Last 15th of March, Standard & Poor’s decided to upgrade Portugal’s credit rating to BBB, an announcement quickly followed by the one of Moody’s, which, chose to leave the one of Italy unchanged. Later this months the S&P’s maintained Spain’s rating at A- with a positive outlook, opening the debate on a future increase in the short run. In a climate of Bond Rallies, those decisions drove investors to rush on those countries’ bonds, as well as those of their neighbors. What parameters did rating agencies consider in their assessment? What can we expect from the apparent recovery of “Mediterranean” economies in the debt capital markets, both sovereign and corporate?
Facts and Macro Explanations
In Portugal, the reforms undertaken by the government over the last years appear to pay off as the countries’ economy is expected to grow between 1,5% and 1,7% during the next two years. Moreover, Portugal is expected to record a budgetary surplus (including the debt reimbursement) by 2020, allowing them to reduce their debt to GDP ratio. Enough for S&P’s to upgrade the countries’ credit rating.
Net contributions to real GDP growth (Portugal) | In percentage points
Sources: Banco de Portugal and Statistics Portugal
The picture seems a little less bright for Italy where the Treasury revised its GDP Growth estimate to 0,1% , after slipping into recession in the second half of 2018. Moody’s decision appears to be more motivated by next week’s agenda and it still unclear whether the other rating agencies will also postpone report scheduled at the end of May. Indeed, the vote on 2020’s budget proposal is scheduled next month and the possible increase of the Value Added tax with it. Moreover, the outcome of the EU election is likely to have an impact on the Government’s policy.
In Spain, S&P’s decided to maintain the current rating of A- with a positive outlook, although some analysts were expecting to see it rise. The agency pointed out that their position could evolve in the coming months if the government manages to consolidate the deficit level and improve the payout of exterior debt. On the political side, the outcome of the Catalonia crisis and the anticipated election could also be preponderant. The Spanish economy is expected to grow at 2,2% this year and then deaccelerate as the economic cycle will mature, sustained by a growing internal demand, according to S&P’s. The rating agency also expects the private consumption to rise as salaries will keep growing. Nevertheless, the recent growth of the minimum salary could reduce the pace of new employments creation.
Consequence on Sovereign Bond Markets
Shortly after Moody’s decision to leave Italy’s Baa3 credit rating unchanged, the Italian Treasury 10y Bond yield was pushed to 2.42%, its lowest since May 2018. Its spread over Germany’s narrowed to its tightest since last September at 234 basis points, far from its end of 2018’s level when it crossed the 300bp.
On its side, Portugal’s 10y bond yield dropped to its lowest in at least 25 years, to 1.25%. This only confirmed the market trend as the gap over Germany has narrowed by about 30 basis points since the start of the year and was last at about 137 basis points after investors rallied on the German Bond, pushing it to negative levels.
At the end, Spanish 10y Yield curve could be even more significant to analyze investors views on the region. Indeed, if S&P’s announcements on Spain didn’t influence consequently its 10y Yield curve, the one on Portugal’s upgrade had it decreased by 4.5%. Now looking back to the last 6 months, the Spanish curve went from 1,73% to 1,10% since October, showing investors overall optimism on the region.
Spain Generic Govt 10Y Yield
To recall, Spain broke a national record on its 10-year bond sale last January, with about 47 billion euros of orders on a 10 billion-euro issue. This paved the way for Italy and Portugal to go out in the market. But the most iconic case is surely the one of Greece that issued its first 10y Note in the last decade after Moody’s improved the country’s credit rating to B1 with stable Outlook. This allowed Athens to capitalize on it and go test investors’ confidence after the mixed success of a previous a shorter-term bond sale two months before. In the meantime, yields on old 10y bonds dropped to their lowest since 2006 (It is currently trading around 3.77%). To recall, Greece is just going out of one the biggest recession in its history and was disabled to issue new bonds, receiving emergency loans from the EU and the IMF for financing. This drove the Government Bond 10y yield to a record high of 48.60% back in 2012.
First sovereign issuers, then corporates?
It is usual to see banks benefit from countries upgrades, especially in southern Europe. This time, the upgrade of Portugal’s rating was quickly followed by S&P’s rising Santander’s long and short-term credit rating in Portugal to BBB and A-2. In Spain, Fitch improved Abanca’s rating to BBB- and F3, meaning that the Galician bank is now considered as Investment Grade. In the meantime, it increased Liberbank’s rating from BB to BB+ with a stable outlook.
It could not take so long to see the trend spreading to companies which are partly owned by local governments or with the biggest exposure to such economies.
Sources : Reuters, Bloomberg, S&P’s, Moody’s, Fitch
On the 3rd of January 2019 at market openings in Asia, volatility spread to the currency exchanges one hour after Apple released a profit warning forecasting disappointing sales figures. This news, added to fears of global economic slowdown, resulted in a rush to the Japanese currency which surged 7,36% against the Australian Dollar and 4% against the American one.
Lack of Liquidity and Market volatility
Liquidity is a key parameter in the currency markets and the hour during which neither of New York and Tokyo traders is properly active has always been a critical time for investors, who usually avoid trading if possible. This phenomenon, happening between 5pm and 6pm (NY Time), was this time exacerbated by a public holiday in Japan and, most importantly, by the Apple News which drove investors to the Yen.
At the start of the Asian session, the yen temporarily surged, taking more than 3.6% against the dollar at 104.87 yen, its highest level since March. Facing the euro, it gained 4% and rose to 118.71 yen, a level last seen in April 2017.
This flash crash was not only due to the Apple warning and lack of liquidity in the foreign exchange market but also came as a confirmation to analyst’s fear on the recent worldwide economic slowdown. Indeed, the move was not confined to one or two currency pair and, as we have seen above, also concerned the Australian dollar and some other emerging countries’ currencies.
The Yen is usually a Safe Haven for investors
As a safe haven, the Japanese currency tends to appreciate in times of political or economic uncertainty. It gained this status due to the stability of the Nippon economy (although its inflation has been anemic in the last years) and political stability. The country also accounts with a large number of investors holding money overseas and thus willing to rush back into domestic values in times of high volatility,
This tendency also spreads to Gold and Bond markets, also considered as safe havens by traders. Indeed, Bonds of G7 governments have had their best December in the last ten years according to a Bank of America Merrill Lynch index. For instance, the U.S Treasury yields have dropped 60bps since the beginning of November, while the German 10y yields are around their lowest in 26 weeks. On its side, Gold price hit its highest level in 6months at 1.292,42 dollars.
The yen has been surging at a 5% rate in the five last weeks, its biggest increase in 2 years. In the meantime, the Dow Jones suffered its worst weeks since 2008, down by 11,4% over the month on mounting worries over the direction of the global economy.
USD/JPY 1 Months Chart (01/04/19)
What are the reasons for such moves? Investors are generally worried over global eco slowdown (particularly in Europe and China), and Political risks (shutdown in the US, Brexit in the UK, etc.). To that fear recently summed up the first real effects of trade war on companies’ earnings (e.g. Apple) and the announcements of the Fed on more moderated than expected interest rate hikes.
Global fear has only been confirmed during the first days of 2019 with the release of economic statistics: the euro area PMI has reached a low for several years, following a sharp decline in the Chinese PMI at its lowest point in 19 months. In the US, the manufacturing activity indicator (ISM) saw its largest decline in a month since 2008, to reach a low for two years, suddenly lowering the dollar.
Whether this market trend will last will then highly depend on next months economic figures and whether a growth slowdown is confirmed or not. This will automatically depend on a various range of factors including US-China trade talks, Brexit or Central bank policies.
Sources: Bloomberg, Reuters, Financial Times
Ever since the Subprime and Eurozone crisis happened, the world was living under a constant perfusion of monetary liquidity coming from Central Banks. If that ended up becoming a norm, this policy was not suitable to the economic growth cycle the US and Europe are now experiencing. This is the reason why the European Central Bank (ECB) decided to follow the US Federal Reserve (FED) and fully terminated their bond purchase policy.
What is quantitative easing?
When interest rates fixed by central banks are already at record low levels, they can play on another field in order to stimulate the economy: they can decide to implement a bond purchasing program. This method is called « quantitative easing » and has been used by the ECB for the last four years (whereas it was originally supposed to run for only two years), injecting more than 2,6 billion Euros in the economy.
The constant demand for national and corporate bonds (banks mainly) ended up increasing their market prices and, therefore, lowering their yields. According to Goldman Sachs, the purchase policy caused the yield of the French and German 10 years bonds to decrease between 50 and 80pbs while the Italian and Spanish ones fell by 50 to 100bps.
This is what allowed countries and major companies of the Union to get access to financing at historically low interest rates levels. The objective of the ECB being that those countries ended up spending this money on various growth-stocking initiatives.
Nevertheless, from some economist’s point of view, it seems unsure that the purchase policy managed to have the desired effects. On its side, the Central Bank stated that the stimulus added a cumulative 1.9 percentage points each to growth and inflation from 2016 to 2020.
How does the suspension of quantitative easing will affect the markets?
In the US, the FED decided to capitalize on the Economic growth to increase interest rates and thus increasing costs of financing. Such rise is not planned to happen in the Eurozone as Mario Draghi repeatedly reaffirmed that they will maintain interest rates close to zero as long as inflation doesn’t bounce back. Nevertheless, inflation is not going to happen any soon, especially when the Economic growth of Europe is slowing down. For 2019, the ECB sees the eurozone economy expanding by 1.7%, while previous expectations were of 1.8% and analysts table on a 1.6% growth.
Still, even though the interest policy won’t change until, at least, another six months, analysts are reserved about 2019 and the ability of the European economy and financial markets to adapt into this system with no such “inflow of money”.
Indeed, in abandoning its bond purchasing program, the ECB automatically reduces some future demand (again, €2,6b in 4 years). That will likely result in driving bond prices down and increase yields (just as increasing interest rates would do).
Higher costs of financing can be problematic for the most indebted countries of the Euro area like Italy (even though the country agreed to adapt their budget to the European Commission standard and reduce their deficit around 2%) or France where the new measures announced by president Macron will certainly drive deficit above the mandatory 3%.
As expected, a few days ago, the European Commission has rejected Italy budget, acting in an unprecedented way. As a consequence, it has asked the Italian Government to make relevant changes to the presented measures within the next three weeks, in order to comply with the level it committed to in July.
On the EU side, a target deficit equal to 2.4% is considered to be excessively liberal with respect to the path that has been set previously, allowing a deficit around 1,6% over the GDP, with the aim of progressively reducing it in the future. However, on the other side, the League-5 Star Movement coalition has clarified that it would not even consider the possibility of reviewing the plan. Their belief is that, being Italy a sovereign State, any decisions concerning the economy should be taken internally without any other external influence. Nonetheless, the EU Commissioner in charge of the euro, Mr. Valdis Dombrovskis, invoking the principle of trust and the agreed rules on which the European Union poses its bases, wishes for an “open and constructive dialogue” with the Italian authorities, as hoped by the Prime Minister, Mr. Giuseppe Conte, as well.
As for markets’ reaction, after the EU Commission’s rejection, the FTSE MIB, the main Italian stock index, fell by more than 5% with the banks’ stocks registering the worst results. In the following days, the stock market has rebounded partially recovering what had been lost.
As for the fixed income market, a significant sell-off of Italian Government bonds occurred leading to rising yields due to a higher risk premium required by investors. As a matter of fact, the yield on 2-year sovereign bond jumped from 0.79% to 1.25%, whereas the one referring to the 10-year Italian government bonds increased from 2.91% on Thursday evening to 3.25%. The spread over the 10-year German Bund has been put under pressure as well, breaching 340 bps before getting back below 320 bps. In addition to what has been said already, the downgrading inflicted to Italy by Moody’s, that cut the rating from Baa2 to Baa3, has worsened the turmoil on the markets.
What are the next steps now? Well, assuming that the Government will keep its word and will not intervene to change the budget, the EU would open an “excessive deficit procedure” that, in 2019, could result in pecuniary sanctions. Nonetheless, it seems quite unlikely that these sanctions will ever come into force because they could just bolster the populist sentiment in the country, increasing people’s preference for the coalition already in place.
As for investors, they should watch closely the future events related to Italy, since they could put under pressure the Euro and other European countries, which now represent a solid alternative investment to Italy, especially dealing with corporations of safer countries like Spain and France.
Corriere della Sera
Photo by Elliot Brown- Italian and EU flag- CC BY SA 2.0
After the $50b Argentina loan agreement in June with the IMF supposing to allow the second biggest south American economy to get back on track and stop the dramatic downturn that its currency was facing (the peso has slumped 50% this year), Argentina is back in a complicated situation. Indeed, in the process of reducing inflation, the BCRA decided to increase interest rates from 45% to 60%, making it the highest in the whole world, in the meantime, the president is undergoing drastic reforms to fit with the IMF criteria. Such policies didn’t stop Argentina’s peso to plunge down to 41 pesos the dollar.
Even if undergoing policies are completely different between Argentina and Turkey, the challenge is similar: both countries need to take back the control of their currency, reduce their fiscal deficit and big amounts of debt denominated in US dollars. In Turkey, the Central Bank vowed to reshape its monetary policy to shore up the lira (biggest monthly drop since 2001) and stop inflation after seeing it grow at the fastest pace (+17,9% in august) since 2003.
Is there a risk of structural contagion between Emerging Markets?
While Argentina is deepening into a financial and political crisis and Turkey’s currency trying to recover from a dramatic month of August, all eyes are pointing to other emerging markets, fearing a structural contagion. Indeed, the number of emerging markets at risk goes well beyond Turkey and Argentina and the main reason is their debt. In the emerging-market, total borrowing is hitting record levels, from $21 trillion (or 145% of GDP) in 2007 to $63 trillion (210% of GDP) in 2017. Since 2007, the foreign-currency debt – in dollars, euros and yen – of these countries doubled to around $9 trillion. China, India, Indonesia, Malaysia, South Africa, Mexico, Chile, Brazil and some Eastern European countries have foreign-currency debt between 20% and 50% of GDP.
On specific levels, China and India face difficulties in their financial systems (true level of Chinese non-performing loans could be higher that the official 1.75% and India’s NPL ratio is around 10% of all loans), Brazil ’s political uncertainty disables it to conduct the necessary policies to outsize its fiscal deficit and South Africa unexpectedly fell into its first recession for almost a decade (Africa’s most-industrialized economy shrank an annualized 0.7% in the second quarter).
What consequence on financial markets?
An economic downturn combined with a weak financial system will drive emerging-markets into a vicious cycle as capital withdrawals undermine currencies, driving down prices of financial assets. This cycle is deepened by the reduced availability of finance and potential credit rating and investment downgrades. Moreover, in certain cases, as we have seen recently with the Argentinian Central Bank increasing interest rates to 60%, policy responses may not have the expected impact. It can also be the case for countries applying IMF rigorous policies which are often found unacceptable by part of the population and can aggravate the political and social situation.
It is the high return on local-currencies debts that attracted foreign investors to emerging-markets. But weakening currencies may now drive them to exit, hurting all kind of financial assets. We can already notice that the pressure on emerging markets shifted from currencies to stocks, especially in the Asia region. This summer, emerging-market stocks and currencies hitted their year’s lowest levels. Indonesian shares have been the worst performing where the depreciation of the currencies drove down the share to their lowest level in three years.
This trend is also spreading to Fixed income. The Bloomberg Barclays emerging-market index for dollar bonds is around 4% down so far in 2018. This would be its first negative annual performance since the 2013 surge in U.S. Treasury yields. In the meantime, a similar indicator of local-currency debt has fallen almost 8% this year. South African bonds led the sell-off in fixed income, while the local currency reached its lowest level since 2016.
According to analysts, emerging-markets assets will keep on representing a highly risky investment as long as the dollar keeps strengthening (trade wars, Fed’s policy). Nevertheless, they still represent the best asset class in the long-run due to their growth potential.
Photo by G20 Argentina- G20 Argentina Bilateral Meeting – Mauricio Macri and Recep Tayyip Erdoğan- CC BY 2.0
The last few days have really put everyone to the test, starting from politicians to the citizens, passing through worried investors, following long hours of uncertainty where, finding an agreement to form a political Government, after the national elections held at the beginning of March, seemed almost impossible.
Starting from the first half of May, the two Parties who got most of the votes, the 5-Star Movement and the League, have negotiated, through their leaders Di Maio and Salvini, to draft a “contract” that would include all the changes that will be pushed forward with for the next years by this totally unexpected coalition.
Eventually, on the 27th May, a list of Ministers was presented to the President of the Republic Sergio Mattarella by the PM-designate Giuseppe Conte. However, due to the presence of the Eurosceptic economist Paolo Savona as Minister of Economy, the President vetoed the proposal so as not give a bad signal to the markets, namely a possible “Italexit”.
As a consequence, a political crisis followed and markets reacted promptly by massively selling Italian Government Bonds, leading the spread to the highest levels since 2013. Indeed, for the 10-year bond, the spread overtook the threshold of 300 bps, up to 320 bps, then reaching 273 bps on the 31st May. At this point, three possible scenarios were considered: the first one saw new national elections in autumn with a “transition” Government led by the former PM Gentiloni; the second one dealing with the chance of having a political Government led by the League and the 5-Star Movement and, finally, the formation of a technical Government that could guide the country until new elections in July.
After this, on the 1st June, finally an agreement was reached to form a political Government with Conte as PM and Savona moved from the Ministry of Economy to that dealing with European Affairs. As far as the two leaders are concerned, both Salvini and Di Maio have been nominated not only vice-PMs, but also Minister of Internal Affairs and Minister of Labour, respectively. After this news, the spread on the 10-year bond fell by 24 bps, from 257 bps to 233 bps, meaning that it was fairly appreciated by the markets, looking for a bit of calm after the storm.
Will it last? It is not easy to say, because it will strongly depend on how the new Government will act, especially regarding the relationships with the European Union, that has always represented a “delicate” matter for the two winning political parties. In addition to this, it should also be considered what is currently happening to the surroundings, especially Spain. Indeed, after the Parliament’s vote in favor of no-confidence towards the ex-PM Rajoy, on the 1st June, and the appointment of the socialist Pedro Sanchez (PSOE), the spread for 10-year bonos has gone through pretty volatile hours, but it is now stabilizing again below the 100 bp threshold, after even breaking the barrier of 130 bps.
What are the takeaways for the investors? Calm and cautiousness are key. Generally speaking, the outlook for the Eurozone is very good. So, even in these times of volatility, it is useful to look at fundamentals: both Italy and Spain are rich countries and with good economic growth perspectives. Having said that, it seems safe to state that investing in these countries is always a good option, even in difficult times, since, due to this positive economic momentum, companies are always willing to invest in their growth and future.
References: La Repubblica / Ilsole24ore / El Pais
Photo by European Parliament -© European Union 20XY – CC BY-4.0
Companies around the world are constantly being affected by fluctuations in financial markets. There is no doubt that globalization has made companies better off as they can export and import goods and services from places that will make sense in terms of costs and efficiency for their operations.
If we look into the European continent, infinite number of corporations have taken advantage of the foreign demand for their goods and services, and have increased their margins by exporting to other countries. However, this process of selling and buying in different currencies will always represent both a cost and an advantage for multinationals, and this is where the currency market becomes a risk that has been influenced by economic, political and social factors globally. It is therefore recommended that European corporations become aware of this risk and take necessary measures to ride these currency fluctuations without ‘collateral damage’. In today’s markets, corporations are affected by one of the most traded currency pairs, the EUR/USD and, as it’s well known within the financial markets, accurate information is the key.
In 2017, the dollar has been gradually declining against the euro, starting debate upon Trump´s first year in office, and the future of the Euro Zone. The decline of the dollar to a three year low seems to go against the recent interest surge in the U.S.. While Trump and his administration have spoken openly in favor of a weak dollar to boost competitiveness, the decline in dollar value seems to be related to a decrease in the United States´ reputation as a security guarantor. Degrading confidence in the U.S. can be linked to President Trump´s unpredictable behavior, creating instability in the country. Moreover, the Special Counsel investigation on President Trump has impacted negatively the value of the dollar. Another factor of the weak dollar is the pace of increase of interest rates, which has not been increasing as quickly as expected. Finally, late inflation and employment data releases, added to slow progress on the policy agenda have impacted negatively the greenback. The fact that the Fed is slowing down the interest rates hike is disappointing the market, and the Euro outlook seems a lot brighter.
On the other hand, the EU´s bright prospects and solid growth over the last quarter of 2017 have been increasingly attracting U.S. investors. As professional forecasters lift inflation and growth projections for 2018 and 2019, and Draghi announces positive outlooks for the Euro zone, the common currency seems to have greater potential than the USD.
Corporate Problematics Arising from a EURUSD spot rate increase
Ultimately, a rise in the EURUSD spot rate will impact European companies, especially on the long-term, if they do not adopt a dynamic hedging strategy. According to Confindustria, the Italian Employers´ Federation, every 4% gain in the Euro against the Dollar would decrease GDP by 0.2%. Clement Fuest, President of the Ifo Institute said that corporate concerns would appear at a EURUSD spot rate of $1.20.
The rise of the EURUSD spot rate is affecting many industries, especially retail as their exports to the US´s revenue need to be converted in Euros. Luxury brands, amongst others, are highly impacted by interest rate changes. Firstly, because these brands produce mostly domestically, which means that costs are in euro and they do not benefit of the natural hedge provided by producing abroad. The second effect of a strong dollar is, inevitably, that revenues made outside of the Euro zone will have to be translated back into Euros, which means a weaker revenue.
For example, Airbus’s half year results show effects of foreign exchange rate changes on cash and cash equivalents of -170MEUR in 2017 against -35MEUR in 2016. While the company has put in place different hedging strategies, including 60% of natural hedging strategy, it cannot fully cover such a high and sustained rise in interest rates.
As shown in the above chart, the Euro surge is not over, according to ING Bank, it could even reach $1.30, a 3-year high which could become very problematic for euro exports. According to UBS Wealth Management, EURUSD will reach $1.28 for 6 months, a forecast which has been improved by the end of January from $1.22.
In conclusion, all European exporters will get by hit by the strong fluctuations of the EURUSD spot rate, and while some sectors can be hit harder, it is evident that almost every company with operations outside Europe or exporting to US will see their financial results exposed to a weaker dollar. Moreover, companies doing natural hedging strategies are not completely shielded against highly negative financial impacts, as experts say that there is a threshold that might give red flags for corps in EU and this is 1.20 EURUSD cross. This means that we are at a point where companies are facing a substantial challenge this year as the EURUSD has surpassed this point since the beginning of 2018.
Camille De La Rocque de Severac
References and Sources:
The new year has undoubtedly started with the best premises, if considering positive global growth forecasts, rising commodity prices and limited strain deriving from inflation.
Notwithstanding, there is one topic that is rightfully considered crucial for the market’s becoming, i.e. the heterogenous strategies written on central banks’ agendas. Why are they so important? Because they significantly drive the path of relevant factors, such as inflation and interest rates.
Starting from the Eurozone, during the press conference, held on 25th January, at the end of the ECB meeting, Draghi’s words have been aligned to market expectations one more time. Indeed, as anticipated by market actors, the ECB left unchanged its plans. As a matter of fact, the QE has not been reduced and it might rather be prolonged if needed, in order to sustain the inflation rate, whose ideal value is close but not higher than 2%; the level of interest rates remains stable at -0.40% for the deposit facility, 0.00% for refinancing operations and 0.25% for marginal lending facility. In addition, according to the President’s speech, they could be maintained at the current level even after having ended QE, keeping unaltered the forward guidance.
EUR/USD February 2017 – January 2018
As for the EUR/USD exchange rate, it went up during and immediately after the speech, hitting +0.67% while Draghi was pointing out his worries due to the strengthening of the unique currency during the last days, and how this behavior might increase uncertainty about the immediate future.
EUR/GBP February 2017 – January 2018
Similarly, the Euro gained 0.27% against the GBP, lightening the pressure undergone at the beginning of this week. Moving on to the bond market, right after the announcement, German 2yr and 10yr bunds have seen their yields go down at -0.591% and 0.577% respectively, losing about 2-3bps. As far as Spanish and Italian 10yr bonds are concerned, they presented, at first, an opposite behavior. The former went down, in terms of spread over the related bund, by 7-8bps, whereas the latter increased its spread by 7bps. However, they went back to their previous values and eventually set at 1-2bps higher than their initial level.
On the contrary, in the US, there is something different going on. Overseas, the Fed keeps following the path of rising interest rates traced in December 2016. Currently, after the last hike in December 2017, the fed funds rate has a target range of 1.25%-1.50%. On 23rd January, the US Senate confirmed Jerome Powell as new Governor, succeeding Janet Yellen, in charge starting from February 2014. According to the expectations, the new head of the Federal Reserve should not walk away from the current policy, therefore, new hikes are expected to take place over the next months. These decisions have immediately had a significant impact on US bonds’ interest rate curve. However, not all the maturities have been equally affected, since, usually, the shorter maturities are those undergoing a more relevant impact due to policy changes.
Daily Treasury Yield Curve Rates
Source: US Treasury website
In fact, looking at the Treasury Yield Curve Rates chart, it seems safe to state that the curve is flattening, due to the marked rise of rates for shorter term maturities, while those of longer maturities have slightly decreased. Currently, the spread between 1-month bond and 30-year bond rates is lower than 170bps. On January 2016, i.e. eleven months before the first hike by the Fed, the spread was consistently higher, at 255bps. As a consequence, it is possible that this contingency might lead to higher savings and investments in money market instruments and credit-deposits, as profits for short-term and safer products are increasingly growing.
In conclusion, considering the present situation, in the US, Government bonds seem to represent a good compromise between return and risk, even at shorter term maturity. On the contrary, having examined what is happening in the Eurozone, investors, who are striving to capture proper remuneration on the market, seem to be willing to accept to invest in alternative products, walking away from traditional instruments that, for now, are not paying out.
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The crisis of independence in the Catalan region has brought yet another period of uncertainty, one even bigger and probably with more negative effects to the EU than the Brexit vote. However, even though there is no guarantee of what could happen over the next months, markets have remained calm.
As a starting point, markets did not react as expected as the Spanish risk premium (the spread between the interest rates of a 10-year Spanish government bond and a 10-year German bund) has decreased to under 120 basis points. Moreover, the economy minister, Luis de Guindos, has ruled out that investors are fleeing from Spain as a result of the political tension. According to him, the scenario that investors are considering is one where Catalunya will remain a part of Spain. However, the Spanish financial regulators don’t seem too calm regarding the future of markets over the next months. The regulators in Spain, known as the CNMV, have warned that, over the medium term, the prolongation of the Catalan crisis could have a significant impact on economic activity and markets overall. They explained that there could be a tightening of the conditions required to get funds and a loss of trust that might bring down valuations and outbreaks of volatility. However, Spain remains the fastest growing economy in the Eurozone with a 3.1% increase in GDP over the second half of 2017 and one of the most attractive countries in the Europe for investments.
Spain’s Risk Premium compared to Germany
Spanish risk premium
On the 23rd of October the regulators in Spain published an indicative stress index of the financial markets corresponding to the 3rd quarter 2017 and October. The index had a minor upward movement which was attributed to the crisis in Catalunya, but the level remains low.
Until now, the highest level of stress remains within the fixed income segment, due to the increase of volatility as much as to the worsening of liquidity. Furthermore, if we focus on the Catalan region we see a strong effect caused by the sovereign crisis given that the yield of the Catalan bond violently jumped as Catalunya’s president Puigdemont came before the parliament where the declaration of independence was expected to be announced. In only one week the Catalan bond yield maturing in June 2018 went up from 2% to 3.6%. These yields are not normal for securities of less than one year in the eurozone. Also, the spread between the Catalan region risk premium and that of Spain reached 300 basis points.
Autonomous Community of Catalonia Bond 06/2018
The euro has not looked away from the Catalan crisis. During the first weeks of October, the European currency lost position against the USD decreasing by as much as 0.5% in one day. However, the markets felt relieved when the central government decided to bring back normality by using article 155. This is yet another situation where the exchange rates have demonstrated to be highly influenced by the international political-economic circumstances.
EUR/USD October 2017
As for equity markets, on the 4th of October, the IBEX-35 went down as much as 2.8% in one day, being the biggest registered fall since BREXIT. Over the next days, this fall has started to stabilize as two of the key Catalan banking players, Sabadell and Caixabank, announced that they will move their headquarters out of Catalunya.
IBEX-35 October 2017
The independence movement is struggling to find a way forward after the regional leader fled out of the country and is now seeking asylum in Belgium. As of today, only 33% of the people in Catalunya are supporting the independence process. Two things are for certain, markets have shaken off any negative effect caused by this political uncertainty as tensions are dissolving, and it seems that the central government has pulled off its strategy to invalidate Catalunya’s shout of independence. Also, there is a trend in currencies where political and economic scenarios are the most influential power in volatility nowadays, which is why it is important to focus on these areas when assessing an efficient risk management strategy before moving on to the fundamental analysis.
References and sources:
Photo by Josep Renalias- CC BY 3.0
MiFID II should have been transposed on July 3rd in all the Member States of the European Union; however, there still are seventeen countries that are working on it.
The main issue here, apart from the little time ahead, is that even if the deadline of January 3rd arrives, the directive is not directly applicable into the countries, it is necessary to convert it into a national law to apply it to companies or individuals.
Even though directives are binding, these legal acts let some discretion in how to achieve the intended result. Directives serve as a guide; they establish common points that every Member State must follow. Nevertheless, each EU country can consider the different financial context and make a made-to-measure law because the directives allow a range of flexibility in order to make this happen. That is why certain aspects of the directive can be more restrictive in some countries than in others, always within this range of flexibility. However, the final result has to be the same in all the Member States, in this case, the investors’ protection.
The main risk now for those countries that have not transposed the directive yet is the possible infringement proceedings that they can face if they don’t comply with the transposition and, by consequence, the amount of the fine that the commission can charge.
In Spain, the Government has already said that, probably, it will allow up to six months since the moment the national law is published for the companies to adapt. This is a silver lining for all the Spanish investment companies that are still waiting for some indications regarding this matter. Also, in Germany BaFin has said something similar, they will maintain “a sense of proportion” at the beginning. So, it seems that in general the local authorities and supervisors will not be strict and will take into account the huge amount of work and the big investment the firms are making to comply with the new regulation framework.
All in all, this regulation demands a bigger effort by the Member States and the lack of national laws can have harmful consequences not only for the financial entities but for the investors since the main objective is to increase their protection in the financial world and this is being subject to a delay. Let’s hope we will see MiFID II fully transposed by the end of the year and from then six months -again, hopefully- to meet the requirements. But for sure, it is going to be a rough journey.
Bibliography : Bloomberg / Securities lending times
As the mandate of Ms. Yellen approaches its end, there’s still a lot of uncertainty regarding the tapering path policy of the FED. A path that seemed clear only 1 year ago, because of the improved U.S. market labor conditions, continue to be very uncertain. But why, despite a U.S. unemployment rate that has reached 4.4%, do Mrs. Yellen and the FED continue to be doubtful about the implementation of a strong tapering policy? The answer is simple, U.S. core inflation rate (1).
In fact, the FED makes decisions regarding the Federal interest rates based on the conditions of the labor market and the U.S. core inflation rate. While the first has gone up significantly as of today, the second one is still weak. The FED inflation target over the long period is 2%. In order to comply with this objective, taking into account overshooting, the short-term inflation should be at a level near 3%. The data of July show a core inflation rate of 1.7%, well below the target rate. The data released by U.S. authorities today, 13th of September, seem better, but not conclusive.
President Yellen, inside the FED board, is the principal supporter of a cautious policy of tapering, waiting for the inflation rate to reach target level. In various statements, Mrs. Yellen argued that inflation will eventually materialize given the continued improvement in the job market.
Some critics of the Fed president argue that it is not so sure that core inflation will rise near FED’s target in the short period. This is because a long period of low inflation (up to now it’s five years of core US inflation rate below the FED expectations) creates expectations for more of the same, and so consumers are not concerned about buying today if they can wait some years. For this reason, they sustain that it is meaningless to wait for a higher inflation to raise the Federal interest rates for the simple reason that it is possible that the inflation will be as low as now for many years.
But what are the effects of low interest rates on the economy? The interest rates have a strong impact on the bond, equity and on the FX market (USD).
As the easy money policy is reaching his 10-year anniversary, the equity market is still booming. There are concerns about the equity market has finally got used to these extraordinary measures, but the consequences of this assumption could be disastrous. A future clear path of tapering could in fact bring the equity market to collapse, with effects similar to those of the financial crisis of 2007, that led to the economic crisis of 2008.
Another effect of persistent low Fed interest rates is felt on the level exchange of the USD. The US currency exchange rate, without the implementation of a clear tapering policy, will likely remain low versus other currencies like Euro and Pound. Many observers argue that the Fed and the US Government want to keep the dollar competitive on the FX market, and this could be another explanation for persistent low Fed interest rates.
As Ms. Yellen will end her mandate on February 3rd 2018, and it is quite sure that she won’t be nominated for another mandate, the next Governor will have to decide whether to continue with the cautious policy of Yellen or begin a hawkish tapering policy. This choice will have a huge impact on the bond, equity and FX market, and in general on the US and World economy.
The market is anticipating what could be a spike in volatility ahead of the summit where Brexit talks are going to be resumed. These talks could mean that the United Kingdom will face a difficult divorce from the European Union or that these agreements might take a different direction that could make this separation less chaotic. In any case, the benchmark three-month sterling volatility is showing what could be a 3-month period of extreme uncertainty and infinite amounts of market expectations ahead of the Oct. 19-20 summit.
The market is anticipating what could be a spike in volatility ahead of the summit where Brexit talks are going to be resumed. These talks could mean that the United Kingdom will face a difficult divorce from the European Union or that these agreements might take a different direction that could make this separation less chaotic. In any case, the benchmark three-month sterling volatility is showing what could be a 3-month period of extreme uncertainty and infinite amounts of market expectations ahead of the Oct. 19-20 summit.
More specifically, this three-month implied volatility gives us the price swings of sterling based on options. In this case, the market is anticipating a significant bounce back to the levels seen during the Brexit vote. However, other events could affect market movements considerably, such as the two Bank of England meetings and Germany’s federal elections in September.
Over the last year the market has shown aggressive British pound swings, and it seems that this tendency will remain during the next months as UK’s prime minister Theresa May will face her own challenges domestically. This is because the Parliament has yet to debate her bill to transpose EU legislation into U.K. law, which the Labour party and Liberal Democrats said they would seek to amend.
Furthermore, based on hedging strategies that corporations with operations in the UK could put in place to cover risks, there are some indications pointing to GBP weakness. The three-month premium to sell GBP versus the dollar was at 0.61 percentage points, down from 1.8 percentage points on January 17th, the day markets reacted to Theresa May’s speech about pulling out of the EU’s single market.
Based on Bloomberg data, a three-month straddle option on sterling versus the dollar will start to make money at the expiration date if the spot rate moves below $1.27 or above $1.35, approximately.
Ups and downs
If we consider a straddle option for the EUR/GBP, on the 14th of June 2016 the 3-month implied volatility was at 17.36%, with a premium of 621 GBP basis points to buy this straddle. Almost a year later, on the 24th of July 2017, the 3-month implied volatility is at 7.82% with a premium of 280 GBP basis points. The breakeven boundaries are at 0.83/0.95 and 0.86/0.92, respectively. This means that volatility has significantly decreased from the Brexit vote until today, however, it should not be taken for granted that markets have survived to the storm because despite having a current lower implied volatility than that during Brexit (17.36% to 7.82%), it is important to remember that, before the Brexit event, the EUR/GBP 3-month volatility was below 6%, meaning that the waters haven’t calmed down to the levels we saw before Brexit, they are still moving violently and post-Brexit seems to be showing more volatility than pre-Brexit.
The next months preceding September will be a period of uncertainty as many businesses are preparing contingency plans in anticipation of Brexit negotiations.
In the end, no business of any size can wait until the end of these talks before putting an action plan in place. In this sense, markets are hoping that the government avoids a “no deal” because it would mean economic disaster for most people. However, the prime minister remains certain that “This is not just about the U.K.’s position, it’s about the interests of the EU as well,” she said. “If you look at the issue of cooperation on security matters, if you look at the issue of trade agreement with the European Union, this isn’t just about what’s going to be good for the U.K.”
After months of uncertainty, it seems that the Monte Paschi di Siena situation has come to an end. After the approval by the European Union of the rescue plan (with a recapitalization of 5,4 billion), the Italian government will have a 70% stake in the bank.
Shareholders and non-privileged debt holders will also contribute for 4.3 billion, with a strong protection for the mis-selling debt holder that will receive their money back (approximately 1.5 billion). On the 5th of July, the CEO of Montepaschi Marco Morelli has announced a five-year plan for the bank, with huge structural and staff cuts (up to 5.500 workers until 2021) and the dismiss of 28.6 billion of non-performing loans at the end of the plan. The forecasts are of a net profit of 1.2 billion and a ROE of 10,7% by 2021.
This rescue presents a completely new structure compared with the previous ones. Only ten days ago, the Italian government approved a plan that can cost up to 17 billion to the State to facilitate the sale of Banco Popolare di Vicenza and Veneto Banca to Intesa San Paolo (it must be said that the situation was unsustainable and a rescue similar to MPS was impossible). MPS rescue plan mix the bail-out (Monte dei Paschi has been substantially nationalized) with a light version of the bail in (there is a substantial contribute of shareholders and non-privileged debt holders), with a full reimbursement to the mis-selling debt holders. The Italian minister of Economy Pier Carlo Padoan has said that this operation represents a milestone in the consolidation of the Italian banking system, and the government will continue its efforts in this sense. He also added that the intervention of the State will be temporary.
Despite the obvious differences regarding this case, the Italian government struggled and it’s still struggling to get rid of Alitalia, the flight company that received the first government aid in 1974. At first sight, the rescue plan doesn’t seem like a big deal for the centre-left Gentiloni government.
However, the opposite could be true given a set of facts that should be considered. Gentiloni has learnt from the Banca Etruria experience of his predecessor Matteo Renzi, where the mechanism of the bail-in was fully applied. The two main opposition parties in Italy, the Movimento 5 stelle and the Lega Nord, have been extremely critical on the operation claiming that the government had left the investors alone. After that experience, the Movimento 5 stelle and its recognized leader Luigi Di Maio publicly declared the preference of the party for the bail-out system. Even the exuberant leader of Lega Nord, Matteo Salvini, seems not to be so critical about the MPS rescue. In this sense, the political repercussions of the operation for Partito Democratico appear to be limited.
Regarding the repercussion on the stabilization process of the Italian banking system, this operation presents huge risks. First, because it moves exactly in the opposite direction with respect to the European directive of bail-in. The European Union is trying to shift the bank’s failure risk from states to investors, but in this case the greater amount of the risk has fallen on the Italian government. Secondly, this can represent a danger precedent to future critical situations, with Italian regional banks full of non-performing loans. The big question is whether the State can transform MPS into a profitable bank, and then sell the bank on the market within a few years.
In any event, it will be fundamental for Italy to best manage the Monte dei Paschi di Siena rescue, because a potential failure could have a disastrous impact overall the Italian banking system.
MIFiD II is the new (huge) regulation that is going to change the financial market in the European Union. We are talking about an extensive regulation composed by a Directive, a Delegated Directive and several Development Regulations. The main objective is to improve market transparency and investors’ protection.
MIFiD II introduces several changes on the business model of financial entities. It is going to be a challenge, but certainly will be a step forward to offer a more transparent market. It is going to change the public eye about the financial markets.
Although we have to wait to see how the national regulations transpose the Directive in each Member States (deadline is on 3th of July), we already know which are the main keys and challenges:
This matter is related to the proper design and manufacture of the products. It will be needed to identify the target customer group for each product, considering all the risks, costs… of the product.
Regarding the distribution of the product it is necessary to implement the reasonable measures to spur and verify that the product is distributed to the target customer group that has been previously established by the designing entity.
In addition, the entity must assess the characteristics of the product to meet the needs of the public target. The main idea is to look for the client, and especially for his best interest.
More theoretical and practical training.
All the staff providing information or advising to clients shall have a very specific formation and knowledge.
It is very important that an investor manage to know what he is investing in, what the product offers to him and what are the potential risks he will be subject to. As in school where a good teacher passes his knowledge, here it is very relevant that the employee knows well the products the entity offers and have the enough knowledge to make an easy but clear explanation to the client.
This measure is going to help not only the investors but also the firms that will make sure they have competent staff. Since it is not mandatory that the education is provided by an external formation organism, the own entity can teach all about its financial products themselves.
Fees and commissions
Probably, this is the most feared measure of all the regulation. In some countries, fees and commissions have been totally prohibited (Netherlands or UK), but the regulation only prohibits the fees and commissions to the entities that declare themselves as “independent” – giving discretion to the State Members to impose stricter measures. For the other State Members, this option to allow fees and commissions for “Non-independent” entities will still be on the table, but under certain requirements:
Increase the quality of the service
Always favour the client’s best interest
Information to the client
Entities will have to be more thorough. First, they will have to notify the client about if they are independent or non-independent. Then, they will have to give orientations about the associated risks of the product, investment strategies, and, probably one of the most important requirements, it is going to be necessary to inform about all the expenses and costs, including the ones derived from the services of investment advising and the ones from the financial product itself.
So, the financial market is about to become a little more transparent and, by extension, more ethic. Let’s see how it evolves!
By Daniela Mejuto Pita
Directive 2014/65/UE of the European Parliament and Council
Some of the most important companies in Spain registered these last months the lowest cost of financing that they’ve ever had due to the issue of bonds through the market. Companies are considering taking advantage of the arbitrage opportunity in the fixed income market.
Telefonica, Repsol, Iberdrola and other corporates of the same size reached rates close to 0% letting them reduce the higher bank margin taken years ago. Now, investors want to hedge against a potential rise in rates and inflation. However, returns are still low, much more than in almost any other time in history since last year.
« New issues throughout the year in the Alternative Fixed Income Market amounted to 831 million euros (+ 70%), to close December with a figure of 1,029 million euros (+ 106%). »
BME Renta fija Informe annual 2015
A market anomaly is allowing the companies to issue convertible bonds of 2-10 year’s maturity with almost 0% rate but… ¿is a convertible bond a chance for the issuer or for the investor? In this case, at the end of maturity the issuer must give to the investor an agreed number of the company’s shares or the amount equivalent (price lower than market quotes). That means losing part of the control of your company which in turn makes this option less attractive because of the extra cost burden, this cost is reflected in the close-to-zero rates.
« Different types of maturity debt growth through 2015 »
BME Renta fija Informe annual 2015
What is the right option instead? Considering the benefits of this system, corporates might continue using this alternative because there is a mutual profit relation in the deals arranged between corporates.
On the one hand, investors have cash and liquid assets and represent a strong demand on any kind of bonds. On the other hand, the offer is limited, but we have an advantage here, the negotiation of the amount, rate and maturity of the debt you are issuing or buying, is tailor-made for each case as long as we are talking about a counterpart of the same size. Investors can fix the parameters they are looking for in terms of the counterpart’s credit risk defined by the credit ratings and the counterpart´s health and position in the market, which allow them to decide on the flexibility and “freedom” that they need.
The market components are waiting for other companies and institutions to get in there and experience a reduction of the cost of financing and thus the optimization of their financial result. All of that sounds great but, can any company go for it regardless of their size? Yes, if you know where you are and you accept the rules.
Of course, being a big and liquid corporate is the eternal target of any player in the business game, but there are many other smaller but skilled and qualified players that want to change their strategy to achieve the same goal outside the premier league.
Breaking with the conventional and classic team alignment and playing styles (company’s organization and activities) empower the team to score the goal working all together, helping each other, passing the ball to your mate to go ahead. This mutual help with the eleven players of your team lets you win more efficiently and establish long term relationships for the future needs between equals. Now the question is, does your coach know that?
In the United States, growth indicators are on the rise. Janet Yellen, the president of the Federal Reserve confirmed this favourable development and announced rate hikes that did not worry investors, on the contrary. The same cannot be said of the much more uncertain case of Europe. Europe is facing the crisis of immigrants, the Brexit and the difficult recovery of certain countries within the European Union.
2017 is a decisive year for the future of Europe with these different presidential elections. In March, we will assist of the election of the Netherlands, before the Germain election in this autumn. France will elect its new president on 7th of May 2017. These elections are decisive for the whole Europe and the CAC 40. With its partners, the future presidents of these countries will decide about the new trajectory of Europe, which is currently facing several crisis.
In a global way, Europe growth is confirmed but it is not accelerating. For example, in France, the end-of-year accounts for 2016 show an upturn for most major French companies. Nevertheless, the discount of European large-cap and mid-caps compared to the US is measured with a difference of more than three points of the multiple of capitalization of profits. This 20% delay could be reduced by the confirmation of economic trends, but it is politics that will have the greatest impact on the future of the economy.
As for the French elections, Front National candidate leads all polls. From February 20 to 24, Marine Le Pen remains in the lead in the first round despite the affair of the parliamentary assistants of the FN. However, it lost ground in the second round after starting the week at its highest level. The case of the « Penelope gate » has dropped the right candidate, Mr. François Fillon. Currently, France and more globally the world fears a rise of populism and a fear of Europe. Marine Le Pen advocates an exit from the Monetary Union if elected.
Let us take a point to illustrate the case of France. If Mrs. Le Pen is elected as president, France will be forced to change money; The question of debt will arise. If France were to return to the Francs, she would have to pay her debt in the new currency to her creditors. In fact, forced conversion into French francs will be detrimental to French creditors because the new currency will lose its value compared to the euro. Some analyst talk about two possible scenarios, the devaluation of the state or the attack of the markets against this currency.
The possibility of the election of Le Pen scares foreign investors in the French debt. They prefer to turn to a value called « refuge », the German debt, which is considered safer. This is at its peak. The German treasury raises the question of increasing its debt to meet market demand. In recent weeks, the rate of German debt collapsed down to negative. The German rate is currently around -0.96%. Even the ECB buys its German debt with pleasure over short or medium periods.
Moreover, the evolution of the euro is correlated with the French political context. After going down on the 22nd of February, the announcement of M Barou to join the centrist M Macron put the euro back on the rise. The financial markets, financial analysts and other countries of the world keep a suspicious eye on the French political situation and fluctuations in voting intentions.
After a tight debate in Vienna last Wednesday regarding the production of Oil, the OPEC has finally agreed on an output cut this time. The effects on oil price were felt immediately after the news went public. This was the first cut since 2008, a move that counteracts the strategy of producing as much oil as desired.
How much have they agreed to reduce output by? OPEC will collectively produce a maximum of 32.5 million barrels per day, which means they have decreased output by 1.2 million bpd.
RBC Capital Markets
Why the output cut?
The oil production cut is mostly intended to end the oversupply of this raw material, which has made oil prices to fall for over two years, mainly affecting oil-exporting nations.
The market found out about the agreement and, thus, the West Texas Intermediate crude oil was up by 8.5%, whereas Brent Crude (International Benchmark) was up by 8.8%. by 12 pm E.T. on Wednesday.
Regarding volume and volatility, both the Nymex WTI and ICE Brent hit record levels on Wednesday, these are the two most actively traded crude contracts. On the other hand, oil market volatility measured by the Chicago Board Options Exchange Crude Oil Volatility Index dropped by 20% after the agreement took place.
FX markets after the agreement
Who were the big winners in FX markets after the agreement? Oil-linked currencies were indeed the biggest gainers as crude price surged. More specifically, the Colombian Peso and Russian Ruble became the best emerging-market performers after the OPEC agreement. But this was just a happy ending to the increasing volatility that currencies of oil-exporting nations were facing in recent weeks amid concern that OPEC’s three biggest producers (Saudi Arabia, Iraq and Iran) would fail to agree on a production cut. It is also important to consider the fact that Mr. Trump’s election to the U.S. presidency and a better than expected economic data from the world’s largest economy boosted the dollar. In this sense, even though the currencies of oil-exporting nations are up as one would expect them to be given the oil price increase, they haven’t gone up as much as they could because the strength of the U.S. dollar has put more pressure on them.
Overall, the markets have reacted to OPEC’s meeting but volatility could increase in FX markets depending on 3 main reasons:
*How OPEC’s agreement develops over the next months.
*The movement of the USD amid the economic transformation of the United States under Trump’s command.
*The result of the upcoming referendum in Italy on the 4th of December which could have a significant impact on the Euro and global markets overall.
*The evolution of the BREXIT process in 2017.
During 2016, volatility in FX markets evidently became a constant caused by global uncertainty regarding economic policy, political transitions (US Presidential Elections and Brexit) and the society itself (terrorism, protests in the U.S and an ongoing immigration crisis). In 2016, themarket has seen historical moves of main currencies (USD, EUR, GBP) as the world is experiencing a new set of conflicts and transitions that it has never seen before and international corporations that have operations in the US. and in emerging markets such as Mexico, are suffering from this, or at least their financial results are.
Taking the USD/MXN and the EUR/MXN as a reference, there has been a clear depreciation of the Mexican currency when the presidential elections saw Trump leading over Clinton. From this point on, the polls became a reliable reference of the MXN performance. We should also consider that the EUR/MXN has suffered considerably from the OIL CRUDE depreciation over the last 2 years, and the domestic conditions in Mexico are accentuating this effect.
Moreover, the US elections and the peso have been flirting with each other, evidencing a correlation between fluctuations in the MXN and official presidential polls. Then, the presidential debates started and, after a weak performance of Mr. Trump during the first debate, the Mexican market felt relief. The EURMXN went back to the 21.0000 level (-1.67% change in one day after the second presidential debate). It is evident that the U.S election barometer gives a clear picture of how the MXN reacts to changes in the presidential race. Since the first debate most of the US citizens agreed on the fact that Clinton took the lead over Trump and it continues this way even after the final debate. The MXN is facing a violent correction now that Clinton’s policies will most probable be the next US economic and social policies by 2017, which are not as harsh to the Mexican economy as Trump’s proposals.
However, the currency that everyone is suddenly talking about (MXN) isn´t just getting crushed because of Donald Trump. The peso was still lagging its regional counterparts well before Trump’s rise in the polls. We should note that the peso has weakened by more than any other major emerging market currency, except for the Argentine peso, which has suffered from the country’s inflation. Also, Mexico is facing the risk of credit rating downgrades if it fails in cutting back spending next year and shrinking its deficit.
Source: Capital Economics
During 2015, the state-owned oil giant Pemex was facing short term financial difficulties after reporting a $32 billion full-year loss. Additionally, some analysts argue that Mexico’s “chronically weak productivity growth” is also to blame for the weakness in the MXN because Mexico’s industrial production has stagnated since early 2015. But after considering all these political and economic effects on the MXN, is it a good time to buy MXN?
Probably not, since it is important to recognize all other drivers for the second actively traded emerging market currency besides US politics. Factors such as macroeconomics, domestic political forces, and the general risk appetite have powerful influence over the peso. In any way, European and American exporters should acknowledge the fact that the current market scenario is putting Clinton as the next president of the US. which could make the MXN appreciate even more against the dollar. In any case, volatility in FX market will be a major concern for international corporations for the upcoming years and efficient hedging strategies should be put in practice to prevent negative impacts on financial results.
New Momentum will keep tracking the FX market ahead of the U.S. presidential elections on the 8th of November 2016.
At the general surprise (main surveys were announcing BREMAIN advance yesterday night) BREXIT won. What now? Well considering the market impact this morning, I would say a no man’s land area. Consequences will be spread on years but what is certain, Europe will be never the same…. Markets absorbed the impact and is currently stabilizing (06/24/2016, 12.30 GMP time) with GBPUSD -8pct, EURO STOXX 50 -9.10pct, CAC 40 -8.50pct, IBEX 35 -12.50pct….
Instead of analysing the hypothetic consequences on Europe and global financial system, we prefer to analyse area by area what this decision means, any forecast would be anyway at that time a crystal ball vision…
Cameron announced his resignation, Brussels has to face to a gigantic expression of disapproval. All European countries has a direct or indirect link to UK. Now, the first question is: what happens if all the other European governments use of that occasion to make their history as well?
Eurosceptic parties all around Europe have already express their willing to push for a referendum about Europe and this will be for sure the main topic in the next President/PM elections in the other European countries.
UK economy wise
Likely UK central bank should in a first time calm the situation by announcing that they have the tools to face this situation (currency, liquidity, etc.). On government’s borrowing part, markets should penalize this decision by expecting higher return on its UK government bonds.
This could also mean the end of the UK as we understand it: Scotland and Northern Ireland has voted massively for BREMAIN and Scotland has already asked for a new referendum on their independence in order to stay in the EU. Would Northern Ireland (and maybe Wales) follow the same path, the UK would disappear.
The disintegration risk of the Europe is the main topic. Merkel appears now as the only figure of a historical strong Europe. The next EU summit will be for sure mostly concerned by that risk and the proper solutions to deliver now.
UK rates and currencies wise
-8pct GBPUSD with probably more room to the downside. Markets consider that surprise as a very negative impact on the future UK economy so by consequences a negative impact on the GBP as well. The graphics below showed the overnight market impact of the Brexit…
-3pct EURUSD showed all-in a negative impact on EUR currencies against the safe USD. Spain and Ireland are particularly impacted by that decision and should see in a near future the consequences. European credits spread should gap wider as well.
As you can see below, all European markets have taken the shock. Banks are particularly impacted (Barclays -25pct, Santander -20pct, Société Generale -18pct…).
The market recovery will depend a lot on the UK implication of each stock.
One thing is clear, this unexpected event will imply deep and strong implications in many different topics. But most of all, more politic incertitude will be added to an already very complicated situation…
Bertrand DEBIZE, Chief Compliance of New Momentum
Bruno ATLAN, CEO of New Momentum
Sterling Needs Drop of 2.4% for Brexit Options to Pay Their Way 2016-06-08 09:45:05.9 GMT Link to the article
By Todd White
(Bloomberg) — For all the investor frenzy over a possible
Brexit, pound bears need a decline of about 2.4 percent to make
money through options should Britain choose to exit the European
A trader will cover the cost of an option premium if
sterling falls to $1.4186 over the next month, from $1.4537 at
10:33 a.m. in London, according to broker quotes compiled by
That pricing suggests that either traders are more sanguine
about the risks of Brexit, or they see less of an effect on the
currency than some banks and money managers who have predicted
the pound will lose as much as 20 percent of its value if the
U.K. quits. A smaller move, or a gain, will see a trader lose
all the upfront premium they paid for the put option.
The run-up to Britain’s unprecedented vote on June 23 has
driven brokers to price in the highest one-month implied
volatility since 2009. They’re seeing the pound liable to swing
higher or lower by an annual 22 percent. That’s boosted the cost
of options, particularly the one-month contracts expiring after
the referendum’s results are published. Even so, downside
protection is still not prohibitive, according to some
“Considering this is the biggest volatility since Lehman
Brothers’ bankruptcy, the hedge is still cheap to make if you
really think Brexit can happen,” said Bruno Atlan, a former
currency trader who’s now chief executive officer of New
Momentum Consultant SL in Madrid, an adviser to corporations on
investments. “I don’t think Brexit will happen, but hedge funds,
corporates and other players are speculating on it.”
The U.K. currency has had a tumultuous start to the week as
opinion polls gave conflicting messages about the likelihood of
an EU exit. It fell by as much as 1.1 percent on Monday, and
gained as much as 1.5 percent the following day. On Wednesday,
it fluctuated and fell as low as $1.4501.
For money managers, options are an integral part of
managing risk, with a daily average turnover of $104 billion in
the U.K. alone, according to Bank of England data. The current
level of volatility is raising the cost of seeking such
protection. The pound’s implied volatility compares with a 10-
year average of 9.3 percent, and a current level of 9.6 percent
for the euro.
Preparing for Aftermath
As Brexit risks become more imminent, traders and market
operators around the world are preparing for the decision.
Margin requirements are getting raised, bank traders will be
working overnight in London, and investors from Thailand to
Boston are waking up to how their positions may be affected if
Britons choose to leave the trading bloc they’ve been in since
Investors and analysts are forecasting turmoil if a Brexit
occurs. Adrian Lee, the founder of Adrian Lee & Partners, which
oversees $9 billion of foreign-exchange investments for money
managers, predicts sterling would fall 20 percent on a vote to
leave the EU over the course of two to three days, with much of
it on day one.
A Bloomberg survey of economists in February showed 29 out
of 34 economists in a Bloomberg saw it sinking to $1.35 or below
within a week of a vote to leave — levels last seen in 1985.
–With assistance from Tanvir Sandhu, Itay Dafna and Vassilis
Following the last ECB meeting on Thursday 10th, market expectations were met by Draghi’s speech regarding further quantitative easing and negative interest rates.
More specifically, the ECB lowered all three key basic interest rates, the marginal lending facility rate is at 0.25%, the rate for main refinancing operations is at 0.00% and the deposit facility rate went from -0.3% to -0.4%. On the other hand, the increase in monthly bond purchases from previous €60 billion to €80 billion beat expectations, and the ECB decided to include investment grade corporate bonds in its purchases.
Moreover, Targeted Longer-term Refinancing Operation II (TILTRO) was introduced in order to provide loans from the ECB to commercial banks at extremely low interest rates to offset any deposit flight that may follow the negative interest rates. The market reaction was significantly positive; this was reflected on the euro as the currency lost more than 1.5₵ against the dollar, whereas European equities and US equity futures surged. Also, sovereign bond yields plunged all over Europe, except for Germany, the region’s safe haven.
What does all this mean and what are the implications for the US and Europe? Monetary policy has severe limitations at extremely low interest rates in keeping markets up, or sustaining an economic recovery. This can be seen in Japan’s move of introducing negative rates in January which resulted in the Yen appreciating rather than depreciating as the Bank of Japan had hoped. Now the ECB is learning from this. If the central bank went more negative on rates and decided to include corporate bonds in its purchases because it was running out of qualified sovereigns to buy, financial markets showed that they won’t boost equity and bond prices except for a short time.
For now, some Fed members fear that another rate hike could push US into deflation and lead to a market correction, a rate cut or another QE may not be the efficient and reliable bazookas they have been since the financial crisis. The experience in Japan and Europe suggests that other central banks such as the Fed will run out of time and tools to address deflation and economic slowdown. As of now, what seems like a policy limited to a few countries with strong currencies such as Switzerland and Sweden, will now likely stay for a long time. This means bad news for companies that depend on high-yielding assets to make money, such as some banks and most insurers. As the monetary easing continues, the yields on low risk bonds will keep falling.
From this chat from Deutsche Bank we see that Insurance, banks and autos tend to benefit the most when European credit spreads fall.
Furthermore, Draghi’s decision to cut rates even lower could grow to be a big problem for banks. As explained by analysts at Bank of America Merrill Lynch, deposits kept at the ECB skyrocketed since 2014, meaning that 0.4% charge will cost lenders around €20 billion by 2018. Here is a chart that explains just that:
Analysts also explain that:
‘Excess deposits placed by banks at the ECB have risen by 60% of the amount of quantitative easing undertaken to date. If this persists, the current pace of QE would see €2 trillion in excess liquidity by end 2018.’
So how effective are all these policies in the upside down world of interest rates and monetary policy? Remains to be seen.
At the end of 2015 Spain saw how the rise of rival political parties were threatening the long-established Popular Party under the command of Prime Minister Mariano Rajoy.
During the general elections on December 20, Spain understood that the alternation of power between the Popular Party and Socialists had come to a possible end. They now find themselves challenged by the new rising parties of ‘Podemos’ and ‘Ciudadanos’, a far-left party that came third in the general elections and a centrist party that came fourth, respectively. It was indeed one of the most closely-fought legislative polls that Europe has seen in the last decade, and now Spain is experiencing uncertainty since the Popular Party lost its absolute majority and it’s now forced to form an alliance with other party in order to govern.
Since Spain welcomed a new government led by the president of right wing ‘Popular Party’ (PP) in 2011, the country has had major changes in its economy after suffering from the impact of one of the biggest financial crisis the world has experienced. Mariano Rajoy’s administration has intended to put Spain on a new path towards economic recovery by establishing new reforms. The prime minister had positioned himself as the head of state who managed to drag the country away from economic collapse. However, unemployment remains substantially high at more than 21 percent and, during the last political campaign, Rajoy’s rival parties also made emphasis on the increasing inequality that the country is suffering from, brought on by the Popular Party’s drastic spending cuts, tax rises and health reforms. But how does Spain’s economy really look over the last years of the Popular Party administration? How would a government led by the socialist party PSOE, assisted by far-left wing government ‘Podemos’, affect the economic landscape of Spain in the short and long run?
Economic policy under PP has remained static due in part because the party’s administration has already seen a substantial improvement of the economy in terms of less unemployment and more GDP growth than other EU countries. Nevertheless, economists agree that there is a lack of action by the current government and that improvements in the form of innovative reforms should take place right now in order to keep boosting the economy. But Rajoy’s administration is reluctant to intervene with more reforms because they see progress with those imposed back in 2011 (mainly fiscal and labour reforms). In this sense, if the decisions they have made since 2011 have improved the economy, why should they try new things? Some would say that a lack of intervention by the government will keep the economic recovery going, in fact, the Popular Party is waiting for the economic cycle to do its job and bring things back to normal like they were in 2006 before the crisis hit.
We should start by giving a detailed look at how the Spanish economy has evolved after the crisis of 2008 under the command of the Popular Party, and then we’ll move on to analyse the possible economic scenarios under a probable left wing administration led by ‘Podemos’ party.
After the housing crisis and subsequent employment crisis, domestic demand in Spain decreased substantially, for this reason the country needed to become more competitive in the global markets and so the Popular Party decided that decreasing labour costs was the best option, because this would in turn allow Spanish exporters to reduce their prices and foreign companies to settle businesses in Spain, thus creating more jobs. More specifically, Rajoy enacted a monumental labour reform in 2012 with the Royal Decree Law 3/2012, which consisted in reforming the collective bargaining aspect of Spanish labour and adjusting the employment protection legislation. These reforms were aiming at reducing Spain’s labour costs and wrest power from its employees. In this sense, businesses could hire and fire employees without incurring high costs. The fact that a company was less profitable was reason enough to lay off a certain number of employees. With this flexibility, corporations were more eager to hire people. This in fact had a major impact on the unemployment rate, which supports the idea that the reforms imposed by the Popular Party appeared to have achieved a mechanism of decreasing unit labour costs and increasing productivity.
On the other hand, left wing party Podemos is proposing a substantial increase in public spending (96.000 million euros in four years) which most analysts agree would bring consequences to the Spanish economy. A boost in public spending could hit company profits and thus lead to a reduction in private investment and economic growth. This could also increase inflation and, since firms are less certain investment will be profitable, unemployment and inequality could rise in the long term. The anti-austerity measures by the left party include an increase in spending on health, education, dependency and social protection, and an investment fund that will be used for energy transition, which will intervene and nationalize the electricity market. This is a crucial point in Podemos administration since people are more aware of climate change and how important a transition from traditional energy sources to clean renewable energy is for the economy. There can’t be a growth model in this century that neglects the challenge of climate change. Consumption and production subsidies for fossils fuels that damage the environment are serious obstacles to a new green growth model, and this is where the Popular Party and Podemos differ. Spain is still subsidising domestic coal production for power generation (traditional means of energy) and there is limited taxation on fossil fuels, which do nothing to promote the transition to new sources of renewable energy. If the Popular Party keeps its policies away from renewable energy and innovation, the costs for Spain’s economy could be even higher in the long run.
Moving on to the government budget, Spain has had a notable reduction of the deficit since Mariano Rajoy took office in 2011. However, even though the economy has been put on a new path towards substantial recovery, the European Commission estimates that the deficit in 2015 was about 4,8% in 2015, compared to a 4,2% that they had as their objective, and it’s probable that the deficit will stay around 3,6% this year, compared to an objective of under 3%. These numbers are important to consider because Spain could see a coalition of both socialist party ‘PSOE’ and far-left wing party ‘Podemos’, which could take the deficit even higher due to the amount of increasing spending that both parties proposed in their campaigns. But how will the economy react to this? Firstly, not complying with the deficit limits imposed by the European Commission would lead to a conflict between the Spanish government and the Commission in Brussels, this in turn could result in an increase in interest rates as Spain would become a riskier investment, especially if there was a risk that the ECB would stop buying Spanish government bonds. However, this scenario is less probable given that an increase in government bond rates will generate pressure on both parties and will eventually make PSOE and Podemos back off from its public spending decisions, which are key pillars of their political campaigns.
Overall, it seems that the Popular Party has imposed the appropriate fiscal and labour policies, this is evident in the reduction of the unemployment rate and the GDP growth that the country has enjoyed during 2015. However, there is a conflict between meeting the European Commission’s deficit objective for Spain (which is one of the main goals of the Popular party) and meeting the needs of many Spaniards who strongly want to see changes in health, labour, education, and innovative solutions for the younger generations and the environment, which are the investments that PSOE and Podemos are really committed to do.
In brief, Spain’s economy is at a stable position waiting for a final agreement between the parties, unemployment and economic growth are at stake, and it seems that a coalition between parties will still result in conflict and will negatively affect the economy. The Popular Party has done things right but the economy needs new and innovative reforms if Spain wants to boost its economy to the levels it enjoyed back in 2006 before the crisis. In any case, one thing seems to be crystal clear, the two ancient parties, the old left and the old right, won’t have power anymore. For now, a vast number of the population wants to see drastic changes.
The new year 2016 has started in negative zone in terms of interest rates. We saw central banks moving into deeper rates as inflation in the Eurozone remains far below the targeted 2%, while global economic growth is slowing down,
especially in emerging economies, and it doesn´t look like this slowdown will stop any time soon. If we take a look at how financial institutions are responding to negative interest rates, we see that there is fear of financial instability caused by this new policy. Banks may not be interested in passing negative rates on to depositors in fear of losing their customers to other financial institutions or simply of seeing their own customers withdrawing all their deposits. Also, some banks have assets like mortgages, from which they receive payments that are linked to the interest rate. These financial institutions would see lower profits and, overall, this will not help to power a rapid economic recovery of nations given that these institutions are key pillars of the economy, and if they are less profitable or go bankrupt the economy will suffer huge consequences, like many nations did during the 2007-2008 global economic crisis. In this sense, the best hope for success relies on the foreign exchange markets. In theory, negative interest rates will move capital from a given country to offshore markets because investors will be looking for better returns abroad, this will lead to a depreciation of the currency which will raise the price of imports, helping to combat deflation and giving a growth environment for exporters.
Recently, the Eurozone has adopted negative interest rate policies in hopes of encouraging banks to put their excess cash into the economy and stimulate inflation. Now Japan has become part of the club of countries (Sweden and Swiss included) that have cut rates below 0%, but what has been the real effect of negative rate policies in the foreign exchange market?
Source: Business Insider
In 2014 the ECB, along with Sweden and Swiss, decided to bring deposit rates down below 0%. This had an impact on the Euro, which was at its highest level since 2012, declining 20% from 1.4 to 1.20 after the ECB announced its new negative rate policy, and hitting bottom at the beginning of 2015 at 1.10. Despite Japan’s recent rate policy, and market sentiment that the ECB may cut interest rates even deeper into negative territory, the Yen and the Euro haven’t been much affected by this announcements, this could mean that the EUR has arrived to a limit and that it will hardly go further down during the next months. It is also important to consider that the US dollar index closed on the second week of February 2016 at its lowest since October 2015. Moreover, even though the Euro and the Yen strengthened in part because markets are not expecting a further increase in the US rate hike, the CBA stated this month that there is a greater reason than just rate differentials that could explain the currency move: the big surplus in current accounts run by both Japan and the Eurozone. This factor alone could explain why negative interest rate policies have done little to weaken the Euro and the Yen.
With a huge current account surplus, the savings of a given country are greater than its investment which lowers the need to attract capital from foreign markets. As a consequence of this, negative interest rate policies from central banks seek to stimulate greater investment and inflation by using domestic savings, instead of trying to weaken their own currencies.
The depreciation of the dollar against other currencies can be seen clearly over the first months of 2016 and it matches market expectations regarding the U.S. Federal Reserve increasing interest rates. We should emphasize the fact that the market had bet for an appreciation of the USD when the Federal Reserve announced it was going to increase rates on December 2015, and therefore the market was increasingly buying USD hoping that there would be more rate hikes (at least more than 3 hikes) during 2016. However, the Federal Reserve became reluctant to increasing rates too much because this could do more harm than good to the economy in the long run, and now the market is increasingly selling USD causing a depreciation of the currency against the Euro or Yen. Given all these facts there is volatility in FX markets right now, but Japan is hoping to stabilize the Yen with its new policy rather than getting into a currency war with other nations. However, this policy seems to have little effect on weakening a nation’s currency because we would have seen the Euro and the Yen drop even lower than 1.10 against the Dollar, but the case has been the exact opposite since the USD is the currency that is depreciating the most and more rate hikes would not exactly mean that the economy will follow. It seems that the current account surplus of the Eurozone and Japan is indeed responsible for the weak Euro and Yen. However, markets are just starting to react to negative rates, there could be more swings in the market during the upcoming months. On the other hand, we should be asking, will the global economic slowdown continue?
SINCE the New Year, the price of oil has surprised even the most bearish punters, plunging by 18%. On January 12th,West Texas Intermediate (WTI), America’s benchmark, briefly dipped below $30 a barrel, its lowest level since 2003.
The next day an incipient rally was undone by the news that American stocks of crude oil and petroleum products had reached 1.3 billion barrels, a new record. Firms are hunkering down. BP this week announced hefty job cuts; Petrobras, Brazil’s state-controlled oil firm, slashed planned investment.
Some blame factors other than supply and demand for turning increasingly bearish. For instance, Standard Chartered, a bank, said oil might need to fall as low as $10 a barrel before speculators concede that “matters had gone too far”. But it’s mostly guesswork. Such is the level of uncertainty that American derivatives contracts tied to deliveries in April imply an oil price of anything from $25 to $56 a barrel, according to official number-crunchers.
Neil Atkinson of the International Energy Agency (IEA), a forecasting outfit, finds lots in the physical oil market to be bearish about—particularly regarding consumption, which was one of the few factors supporting prices last year. The sell-off in oil in the past fortnight has occurred concurrently with a slide in the Chinese stock market and the yuan, which some investors think reflects weakness in China’s economy and hence in demand for oil. Though Mr. Atkinson acknowledges that possibility, he thinks this risk is overplayed: figures on January 13th showed China imported a record 6.7m barrels a day (b/d) of oil in 2015.
The trouble, though, is that apart from India and a wobbly China, demand is not looking promising anywhere this year. Europe is unlikely to see a repeat of its relatively strong oil-demand growth in 2015. Although America’s economy continues to grow, tightening fuel-efficiency standards cap the upside. Drivers in the Middle East, where fuel use rose last year, are more likely to keep their cars off the road after their governments raised petrol prices or eliminated fuel subsidies altogether to shore up public finances. “There are now considerable uncertainties about oil-demand growth globally,” Mr. Atkinson says.
Adding to the gloom, producers are not turning off the taps as fast as people expected. The latest rout stems from an OPEC meeting in early December in which the producers’ cartel abandoned output quotas. Saudi Arabia, which used to curb output to rescue prices, now refuses to play that role, and instead is bent on driving high-cost producers out of business. Saudi officials privately say that they expect the price of oil to rebound late this year or early in 2017 as global output begins to lag behind demand. The natural decline as fields are depleted saps production by at least 5% a year, they argue, even before accounting for the effects of reductions in new drilling by embattled oil firms.
But there remains huge uncertainty about how much Iran will export when UN sanctions are lifted, possibly in coming weeks. What is more, Mr. Atkinson says, production continued to rise last year from high-cost wells in the Gulf of Mexico and Canada’s tar sands because, however much oil prices fell, operating costs were lower. “The habit of the industry is to keep producing for as long as you can. Anyone who blinks first is handing a lifeline to their competitors,” he says.
To be sure, production in America is falling, thanks chiefly to cutbacks by struggling shale-oil producers. With oil prices at $30 a barrel, America’s oilmen will have an even tougher task shoring up output by drilling new wells, and will face further pressure from their bankers to reduce borrowing. AlixPartners, a consultancy that advises troubled firms, says more will go bankrupt this year. It forecasts a funding gap of $102 billion this year between American oil firms’ projected cash flows and their interest payments and capital spending, up from $83 billion in 2015. It said the downturn “could be one of the most severe and prolonged ever”.
But however big the cutbacks, they are not yet enough to reduce the glut. Global inventories are at record highs, the IEA says. The Energy Information Administration, an American government agency, predicts they will rise a further 700,000 b/d before supply and demand begin to balance out in 2017.
It adds that storage at Cushing, Oklahoma, which can hold 73m barrels, is at record highs of 64m barrels. Brian Busch of Genscape, an industry data gatherer, says it’s a similar story in China, with ships carrying oil spotted waiting at anchor out at sea because storage tanks appeared to be full. Based on the high level of stocks, Mr Busch thinks it could take up to a year and a half before the bear market ends. The only certainty is, the quicker the oil price falls, the sooner that day will come.
FRANKFURT ’ The European Central Bank adjusted its asset purchase program known as quantitative easing on Thursday, extending the scheme's duration into 2017 and agreeing to buy euro-denominated municipal and regional bonds, ECB President Mario Draghi said.
Purchases of mainly government bonds – at 60 billion euros a month – are now seen running until at least March 2017 instead of next September.
He also said that proceeds from the various assets bought would be reinvested back into the scheme.
« We decided to extend the asset-purchase program. The monthly purchases of 60 billion euros (£43.2 billion) under the asset-purchase program are now intended to run until the end of March 2017 or beyond if necessary and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its aim of achieving inflation below but close to 2 percent over the medium term, » Draghi said.
Analysts polled by Reuters last week had expected the ECB to increase the monthly purchases to 75 billion euros as well as extending the purchases.
The purchases have pushed down yields and boosted lending, indicating that quantitative easing (QE) was working, even if only slowly and with a lag, supporting calls for more asset buys.
But critics have said QE has done little for inflation so far, the ECB’s biggest worry, with headline figures hovering near zero and core inflation around 1 percent, well short of the central bank’s target of nearly 2 percent
(The New York Times : Reporting by Balazs Koranyi Editing by Jeremy Gaunt.)
With some rate-setters advocating immediate policy easing last week, European Central Bank President Mario Draghi struck a compromise to keep the doves on side and set up expectations for action in December.
Several influential Governing Council members argued that the ECB’s balance sheet was still relatively small, especially compared to the U.S. Federal Reserve while Denmark’s deeply negative deposit rate illustrated that there was still room to reduce rates, one source with knowledge of the discussion said.
Instead of delivering the wait and see message the market expected, Draghi opted for one that was more dovish and crystal clear, keeping with the ECB’s tradition of building a consensus and putting to shame the Fed, which has fumbled with its communication at a critical juncture.
« It needs to be understood: there is consensus at the ECB Governing Council, » a rate-setter, who asked not to be named, said. « A move in December is likely. »
« Inflation is just not moving higher, there is a risk of falling into a Japanese-style liquidity trap, » the Governing Council member said.
With inflation in negative territory, the ECB is far from its target of getting price growth to near 2 percent and its 60 billion euros ($66 billion) a month asset buys have proven insufficient as lower energy prices and slower growth in emerging economies have worked against it.
Meeting in Malta, the Governing Council discussed a wide range of possible measures and the general view was that instead of one or the other, a combination may be effective, the sources said.
With the Fed postponing its rate hike, Draghi’s comments also had the desired effect of weakening the euro, a key result as the exchange rate is an important channel for policy transmission, another Governing Council member said.
Although increased asset buys could further squeeze liquidity in the market, one source with direct knowledge said concerns over market supplies were overdone as the ECB could move into new instruments and had plenty of room to maneuver even with government bonds.
The ECB could consider corporate debt or equities while there was also room to buy more supranational instruments. Sovereign debt was plentiful due to high net issuance and the ECB could always release debt to be held until maturity, the source said.
There is a constraint about having to buy national instruments in proportion to how much share each country has in the ECB, but substitution rules also provide some flexibility.
Still, another insider warned that the market may have overreacted to Draghi’s words and waiting until December, when the ECB releases fresh inflation forecasts, was normal.
And with monetary policy already ultra-accommodative, room to do more may be limited.
« Itâ€™s hard to do much more monetary stimulus than this, » said French Finance Minister Michel Sapin, who has no direct say in policy but who less than a year ago was one of the loudest voices urging the bank to do more.
« Draghi said there is still scope to respond to certain situations if needed, so there is still a possibility to do more but weâ€™ve already come a long way. »
The consensus from almost 60 economists in a poll conducted by Reuters after Thursday’s meeting shows there is an 80 percent probability of the ECB easing at the next policy review on Dec. 3.
Draghi has been a masterful communicator, repairing the reputation of the ECB, which is run by a 25-member Governing Council that sometimes speaks with as many different voices, leaving the market guessing.
From promising to do « whatever it takes » to save the euro at the height of the bloc’s crisis in 2012 to delivering an unexpectedly large 1 trillion euro plus quantitative easing (QE) program this year, Draghi has become an expert in understanding what the market needs to hear and delivering more.
« The ECB really has become masters of communication: leading the market along, and then over-delivering, » UniCredit chief economist Erik Nielsen said in a note. « I think Draghi more or less gave it away on Thursday: QE2 (in size, composition, duration) and (unfortunately) a rate cut. Remember, they are not in the habit of under-delivering. »
Draghi’s clear stance is now in stark contrast to the Fed, which meets on Tuesday and Wednesday.
Markets have been confused by top Fed officials sending conflicting signals and rate hike expectations have been pushed into next year even as Fed Chair Janet Yellen said she expects that a hike will be needed by the end of this year.
« It is never a good thing when the vice chairman of the FOMC and the vice chairman of the board are saying two different things at a critical juncture for policy, » former Fed research director David Stockton said.
« When comparing the communications of Draghi and Yellen, it is important to remember that Draghi has been dealing with a crisis, » said Stockton, now with the Peterson Institute for International Economics and Macroeconomic Advisers. « Yellen has been in a much different environment, one in which careful nuance has been more important than dramatic statements. »
WORDS NOT ENOUGH
Draghi’s problem now is that he must deliver and the entire world will be watching as market moves induced by the ECB reverberate across the globe.
« If you don’t meet words with action, the market backlash could be quite big » said one Japanese policymaker on condition of anonymity.
The second round of quantitative easing is always less effective than the first one while the consensus in the Governing Council may also be at risk as more easing means lower borrowing costs for governments, which some central bankers see as de facto monetary financing since the ECB is making it cheaper for governments to borrow.
Governments are also not always doing their fair share to boost growth and accommodative policies by the ECB take pressure off governments to enact long-term measures that may be politically costly now but would support growth over the long term.
(Reporting by Frank Siebelt, Balazs Koranyi, and Francesco Canepa in Frankfurt, George Georgiopoulos in Athens, Leigh Thomas in Paris, Howard Schneider in Washington and Leika Kihara in Tokyo; editing by Susan Thomas)
The U.S. Federal Reserve kept interest rates unchanged on Wednesday and in a direct reference to its next policy meeting put a December rate hike firmly in play.
Investors had expected the Fed to remain pat on rates, but the overt reference to December came as a surprise.
The central bank also downplayed recent global financial market turmoil and said the U.S. labor market was still healing despite a slower pace of job growth.
« In determining whether it will be appropriate to raise the target range at its next meeting, the committee will assess progress – both realized and expected – toward its objectives of maximum employment and 2 percent inflation, » the Fed said in a statement after its latest two-day policy meeting.
Investors quickly placed bets reflecting a higher chance the U.S. central bank will raise rates in December, with futures contracts implying a 43 percent possibility compared to 34 percent prior to the statement.
« The Fed is seriously considering a December rate hike, » said Harm Bandholz, an economist at UniCredit in New York.
Going into the Fed meeting this week, the market had viewed March as the most likely time for the central bank to begin its rates « liftoff, » but it now sees a greater chance of that happening in late January.
The U.S. dollar rose sharply and yields for U.S. government debt soared in anticipation of higher rates. U.S. stock prices initially fell but regained momentum and closed sharply higher.
Michael Feroli, a former Fed economist now at JPMorgan, said the Fed statement was the first since 1999 in which policymakers pointed to a possible rate increase at the next meeting.
« By specifically referring to that meeting they are basically testing the waters a bit, » said Aneta Markowska, an economist at Societe Generale in New York. She described it as a « subtle attempt » to gently nudge the market in that direction.
LEAVING DOOR OPEN
The Fed has been struggling to convince investors a rate hike was imminent in the wake of data this month that showed U.S. employers slammed the brakes on hiring in August and September.
But it countered the skepticism on Wednesday by saying even slower hiring was still enough to get it closer to its goal of maximum employment.
Central bank policymakers also pointed to « solid rates » of growth in consumer spending and business investment, while eliminating a reference from their previous statement warning a global economic slowdown could sap U.S. economic strength.
Fed Chair Janet Yellen has been saying for much of this year that a rate hike would likely be needed in 2015 to keep the economy from eventually overheating.
More recently two Fed governors urged caution over rate hikes while questioning Yellen’s views on inflation, though such doubts appeared muted in Wednesday’s statement.
The Fed now has several important economic readings to parse, including two monthly employment reports, before it makes up its mind on whether to tighten policy at its Dec. 15-16 meeting.
It will also get a chance to see how monetary policy easing in Europe, Japan and China plays out in financial markets. Easy money policies abroad push the dollar higher, hurting U.S. exporters and making it harder for the Fed to get inflation back up to its 2 percent target. That may explain why the Fed sought to leave the door open for a rate hike rather than paint the economy as fully ready for a monetary policy tightening.
« The Fed has dialed down its anxiety over international developments, but it’s best to play it safe, » said Brian Jacobsen, a portfolio strategist at Wells Fargo Funds Management in Menomonee Falls, Wisconsin.
(Reporting by Lindsay Dunsmuir and Jason Lange; Editing by Paul Simao)
Les pays Ã©mergents ont assurÃ© un relais de croissance depuis le dÃ©but de la crise en 2008 mais aujourdâ€™hui, alors que les Ã©conomies dÃ©veloppÃ©es ne sont pas encore relancÃ©es totalement, les pays Ã©mergents se retrouvent en grande difficultÃ©.
La situation dans les pays Ã©mergents de 2008 Ã 2014
Depuis 2008 et le dÃ©but de la crise dans les pays dÃ©veloppÃ©s, les pays Ã©mergents Ã©taient devenus un eldorado pour les investissements mondiaux. Alors que les Ã©conomies europÃ©ennes et amÃ©ricaines Ã©taient lancÃ©es dans une spirale de rÃ©cession et de hausse du chÃ´mage, les principales banques centrales ont unanimement dÃ©cidÃ© de lancer des plans dâ€™envergure dâ€™injection de liquiditÃ© sur le marchÃ© et de rÃ©duction de leurs taux directeurs Ã des niveaux nuls. Les pays Ã©mergents, dont les Ã©conomies sont plus axÃ©es sur lâ€™industrie et les matiÃ¨res premiÃ¨res que les pays dÃ©veloppÃ©s Ã©taient moins touchÃ©s par la crise mondiale, prÃ©sentaient de belles perspectives de croissance et surtout des taux attractifs, bien plus hauts que les taux pratiquÃ©s dans les Ã©conomies dÃ©veloppÃ©es.
Tout naturellement, lâ€™argent gratuit et en abondance distribuÃ© par les banques centrales occidentales a Ã©tÃ© massivement investi dans les Ã©conomies Ã©mergentes comme le BrÃ©sil, le Mexique, la Turquie et les pays dâ€™Asie du Sud-Est comme la ThaÃ¯lande.
Selon Mediapart, qui relaie les donnÃ©es de la BRI, la dette extÃ©rieure des pays Ã©mergents est passÃ©e de 2800 Ã 7500 milliards de dollars. Lâ€™endettement a augmentÃ© de plus de 50 points pour atteindre 167% du PIB.
A court-terme, les pays Ã©mergents ont surfÃ© sur cette manne financiÃ¨re. En effet, les Ã©conomies Ã©mergentes, aidÃ©es par une opinion favorable des marchÃ©s qui voyaient en elles un relais de croissance nÃ©cessaire pour la croissance mondiale et entrainÃ©es par la bonne santÃ© chinoise, ont affichÃ© une croissance Ã©conomique trÃ¨s intÃ©ressante.
Cependant, malgrÃ© un bon comportement de faÃ§ade, de nombreux dÃ©sÃ©quilibres sont apparus.
Quels ont Ã©tÃ© les facteurs de risque expliquant la situation actuelle des pays Ã©mergentsÂ ?
Dâ€™une part la nature des investissements rÃ©alisÃ©s par le transfert de capitaux en provenance des pays dÃ©veloppÃ©s. Les pays Ã©mergents ont peu mis Ã profit les investissements Ã©trangers pour se dÃ©velopper structurellement (construction dâ€™infrastructures, diversification de lâ€™Ã©conomie, etc..) et les capitaux Ã©trangers ont plutÃ´t Ã©tÃ© dirigÃ©s vers des placements opportunistes en lien avec les marchÃ©s.Les pays Ã©mergents sont restÃ©s Ã la merci dâ€™une fuite de capitaux aussi rapide que leur arrivÃ©e avec peu de changement structurel en mesure de pÃ©renniser la bonne santÃ© de lâ€™Ã©conomie. Ainsi, ils sont restÃ©s trÃ¨s dÃ©pendants des politiques monÃ©taires des banques centrales des pays dÃ©veloppÃ©s car les investisseurs ont finalement investi dans les pays Ã©mergents en attendant que les pays dÃ©veloppÃ©s se remettent en marche.
Dâ€™autre part les pays Ã©mergents sont trÃ¨s liÃ©s Ã la Chine qui est le premier importateur des matiÃ¨res premiÃ¨res quâ€™ils produisent en abondance. On ne peut pas dire quâ€™ils avaient le choix, tant la Chine sâ€™est posÃ© en moteur de la croissance mondiale depuis 2008. Le risque de cette relation Ã sens unique Ã©tait doubleÂ : La dÃ©pendance au prix des matiÃ¨res premiÃ¨res et la pÃ©rennitÃ© de la bonne santÃ© chinoise.
Quelle est la situation aujourdâ€™huiÂ ?
2015 a marquÃ© un retournement de tendance fort pour les pays Ã©mergents.
La Fed a amorcÃ© un resserrement de sa politique monÃ©taire avec la fin du QE et a annoncÃ© un relÃ¨vement de taux qui, mÃªme sâ€™il tarde Ã se concrÃ©tiser, a provoquÃ© un retour dâ€™une partie des capitaux des pays Ã©mergents vers les pays dÃ©veloppÃ©s jugÃ©s aujourdâ€™hui plus sÃ»rs.
Le prix des matiÃ¨res premiÃ¨res est en chute depuis 2014, notamment dans le sillage du pÃ©trole qui reste bas pour des raisons Ã©conomiques et politiques, et les petits pays Ã©mergents dont les matiÃ¨res premiÃ¨res sont la principale richesse en souffrent.
La Chine connait une annÃ©e 2015 particuliÃ¨rement difficile. En effet, les perspectives de croissance ont Ã©tÃ© revues Ã la baisse par rapport aux annÃ©es prÃ©cÃ©dentes, la bourse chinoise a connu un mini krach en aoÃ»t et la banque de Chine a lancÃ© un signal trÃ¨s prÃ©occupant en dÃ©valuant lÃ©gÃ¨rement son Yuan en aoÃ»t, rompant momentanÃ©ment le peg liant le Yuan au Dollar.
Croissance du PIB chinois par anÂ :
|Croissance du PIB||9.3%||10.4%||9.4%||7.7%||7.7%||7.4%||7.0% (annoncÃ©)||6.3% (annoncÃ©)|
SourceÂ : Bureau national des statistiques
GRAPH INDICE COMPOSITE SHANGHAI en YTD
GRAPH USD/CNY en YTD
Quelles ont Ã©tÃ© les consÃ©quences pour les pays Ã©mergentsÂ et sur les marchÃ©s ?
Les Ã©conomies des pays Ã©mergents se sont retrouvÃ©es dans une situation difficile avec une croissance en perte de vitesse du fait de la baisse dâ€™activitÃ© de la Chine et le retour des capitaux vers les pays dÃ©veloppÃ©s. Alors que les banques centrales des pays Ã©mergents auraient pu baisser leurs taux directeurs afin de contrer la baisse de la croissance, elles Ã©taient bloquÃ©es du fait dâ€™une inflation importante rÃ©sultant des annÃ©es dâ€™investissement qui se sont Ã©coulÃ©es.
Ainsi, lâ€™un des seuls leviers restant est la dÃ©valuation de la monnaie. Le double impact de la dÃ©valuation volontaire de la monnaie et de la fuite des capitaux vers les USA et lâ€™Europe a eu un effet incroyable sur la valeur des monnaies des pays Ã©mergents.
Performance depuis le dÃ©but de lâ€™annÃ©e des devises Ã©mergentes
La 2e consÃ©quence plus inquiÃ©tante pour les pays Ã©mergents se rapporte Ã la dette. Alors que la tendance et lâ€™opinion des marchÃ©s sur les pays Ã©mergents sâ€™est retournÃ©e, les taux de financement des Ã©conomies Ã©mergentes ont fortement augmentÃ©, ce qui est matÃ©rialisÃ© par le marchÃ© des CDS.
Graph du CDS 5Y du BrÃ©sil, Afrique du sud, Turquie, Mexique, ThaÃ¯lande et Chine
Aujourdâ€™hui les pays Ã©mergents se trouvent dans une situation oÃ¹ les capitaux sâ€™en vont, les financements sont plus durs Ã trouver et plus chers et lâ€™Ã©conomie locale ne sâ€™est pas suffisamment solidifiÃ©e pendant la pÃ©riode Â«Â fasteÂ Â» de 2008 Ã 2013.
Lâ€™eldorado annoncÃ© ces derniÃ¨res annÃ©es pourrait donc bien connaÃ®tre une crise semblable Ã ce que les pays dÃ©veloppÃ©s ont connu depuis 2008.
The recent EURUSD spot move is drawing a new FX world picture. The acceleration of the move has been quite unusual for the last 5years (between the summers 2014 and today EURUSD spot lost almost 25%).
The market seems consolidating the current level around 1.0500-1.0700 which gives us the opportunity to analyze the situation.
What has changed in the EURUSD market which can explain this spot acceleration?
We can easily find arguments to demonstrate that what happened was predictable but without back trading consideration lets summarize some facts.
At the countries levels, Europe has to manage social tensions and political crisis. Greece, Ukraine, France (extreme right party increase) are elements which can explain the lack of trust in European countries to manage those issues. Terrorism represents as well in Europe a threat particularly imminent. European institutions have, by consequences, to deal between urgent threats with heavy political process and unlikely consensus making any solution very slow.
At the financial level, Central banks seem more and more isolated with a bigger distance with real problematic and finally a panel of solution quite limited to fix the economic situation. The SNB PEG release has been the perfect demonstration of this situation. By unexpected decision EURCHF collapsed from 1.2000 to 0.8500 in less than one day, making the FX market much more volatile and strengthening the trust issue in those institutions. All CHF exporters have seen their margins considerably reduced by that decision jeopardizing the Swiss economy. Even if the PEG was probably very expensive to maintain and unilateral decision created an extra tension to a situation already uncomfortable. In Europe, ECB decision to unleash QE seems to convince less than in the others countries due to the fact that it is difficult for nineteen Europeans nations to do the same thing. In New Momentum, we saw a lot of our customers (corporates and Institutional) believe finally in a limited centrals banks impact on the economic world.
What are the market anticipation and why the idea of breaking the parity is more and more credible?
One of the best way to have the market feelings about a trend is reflected in the market prices and more particularly in the FX options pricing. Why those products particularly because every parameter is priced: the level of volatility given by the implied volatilities and the smile which included the asymmetry between the upside or downside level (given by the Risk Reversal or RR).
The implied volatilities for example moved from the lowest levels ever this summers at a level almost three time higher (3 Months implied volatility moved from 4.88% the 30june14 to 11.31% actually (Bloomberg source)). The acceleration of the move is as important as the current level itself because it traduces the market tension with the current situation. All the elements explain in the previous part contributed for sure for a good part of it but the technical level of the current spot around 1.0500 very close of the psychological level of the parity maintains a high level of uncertainty. LetÂ´s relativize a bit those levels, in capital market world, FX remains an asset with the lowest volatilities. For example Lehman crisis brought EURUSD 3 Months implied volatility at 23% when the VIX reached more than 45%. Last point, does an asset with 25% move in few months is worth 11% vol Implied? The ratio seems to us still interesting even if the best level of the last summer seems definitively gone.
The smile component completed this analysis by the information regarding a trend. The 3 months 25d RR is quoting 2.10% PUT EUR over, it means that a PUT EUR 25d (strike 1.0165 with 1.0600 spot) will have a volatility 2.10% higher than CALL EUR 25d (strike 1.1003 with 1.0600spot). In other word the market is paying more to buy a hedge in the downside than the upside. Higher is the extra cost, more the market is ready to pay for the downside. To translate that with the market data the 3 months 25d RR moved from 0.55% PUT EUR over this summer at 2.10% currently, or almost 4 times higher.
The Graphic aboveÂ shows the 3 Months Implied volatility and 3 Months 25d Risk Reversal, confirming all the elements explained above with first an Implied volatility much higher and Risk reversal paying more for PUT EUR (-0.55% to -2.10%). The green curve reflects the spread and we see that during the last summer we were in a configuration where volatility and smile were the cheapest. It traduces a very interesting idea probably more explicit in the graphics below that PUT EUR 25d was on its cheapest level.
Between this summer and today, the PUT EUR 25d increased from 5.30% to 12.67%. This reflects all the ideas expressed above, the market prices the bearish trend much more than 8 months ago. An interesting exercise can complete this demonstration, letÂ´s consider the current spot 1.0600 (to be able to compare the volatility and smile effect we will assume a constant spot at 1.0600) and letÂ´s take the 01july2014 market data and the current one:
01july2014 : EUR PUT 25d with Spot at 1.0600 would be equivalent to a strike of 1.0415
17march2015 : EUR PUT 25d with Spot at 1.0600 is equivalent to a strike of 1.0202
What does that mean? If we had the July market data today, the strike would be closer than the current spot. The fact that we see more than 200pips between the two strikes reflects that today the market anticipates a much bigger potential on a downside movement. A corporate exposed to a EURUSD lower will have to pay a more expensive premium to get a hedge at a similar strike.
The previous elements finally have shown that the market anticipates all the current events as a serious and credible risk for EUR against USD (or others currencies). It would be probably interesting to quantify that risk and get some answer about a potential timing. Once again a part of the answer will be given by the market pricing but instead of considering vanillas options we will focus on One Touch options which reflects the price during a maturity to touch a certain level. On a spot ref of 1.0600, a 3 Month One Touch 1.0000 is priced 28% and a 6 Months One touch around 50%. In other words, the EURUSD Spot has 50% to reach 1.0000 in 6 months regarding the market anticipation.
Beside the mathematics, what would change a break of the parity?
LetÂ´s consider another effect very important and probably underestimated by the market, the psychological impact of a EURUSD below the parity. In New Momentum, we see a lot of customer under hedge on a level below 1.0000. That fact mixed with the bank risk aversion is creating a perfect situation for an acceleration below the parity. It means that the market is probably long EUR and will contribute to a panic situation when everyone will run behind their exposures. A lot of market experience disappears from the banks with the new bonus regulation, making the market with less memories than before. The recent EURCHF movement can give us a good idea of what can be a market panicking. Even if for the moment we believe in a consolidation of the spot (if any politic announcement or critical event happens), however we are firmly convinced than below the parity all the negative effects will accelerate the trend.