Global Investing

Funding stress in the FX swap market

Signs of the wholesale funding stress are cropping up in the FX swaps market, with the premium for swapping euro LIBOR into dollar LIBOR over 3 months (so-called cross currency swap) rising to 141.5 basis points, which is the post-Lehman Brothers high.

The premium has skyrocketed in the past six months (back in May it was only 16.5bps) because European banks needing funds are forced to turn to the FX swap market, and other banks are reluctant to lend to European companies in the United States.

And it looks like the situation is going to get worse from here, because of weak dollar bond issuance by euro zone companies.

JP Morgan says companies across the euro zone are not issuing very much — the average issuance over the past two months stands at only $1.3 bln, compared with a $4.5bln per week pace seen over the first half of the year, when dollar funding conditions were less stressed.

“The fact that dollar issuance is so subdued even for euro area non-financials is worrying as it suggests investors do not differentiate between euro area issuers. This is reinforced by the fact that dollar issuance by European companies outside the euro area appears relatively unaffected,” JP Morgan writes.

Good reasons for rupee’s fall but also for recovery

It’s been a pretty miserable 2011 for India and Tuesday’s collapse of the rupee to record lows beyond 52 per dollar will probably make things worse. Foreigners, facing a fast-falling currency, have pulled out $500 million from the stock market in just the last five trading sessions.   That means net inflows this year are less than $300 million, raising concerns that India will have trouble financing its current account gap.  The weaker currency also bodes ill for the country’s stubbornly high inflation.

Why is the rupee suffering so much? First of all, it is a casualty of the general exodus from emerging markets. As a deficit economy, India is bound to suffer more than say Brazil, Korea or Malaysia.  And 18 months of interest rate rises have taken a toll on growth.

UBS analysts  proffer another explanation. They point out a steady deterioration in India’s net reserve coverage since the 2008 crisis. The reserve buffer — foreign-exchange reserves plus the annual current account balance, minus short-term external debt — stands at 9 percent of GDP, down from 14 percent in 2008.  Within emerging markets, only Egypt, Venezuela and Belarus saw bigger declines in net reserve coverage than India.

“What it really means for the present, in our view, is that the rupee is now joining the ranks of higher beta “risk” currencies,” UBS said.

Still not everyone is overly perturbed. Some expect the rupee to rebound as the global picture improves. One reason is that the rupee is generally seen as undervalued in nominal terms, as well as on purchasing power parity (PPP) basis, more so than most emerging currencies. The latter is the rate at which one currency would convert to another to buy the same amount of goods and services in each country. On that basis the Indian rupee would equate to 20 to the dollar, data from the World Bank/IMF shows.  Given the strong underlying story, investors are more likely to buy back the rupee than say the South African rand when risk appetite improves.

Furthermore, Indian equity valuations are looking more reasonable than before, despite the slowing economy. Stocks trade now around 12 times forward earnings, compared to 17 times a year ago. That should lure some overseas cash once the dust starts to settle.

“This may not be bottom of the market but for us, investing at these levels of currency and equity valuations is an attractive proposition,” says Phil Poole, head of global and macro strategy at HSBC Global Asset Management.

Healthy flows into money market funds

Despite concerns about contagion from the euro zone, investors injected fresh funds into U.S. mutual funds, including money market funds, latest weekly flow data from Lipper shows.

The week ended Nov 16 saw a net $10 billion inflow into mutual funds, including ETFs, while investors were net buyers of equity funds with flows at $2.8 billion. Equity funds, including ETFs, witnessed their fifth consecutive week of net inflows.

Reflecting jitters over the debt crisis however, investors injected $2.8 billion into taxable fixed income funds and for the second week in a row bought into money market funds to the tune of $2.9 billion.

Despite tensions in the funding market (LIBOR dollar rates were up again and 3-month euro/dollar cross-currency basis swaps hit their widest since December 2008 at 134bps yesterday), money market funds especially in the United States are attracting safe-haven flows. According to flow data from the Investment Company Institute, total U.S. money market mutual funds increased by $6.41 billion to $2.645 trillion for the week ended Wednesday.

So it seems no “breaking the buck” fears are resurfacing just yet.

Timing the next bull market in stocks

Markets are down again today (MSCI world index down 0.7 pct so far this morning) and the market overall is nearing a bear market territory again (from a three-year high hit in May).

But asset managers are starting to look forward.  JPMorgan Asset Management reckons that if one assumes the current bear market for most equity indices started in 2000 and that the the trend of the previous experiences is to be repeated, then the current environment should be ending around 2014 (By the way, those who predict stock market cycles with sunspots activity reckon the year 2012 or 2013 is the bottom, but that’s a different story.)

But 2014 does seem a long way off.

“While this may sound depressing from 2011, we hasten to add that we are not expecting the ongoing bear market to result in continued downside, but rather in persistence of broad range-trading prior to a sustained breakout to the upside,” Neil Nuttal of JPM AM writes.

Nuttal says that since 2000 the  S&P 500 average level is close to 1,200 (compared with Thursday’s close of 1,216.13) , meaning the market has not slid too far out of range.

“At present, the wall appears to be very much in evidence while providing very little opportunity for ascent, notably in Europe, but not exclusively so… The majority of investors are light of risk, meaning that the pain trade (the development that would cause the most pain to the most people) would be a sharp rally in risk assets,” he adds.

In Africa, they’re getting older too

In France, they protested about rising retirement ages.  Across the globe in China, the country’s ageing population is expected to dent productivity and growth.

But it’s not only in the more prosperous corners of the world that governments are worrying about how to cope with the needs of increasingly older people.

Africa and the Middle East are usually seen as hotbeds for the young, with all the issues that can bring in terms of unemployment, migration and social unrest.

But a report by the African Development Bank today suggests growing old is a problem for Africa too. According to the AfDB:

Africa’s population is ageing, just like in the rest of the world, but the continent’s governments are ill equipped to handle the growing number of older people. The percentage of people aged over 65 in Africa has grown to 3.6 percent in 2010 from 3.3 percent in 2000. It is a long-term phenomenon, having steadily grown over the last 40 years, and it will accelerate in coming years.

Better life expectancy is causing the change, but most African governments are spending too little on healthcare, the AfDB says. And while pension funds in the developed world are scrabbling around to secure high enough returns to pay out to pensioners, many older Africans do not have a pension.

No wonder African investors, particularly private equity firms, see some of the biggest growth in the continent in healthcare and financial services.

Hungary and the euro zone blame game

More tough talk from Hungarian officials on the ‘unjustified’ weakness of the country’s currency, which has dropped 11 percent against the euro this year to all-time lows.

This time, it’s central banker Ferenc Gerhardt arguing that the weakness of the forint is out of sync with economic fundamentals and blaming it on the debt turmoil in the euro zone.

Perhaps he should look a little closer to home.

Hungary’s drift from orthodox economic policy since the centre-right government took over the reins last year has made it the most exposed of eastern European economies.

The ruling party Fidesz swept into power  promising to create a new social contract that would subject the economic system to the “popular democratic will”. Ironically, the policies of Prime Minister Viktor Orban have made Hungarian markets more sensitive to the global sentiment than ever.

Domestic investor participation in local bonds and stock markets has fallen since the government controversially seized private pension fund assets to boost state coffers this year.

Average daily trading volumes on the Budapest stock exchange have slipped 25 percent this year while non-resident ownership of local-currency bonds are at elevated levels — as high as 40 percent — and estimated to be worth a considerable 4.8 trillion forints ($20 billion)

from MacroScope:

Who are hedge funds dating?

The world of hedge funds is as mysterious as it is profitable, and remains highly opaque even after a raft of new reforms aimed at strengthening financial stability. While there is general agreement among policymakers that the the so-called shadow banking system was at the epicenter of the financial crisis of 2008, hedge funds still face little or no regulatory scrutiny, despite their size and importance in financial markets.

That worries Andrew Lo, a professor at MIT’s Sloan School of Management. For him, the basic registration requirements for hedge funds are not nearly sufficient to give regulators a broad sense of the potential risks present in the markets. On the sidelines of an International Monetary Fund meeting, Lo compared the relationship to that of a parent keeping tabs on a growing teenage child.

Let’s say you’re a parent and your child has started dating. You don’t necessarily need to know everything they are doing, but you’d at least like to know who they are going out with.

That’s a particularly apt analogy since the main concern for financial sector regulators is that losses in the unregulated sector might deal a large blow to the banking system itself, forcing another round of bailouts.

Lo, who also runs an investment fund called Alpha Simplex, said during his presentation that the Dodd-Frank financial reform law still leaves regulators powerless to manage this highly-influential part of the financial system:

Central banks simply don’t have the tools right now to deal with this sector. They cannot control leverage or stop runs that go on in the sector, in the same way that they couldn’t control Bear Stearns and Lehman Brothers, and in the same way that they cannot control what’s going on today with MF Global.

from Anooja Debnath:

When it comes to recessions, 40 is the new 50

If it were about age, 40-somethings would cringe. But it seems a dead certainty that 40 now means 50 -- or even higher -- when it comes to predicting the chances of a recession taking place.

Going by past Reuters polls of economists, every time the probability hits 40 percent, the recession's already started or is perilously close to doing so.

After the brief recovery period from the Great Recession, Reuters once again started surveying economists several months ago on the chances of developed economies stumbling back into the muck.

As the data get nastier and euro zone politicians wrangle over the sovereign debt mess, the probability goes higher. Just not high enough or fast enough.

The probability that Britain slides back into recession hit 40 percent in the Reuters poll this week, up from one in three last month.

The last time that happened was in July 2008, a few months before U.S. investment bank Lehman Brothers collapsed. The British economy contracted by 2 percent that quarter, its second contraction of 2008. And we all know what happened next. If 40 is the new 50, we're in it.

"It is a very big thing to say we are going into recession ... it is one of those things people are cautious sticking their necks out about," said Alan Clarke, who said there’s a 75 percent chance of that happening.

RIC (without the B) carry extreme risks, index says

They may be among the only economies left to save the world — or at least the euro zone – but Russia, India and China are extremely risky bets, according to an economic, social and governance scale compiled by risk consultancy Maplecroft.

The company’s ESG Atlas and Risk Calculator allows investors to choose across ESG issues from 47 risk indices, to make country scorecards.

On that basis, China and India are among 38 countries classified as “extreme risk” in one or more categories. Among those, India is in the bottom 10 for environmental issues.

Russia, meanwhile, shows extreme governance risks, like poor rule of law and systemic corruption.

Bottom of the pile, however, are Somalia, North Korea, Myanmar and DR Congo, while Greece and Italy don’t do too well on governance and auditing standards.

These risks don’t appear to have deterred Jim O’Neill, chairman of Goldman Sachs Asset Management and coiner of the term BRIC — O’Neill is an investor in Maplecroft.

Contemplating Italian debt restructuring

This week’s evaporation of confidence in the euro zone’s biggest government debt market — Italy’s 1.6 trillion euros of bonds and bills and the world’s third biggest — has opened a Pandora’s Box that may now force  investors to consider the possibility of a mega sovereign debt default or writedown and, or maybe as a result of,  a euro zone collapse.

Given the dynamics and politics of the euro zone, this is a chicken-or-egg situation where it’s not clear which would necessarily come first. Greece has already shown it’s possible for a “voluntary” creditor writedown of  the country’s debts to the tune of 50 percent without — immediately at least — a euro exit. On the other hand, leaving the euro and absorbing a maxi devaluation of a newly-minted domestic currency would instantly render most country’s euro-denominated debts unpayable in full.

But if a mega government default is now a realistic risk, the numbers on the “ifs” and “buts” are being being crunched.

In that light, Mark Schofield and Jamie Searle, strategists at U.S. investment bank Citi,  on Thursday attempted to figure out “fair value” for Italian government borrowing rates in the light of the week’s dramatic events that saw 10-year yields on the bonds briefly top the “make-or-break level of 7% . Their conclusion was that Italian debt crunch was likely to get get a lot worse before it got better, absent a “significant and sizeable” political intervention.  By this, they are referring to the only scenario that they see would trigger a near-term turnaround — open-ended ECB buying on a scale far greater than currently being seen.  However, they reckoned they still seems unlikely, for now.

What’s left of the 440 bilion euro bailout fund is not big enough to rescue Italy — where more than 300 billion euros needs to be found next year alone to pay interest costs and replace maturing debt. And with the recently-agreed, leveraged-up version of that EFSF unlikely to be finalised until next monthat the earliest, the Italian market is left in limbo.

As a result, the Citi analysts say it’s become impossible to assess fair value for the market based on macro  fundamentals such as debt stock, budget deficits, national growth, inflation and central bank interest rates. So, they reckon they have to apply a “recovery-based default model” that takes in hypothetical debt restructurings and default probabilities. Given the recent Greek example, the 50% debt haircut has inevitably become a reference point.

Given that scenario, they reckoned 10-year Italian borrowing rates would have to rise as high as 14.5% — more than twice current rates — to compensate for the risks.