While all eyes have been on the US this week, pressure is rapidly mounting on the eurozone periphery as the perceived risk of restructuring or even default is now reaching a tipping point. Portugal this week paid 3.26% for 12-month loans compared with 2.88% last month. Irish 10-year bond yields have hit new highs above 7.5% while Greek debt pushed back above 11% and Portuguese 6.4%. Currency investors seem strangely nonchalant so far, but that will change. A Franco-German push to ensure that private bondholders and investors shoulder more of the costs of future sovereign bail-outs under a new rescue system was approved at last Friday’s summit of European leaders. I’ve been saying for a while that Germany was putting the legal framework in place for sovereign ‘administration’ and an orderly restructuring of peripheral debt; last week that inevitability moved a key step closer. Underlining the risks last week, Greece downgraded its growth forecast to minus 4% for 2010 and minus 3% for 2011 as a deflationary death spiral takes hold.
Meantime the chief economic advisor to the Irish government announced that the IMF would be running the country by February if mooted budget cuts didn’t reverse bond investor sentiment before new auctions begin. While China says it may buy Greek and Portuguese bonds, Russia has just announced that its oil wealth fund will exclude Irish and Spanish bonds from its portfolio. Ireland has no bond auctions scheduled until mid 2011 and is pushing through another €15bn in budget cuts to bring its deficit to 3% of GDP by 2014 from 32% this year. Portugal needs to raise over €30bn of new funds in 2011, with nearly €20bn of redemptions in H1. Unless investor confidence is restored swiftly, it now seems only a matter of months before at least one member of the eurozone periphery will need the support of the newly created European Financial Stability Fund if not quite yet the IMF.
The rally I expected through the summer has been powerful and can push on further into early 2011 on a combination of attractive earnings versus bond yields , growing share buybacks as blue chips adjjust their capital structures accordingly and ample liquidity. However, we are now very extended near-term, and the blowback from QE2 in terms of inflation pressure and EM capital controls, as well as renewed eurozone funding concerns, are sufficient to generate a correction from overbought levels, as we saw in April. Medium term, this attempt to yet again artificially boost asset values rather than focus on investing on sustainable, productive growth is doomed to failure; money printing, like debt, suffers diminishing marginal returns and on a net basis the impact on real living standards via the cost of clothing, food etc will be negative at a time when real incomes are stagnant. With the hardening of political attitudes in Washington post the mid-terms, as a result Ben Bernanke may well end up being the last Chairman of the Federal Reserve as we currently know it, which would be quite a legacy.
Back on July 28th amid panic about an imminent double dip I wrote that:
The US is slowing to about 2% annualized growth in H2, which is mediocre in the context of the recession we've just seen but hardly justifies the fear and loathing we've seen recently among investors. Meantime, it's notable that emerging markets such as Turkey and Indonesia are hitting new all-time highs, while trade and export oriented indices from South Korea to Germany are hitting new recovery highs. While U.S. investors are busy getting scared, the rest of the world is busy getting rich.'
Having just spent a week visiting clients across Asia, they'e getting rich at quite a pace and America's relative decline is accelerating, with the Fed's reckless throw of the monetary dice drawing scathing criticism from global central bankers.
As the Fed injects another $900bn (with $600bn of that from QE2) in liquidity through H1 next year just as the global economic ‘soft patch’ seems to be passing, it risks pushing global input price inflation to multi-decade highs and force Asian central banks to introduce aggressive capital controls. This week’s ISM Non Manufacturing index showed the second straight month of growth, which hasn't happened since March this year. Global PMIs last month recorded their first m/m rise since the growth scare began in May, and the change has been positive in each of the major economies except Japan with generally encouraging rises in new order/inventory ratios suggesting that the much hyped double-dip is receding into the rear view mirror.
US auto sales jumped to an annual pace of 12.3m units during October, up from 11.8 million in September; Ford is now up nine fold since March 2009 while GM is about to IPO at a pretty aggressive valuation. The October sales level is the highest in two years, excluding the distortion of the temporary sales incentive program in 2009. The rise in US long bond yields since early September has been relentless and the 5yr-5yr forward breakeven inflation rate (which is more sensitive to changing expectations than the spread between 10-yr Treasury yields and equivalent TIPS yields) has surged from 1.92% in late August to over 3% this week. This measure of inflation expectations is hitting levels rarely seen since TIPS were first launched in 1997.
Disclosure: No positions