Recent posts


Two charts for anyone who still believes in ‘decoupling’

Q2 was a grim quarter, not just for the Eurozone economy but for the global economy. The downturn in Citigroup’s economic surprise indices that began in March picked up speed through to June, while PMIs in almost all corners of the world weakened in Q2 as can be seen by the PMI heatmap.

The good news is that the authorities have begun to respond to the downturn with more stimulus (as seen by yesterday’s actions from the BoE, ECB and PBoC). Some would argue that economic data are all different degrees of lagging indicators, so people may take more comfort from the forward looking financial markets having bounced since the end of June (although I think is misplaced optimism – political and fiscal union remains miles away, and the EFSF/ESM bailout mechanism is deeply flawed).

The bad news is that areas of the bond market are showing severe distress once more. Long dated Spanish government bond yields have jumped again, and yields are right on the intraday record high set on June 18th at the time of writing. Long dated Slovenian government bonds are yielding 7% amid mounting speculation that a bailout is imminent. And two year German government bond yields have again turned negative.

This entry was posted in macro and politics and tagged by . Bookmark the permalink.

Please note the content on this website is for Investment Professionals only and should be shared responsibly. No other persons should rely on the information contained within this website.


Competition: win David Graeber’s “Debt: the First 5000 Years”

I’ve not read David Graeber’s “Debt: the First 5000 Years” yet – an anthropological investigation into the origins of money and debt – but have had it highly recommended to me and the reviews on Amazon suggest it’s a staggering original work. So I’ve bought a job lot for the team, and 10 extras for you to win in today’s competition.

Question: Denmark yesterday cut official interest rates on its certificates of deposit. To what level?

Please see here for terms and conditions, and submit your answer here by 5pm on Thursday 12th July 2012. The first 10 correct answers out of the hat will win a copy of the book.

This entry was posted in credit, macro and politics and tagged by . Bookmark the permalink.

Please note the content on this website is for Investment Professionals only and should be shared responsibly. No other persons should rely on the information contained within this website.


US – a video from Chicago. Research trip on the US High Yield market

I recently returned from Chicago after a research trip. We put together a short video to share a few of our findings with the wider world. The mood of most economists, investors and indeed the man on the street was noticeably more upbeat than in Europe. With positive GDP growth, a housing market showing the first signs of stabilisation, if not growth, and – in our opinion – a banking system that is in better shape than its European equivalent, the US continues to provide a more benign context for High Yield investors. Indeed, whenever we encountered concerns and pessimism it was firmly focused on this part of the world. Consequently, we continue to find some interesting themes and opportunities in the US, both from a top down perspective and also for individual issuers and bonds.


Why does UK government guaranteed Network Rail keep issuing debt in its own name – and at a higher cost?

Network Rail, the organisation that owns and manages the UK’s rail infrastructure, has just issued more of three tranches of its index-linked corporate bonds.  These bonds are, like all of Network Rail’s debt, rated AAA and fully guaranteed by the UK government (the business was effectively nationalised in 2002 having bought Railtrack out of administration) .  These bonds were issued with spreads around 30 bps over similar maturity UK index-linked gilts.  That level of spread is typical of where Network Rail’s corporate bonds trade at the moment – and there is over £28 billion of this public debt outstanding.  This means that if that corporate debt were issued today it would bear a total interest cost that is £84 million per year higher than the cost of issuing gilts (plus the costs of issuing debt as a corporate, e.g. separate listings, investment bank fees).  Present value a perpetual income stream of £84 million at, say, 3% (the yield of ultra long dated gilts) and that is an additional cost of £2.8 billion.

So why isn’t the government borrowing in its own name at rates 0.3% per year lower than Network Rail and then directly on-lending the money to it?  After all it has already assumed all of the credit risk through the guarantee.  I know that £2.8 billion is relatively small in the scale of the UK’s debt problems nowadays (it was roughly the overshoot in May’s government borrowing requirement), and that assuming Network Rail’s debt obligations directly would increase the total UK national debt, but we’re talking about a simple accounting change to save billions of pounds.

Just don’t let’s get started talking about PFI…


The UK’s AAA rating looks increasingly vulnerable. Growth negative, borrowing up. It might not matter though.

On 14th February this year, Moody’s put the UK’s AAA credit rating on negative outlook.  This means that the agency says there is a 30% chance of the UK being downgraded within the next 18 months (i.e. by mid 2013).  A month later, Fitch moved the UK’s AAA rating to negative too – for them this means a slightly greater than 50% chance that there is a downgrade within the next two years.  At the time Moody’s said that “any further abrupt economic or fiscal deterioration would put into question the government’s ability to place the debt burden on a downward trajectory for fiscal year 2015-16″.

Since that Moody’s action, we have seen deterioration, both in economic growth and on the fiscal side.  Q4 2011 GDP was revised down from -0.2% to -0.3%, and now today to -0.4%, and an official recession is now occurring with 2012 Q1 GDP growth coming in at -0.3%.  Whilst the latest survey of economic forecasts has a median Q2 GDP growth of +0.1%, the impact of the extra bank holiday on economic activity has 35% of forecasters expecting a third consecutive negative quarter.  At the same time, and as a direct result of that weak growth performance, government borrowing is overshooting.  In May the UK borrowed £18 billion, compared with an expectation of £14.5 billion.  This is £3 billion more than in May 2011 and was driven both by weakness in tax receipts (-7% year on year) and higher government spending (+8% year on year).

The government then came out and announced a freeze in petrol duty, postponing a planned 3p rise in the rate due to take place in August.  The cost of this, whilst “only” £550 million, appears to be unfunded – there was talk of departmental underspends, although the monthly borrowing numbers don’t seem to reflect such savings yet.  As Treasury minister Chloe Smith said in “that” Newsnight interview, “it is not possible to give you a full breakdown (of the underspends)…because the figure is evolving somewhat”.  Whilst as a good Keynesian I’m all in favour of fiscal stimulus helping to support the existing monetary stimulus in the UK, this is not the implicit deal that Chancellor George Osborne made with the rating agencies – that being that he would deliver both growth and austerity together and thus get the UK’s debt/GBP ratios down in coming years.  Failing to both get government spending down, and to grow the economy means that that debt/GDP ratio will continue to grow, and it becomes increasingly likely that the UK will lose its prized AAA ratings.  Whether this matters is a different question – our sovereign CDS spreads are lower than AAA Germany’s (70 bps vs 103 bps), our bond yields are as low as they’ve ever been, and whilst the Eurozone crisis continues the UK remains a safe haven for capital.  And as we know, when S&P downgraded the US last year its bond yields subsequently fell.  It’s also unlikely that gilts will sell off, as UK rates are pinned at 0.5% (or lower) for the foreseeable future, and more Quantitative Easing is on its way.  A downgrade might therefore just be an embarrassment for the Chancellor, rather than the starting gun for a race out of UK bond markets.


Lonesome George (Osborne) should get rid of one and two penny coins

Some sad news has reached us on the bond desk. Lonesome George, a giant tortoise that lived in the Galapagos Islands, has died. Lonesome George was known as the rarest creature in the world because he was the last known individual from his subspecies. Which is kind of relevant, as today’s blog will be covering another endangered species – one penny and two pence coins.

It was announced earlier this year that in an effort to cut costs, the Canadian government would be eliminating the penny from Canada’s coinage system. Canada isn’t the first country to pinch its pennies. Australia removed its one and two cent coins from circulation in 1992 due to the high cost of production, the United Kingdom lost the half-penny in 1984 when it became more expensive to make than its face value, and after getting rid of its one and two cent coins in 1990, New Zealand followed suit in 2006 with the five cent coin.

The Canadian government has asked businesses and consumers to simply round up (or down) to the nearest five cents at the cash register. Businesses will be asked to return pennies to financial institutions. The coins will be melted and the metal content recycled. Could the UK and Eurozone announce similar measures in the future?

Last year, the UK issued 304,304,000 one penny and two pence coins. The value of these coins is around £4 million pounds. They are copper-plated steel and are around 93% steel and 7% copper. Our rough estimate suggests that this equates to around 1,314 tonnes of steel and 100 tonnes of copper. For some context, a London double decker bus weighs about 15 tonnes.

At current market prices, the value of all this metal is about $1.2 million (metal prices are quoted in USD/tonne). But what if all the one penny and two pence coins in circulation were melted down? We could use this metal for other purposes (for example, the Aussies made Bronze Olympic medals out of their one and two cent coins). Using figures from The Royal Mint, we have found that there were 16.7 million coins produced between 1992-2011 (93% steel, 7% copper) and 14.2 million coins produced between 1971-1991 (97% copper), equating to 39,000 tonnes of steel and 73,000 tonnes of copper. If all the coins that were produced over this period were melted down, the value of all that metal on the open market would be $554 million (assuming that not a single penny was lost or destroyed).

The same analysis for the Eurozone shows that last year’s one and two cent issuance has a scrap value of $17.8 million. Do the peripheral Eurozone nations really have the spare change to mint these coins?  The scrap value of all the one and two cent euro coins in existence is almost $200 million.

So is it time the UK and Europe did away with these fiddly coins to save on minting and metal costs for the taxpayer? Some monetary union countries already have. The Netherlands and Finland produce only a small number of one and two cent coins for collecting purposes only. In these countries, businesses round prices up or down to the nearest five cents (Swedish rounding) if paying with cash. Eliminating lower denomination coins in Australia and New Zealand had negligible impact on inflation. Speaking of inflation, one penny in 1970 would buy 13p worth of goods and services today. There are also efficiency gains to be had at shopping tills around the country as businesses move customers through their tills at a quicker rate. And hopefully I would be able to get on my bus faster.

At a time when we are all penny pinching, it’s about time that those in government – including the UK Chancellor George Osborne – started thinking about it too.


Should Europe let the single currency go to save the Union?

Today is the day on which football is going to meet the Eurozone crisis when Germany and Greece compete in the Euro Cup’s quarterfinal. Spectators will be watching closely any gestures by Angela Merkel sitting in the stadium next to other political and executive representatives, any behaviour (and banners) of both team’s supporters inside and outside of the stadium, and any appearance and words of the squads on the pitch and during the post-match interviews. The fact that much of the recent news coverage has been centred on the political dimension of this match shows once more the polarised times in which we’re currently living. A match that, frankly speaking, has never been a big deal for either nation before, suddenly has turned into a highly emotional act about success, respect and even dignity, according to some commentators and officials. Nowadays European integration looks more and more like a very complex theory whose (successful or unsuccessful?) proof might turn out to be one of the biggest challenges of the 21st century. Interestingly, I will have insider status tonight. Being a German watching this match in the European capital of Brussels, the main hub for European bureaucrats, politicians, enthusiasts and sceptics, this experience will be insightful. Let’s see in which way, given that my past experiences in Brussels made it feel rather like a bubble than a true reflection of common sentiment.

Knowing that I’m going to be in Brussels this weekend and having spoken with many of my peers who work for institutions and companies closely related to the European Union, I couldn’t really stop thinking about the political dimension of the Eurozone crisis. I asked myself the question “if the European Union is particularly a political project or even a political and economic project which was meant to develop both political stability and economic prosperity, can’t one possibly argue that it does currently not only fail on the economic dimension (as argued before), but also on the political dimension?”

Why is this? My first thought is this. If the euro is interpreted as a continuation of the European integration process which by nature was about

  • preventing a dominant state in Europe after the second world war which is able to dictate the fate of the continent
  • enhancing social and economic mobility and establishing a European identity
  • supporting democracy and, consequently, making democratic institutions an inevitable pre-condition to any membership,

then don’t we find ourselves currently in a situation in which the single currency union has led to a failure of delivery, given that

  • Germany appears to dictate the agenda and appears to be the elephant in the room
  • we’re seeing increasing nationalist tendencies in parts of Europe, and negatively polarised sentiment towards fellow member states
  • Italy, founding member of the Union, empowered a non-democratically elected prime minister (incl. a technocrat government) to run the country for around 1.5 years, assuming that the next general elections will take place in April 2013?

My second thought is about the legitimacy of any further European integration (fiscal union, Eurobonds, political union) which is currently being discussed as part of the solution of the crisis. If the European project is also defined around the lines of democracy, a value which is primarily promoted, isn’t there still a long way to go for politicians in order to convince the electorate that further integration is actually what they want, given that

  • the electorate in parts of Europe is not prepared for the idea to bail out other countries, i.e. share the burden
  • a common European identity is apparently not reality
  • social and economic mobility is far away from being fully fluid, and current political discussions at the national level across Europe rather suggest a decreasing tendency in the light of talks about the part suspension of the Schengen agreement.

The third thought to conclude the argument is about the nature of integration and, consequently, the European Union. Isn’t European integration rather something ex post than ex ante? That is, it is not the idea that you force upon someone, but rather a process facilitated by institutions and paced by the electorate at whose end integration is concluded. Institutions and electorate interact closely during the process, and one cannot really deviate too far from the state of development, from the ‘mind set’ of the other because then it turns into an unhealthy relationship in which legitimacy and accountability become problematic. That is, the formalisation of political union may require a common sentiment, a common identity in this direction first before a new treaty should enact it.

But what could be the pre-requisite of further integration? Away from all the economics, I think that Wilhelm von Humboldt, the German philosopher, has a point by saying that a language draws a circle around a nation, deciding upon inclusion and exclusion. Going back in history, isn’t one of the main differentiating factors between the United States of America and the idea of a United States of Europe that the separate states of North America emerged as satellite states of a single country – Britain – whose language, culture and legal system built the shared founding ground, as Tony Judt argues in ‘Postwar’?

If the European integration process was to resume in political union at one point in the future, shouldn’t we start to acknowledge that the electorate isn’t ready for this step yet and, equally importantly, that we’re currently jeopardising this prospect? There may be some valid economic arguments for steps to more integration, but the political arguments don’t seem to be matching this. European integration has been on the fast track over the past decades, and much of it has shaped the interaction of states, companies and individuals across countries very positively. But the Eurozone crisis also seems to show that the electorate might not have kept up with the institutionalisation process. A full political union looks to me like something bigger than an emergency solution to a financial crisis. There is another dimension to it defined by identity and democratic legitimacy. If the Eurozone crisis jeopardises, rather than facilitates, further integration on both dimensions, politically and economically, wouldn’t it be sensible to take a step back (euro break-up?) in order to overcome the structural imbalances, allow for slower, but more persistent structural alignment, and a less heated atmosphere in which a more shared identity can flourish? It is likely that a break-up will have adverse effects in the shorter term, but isn’t there the possibility that it could lay the ground for a stronger subsequent economic, political and social recovery and, consequently, mark two steps forwards towards political stability and economic prosperity in the long term? That is, let one project go (optimists might argue here “put on hold”) in order to ensure the survival of the bigger one.

Fingers crossed that Germany wins tonight – and Europe succeeds as a project in the long term.


German government bond yields may need to get very negative for the euro to weaken much further. And it could easily happen (update)

In January I argued that negative German government bond yields would be a rational response to the rising probability that the euro breaks up and Germany reintroduces the Deutsche Mark (see here).  This was because German government bonds have significant optionality.  Assume that the Eurozone is forced to reintroduce national currencies – if you are living in Spain, then a German government bond yielding -0.5% won’t necessarily provide the investor a -0.5% return if held to maturity, it could result in a capital gain of perhaps 40% since the Deutsche Mark would significantly appreciate versus the new Spanish Peseta.

German 2 year government bond yields did indeed turn negative on May 31st, while 2 year US Treasury yields have remained little changed since January.  The euro has weakened so far this year, and the correlation that I discussed in January has continued to hold reasonably well.  The chart below is an update from January’s blog comment.

German government bond yields have sold off in the last two weeks, prompting speculation that Germany is becoming the next Eurozone country to be hit by the bond vigilantes.  I disagree, and believe this is much more to do with profit taking of some very long positioning ahead of Greek elections.  The investor base seems to have moved from extremely overweight Germany to very overweight Germany.  As is always the risk with such crowded positions, the sell off that began at the beginning of June resulted in a number of banks and leveraged investors falling over eachother stopping eachother out, leading to a further sell off. It is reminiscent of the last notable wobble in Germany that occurred in November following a weak German auction, but it didn’t take long for the bund rally to resume back then.  The long term trend of deposit and capital flight from Southern Europe to Northern Europe remains in place as investors become increasingly concerned of the risks of Eurozone breakup, and this should continue to support German government bonds.

How negative can German government bond yields get?  It’s interesting to look at Switzerland, where five year government bond yields are now negative, i.e. if you want to buy 5 year Swiss government debt, you have to pay them for the privilege.  The reason for negative bond yields in Switzerland is all to do with growing speculation that the Swiss franc peg against the euro is unsustainable (or the euro will cease to exist), and in the event that it breaks, investors would realise a potentially large capital gain in owning Swiss government bonds. In a similar way, Denmark 10 year government bonds yield 10 basis points less than German government bonds of the same maturity since presumably if the Eurozone begins to splinter then one of the first things to break would be the Danish krone peg against the euro.   As Eurozone stress increases, German bund yields could easily become very negative, and across the whole yield curve.


Americans are inconsistent in how they believe the budget deficit should be tackled. But growing signs of pragmatism?

It looks as if we might see a repeat of 2011′s brinkmanship regarding the US budget – remember that this game of chicken between the Republicans and Democrats was a contributory factor to S&P downgrading the US from AAA.  Few expect American politicians to make progress on debt matters until after November’s elections – but that doesn’t leave them long to prevent many automatic cuts to spending and hikes to taxes occurring in January 2013.  This fiscal cliff on 1 January will cause automatic defence spending cuts, and hikes to income, capital gains, dividends and estate taxes.  How big an impact would this have on US growth?  The Congressional Budget Office estimates it would mean that the US economy would shrink by 1.3% in the first half of 2013, but Goldman Sachs thinks that the impact could reduce first half GDP by as much as 4%.  With China slowing, and much of the Eurozone in recession, it doesn’t feel like a good time to take $600 billion out of a major economy that has at least been growing in recent quarters.

But the inability of politicians to decide how and when to tackle the US’s growing debt problem is mirrored by its population.  Here are a few opinion polls to show how it’s possible for voters to want to a) keep social security and healthcare benefits unchanged, but b) cut spending, c) not increase taxes, and d) not increase the US debt ceiling.

Which is more important: taking steps to reduce the budget deficit or keeping Social Security and Medicare benefits as they are?

Reducing budget deficit 32%
Keeping benefits as they are 60%

(Source: Pew Research Center, June 2011)

What is your favored way of reducing the budget deficit?

Spending cuts alone, or more spending cuts than tax hikes 58%
Tax hikes alone, or more tax hikes than spending cuts 23%

(Source: Reuters/Ipsos, April 2012)

In order to reduce the budget deficit do you think it will be necessary to increase taxes on people like you?

Necessary 41%
Not necessary 56%

(Source: NYT/CBS Poll, January 2011)

Would you want your member of Congress to vote in favor or vote against raising the debt ceiling?

Vote for 22%
Vote against 42%

(Source: Gallup, July 2011)

Given that Medicare, Medicaid and social security are already around 60% of government spending, it would be a tough ask to reconcile a) leaving these unscathed and b) cutting spending.  Additionally these expenses are growing at a rate far outstripping US GDP growth, so the baseline is for significant increases to these programmes rather than cuts (mainly due to the aging population and advances in medical treatments).

But perhaps there is a growing realisation that these inconsistencies need to be addressed.  Having spent a decent amount of time in the US over the past few years, we’ve found recently that it’s become difficult to keep economists, strategists and policymakers focused on our US-centric questions and away from them asking us about the Eurozone’s problems.  And with municipalities experiencing debt distress across the States already, the question “Could we be Greece one day?” is crossing into the mainstream.

So it is interesting that a couple of developments recently suggest that American voters are thinking more holistically about the future structure of their nation’s economy.  An interview in this weekend’s Financial Times with civil rights lawyer Molly Munger discussed her success in getting a proposed income tax hike onto California’s ballot paper in November.  This new tax, currently supported in opinion polls, would boost the state education fund.  Another tax hike for deficit reduction purposes is also on the ballot paper.  At the same time voters in Wisconsin last week rejected a Trade Union backed recall vote to try to eject Republican Governor Scott Walker from office after he proposed the Wisconsin Budget Repair Bill.  The Bill would have increased pension and health contributions for state employees and reduced Union powers in bargaining.  Walker actually increased his victory margin in the recall vote compared with his 2010 election, and he is the first ever Governor to keep his seat in a recall vote.

Signs of a changing attitude towards the debt burden?  Possibly, and that has to be positive – but we still expect a great deal of turbulence around the debt ceiling issue after the Presidential elections.  That turbulence will be exacerbated by a likely split between control of the Presidency and that of Congress, although some have suggested that this would be the best outcome as there will have to be a compromise in the breakdown of long term budget reduction between spending cuts and tax hikes, rather than one or the other taking all the strain.

Finally, there is increasing discussion of a nationwide consumption tax (VAT) in the US.  Even a small VAT could make significant inroads into the deficit each year.  Is this a popular view in the States?  Well when I typed “us consumption tax” into Google, the second automatically generated search is “u.s. consumption tax is tempting vat of poison” so I’m guessing that’s a “no”.  However this is a silver bullet still available to the US whereas Europe, with many nations having VAT rates already at 20% has little scope to raise additional revenues through this route.


Financial salvation not repression

There have been a lot of investors and commentators talking about financial repression. The fact that nominal interest rates are set at or close to zero, and the subsequent transmission of these low returns along the yield curve means that returns in both nominal and particularly real terms are historically scant. This is seen as a government and central bank policy that is punishing savers.

However, in many cases savers have been helped  and not punished by governments. Whether that be the humble saver in Northern Rock who was bailed out, or at the other extreme sophisticated funds who loaded up on debt issued by Fannie Mae or Freddie Mac in the US. These savers were not repressed but were saved as governments and central bank actions (like the implicit subsidy of banks) protected the value of their capital investments. Total returns have been boosted to savers versus a free market outcome which would have resulted in significant losses.

Commentators seem to have forgotten how much savers have been and continue to be protected by the authorities, which are providing financial salvation and not repression.  Unfortunately we may now be coming to the point where some authorities are no longer able to save the savers. Investors would then be faced with actually losing capital as opposed to getting a meagre return. That is when the salvation gets replaced with repression.

Page 20 of 80« First...10...1819202122...304050...Last »