24th June 2010 by Shaun Richards
This week has been somewhat quieter than recent weeks so far for equity markets. In terms of currency markets we had at the beginning of the week some excitement about China’s announcement that she would abandon the peg in her exchange rate to the US dollar. Since then we have seen some slow change in her daily fixings of her exchange rate. For example today’s exchange rate is 6.81 to the US dollar and yesterdays was 6.8124, these compare to the pegged rate of 6.8275 (there is a range of 0.5% around each daily fixing). However we do have a G20 meeting at the end of this week and there are plenty of world economic imbalances for them to discuss not least the debate between austerity and fiscal stimulus. In a rather amusing swipe at the importance of G20 meetings and indeed the way that the G20 is portrayed the Norwegian Foreign Minister Jonas Gahr Støre gave an interview this week to Der Spiegel from which I quote below.
But the G-20 is a grouping without international legitimacy — it has no mandate and it is unclear which functions it actually has………The G-20 is a self-appointed group…….(and when asked about the G20 interfering with other international bodies) It would mean a further creeping devaluation of the responsible world organizations.
Compared to the sycophancy which normally surround such (self) important events his interview made me smile and in some respects his lack of reverence is rather refreshing I feel.
European Government Bond markets
Yesterday saw Greek government bond yields rising again and as the day went on the move accelerated. Her ten-year government bond yield closed at 10.49% which was up 0.61% on the previous close of 9.88%. The spread between her ten-year government bonds and the German bund equivalent rose to 7.83% (the high at the peak of the crisis was 9%). If you look at her shorter dated government debt then there was an even more severe move as her three-year benchmark bond yield closed at 11.36% which is up 0.74%. Putting this into price terms the ten-year bond which Greece issued only a couple of months ago is trading at 74.36. We are back in a zone where there must be plenty of singed fingers.
There are a couple of reasons for this move. It looks likely that the ratings downgrades are having their effect. I wrote when the last one happened that this meant that Greece would fall out of some government bond indices and that some holders would have to sell as her debt was no longer eligible to be held by them. This is now happening. Also there was some confusion and retractions over an interview given by the Greek Finance Minister to a German news agency which hardly enhances Greek credibility.
What is somewhat disturbing is that this is happening whilst the European Central Bank is following a policy of buying peripheral government debt and an enormous rescue package has been operated by the euro zone. Of course Greece is not immediately affected as her government can fund itself from the euro zone and IMF for a while but even so this is not entirely auspicious as one day she will have to return to the markets.
Portugal and her debt auction’s implications
Portugal’s debt agency ( Instituto de Gestao de Credito Publico orIGCP) sold 943 million Euros of her five-year benchmark bond ( 3.35% Oct 2015) yesterday at an average yield of 4.66%. Where this is significant is if one compares it to the last time she issued some of this stock back on May 26th where a similar amount of 1 billion Euros was issued at a yield of 3.7%. So a rise of just under 1% in less than a month which must be very disturbing for the Portuguese debt agency and her government.
This poor result led to the yield on Portugal’s ten-year government debt rising to 5.89% up 0.22% on the day. The last time she issued some of this bond she had to pay 5.22%. Even at that level there was a discussion whether it would be cheaper for Portugal to take advantage of funding from the newly established European Financial Stability Facility. Should these new much higher levels be sustained then Portugal would be better off borrowing from it then next time she issues some debt of this maturity as this fund is expected to provide funding at approximately 5%. Also if one looks at the situation of Portugal and the fact that she is part of the support package for Greece, we are getting into a zone where it will cost money for her to provide finance to Greece and the euro zone will have to enact its cross-subsidy agreement.
One factor in recent problems has been Europe’s banking system. We received some news on this front from the Bank of Portugal yesterday which announced that Portugal’s banks borrowed some 35.8 billion Euros from the European Central Bank (ECB) in May which is double the 17.7 billion Euros they borrowed in May. This is clearly rather disturbing and show the stress that Portugal’s banking system is under. Most of the focus on this matter has been on her neighbour in the Iberian Peninsula Spain but it is plain that Portugal’s banking system is feeling the squeeze too.
Furthermore it would appear that it is the case that banks in the four peripheral economies under pressure ( Greece, Portugal, Ireland and Spain) have accounted for more than two-thirds of the increase in lending to euro zone financial institutions by the European Central Bank since the summer of 2008 as many struggle to access financial markets. The ECB has raised its lending by £332 billion over the past year according to Royal Bank of Scotland so that it had lent a total of €815bn to euro zone banks at the end of this May compared with €483bn in June 2008. According to their analysis of this rise then the four countries stated above have borrowed 225 billion Euros of the 332 billion increase in lending since June 2008. So whilst they represent some 18% of the euro zones Gross Domestic Product they have taken 68% of the increase in borrowing. The estimated breakdown of the borrowing is Greece 78.1 billion Euros, Ireland at 54.3 billion, Portugal at 34 billion and Spain at 58.4 billion.
What these figures give us an insight into is the stress that the euro zone banking system is under and how much the ECB is having to prop it up. What we are seeing is another way of looking at the fact that banks in Portugal,Ireland,Greece and Spain are struggling to get liquidity from the markets and so they are being forced to get it from the ECB and if the latest Portuguese numbers are anything to go by they are being forced to do so in ever-increasing numbers. As banks are lending to each other less and less they are forced to rely on the central bank. Remember this is the same central bank which was planning an exit from its monetary stimulus programmes in this year and instead is finding itself ever more entwined in them. Having stepped up its liquidity programmes in September 2008 after the collapse of Lehman Bros. the ECB has a real problem in getting the patient off the operating table let alone make a recovery.
The European Central Bank
One curious aspect of the recent behaviour of the ECB is the way that its Securities Markets Programme has declined in size in recent weeks. For example it announced earlier this week that it has purchased a total of 47 billion Euros of peripheral countries debt which meant it had only bought some 4 billion Euros worth in the previous week. This continued a declining trend. Some may look at the rise in yields in peripheral government debt and think that it is because the ECB has reduced its purchases. Others who are more aggressive may wonder if this is implying it is the only or at least the main buyer.
To my mind the ECB is showing the signs of being confused as to what it is trying to do. I do not believe it has a clear mandate or programme at this time. If it did it would publish how much in total it intends to buy like the Bank of England did with its QE programme. I am starting to wonder how committed it really is to this strategy as if it was then to my mind it should be buying more at this time and not less. It has seen a reduction in its credibility this year due to its apparent volte faces on collateral loan rules and purchases of government debt it does not need to reduce this further by dithering.
July 1st 2010
This is an important date because it is the day that the European Central Bank’s first and largest 12-month Long Term Refinancing Operation (LTRO) will run out. This LTRO added some 442 billion Euros to market liquidity when it came into being a year ago. As market liquidity is under pressure as discussed above there could be a lot of action on that day and what happens will tell us much.
The first clue as to the real state of play will be how much the ECB has to do around that date. The more it does the more problems there are. It is already moving in this direction as it has a 3 month LTRO ready for money to go to. But if it gets all the money again then everybody will think two things.
1. What is the quality of the assets pledged to the ECB in return for the money? ( i.e what is the state of play on bank balance sheets)
2. Money markets have not yet recovered enough to take the money and counterparty risk remains a big problem.
This LTRO hits right on the subject of central banks exit strategies from their monetary stimulus programmes. Earlier this year the ECB was planning to abandon LTROs and this would pretty much have been left to expire. So in this sense the situation has deteriorated and not improved. This is a metaphor for where we now stand the hopes of early 2010 and beginning to be dashed a little.
In terms of what it does I am afraid that there is no easy way out for the ECB in some respects it is damned if it does and damned if it doesn’t!
Some further insight into the scale of these issues was suggested by a comment on here a week or so ago which referred to the recent report from the Bank of International Settlements. The link to this is http://www.bis.org/publ/qtrpdf/r_qt1006.htm and the graph/table which is most relevant is on page 19.