Posts tagged ‘Spain’
We saw recently how the ECB’s new bond-buying programme helped draw a line under the recovery in market sentiment. It feels as though a number of people are now less afraid of Europe than they were a few months ago.
Among those people, so it would seem, are the ratings companies. Last week we saw S&P downgrade Spain to a notch above junk – not good news, exactly, but a relatively moderate move (from BBB+ to BBB-). And then on Tuesday, Moody’s – who already had the country rated at the BBB- level, and “on watch” for future downgrades to boot – resisted the opportunity to put some distance between themselves and the competition by leaving their rating at investment grade. They specifically cited the possibility of further emergency lending together with bond market intervention by the ECB as reasons for their decision.
How times change. In July of 2011, Moody’s junked Portugal because of the intervention in debt markets being hinted at – but not by then even formally discussed – as part of the renegotiation of the Greek bailout. The following week they junked Ireland because they thought further emergency lending might be required to see it through its difficulties. Not to be left out, S&P waited until August then took some elegantly left-field action by notching the US down from AAA.
Back in 2011 the ratings companies were worried about falling behind the market and risking the same charges of over-optimism, incompetence or even negligence which they had faced as a big part of the credit market boom prior to the collapse of 2007-8. So what has changed?
The European downgrades last year were not well received. S&P’s and Moody’s offices in Milan were raided by police as Italy feared its ratings would be next. The EU began to take an interest in regulating the companies and there were appeals to take antitrust action against a perceived oligopoly. And action was taken by the ECB, ISDA and others to reduce the mechanistic reliance on credit ratings for the acceptance of loan collateral or the triggering of credit derivatives.
But more important than any of this must be the change in sentiment which recent months have seen. Last year’s downgrades really were chasing the market. Portugal’s five year bond yield began 2011 at 5.7%. By the time Moody’s slashed the rating in July this had more than doubled. This year things have taken a very different turn. When Moody’s cut Spain’s rating in mid-June its five year yield had jumped up past 6%; now it’s back to 4.2%.
None of this is to say that ratings are irrelevant – or that they were then. Portuguese paper suffered sharp falls when Moody’s pulled the plug, and Spanish bonds have found renewed support since they decided to hold fire. But what we surely can say is that these ratings decisions are a further sign that sentiment over the European crisis is bottoming out.
In the months ahead there is plenty of room for more scares. Ratings companies, governments, markets – the game goes on, and can always change. Still: it is encouraging to see that Moody’s, too, has drawn the line this week.
As readers know, markets enjoyed a period of relative stability across the summer of 2012. Despite the mild nerves shown over the last week or two, that stability has largely continued. But one of the events which has emerged to threaten it of late should serve as a reminder that this should not make us complacent.
Barcelona has voted for independence from Spain. A short year ago this would have seemed unthinkable – not to mention rather ridiculous. It is a classic “black swan” event. Everyone has been worrying about the breakup of the eurozone; no one has worried about the breakup of a European country since the dissolution of Yugoslavia. And as for the breakup of Spain in particular, who would ever have thought of betting on the Catalans over the Basques?
Of course, local politics is still politics. The region of Catalonia has been begging for a central government loan for some time. (It is surely a tribute to humanity’s persistency of spirit that so many of us believe in borrowing our way out of a debt crisis.) Perhaps their threatened secession is no more than a bargaining chip.
From the market reaction so far the threat does not seem too powerful, but it is instructive. This year might have been quiet – so far – but remember what happened in 2011: the Arab spring, the Japanese earthquake and tsunami, the referendum gambit in Greece and subsequent fall of the government … All these things were unpredicted and unforeseen.
Over the next few months, who is to say what might not happen? We wait anxiously for military action against Iran while there is civil war in Syria. Anti-Japanese sentiment in China has had real social and commercial effects. Then there is the enigma of North Korea. The dominant military power in the Pacific is the United States. Could it be possible that, one day, America will have to learn the lesson it taught Britain over Suez: that an indebted nation can only fight with the permission of its creditors?
It doesn’t pay to be too terrified, however. There is more to markets, and economics, than political events and natural disasters. A year after Suez, and Harold Macmillan was telling people they had never had it so good; according to the Barclays Equity Gilt Study, British stocks during the period 1956-1960 delivered a compound annual return of over 13% in real terms.
As we have all been reminded in recent times, volatility can be painful. But left field events cannot be planned for. Difficult as it can sometimes seem, the safest option is to back the fundamentals.
S&P have downgraded Spain. The UK is technically back in recession. Employment growth in the US, which had been cracking along so nicely, seems to have stalled. The manufacturing sector in China may still be weak.
There is plenty to be gloomy about. Might we be due a rerun of Q2 2010, when the Greek crisis saw the FTSE 100 fall by 13.4%? Or Q3 last year, where stagnation in the US combined with further deterioration in Europe to knock the index back 13.7%? Some people think this is inevitably the case: that history will repeat itself, and that we remain firmly set on the way to some sort of global economic doomsday.
Parallels with recent history, however, are not quite so straightforward as they may appear.
In April of 2010, Eurostat calculated the previous year’s budget deficit for Greece at over 15%, bringing its debt-to-GDP ratio up to almost 130%. The government asked for emergency funds, S&P downgraded Greece from BBB+ to BB+ (junk) and the country’s ten year bond yield shot up to 12% (the market was effectively closed).
This month, Eurostat data for Spain showed a 2011 budget deficit of 8.5%, bringing debt to GDP up to 68.5%. (That’s over 17% lower than here in the UK.) S&P’s downgrade was a meagre one “notch”, from A- to BBB+, at which level the country remains investment grade. The government has explicitly stated that it does not need and is not seeking a bailout. And Spain raised two and ten year funding only last week (at 3.5% and 5.7% respectively).
Now Q1 GDP data for Spain is out on Monday, and there’s no doubt that the bond market has the country in its sights. But the point is that Spain’s financial situation in 2012 is different from – and better than – that of Greece two years earlier.
What about the US? Well, of course it is possible for the pace of expansion to slacken as it did a year ago. But what really set the cat among the pigeons over the summer was that GDP growth was revised down across the whole period of recovery (one of the worst revisions being to Q1 2011: initially estimated at 1.8% annualised this was slashed to an emaciated 0.4%). This reflected a change in methodology – specifically, a new procedure for seasonally adjusting petroleum imports, as one of those responsible put it at the time. A cynic might hold that such an adjustment is less likely in a presidential election year.
We last looked at worries over China a month ago, observing that the indicators scaring the market are in a much better state than they were during the 2008-9 recession.
Altogether, then, while there are always problems around, those we face today do not seem quite so severe as those which triggered the panics of the last couple of years. Selling in May this time might not turn out to be the surefire money-saver it was in 2010 and 2011.
“We are seeing light recovery blowing in a spring wind.”
That was how the IMF’s Christine Lagarde – clearly more of a poet than her predecessor – described the Fund’s latest World Economic Outlook report, out this week. The big news was that its growth forecasts have been revised – gasp! – up.
Of course, the report is laden with the usual caveats, and understandably so. After all, the commentariat tells us solemnly that when it comes to bond yields, 6% is the new 7%, and that borrowing in Spain has thus become unaffordable. (This is moot. But having failed to bankrupt a country with no deficit problem – Italy – perhaps the market will succeed in respect of a country with no debt problem instead.)
Nonetheless, seeing an important economic forecast revised up is encouraging. Unsurprisingly, given the strong data, one of the key revisions was in the case of the US, where projected growth of 2.1% for this year is 0.3% higher than the IMF was forecasting in January. And that brings us on to another type of prediction.
Amid the gloom and woe of the second half last year, Wall Street analysts slashed their expectations for stock market earnings. At one point, reported earnings for the season that has just begun were expected to fall.
The consensus as reports began was less bearish, with average EPS growth across the S&P 500 anticipated to reach about 1%. But with a quarter of the index’s constituent companies having announced their results, the outturn so far is running at 7.2% (6.2% excluding financials – some of the big banks have been doing especially well).
Over 80% of reports have beaten expectations. Forecast earnings growth for the index as a whole this quarter has now risen to over 3%.
Mindless optimism is of no more use to the careful investor than the hysterical pessimism that has dominated of late. But it is surely not imprudent to observe that, even with renewed panic over Europe, proper gloom is becoming harder to sustain.
Europe was the main focus of investor attention this week. For once the latest proposals from the continent’s leaders received a warm reception from markets. The catastrophic failure of the eurozone is not being taken quite so much for granted.
Amid the avalanche of comment on the expansion of the EFSF, the 50% haircut on Greek debt, the financial strength of the zone’s banks and so on, it has been easy to lose sight of what went wrong for Greece, and what might still go wrong for Italy and the others. To assess the risk of full scale catastrophe it is necessary to look in one place only: the bond market.
It was not the banks alone, or the recession alone, or the burden of government debt alone that did for the Greeks. It was the cost of debt. This cannot be emphasised enough. The idea in some quarters that a debt-to-GDP ratio of 100%+ is automatically unsustainable is simply wrong – and not just wrong for giants like Japan, or the US, but for lowly-rated borrowers like Lebanon. Or like Greece, which enjoyed an interest rate on its ten year bonds only 0.27% above that of Germany as recently as 2007. Today that would mean paying 2.5%; at that rate, debt to GDP of 300% would be perfectly affordable.
It was the bond market that broke Greece. The last emergency summit in Europe, remember, was convened back in July to agree a revised bailout for Greece: the continued effective closure of debt markets to the country made the refinancing pathway envisaged under the terms of the original 2010 deal impossible.
At the same time, concerns about contagion through the banking system do not convince. Those expecting lightning to strike in the same place twice need to remind themselves of the scale of banking losses suffered on the back of the subprime crisis: Bloomberg gives a figure of over $2.1trn in writedowns worldwide, with over $1.6trn of capital needing to be raised. For Europe alone the losses were over $730bn. And that crisis took the world largely by surprise. The restructuring of Greek debt, as well as being a much smaller event, is hardly coming out of left field. It is frankly obtuse to expect a comparable degree of systemic dislocation to ensue.
But the bond market is a different matter.
Italy tapped the market for just under €8bn of 3-, 8- and 10-year money this morning, paying rates in the 5-6% range for the privilege. Demand for the new bonds was weak, and this has received a lot of attention, but a rate of 6% is far from disastrous. Italy has about €300bn of debt to refinance next year; at 6% this would cost €18bn in interest per year. If rates were to rise to 10%, however, the cost of servicing the debt would increase by €12bn, wiping out the whole benefit of the austerity budget agreed last month.
Still, the very fact that today’s auctions took place shows that the bond market is still open to Italy. The bear case that the expansion of the EFSF to a hypothetical €1trn is “too little, too late” rests its logic on the size of Spain and Italy’s financing requirements (between them they are likely to need to raise that amount between now and end-2013 or so). But so long as they are able to raise debt without any assistance from the EFSF this is not entirely relevant.
It was hugely significant during the recent crash that Italy’s bond yields did not rise to dangerous levels. If they continue to hold their ground – or better yet, if confidence improves and they fall – catastrophic contagion in the eurozone is unlikely to occur. Talk about the banks, and haircuts, and credit derivatives is all very interesting. But if you really want to know how afraid to feel, just keep an eye on those bonds.
No, not the one between Mr Osborne and Mr Balls on Wednesday – the one between Portuguese prime minister Jose Socrates and the country’s opposition parties the same day. Portugal’s government saw its latest package of austerity measures defeated, Socrates resigned, the country is heading for an election and (so the consensus believes) a Greco-Irish bailout courtesy of the EU / IMF.
The consensus view finds support in recent bond market movements – specifically in the widening of the spread of Portuguese government debt over that of Germany. (Similar moves preceded the Irish bailout last November.) In fact, ten year Portuguese paper yields 4.3% more than Germany’s at time of writing – this remains well short of Greece and Ireland, at +9.1% and +6.4%, but well clear of Spain and Italy too (+1.9% and +1.5%).
Furthermore, Mr Socrates’ likely successor as Portugese PM, Pedro Passos Coelho, has been a bit cagey about his commitment to fiscal discipline and the avoidance of bailouts.
Before we treat the bailout as a foregone conclusion, however, let’s look at the numbers.
Portugal’s budget deficit on a Maastricht basis peaked in calendar ’09 at 9.3% – bigger than the eurozone average but much lower than equivalent figures for Greece, Ireland and Spain. The deficit for 2010 is estimated at 7%, and on the proposed measures was targeted to reach 4.6% this year. In the Greek and Irish cases, a large part of the problem was that deficits into 2010 were continuing to widen.
Taking a thoroughly non-random example to compare: the UK’s 2009 fiscal deficit on the same basis came in at 11.4%, is estimated at 9.8% for last year and forecast to come in at 7.9% in 2011.
Now Portugal has other problems. Its growth rate for the last ten years averaged a miserly 0.7% p.a., and unemployment, though stable, is rather high for comfort at some 11%. But it is clearly in a stronger fiscal position than the countries which have already been bailed out.
One view of Portugal’s vote this week is that it was about politics rather than economics. That Mr Coelho and his supporters are happy to continue on the path of deficit reduction – albeit by different means – but that they also want to overhaul a sclerotic economy viewed as increasingly corrupt. They must also understand that a bailout would come with austerity measures attached that would be harsher than those they have just voted down.
Ultimately, as one senior European politician put it, “Portugal won’t be left alone by the other Europeans.” We have already noted that such an attitude augurs well for the euro’s long term survival. But evidence that the eurozone’s less responsible borrowers are capable of getting their houses in order independently would bode even better.