Posted by Gregg Killoren on January 29, 2010
Of all the issues lately that have caused jitters in equity markets (Washington, D.C.’s assault on banks, China’s tightening of lending standards, etc.), one of the most fearful, and perhaps least understood, is another sovereign debt default that would freeze up global financial markets. Events in Greece have lately risen that spectre again. In its latest missive, Roubini Global Economics (RGE) discusses the debt situation in Greece and what needs to be done to resolve it.
RGE’s summary of Greece’s sovereign debt crisis is reproduced below:
Greetings from RGE!
This week we address an issue that puts the credibility of the euro and European institutional arrangements on the line: Greece’s sovereign debt crisis. At their January 18, 2009, meeting, eurozone finance ministers kept pressure on Greece to fulfill its commitment to cut its budget deficit below 3% of GDP by 2012. In February, the eurozone finance ministers will more fully evaluate the country’s spending plans and recommend a timetable for Greece to trim its deficit, estimated at close to 13% of GDP in 2009. Because the eurozone is a monetary union with a no-bail-out clause, rather than a political or fiscal union with the associated fiscal federalism, budget cuts to contain the explosion of Greek public debt are urgently needed. In 2010, a sustainable fiscal adjustment must be delivered to restore policy credibility, market confidence and ECB/EU member-state solidarity. In RGE Analysis available to clients, we discuss possibilities for such an adjustment in greater depth.
Three coinciding events—Greece’s sharp budget deficit revisions from as low as 3.7% of GDP to 12.7% in October, the announcement of the beginning of the ECB’s exit strategies and the Dubai default—have triggered renewed risk aversion in the sovereign bond markets of developed countries. While in March spreads were broadly driven by a common systemic risk factor, the latest spike bringing Greek yields and CDS spreads to new highs is mostly a country-specific story, brought to light by a change of government and the revelation of far larger budget deficits than previously known and a severe cyclical and structural deterioration in public finances.
In tackling the deficit, Greece faces a Hobson’s Choice: whether to accept social pain with financial and economic stability, or instability. Whatever it chooses, Greece will face economic pain and difficult socio-political fallout. More aggressive spending cuts or tax hikes than initially envisaged in the stability program Greece presented in December could curb or even derail recovery, perhaps inciting social unrest. But if the debt becomes unfinanceable in the primary market or if Greece elects to exit the euro and devalue and redenominate its liabilities (a la Argentina), this could render its banking system insolvent and tip it into economic and financial isolation and decline, also with dire socio-political consequences.
While a buyers’ strike has been averted for now with Greece’s successful auction of five-year government debt at 6.2%, the additional yield investors requested was substantial. The possibility of a buyers’ strike in the primary market in the future may further test Greece’s political commitment to fiscal adjustment and economic stability, as demanded by its treaty obligations and the strictures of a currency union.
Going forward, once Greece has delivered what the EU Commission, ratings agencies and stakeholders in the markets judge to be an adequate pound of flesh, we expect the ECB to take on a more constructive stance, especially in view of the stricter collateral requirements that will be put in place by the end of 2010. The risks of not doing so would entail a judgment that Greece could, in theory, be surgically removed from the eurozone without starting a domino effect in other countries with high or escalating public debt burdens, some of which are far larger economies and hence could have an impact on the regional and global financial and economic systems. Alternatively, a sovereign upgrade to A- by two ratings agencies after the budget effort meets approval could also be part of the solution.
The endgame we expect is the extraction of a pound of flesh and a bit of a fiscal compromise that together restore debt sustainability. This will require a combination of further sharp fiscal adjustment, a la Ireland (which has committed to cut public spending in 2010 by €4 billion, or about 20% of the 2009 deficit), and a signal of support from the ECB. In response, improved signals from the ratings agencies will bring cash bond yield spreads back down to earth. Over the longer term, of course, there is no alternative to tackling the competitiveness deficit in Greece and in other member countries as well.
Posted in Central Banks, Economy, European Central Bank, European Union | Tagged: Economy, European Central Bank, European Union, Greece, sovereign debt | Leave a Comment »
Posted by Gregg Killoren on January 28, 2010
The Federal Open Market Committee of the Federal Reserve Board voted to leave the benchmark federal funds rate at near zero percent. This time, there was one dissenting vote by Thomas M. Hoenig, “who believed that economic and financial conditions had changed sufficiently that the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted.”
The FOMC also believed that inflation would remain subdued due to the substantial resource slack in the economy. It also reiterated that it will be closing the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, the Commercial Paper Funding Facility, the Primary Dealer Credit Facility, and the Term Securities Lending Facility on February 1 and announced the winding down of the Term Auction Facility and the Term Asset Backed Securities Loan Facility.
The full FOMC statement follows:
Information received since the Federal Open Market Committee met in December suggests that economic activity has continued to strengthen and that the deterioration in the labor market is abating. Household spending is expanding at a moderate rate but remains constrained by a weak labor market, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software appears to be picking up, but investment in structures is still contracting and employers remain reluctant to add to payrolls. Firms have brought inventory stocks into better alignment with sales. While bank lending continues to contract, financial market conditions remain supportive of economic growth. Although the pace of economic recovery is likely to be moderate for a time, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability.
With substantial resource slack continuing to restrain cost pressures and with longer-term inflation expectations stable, inflation is likely to be subdued for some time.
The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period. To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve is in the process of purchasing $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt. In order to promote a smooth transition in markets, the Committee is gradually slowing the pace of these purchases, and it anticipates that these transactions will be executed by the end of the first quarter. The Committee will continue to evaluate its purchases of securities in light of the evolving economic outlook and conditions in financial markets.
In light of improved functioning of financial markets, the Federal Reserve will be closing the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, the Commercial Paper Funding Facility, the Primary Dealer Credit Facility, and the Term Securities Lending Facility on February 1, as previously announced. In addition, the temporary liquidity swap arrangements between the Federal Reserve and other central banks will expire on February 1. The Federal Reserve is in the process of winding down its Term Auction Facility: $50 billion in 28-day credit will be offered on February 8 and $25 billion in 28-day credit will be offered at the final auction on March 8. The anticipated expiration dates for the Term Asset-Backed Securities Loan Facility remain set at June 30 for loans backed by new-issue commercial mortgage-backed securities and March 31 for loans backed by all other types of collateral. The Federal Reserve is prepared to modify these plans if necessary to support financial stability and economic growth.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Donald L. Kohn; Sandra Pianalto; Eric S. Rosengren; Daniel K. Tarullo; and Kevin M. Warsh. Voting against the policy action was Thomas M. Hoenig, who believed that economic and financial conditions had changed sufficiently that the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted.
Posted in Banking, Central Banks, Economy, Federal Reserve Board, Monetary Policy | Tagged: Central Banks, Economy, Federal Open Market Committee, Federal Reserve Board, Monetary Policy | Leave a Comment »
Posted by Gregg Killoren on January 27, 2010
In another piece of economic data that can be filed under the heading “Less Bad,” the S&P 500 Case-Shiller Home Price Index showed a 10th consecutive month of improvement in November 2009. But “improvement” is a relative term. The reading still showed a decline in home prices.
The annual returns of the 10-City and 20-City Composite Home Price Indices declined 4.5% and 5.3%, respectively, in November compared to the same month last year. All 20 metro areas and both Composites showed an improvement in the annual rates of decline with November’s readings compared to October.
“While we continue to see broad improvement in home prices as measured by the annual rate, the latest data show a far more mixed picture when you look at other details.” says David M. Blitzer, Chairman of the Index Committee at Standard & Poor’s. “Only five of the markets saw price increases in November versus October. What is more interesting is that four of the markets—Charlotte, Las Vegas, Seattle and Tampa—posted new low index levels as measured by the past four years. In other words, any gains they might have seen in recent months have been erased and November is now considered their current trough value. On the flip side, there are still some markets that continue to improve month-over-month. Los Angeles, Phoenix, San Diego and San Francisco have seen prices increase for at least six consecutive months. Looking at the annual figures, four markets – Dallas, Denver, San Diego and San Francisco – have finally entered positive territory, something we really haven’t seen in at least two years in most markets.”
And here is the most important quote from Mr. Blitzer: “On balance, while these data do show that home prices are far more stable than they were a year ago, there is no clear sign of a sustained, broad-based recovery.”
For additional statistics on home prices, please click on the “Housing Statistics” page on the menu bar.
Posted in Economy, Housing | Tagged: Economy, Housing Prices, S&P 500 Case-Shiller Home Price Index | Leave a Comment »
Options Signal Bond Market Rally May Be Ending
Posted by Gregg Killoren on January 26, 2010
Investors in recent days have flocked back to Treasuries as uncertainty surrounding financial regulatory reform has had equity markets in fits. This move has continued a long-term bull market in bonds, and especially government bonds. When bond prices rise, yields decline, and the 10-year Treasury Note yield recently fell to 3.61 percent. However, options traders have lately been betting that the bull market in bonds is coming to an end.
Bloomberg.com reports that, “Barclays Capital indexes show interest-rate volatility rose from a six-month low in November on speculation borrowing costs will increase as the improving economy allows the Federal Reserve to remove the unprecedented cash it pumped into the financial system. At the same time, confidence in the outlook for profits helped push the Chicago Board Options Exchange Volatility Index to an almost two-year low this month.”
The Federal Reserve Board’s Federal Open Market Committee meets today and tomorrow to discuss the economy and the future of interest rates. With corporate earnings coming in so far at or above expectations, the economic outlook seems brighter than many had forecast. This may prompt the Fed to begin raising rates this year. That would be bad for bonds because higher rates eat into the income from bonds, but it may be positive for equities.
Bloomberg.com reports, “Stock investors may see higher Fed rates as a signal the banking system and consumers are on more solid footing, said Tim Freeman, head of U.S. equity derivative sales in New York at Capstone Global Markets LLC, which specializes in volatility trading.” Freeman continued, “You could see interest rate volatility continue to go higher as expected rate hikes are priced into the marketplace, while in the equity market you might not see any uptick in volatility. You could actually see the equity market react very positively to the Fed raising rates.”
We will be watching the Fed’s statement, due tomorrow at approximately 2:15 p.m Eastern Time, for any changes from previous language and hints that rate increases may be coming.
Posted in Economy, Fixed-Income, Investing, Market Commentary | Tagged: Bonds, Economy, Fixed-Income Investing, Market Commentary | Leave a Comment »