Fear returns to markets
News Article Date: Wednesday 17th of June 2009
In their biggest fall since April 20th, equity markets retreated yesterday. Investors feared that the state-sponsored green shoots would shrivel, faced with the implicit threat from the G8 that central banks and governments were thinking of taking away the punch bowl of ZIRP and massive fiscal stimuli hammering the reflation trade. Policy makers now look set to repeat the errors of the late 1930’s. The Greenback also went on the rampage on the back of soothing comments from Russia taking the shine of the commodities / metals / oil trade while VIX popped up 10% on the day.
Today’s Market Moving Stories
The ECB said additional losses due to the recession would be $283bn. It said the risk to the financial sector remains high. The FT quotes Lucas Papademos as talking about a negative interplay between the financial sector and the economy, but he stopped short of calling for national stress testing. The IMF’s estimate in April was much higher, based partly on technical differences, and on different assumptions about loan performance. The main risks identified by the ECB are a renewed loss of confidence in the banks; balance sheet trouble for insurers; larger-than-expected fall in US house prices; and an even stronger recession. For the full report, see here.
The pain in Spain continues as forever playing catch up with reality rating agency Moody’s downgrades 30 Spanish banks, and issues warnings for Santander (STD) and BBVA. And it could have been worse, had it not been for the Spanish government guarantees to the banking sector. The real concern to Moody’s is no longer the bad property loans, which marked the beginning of the crisis, but the deteriorating economy. So it is the feedback loops that Papademos was talking about in the story above.
Frankfurter Allgemeine had an uncharacteristically alarmist editorial on the coming credit crunch. It’s not yet there in the data, but it is going to play out over the next few months, as banks will tighten their credit policies, as the ratings of their customers deteriorate. The falling credit worthiness of their customers is not yet reflected in bank balance sheets, which are likely to take a big hit in the autumn. The paper said this is not only a cyclical problem, but also a structural one, as banks will not return to their before-crisis credit policies.
In equity news, Tullow Oil (TUWLY.PK) announced this morning its eighth successful test of the Victoria Nile Delta play. The Kigogole-3 exploration well, which is located in the Butiaba region of Uganda Block 2, has encountered over 20 metres of net oil pay in two separate zones. Tullow’s success rate in Uganda remains at over 95%. In addition, the group aims to drill one well a month in Uganda this year and guides to significantly greater than 1bn BOE potential in Uganda.
Tesco (TSCDY.PK) is looking perky this morning after reporting same store sales in the UK grew 4.3% excluding fuel and VAT. Non-food growth was “modest”, which implies reasonable strength in food products.
BT is up on a Morgan Stanley upgrade, while defensive Pharma stocks are in vogue at the expense of financials this morning.
Fed Comments Indicate Split?
I’m not sure what the collective noun for Federal reserves speakers is, but there was a lot of back peddling post-G8 from a plethora of governors trying to calm the markets. The Fed’s newbie Elizabeth Duke was dovish in her comments late Monday, noting that the premature withdrawal of policy support for the financial sector would undermine the US economy. In fact, she said much of the additional support can be wound down naturally when the time comes. She noted that market conditions remain far from normal, but that the Fed’s Treasury purchases have helped lower yields and mortgage rates.
Meanwhile, the Fed’s Fisher was also pretty soft in his comments, with the observation that there is so much slack in the US economy that inflation isn’t an issue at the moment. There’s no need for the Fed to tighten in the immediate future, he said. As for exit policies, he said the Fed was working on its plans. Fisher also highlighted the benefits its Treasury purchase program has had, for the economy, and private and corporate credit spreads.
Fed’s Bullard offered commentary in some contrast though, noting he was cautiously optimistic for some economic growth over the second half of the year. He said although there were still many stresses, especially in the banking system, most measures of stress were off their worst levels. Looking ahead, he said some of the rise in long-term yields was likely related to higher expected inflation. If nothing else, he said, deflation fears were abating. Although Bullard didn’t suggest a policy exit was imminent, he did say the Fed would be working on its exit strategies this summer.
The San Francisco Fed offered a somewhat non-consensus view in its latest working paper, suggesting that there isn’t as much slack in the US economy as generally thought, and hence questions the extent to which inflation will slow and raises the risk that it will actually push back up more strongly. What’s at issue is a difference between the way the CBO measures the output gap - it has it at 6.2% in the first quarter, and the reading the San Fran Fed’s models are throwing out, at more like 2.0%. Hence the risk of deflation is considerably smaller than the CBO’s data is suggesting. It said that’s one of the reasons the rate of inflation hasn’t slowed as quickly as might have been expected - core inflation has only slowed from 2.4% in Dec 2007 when the recession started to 1.9% in April.
The IMF - ‘Til Debt Do US Part
Economic uncertainty is a defining feature of the IMF’s concluding statement of the ‘Article IV Consultation’ with the U.S.A., released on Monday. The IMF now predicts a 2.5% real GDP contraction this year (revised from -2.8%). Growth would then turn positive in 2010 (now seen at +0.75%, vs flat previously). But “the near-term outlook is marked by an unusual level of uncertainty, with the balance of risks still tilted to the downside.” Although they do not exclude a typical rapid recovery, “with an emerging virtuous circle of rising confidence and strengthening financial conditions,” the list of downside risks gets much longer. Both the negative bias and the uncertainty itself make the 3-month old collapse of implied equity volatility suspicious. VIX reached a low at 27.0% last Wednesday but is now flirting with 31% - this remains a key driver of global financial conditions so needs to be watched closely.
Other sections of the IMF report make very interesting reading. My picks include: “As in other countries, the financial crisis will also result in a serious and enduring deterioration in public finances, exacerbating the already large challenges of swelling entitlement costs. Over 2009?11, the staff projects that federal deficits will average 9% of GDP, and that debt held by the public will nearly double to 75% of GDP; with debt maturities having shortened, gross financing requirements are projected at 30% of GDP, about double pre-crisis levels.
Looking forward, such a rise in debt may put significant pressure on Treasury bond rates, which—along with lower potential growth—will add to fiscal challenges. In addition, the fiscal outlook is subject to other risks, ranging from possible calls to support private pensions and state finances, to further financial sector spending (including losses on interventions and funds for the FDIC and housing agencies).”
My take there is that a credible fiscal consolidation plan will have to be presented soon, if the U.S. Administration wants to make room for the Fed to continue to run an accommodative monetary policy. Fiscal restraint too will make a strong recovery more difficult. “More generally, for the foreseeable future the U.S. consumer is unlikely to play the role of global “buyer of last resort”—suggesting that other regions will need to play an increased role in supporting global growth and adjustment.”
Plastic surgery indeed - credit card default rates hit a record high in May. Mr. McClelland’s credit card company was calling yet again, wondering when it could expect the next installment on his delinquent account. He proposed paying half of his $5,486 balance and calling the matter even. It’s a deal, the account representative immediately said, not even bothering to check with a supervisor. As they confront unprecedented numbers of troubled customers, credit card companies are increasingly doing something they have historically scorned: settling delinquent accounts for substantially less than the amount owed