an end, and the implied loss rate on all Irish bank loans based on the most recent provisioning data is 24%.”

“Eventually leading to realised losses for subordinated bondholders: The real estate- related loan problems at Irish banks eventually caused subordinated bondholders to accept substantial realised losses. On average, subordinated bondholders recovered approximately 20% of par value.”

And so the chief concern then is that:

“Spanish banks have subordinated debt that could be used for burden sharing: In light of the similarities with Irish banks and the expected need for government capital injections into the Spanish banking system, the question of whether Spanish subordinated bondholders will eventually meet the same fate as their Irish counterparts becomes a legitimate one.”

However, Barclays’ analysts points out that there are three primary differences between the two countries that suggest the outcome for Spanish subordinated bondholders will be different to that of Irish subordinated bondholders:

1. Expected loss rate on loans

2. The ability of the government to support the banking system

3. The amount of subordinated bonds held by retail investors.

Nonetheless, Barclays concludes:

We believe that key differences between the Irish and Spanish banking systems could lead to different outcomes for bank bondholders. Loan losses in Spain are on pace to be lower are than those seen in Ireland. In addition, the potential cost of public sector support remains manageable for the Spanish government, with public debt peaking at 91.5% of GDP under our base case.”

“Although bank bondholder involvement could help reduce Spain’s debt burden, authorities may avoid coercive burden-sharing because of elevated retail ownership of subordinated bank debt. Nonetheless, we acknowledge that there is downside risk to our base case loss estimates and that the risk of burden-sharing for subordinated bondholders of Spanish banks is material. We remain cautious on Spanish banks and reiterate our Underweight recommendations on Santander and BBVA

Whatever the cultural differences between Spain and Ireland, the similarities between their banking sectors looks pretty stark.

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Greece exit contagion watch, more scary facts

17 May 2012 | Posted by Euromoney Skew, Sid Verma

Although international banks have manageable direct exposure to Greece, banks' shares can go much lower and deposit outflows from peripheral European banks' have barely begun. [More]

Bank deleveraging waves, spike in realized liabilities on sovereign balance sheets, safe haven bids, currency adjustments, seizure of banks’ funding markets - you know the drill by now. Take a deep breath. Here’s how it could get even worse – in pictures, courtesy of Bank of America Merrill Lynch. We will stay mum for now and let you digest these charts.

Deposit outflows for peripheral eurozone countries have barely begun; here''s the story between January 2009 and March 2012:

Deposit flows for euro zone countries for the period January 2009 to March 2012

Source: ECB

Banks’ stock prices have seen darker days:

EU banks are back at lows in P/B terms, but experiences from earlier banking crises suggest they can dip further

Bank price-to-book in in financial crises

Source: BofA Merrill Lynch Global Research

Athens has little cash in the attic and is marching towards a financing crunch by the beginning of July without additional EU/IMF funds, according to BoAML.

Here are some in-bunker trading tips:

“

EURUSD, bank equities, and periphery bonds are already at extreme underweights; while they may fall further in the immediate aftermath of an exit, they are probably the most prone to a short squeeze on ECB action.

Cyclical equities and Emerging market stocks have not responded fully to the growing crisis, in our view; cyclical sectors and growth geared Emerging market indices are prone to selling off sharply if the global growth outlook is seen as compromised.

Equity volatility in many regions is reacting slowly so far; we note it is still relatively inexpensive to buy options in some regions, notably Asia and the US; examples include HSCEI and Nifty where put option costs are at 6-month lows.

In the US, technicals in the VIX market could exacerbate the spill over effects from any Greek exit; historically in previous US and European volatilities in European crises, VIX curve flatteners have paid out positively with a probability of over 85%.

Investors are underweight duration, and despite record low yields, Bunds may not be reflecting the weak growth EU outlook; even with a substantial ECB response the EU growth is likely to remain subdued; previous liquidity interventions have pushed Bunds up along with other assets so, in our view, risks are skewed towards lower German Bund yields in most scenarios.

Credit market flows are likely to be initially dominated by a flight to safety with German, UK and Scandinavian credits outperforming. Senior financial spreads have scope to tighten sharply on an ECB response, but subordinated bank credits remain vulnerable even in the event of central bank support. "

Here’s one crumb of comfort – as should be abundantly clear by now, international banks have little direct exposure to the Greek private sector:

According to the IIP [International Investment Position] data, Greek private sector liabilities to non-domestics amount to €107bn. This seems to square with the BIS data which suggest that foreign banks'' exposure to banks and non-banks in Greece is ca. €73bn (of which the euro zone represents €68bn). The European Banking Authority (EBA) exposure- at-default data collection effort suggests international banks have €71bn of total Greek exposure, of that figure €51bn is at four banks – Credit Agricole, Marfin Popular, Bank of Cyprus, and BCP. There are problems with using the EBA data, the most obvious of which is that it reflects year-end 2010 data. However, we believe it provides a good basis for directional analysis. . "

EBA data - exposure at default to corporates, financial institutions, and retail as of YE 2010

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Grexit regional contagion watch

16 May 2012 | Posted by Nathan Collins, Euromoney Skew

Sell-side analysts have had at least two years to hypothesize the likely impact of a Greek exit from the eurozone – here's Nomura's latest take on the likely spill-over effects. [More]

Nomura have put out a series of research reports on the possible consequences of a Greek exit from the single currency – with this particular one looking at contagion effects and deposit dynamics.

One positive note touched on by Nomura’s report is that a Greek exit from the eurozone is unlikely to have too much of an effect on eurozone nation’s trade – because Greece didn’t really do much trading with them to begin with.

The big effect on the rest of the eurozone is, of course, through the banks – though these are markedly lower than if the event had occurred two years ago.

All told, eurozone banks have $65bn in remaining exposures, mainly to Greek corporations. Within this figure, by far the biggest concentration is within French banks, which have $40bn in exposure according to end-2011 BIS data (see Figure 2). These exposures have partially been provisioned for (for the most important entities, provisions are likely to be in the region of 20% of the loan book). When thinking about potential hits from Greek exposures, it is worth considering the option of abandoning Greek businesses entirely to limit hits to equity at the head office level. Nevertheless, a Greek exit could generate significant additional charges for some important eurozone banks

It’s worth noting that the conventional wisdom that Greek eurozone exit would generate massive capital flight elsewhere in the eurozone is weaker than it has been in the past:

In the past, it has been popular to argue that a Greek eurozone exit would generate uncontrollable capital flight, not only in Greece, but also in other eurozone countries with weak banking systems. But this thinking is currently shifting. Policymakers, including German policymakers, are starting to embrace the possibility of a Greek exit. The thinking is that sufficient fire-walls have been built such that the rest of the eurozone can manage a Greek exit. Time will tell whether this policy view is correct.

And, unsurprisingly, the factors outlined above aren’t positive for the euro:

With this new risk looming, it seems likely that eurozone risk premia will continue to rise in the run-up to the second round of the Greek election, scheduled for June 17.

In relation to the euro, the risk premium is the dominant variable at this juncture, and we could well continue to trade lower as a result vs USD and JPY (other crosses are a different story).

Not that that should be news to anyone.

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JPMorgan non-CIO briefer: the rise of the Treasury services unit

16 May 2012 | Posted by Euromoney Skew, Sid Verma

Thanks to international expansion and infrastructure investment, revenue growth prospects at JPMorgan's Treasury and Security Services unit are bright, said Nomura analysts. [More]

Given the recent media frenzy, you can be forgiven for thinking JPMorgan is nothing other than a prop-hedge – or prop-flow – desk, dubbed the chief investment office (CIO), serving as a genetically designed advert for the Volcker rule. But believe it or not, JPMorgan boasts other divisions. And as we have reported, brokers are still bullish on the stock, citing solid earnings capacity and the depressed valuation of the US financial sector, more generally.

On Wednesday, analysts at Nomura – which has a buy recommendation on the stock with a target price of $50-a-piece, a 39.7% upside to Monday’s closing price – lavished much ink on the bank’s margin growth story. After a meeting with Mike Cavanagh, the CEO of the bank’s Treasury and Security Services (TSS), the analysts touted the newfound importance of this division:

“While the same revenue headwinds remain in the near term (but are in the run rate), we think the TSS businesses are an important component of the overall company portfolio, with a majority of growth coming from deeper penetration of existing clients and leveraging the rest of the JPM franchise, including the investment bank, commercial bank, asset management... Importantly, returns are decent now and should improve, as the TSS businesses are capital efficient on a Basel III basis, have scale benefits and high barriers, have pretty steady revenues and earnings, and have solid secular growth trends. Putting it altogether, TSS has competitive profitability now with high-teens ROE (better than the trust banks) and mid 20’s pretax margin (about in line), with a pretty straightforward path towards a 25% ROE and a 35% margin over the next several years.”

The TSS division has outperformed by a large margin during the past year, even amid weak economic activity. In 2011, the unit’s revenues grew by 12%, liability balances by 23%, assets under custody by 14% and trade finance loans by 73%. As we have reported, this division is reaping the upside of strengthening links with its emerging markets, prime brokerage and the global corporate bank – a partnership between the investment bank and treasury services – which serves as fully integrated revenue-sharing businesses.

What’s more, the bank has invested in infrastructure to cut costs and ramped up its client-servicing capabilities in the Asia-Pacific region, with revenues growing 26% year-on-year in 2011.

Still, the TSS unit is expected to represent a modest 7% of JPMorgan’s projected $21 billion net income in 2013. But its strategic importance is expected to rise, reckon Nomura analysts. “The TSS game plan will lead to a better growth story over the next three-to-five years as JPM captures a greater share of wallet and operates more efficiently.”

Just a 100-basis-point rate hike in the one-month rate could add $350 million to its annual net-interest income. But growing the corporate cash-management business will prove a structural boon for TSS earnings – though only time will tell if this will pay off, the analysts say:

“The company is adding corporate bankers aggressively to capture more business, especially in corporate cash management. While the company would like to accelerate the growth, there is only so much bandwidth available to get things done, as developing client relationships, leveraging existing JPM relationships and winning new business takes time. Brand and counterparty strength have also been a clear competitive advantage in seeking new business in these markets.”

While international growth and interest-rate hikes are key to the unit’s revenue growth prospects, the introduction of the Volcker rule might prove a tail risk for its trust services, the bank concludes:

“The trust banks have some downside if the rule was passed in its current form. In their Association of Global Custodians (which includes JPM) comment letter, as well as letters from BK, NTRS and STT, the trust banks argue that the rule could substantially limit their ability to provide certain services to their covered fund clients or asset management affiliates (eg, Bank of New York Mellon, State Street and SSGA). If that is the case, the trust banks say they would have to discontinue certain custody services and restructure their asset management and custody businesses (fyi, we don’t believe this should or will ultimately happen, but it is a risk worth noting).”

Source: Nomura

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Grexit reading list

16 May 2012 | Posted by Euromoney Skew

A focus on the key news and narratives surounding the potential Greek exit from the eurozone [More]

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How to hedge amid Grexit, Europe edition

16 May 2012 | Posted by Kanika Saigal, Euromoney Skew

While markets crumble, Credit Suisse has dished up some hedging strategies, including underweight credit - such as Bunds. [More]

Markets are crippled with fear. European stocks have plummeted. Volatility gauges have spiked. Amid a political vacuum in Greece, the future of the eurozone hangs in the balance - and investors are firmly risk-off. So how can fear-soaked investors navigate the storm - other than cash-under-the-mattress strategies? A Credit Suisse strategy report today proffers some advice:

“German CDS spreads: German CDS spreads are lower than they should be given the rise in Spanish bond spreads or the fall in German 10-year bond yields (Germany sees its bond yields and CDS spreads move in opposite directions during crisis episodes, as bond yields are pushed down by ‘safe haven’ flows, while CDS spreads move up, as markets expect that Germany will either have to commit further resources to bail out the periphery or will have to deal with the fall-out on its commercial banks’ balance sheets). We would agree with our European credit strategists who recommend buying protection on Germany and selling protection on Spain.”

“The euro should fall: Euro-area risk indicators suggest the euro has downside from current levels, with the spreads of the average Euro-area bond yields over German bond yields, for instance, pointing to a weaker euro. Similarly, the relation between the Euro TWI and the ECB balance sheet as well as that between the €/$ and Euro-area lead indicators relative to those in the US all suggest the euro should be considerably weaker.”

“Credit looks more vulnerable than equities: While we see that the performance of credit as an asset class has been supported by the low yields on government instruments (pushing investors looking for yield up the risk curve) and by the ECB’s provision of liquidity (which reduces default risks), we still think credit is likely to underperform, for the following reasons: The Euro-area is already close to a recession (with manufacturing PMI new orders consistent with minus 1% GDP growth) – but implied speculative default rates, at 4%, are considerably lower than the realised default rates during the past two recessions (10%+); The main driver of the outperformance of credit versus equities has been the fall in German bond yields – and, as we have argued above, we think bond yields have upside risk from here; Inflows into corporate credit funds, which had been strong, have now slowed, according to data provided by EPFR Global.”

Interestingly, CS reckons that Bund yields could actually rise - even in a risk-off environment. Here''s the rationale:

“But we think that three issues ultimately argue against Bunds:
■ Germany is going to have pick up some of the bill for peripheral Europe;

■ We think that there is a strong chance that ultimately we end up with some form of de facto capital controls if the crisis were to worsen (i.e. banks informally make it hard to take deposits out of bank accounts in the periphery or insurance companies are told they can only hedge local liabilities by buying their national sovereign bonds).

■ Germany looks set to enjoy a period of strong growth, making real Bund yields rather unattractive to domestic investors as inflation is set to rise.

Without the euro, we believe that appropriate short rate in Germany would be 2.5% and this in turn would imply an ex euro fair value of the Bund yield of 2.5%+."

It continued:

"We halve our underweight of Continental European equities: sentiment indicators suggest high stress (but not quite at May 2010 levels); there are signs that policy makers are willing to allow higher inflation in the core, to stimulate growth and to postpone fiscal tightening. We think there is only a 15% probability of a Greek exit by year-end. Yet, valuations remain mixed.
■ We stay underweight banks in spite of attractive valuations, not least as they tend to underperform into a weaker euro. There is potentially interesting risk/reward in non-EMU banks (domestic UK and Swedish banks).

■ Dividend swaps look attractive."

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Spanish (banking) bombs

14 May 2012 | Posted by Nathan Collins

As markets tumble amid the eurozone crisis, Spain's proposed reforms for the banking sector are looking more and more deficient, say Nomura analysts. [More]

With markets nose-diving this morning – the FTSE Eurofirst 300 is down 2% at time of writing – all eyes are, once again, on known unknowns in Europe: rising Greek eurozone exit risks and the looming threat of a collapse in the Spanish banking system. Here is Nomura''s dispassionate take on the ever-fattening tail risk in Spain:

“Two conditions for market confidence to be restored in the health of the Spanish banking system are 1) that a realistic assessment of any possible capital deficit in the banking system is acknowledged and 2) that a credible plan be in place for plugging the gap. While we have concerns that the first condition will be met via the current reform proposals, the second condition may prove even more problematic unless Spain draws on broader Eurozone support”

Put simply, Nomura’s view is that the Spanish government is continuing to underestimate the scale of the problem.

“For instance, Moody’s expects losses of up to €306bn across loans to small companies and corporates, and mortgages. These estimates were based on more conservative default rates than those experienced in Ireland. CEPR meanwhile has estimated losses at €380bn. Clearly there are many assumptions which affect the estimates, but these numbers are significantly larger than have been recognised by the Spanish government.

Similarly, we are sceptical that we are close to a bottom in the Spanish property market. In a recent report Fitch mentioned that, on average, sales of homes reposed by banks saw prices just 48% of the original estimated value. Even with average LTV rates on mortgages at a conservative 60%, mortgages may need higher provisioning levels. Likewise the current announced scheme allows for no additional provisions on corporate loans.”

While current European rescue mechanisms simply lack the capacity to bail out the sovereign itself, Nomura considers the possibility of keeping the banks directly - but this is a political taboo

“However, currently all bank bailouts need to be routed via the sovereign and therefore will add to the national debt burden, although in theory the source of repayment would not be the tax system. Providing direct injections of capital into the banks by the bailout funds would be one way to resolve this, but this has been ruled out on a number of occasions by European policymakers.”

With Spanish banks poised on a knife-edge – spreads on Spanish bonds hit 486 basis points over Bunds this morning – negative sovereign-bank feedback loops will remain structurally embedded in the eurozone financial system. [Hide]

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Turkey's balancing act continues

11 May 2012 | Posted by Nathan Collins

Turkey's current account deficit is continuing to get better, but it's questionable how much longer that will continue. [More]

While Turkey may still be seething at its credit outlook being cut from positive to stable by Standard and Poor’s, it may be able to take some comfort from the support it has received in recent weeks from the sell-side. RBS’s Tim Ash has bemoaned the ratings agencies apparent dislike of the country, and now Capital Economics has put out a report taking a look at the drop in Turkey’s most publicised weakness: its current account deficit.

“It now looks like the economy is around half way through the rebalancing needed to bring the external deficit down to a sustainable level – but there are also signs that this process will become more difficult from now on.”

So while things may be trickier in the coming months, at least Turkey can take solace from the fact that it has won half of the battle.

“There are three reasons behind the reduction in the current account deficit. First, Turkish exports have held up well. Second, tighter monetary policy has caused domestic demand to weaken, in turn resulting in falling imports. And third, the deficit in March 2011 was particularly sizeable due to an unusually large deficit on the income account (profits being remitted out of Turkey).”

At any rate, while the current account deficit may be on the decline at the moment, Capital Economics are far from confident that this positive trend can continue at its current rate.

“For a start, Turkish exports may be running out of steam. Robust export growth in recent months has come on the back of strong demand from other emerging markets, namely in the Middle East and Asia. However, the most recent activity data from Asia has been softer. Meanwhile, the Turkish Exporters Assembly released figures that point towards a 2.9% y/y contraction in exports in April.”

It added:

“In addition, whereas previously it appeared that rebalancing was coming via reduced imports of capital and consumer goods (a result of weaker domestic demand), intermediate goods are also now falling outright. These are key inputs into Turkey’s manufacturing sector, which has been behind the mini boom in exports. However, it now seems that industry is stagnating at best and could already be in recession. And finally, the acceleration in credit growth since March points towards a rebound in domestic demand (which is consistent with a renewed rise in imports).”

Still, a change in Turkey''s outlook will, at least in the near-term, have little impact on how fixed-income investors view Turkish hard-currency sovereign debt given the issuer''s already well-established yield curve and faithful investor base.

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Are European banks poised for a rebound?

30 April 2012 | Posted by Nathan Collins

Some research from HSBC and Nomura suggests there could be room for very cautious optimism towards European banking stocks. Yes: you read that right. [More]

In an unusual twist, we came across two reports last week that are positive on European banks – particularly surprising is that HSBC notes that international investors are becoming less negative towards Italy and Spain (Not that that says much since it''s coming from a low base...)

Less negative on Italy and Spain

Many investors have questioned the high holdings we report for the Eurozone given the debt crisis but when we dig a little deeper we find that there is a clear split between an underweight position on Italy and Spain with an overweight position on the other markets (chart 4). There are signs that international funds are edging back into Italy and Spain, but they remain clearly underweight.

What''''s more, HSBC also notes that while, in aggregate, investors are resolutely underweight European financials, within that sector they are starting to show a trend of favouring banks over other institutions. No, really:

Positive signals for banks

The impact of the eurozone crisis is plain to see in the weightings in financials. International funds are overweight in every region except for Europe (chart 5). There is no sign of an increase in holdings in European financials overall but within financials there are the first signs of a switch to banks. Holdings in banks have risen a little but other financials (insurance and real estate) have fallen back (chart 6).

Believe it not, investors may begin to make a slow creep back towards European banks. Adding to the surprising conclusion, Nomura has put out some research suggesting that while lending from banks remains weak, this is due to a lack of credit demand from solvent borrowers that want leverage rather than banks' inability to supply.

This was the first survey conducted since the LTROs, and is thus important because it shows some evidence of the operations having their desired effect in freeing up the ability of banks to lend.

Instead, the weakness lies in the demand for credit from non-financial corporations. The reduction in demand from this group was more severe than bank loan officers had expected, with a net 30% saying that demand had fallen in Q1. The weakness was driven by a marked decline in capex spend. This is in a sense a ‘normal’ occurrence at this stage in the cycle, though the reduction in capex intensions was certainly intense.

But the tide might be turning:

The other bullish conclusion that could be drawn from the survey is that a majority of loan officers now expect to see an increase in the demand for loans from corporates over the next quarter, a significant change from the contraction expected over the prior two quarters (Figure 4), they do however expect to see further contraction in loan demand from households, albeit at a lower rate.

At this stage, any crumbs of comfort with respect to European banks are worthy of note. [Hide]

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How to fail in 10 easy steps, Jerome Booth’s guide to investment

26 April 2012 | Posted by Nathan Collins

The omni-present and aggressive emerging market bull at Ashmore Investment, Jerome Booth, who serves as head of research, has penned a snarky manifesto for that old world order. [More]

Here are some select extracts: (Warning: not for the faint of heart.)

1. Driving With One’s Eyes Closed: Passive Investing
It is true that if you close your eyes this saves energy. If you do so whilst driving, this should still save you energy, but this course of action is not recommended for obvious reasons. The first job of an active manager is to reduce risk. Major sovereign problems and crises typically are well-flagged. A country does not default, or take other extreme policy action detrimental to foreign investors, out of the blue. They will typically have had highly visible macro-economic problems for months before it comes to that."

“2. Excessive Reference to DM: Use DM Skills
One aspect of what I call Core-Periphery Disease is the idea that everything in global fixed income revolves around the interest cycles and monetary policy decisions in the developed world. Yet emerging markets have very different, and many, cycles at present. Not only do they not face the deleveraging reality and deflationary pressures of the HDICs (Heavily Indebted Developed Countries), but they have very different cycles amongst themselves. There is no emerging market inflation problem: there is though a Brazilian inflation problem, an Indian one, a Turkish one, and so on. Ignoring the substantial range of domestic inflationary forces and policy choices facing emerging Central Banks is good strategy for missing opportunities."

"3. Treat EM as an Afterthought: Use a ‘Global’ Manager
A psychological support device for Core-Periphery Disease is to treat EM management as peripheral or subsidiary. I remember a conference at which a pension fund presented on the issue of whether to allow global managers to invest in EM equities tactically or to employ specialists. Their empirical conclusion was that the global managers added value (with reference to their benchmark) by tactically investing in EM, but that their portion of EM investments under-performed the EM index, unlike the portfolios of specialists. The conclusion drawn was that one should allow both. However, what was discovered were two things: tactical asset allocation works in EM, and EM specialists are better at managing EM assets than global managers (in this sample at least)."

“4. Hedge Out ‘Currency Risk’: Increase DM FX Risk
Money illusion is the illusion that a currency is not a price like any other, but fixed. The pattern of volatility of EM currencies against the Dollar is now very similar to that of developed currencies versus the Dollar. In other words, it is the Dollar which is volatile. Investing in 30 currencies, and ones which have huge reserves, is arguably safer than investing in one."

“5. Outsource thinking: Use a Rating Agency
Also,in that we are facing financial repression (see ‘The Emerging View’, October 2011) ratings are increasingly a tool by regulators to capture investors’ savings to finance governments. Such behaviour suppresses investment grade yields further, and increases investor homogeneity and so systemic risks. Those investors not so constrained would do well to think about sovereign risk for themselves."

“6. Follow the Crowd: Miss the Really Big Risks
Investors needs to be constantly asking themselves whether there are possible scenarios and structural shifts ahead which could damage or outwit all their peers. If so they should consider doing things differently."

“7. Ignore HIDC Macro-Risk: Buy Multinationals instead
If one is investing in EM in part to reduce risk from the worst scenarios, investing in such multinationals is an inferior approach to investing directly in EM companies. Any excuse not to invest is EM is often sought, and the idea of investing in Western multinationals with EM income streams is one refuge for those persuaded of the benefits of EM but still constrained by their prejudices."

“8. Ignore the Unfamiliar: Deny the Existence of Whole Asset Classes
With the sovereign EM local currency debt market already larger than the US Treasury market for example (see ‘The Emerging View’, February 2012), how is it that some investors are concerned about whether it is significant enough to constitute an ‘asset class’."

“9. Believe What you Want to Believe: that EM is Risky and DM is Not."

“10. Extrapolate & Ignore Factors Difficult to Quantify"

Not much to add here except to say given high management fees and historically poor performance of many active managers, dismiss the virtues of passive management at your peril. And let’s hope investors don’t confuse apples with oranges. Or rather, apples and bushels of apples: don’t perform a quantitative comparison of one type of developed market debt with every type of emerging market debt. The EM local currency debt market, though nascent, is far from an homogenous asset class.

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Sub-Saharan African corporates: more transparency needed

26 April 2012 | Posted by Kanika Saigal

A lack of corporate disclosure tempers the bullish sentiment towards Sub-Saharan African companies. [More]

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Taiwan’s Chinatrust Commercial Bank’s great leap forward

26 April 2012 | Posted by Kanika Saigal

The bank's entry into the mainland this month comes as competition for Taiwanese customers in China is heating up. [More]

This month is supposed to herald an historic shift in Taiwan’s Chinatrust Commercial Bank’s regional footprint. In mid-April, the family-run private bank finally made the great leap forward onto the mainland.

From the press release:

“Chinatrust Financial Holding Company, its main subsidiary, Chinatrust Commercial Bank, officially opened its new branch in Shanghai, as part of its overseas business expansion. It is the seventh Taiwanese bank to set up a branch in mainland China, Chinatrust plans to set up 90 operations in next ten years.”

But how realistic are these ambitions?

Firstly, as the seventh Taiwanese bank to open up shop on the mainland, is it behind the curve? Some of its competitors like Land Bank of Taiwan, Taiwan Cooperative Bank and Chang Hwa Bank have already had representative offices in China when the ECFA (Economic Cooperation Framework Agreement) was signed, and were approved in September and October 2010 to upgrade to foreign bank branches.

Secondly, at this late stage in the game, can banks like Chinatrust compete with those on the mainland?

As previously reported by Euromoney:

Questions remain over the ability of Taiwanese banks to steal back Taiwanese companies that have long been established on the mainland. Although tech company Hon Hai has its headquarters in Taipei, it has been present in mainland China for the past 20 years and is well established there. “A company like this would easily gain support from Chinese or international banks,” says Pandora Lee, Taiwan analyst at UBS. What will motivate them to turn to Taiwanese banks?

Lee argues that Taiwanese branches abroad have accomplished little. “Most Taiwanese banks have branches in places like the Philippines and Vietnam but these branches do not perform as well as domestic branches," she says. "They are only doing business with overseas Taiwanese people in the region. Doing business with a limited amount of people prevents Taiwanese banks from gaining any meaningful presence in Southeast Asia.” Could the same be said for branches in China?

At least the company employees that couldn’t make it are still feeling the love:

“Though not all staff could join the opening, Chinatrust staff from worldwide sent 80,000 hand-made origami stars to give their best wishes, and the stars were used in the following kick-off ceremony."

They are family

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The blind leading the bulls

25 April 2012 | Posted by Nathan Collins

Nomura's Richard Koo explains why - whatever the bulls might like to pretend - the promised cures for the eurozone crisis were never really going to work. [More]

Nomura economist and notorious bear Richard Koo has put out a nice note explaining why the situation in the eurozone doesn’t seem to be improving appreciably. Put simply, European decision-makers have struggled to work out exactly why things are in such a mess, and as such have invested a dispiriting amount of confidence into measures that weren't necessarily going to solve the problems – most notably the LTROs. In his words:

“At first, the vast majority of market participants and policymakers appeared unable to distinguish between a financial crisis, which is a lender issue, and a balance sheet recession, which is a borrower issue. As a result, they overestimated the impact of the LTROs and assumed the ECB’s actions would solve the eurozone’s economic problems.

A senior financial official I spoke with two months ago emphasized that the worst was over and went so far as to say that ‘there is no problem that €1trn cannot solve.’”

Koo neatly explains why the ECB hurling money at the problem while demanding fiscal cuts just isn’t going to cut it:

“First, the experiences of Japan, the US, and the UK show that monetary accommodation cannot stimulate the real economy when the private sector is seeking to minimize debt in spite of ultra-low interest rates during a balance sheet recession.

Second, fiscal stimulus is the only tool a government has for maintaining aggregate demand when monetary policy has lost its effectiveness. Yet Germany and other countries of the eurozone are actively pursuing fiscal retrenchment.

Third, eurozone members hope that structural reforms will lead to growth, but the examples of Japan and the US show that such policies will not have a positive impact on growth for at least five to ten years.”

All this talk of structural reforms may remind you of Japan under Junichiro Koizumi. How did that work out again?

“The Koizumi administration completely ignored the fact that Japan was in a balance sheet recession and pushed ahead with structural reforms, insisting that there could be no economic recovery without them. But the economy failed to improve, and ultimately the only thing that grew was, in the words of one newspaper, the salaries of directors at the newly privatized Japan Highway Public Corporation.."

Oh, that's right...

At any rate, the really interesting idea here is that a Germany-driven penchant for using a blunt instrument to try and immediately solve the eurozone’s problems, may actually have made the problem worse.

“Some believe that senior German officials understand that rescues will ultimately be needed but feel that unless EU authorities take advantage of the crisis to whip the less competitive periphery nations into shape, they will only face a bigger problem down the road. Hence they are delaying rescue efforts as long as possible while the periphery nations undertake structural reforms.

According to this view, eurozone authorities should take this opportunity to force periphery nations to enhance their future competitiveness by, for example, delaying pension eligibility until the standard German age of 67.

While there is something to be said for this argument, if true, it means that Germany’s insistence on structural reforms has postponed a solution and allowed a problem that was initially limited to the small nation of Greece to develop into a major crisis threatening the entire eurozone.

This is a direct result of the authorities’ attempt to use a single tool (rescue) to resolve two fundamentally separate problems— the debt crisis and the need for structural reforms in periphery nations—that should have been addressed with separate policy responses."

Koo has apparently had some success in convincing people to come around to his way of thinking...

“My recent trip to Europe began with a conference held on the shores of Lake Como in northern Italy. There I had the opportunity to debate these issues with Jürgen Stark, former Bundesbank Vice President and a leader of German economic opinion.”

...

Many of the seminar participants said afterwards they found my arguments to be more persuasive than those of Dr. Stark.”

“Even if I do say so myself...” [Hide]