Europe’s government debt market was hit again on Wednesday, with Italy’s borrowing costs above the 7-per-cent level widely viewed as unsustainable despite the European Central Bank buying up its bonds.
Equity markets fell and Wall Street looked set to open lower. The euro itself hit a one-month low against both the dollar and the Japanese yen before recovering a bit on the ECB’s intervention.
Italian 10-year bond yields were at 7.18 per cent, the level generally seen as requiring an outside bailout.
Contagion has spread. Yields on core euro zone bonds issued by France, the Netherlands and Austria also rose as investors fretted about the ability of euro zone policy makers to end the crisis.
Euro-dollar cross currency swaps widened, a move that in the past has past has indicated that European banks are having difficulty raising dollar funding.
Traders said the ECB had bought Italian and Spanish debt, but an initial boost was wearing out. The central banks was “heavily in on Italy and Spain, 2-10 years,” one bond trader said.
Contagion from the weakest debt-ridden euro zone economies such as Greece into bigger ones such as Italy, Spain and even France is now the dominant fear for global investors.
It is no pandemic yet, but yields – how much it costs governments to borrow on financial markets – have been rising sharply almost across the board, with France now firmly in the firing line, suggesting the steps taken by policy makers and governments to contain the crisis have been nowhere near enough.
Investors question the ability of debt-ridden euro zone countries such as Italy to do what it takes to reverse their economic decline and the long-term willingness of the European Central Bank to act forcefully enough to end the crisis.
Up to now, it has bought bonds intermittently and only in sufficient size to stem sharp selloffs.
“The pressure is on the ECB. There are more calls on the ECB to step in more broadly to be a lender of last resort. It is not yet prepared to do these things. That’s why the market will remain fragile,” said Rainer Guntermann, a strategist at Commerzbank.
Attention is turning to France, one of the euro zone’s “core” economies, but with a large debt to GDP ratio. Yields on French 10-year bonds rose to 3.73 per cent, having traded around 2.5 per cent only two months ago.
If France succumbed, the entire euro project would be in peril.
French yields are way below crisis levels but still around 2 percentage points higher than German equivalents, a euro era record.
“We now have to ask ourselves: what if a state goes bankrupt? What if a state gets out of the euro zone?” said Bertrand Lamielle, head of asset management at Paris-based B*Capital.
World shares were generally lower with the MSCI all-country world index off a half a per cent.
In Europe, the FTSEurofirst 300 was down a quarter of a per cent.
“This market is not about macro or micro data, it’s all about sovereign bond yields. The apostles of the value style have been saying for 18 months: ‘stocks are cheap’. They look cheap indeed, but the focus is elsewhere,” Mr. Lamielle said.
The macroeconomic picture, framed by the debt crisis, is not robust. Data on Tuesday showed the economy of the 17-nation euro zone barely grew in the third quarter. ECB president Mario Draghi has predicted the currency bloc will be in a mild recession by the end of the year.
The euro slipped to a fresh one-month low against the dollar and the yen.
The common currency fell as far as $1.3437, its lowest level in more than a month, after the French bond yield spread over benchmark German bunds hit its euro-era high.
It was later flat on the day at $1.348.
“While it is clear that the data in the U.S. is improving, European concerns far outweigh (that) at present,” said David Scutt, a trader at Arab Bank Australia in Sydney.
“Markets are clearly expecting a circuit breaker to alleviate pressure on periphery bond yields. If no announcement is forthcoming in the days ahead, one suspects that the situation could unravel fairly quickly.”
Eastern Europe’s currencies take a euro zone beating
Far from benefiting from being outside the euro zone, eastern European countries are feeling the strain of exclusion from the club. Fears over the effects of euro zone turmoil in the Czech Republic, Hungary and Poland have sent the value of their currencies plummeting.
Since last Wednesday, when the euro began to feel the strain of escalating borrowing costs in Italy, the Hungarian forint has fallen more than 3 per cent against the single currency and the Polish zloty has weakened 1.5 per cent.
Even the Czech koruna, until as recently as last month the relative haven of the region, has lost its crown. After holding up well all year against the euro, the koruna has suffered a fall of 2.5 per cent in the past five days.
Foreign currency analysts have turned against the region in force. Economic analysis notes floating around in September argued confidently that the koruna had haven status among emerging market currencies. Now, many have performed a volte face on the Czech unit and recommend selling it against the euro.
Many analysts are surprised it has taken the foreign currency market so long to work out that the impact of the euro zone crisis on the region’s close trading partners in eastern Europe was likely to be severe.
The Czech Republic is the most exposed emerging market to the euro zone. In the past 12 months, its exports to the region as a share of gross domestic product were 49 per cent, according to data from Haver Analytics compiled by UBS.
Hungary’s exports to the euro zone made up 44 per cent of its GDP, while Bulgaria and Poland both export 20 per cent of their GDP to the region.
By contrast, Russia’s exports to the euro zone are less than 10 per cent of GDP, while Turkey’s are just over 5 per cent.
Consequently the fact that the koruna fell from grace only last week was seen as a rather belated reaction. “I’m surprised it has taken this long,” says Bhanu Baweja at UBS.
The Czech currency has suffered a drastic change to its profile in recent weeks thanks to the actions of neighbouring central banks. For most of the year, the koruna has been used as a “carry” currency for the region – with investors borrowing in the relatively low-yielding koruna to invest in other currencies with higher yields, such as the forint. When risk aversion rose, traders closed the position, causing the koruna to strengthen.
But the actions of Poland’s central bank – it stepped in to defend its currency last month – have made the carry trade far less attractive.
On Tuesday, the Hungarian central bank also indicated that it was not happy with how weak the forint had become. Many analysts are expecting a sizable interest rate rise in the near future. Benoît Anne at Société Générale predicts the Hungarian central bank will need to raise rates by 2 to 3 per cent if it is to have any effect in stemming the tide of money leaving the country.
The Czech Republic, by contrast, is expected to keep its currency weak, in part because of the importance of exports to the country. As a result, the koruna is no longer seen as defensive.
“It was the yen of emerging markets, but the trading characteristics of the koruna have been seriously altered,” says Mr. Anne.
In fact, shorting the eastern European currencies against the euro is becoming the new hot trade – which is lending support to the euro itself.
“You’re starting to see traders talk about this as being the next game, which is more of a European economic slowdown story,” says Geoffrey Kendrick at Nomura.
The prospects for the forint and the zloty are not much better. Hungary’s outlook was downgraded by Fitch last week to negative. The country’s banks in particular are suffering, as a result of the introduction of a law that forces them to allow homeowners to pay back at below-market rates mortgages that were taken out in foreign currencies such as the Swiss franc, which has since soared. The move is expected to harm bank profits.
And on Tuesday, Moody’s, the credit rating agency, revised its outlook for Poland’s banks to negative.
Yet analysts at UBS think shorting the koruna against the U.S. dollar is one of the best ways of expressing a negative view on Europe over the next year, in part because the other eastern European currencies have fallen so much.
A difficult year lies ahead for these currencies. “I think they will continue to underperform,” Mr. Baweja said. “There is no real reason for them to outperform.”
Copyright The Financial Times Ltd. All rights reserved.
Mass bond selloff takes Europe from bad to worse
The European debt crisis is rolling across the continent at alarming speed, proving that almost no country is immune to the contagion unleashed by Greece and Italy as confidence in the region’s ability to reduce its debt loads evaporates.
Yields on the 10-year bonds of France, Belgium, Spain and Austria all soared to record euro zone highs on Tuesday in spite of fresh data showing that the German economy is still expanding and despite the tentative launch of caretaker governments in Rome and Athens with mandates for economic reform.
The mass selloff drove up the debt yields of countries that had been considered havens, including Finland and the Netherlands. “Global financial markets are facing a key pivotal point,” analysts at Barclays Capital said in a Tuesday research note. “A further escalation of the European debt crisis is putting at risk the nascent stabilization of global growth.”
Italy’s post-Silvio Berlusconi honeymoon proved exceedingly short-lived. Last week, yields on 10-year Italian bonds went to a record 7.48 per cent. They dipped after Mr. Berlusconi resigned as prime minister, then came roaring back, climbing back above 7 per cent on Tuesday, even as Mario Monti, his replacement, came close to forming a new, cross-party government. Mr. Monti is to unveil his cabinet on Wednesday in Rome.
The bond selloff hit France, whose triple-A credit rating is at risk. The French bond spread over equivalent German bonds widened by 23 basis points to 188 basis points, the most since the common currency was launched in 1999 (100 basis points equals one percentage point).
The yield on German debt – the euro zone’s last low-yield sanctuary – continues to sink as investors rush to safety. At 1.76 per cent, the yield on 10-year German bonds is now less than half of the French yield.
Spain, where the economy is on the verge of another recession and unemployment is still rising – it reached a new euro zone high of 22.6 per cent in September – saw its 10-year bond yields surge to 6.3 per cent. That took the spread over German bonds to a record 458 basis points.
The resurgence of Spain’s debt crisis was underlined by the treasury’s failure on Tuesday to reach the target sale of €3.5-billion ($4.8-billion) of 12- and 18-month bills. The yield on the 12-month securities went to 5 per cent, well above the 3.6 per cent at a similar sale only a month ago.
The rising bond yields throughout the euro zone, outside Germany, can in good part be blamed on the banks’ wholesale retreat from sovereign debt. The banks are under political pressure to keep their Greek bonds, for fear that a wave of selling would destroy what little remains of the country’s debt market. That means the banks are unloading other risky sovereign bonds, in particular Italy’s, to bring down their overall exposure.
BNP Paribas, one of the largest French banks, reduced its Italian bond holdings to €12.2-billion from €20.8-billion in the third quarter. Deutsche Bank reduced its Italian exposure by 88 per cent in the first six months of the year. Germany’s Commerzbank AG said earlier this month that it is selling sovereign bonds at a loss, and Global Sovereign Open, Japan’s biggest mutual fund, unloaded all of its Italian bonds this month, according to a Bloomberg News report.
Economists think the rush to sell sovereign bonds was triggered by several factors: a European Union agreement with the banks to write down Greek bonds by 50 per cent, creating a precedent that bond investors fear will be repeated elsewhere in the euro zone; the European Central Bank’s reluctance to buy distressed bonds; and European politicians open talk about member countries leaving the euro zone.
On Tuesday, Dutch Prime Minister Mark Rutte said it should be possible to expel members from the euro zone. The day before, German Chancellor Angela Merkel’s Christian Democratic Union party voted to allow countries to leave the euro zone. While the vote carries no legal weight, it reflects the CDU’s rising skepticism about the euro project.
The near certainty that the euro zone is about to enter another recession also spooked the bond markets.
Eurostat, the European Union’s statistics agency, reported Tuesday that the euro zone’s gross domestic product expanded by a mere 0.2 per cent in the third quarter over the previous three months. While Germany performed well (with third-quarter growth of 0.5 per cent) economists warned that 0.2 per cent was probably as good as it gets and that the next figure might be negative because of the escalating debt crisis and austerity programs.
A scary prediction for the collapse of paper money
What should U.S. Federal Reserve chairman Ben Bernanke do next? London-based economist Detlev Schlichter says, succinctly: “Abdicate.” What should U.S. President Barack Obama do next? Mr. Schlichter says, succinctly: “Abdicate.” With Mr. Schlichter, you aren’t left with much doubt about his position. He says the world’s major currencies are destined to crash. “The dollar, the euro and the yen are locked in a race to the bottom,” he writes on his website, papermoneycollapse.com. The only question is which one crashes first.
Mr. Schlichter argues that we are only part of the way through the market meltdown – and that the worst is still to come. How much worse? Considerably worse, he says, than the Great Depression.
U.S. industrial production is 12 times higher now than it was in 1929, he says; but the amount of U.S. dollars in circulation is 200 times higher.
The U.S. net debt was 150 per cent of GDP in 1973, when then-president Richard Nixon took the country off the gold standard; yet its net debt reached a record high in 2010: 370 per cent. The United States will fall further, Mr. Schlichter insists, because it has further to fall.
Mr. Schlichter is the German-born, British-based author of a provocative and disturbing new book, Paper Money Collapse: The Folly of Elastic Money and the Coming Monetary Breakdown. An investment manager with JPMorgan, Merrill Lynch and Western Asset Management for 20 years, he quit to write his stern warning of an impending dollar doom.
From his own melancholy perspective, he thinks the crisis will come a little later on – because, he says, the central banks still imagine that they can keep the printing presses running indefinitely. The longer the presses run, Mr. Schlichter says, the more calamitous the crash. And Mr. Bernanke has hardly begun.
Mr. Schlichter recalls Mr. Bernanke’s famous assertion in 2002 that, with the world’s largest printing press, the Federal Reserve can produce “as many dollars as it wishes at essentially no cost.” Mr. Schlichter says: “Within the logic of the present system, the next step [by central banks] must involve the use of the printing press to fund further state expenditures, to fund corporate spending and, ultimately, to fund consumer spending.” In other words, the central banks won’t stop printing money until they’ve quantitatively eased people’s car loans and people’s credit cards.
Mr. Schlichter’s analysis rests on an Austrian-school interpretation of things. (“There is no means of avoiding the final collapse of a boom brought about by credit expansion,” Ludwig von Mises wrote in 1949 in Human Action. “The alternative is only whether the crisis should come sooner … or later as a final and total catastrophe of the currency system involved.”) The essential premise of the Austrians is that paper dollars get depreciated, sooner or later, “to a dime a dozen.”
Paper Money Collapse traces the history of paper currencies that weren’t at least partly guaranteed by a fixed-quantity commodity (which, for all practical purposes, means silver or gold). The Chinese invented paper and ink in the year 1000, Mr. Schlichter notes – discoveries that led quickly to paper money. He tracks China’s paper money through a number of dynasties. His conclusion: All of these experiments ended with worthless currencies. The Chinese abandoned paper money in 1500 (returning to it, under Western influence, in the 1800s).
Paper currency, he says, hasn’t fared any better in the West. He defines hyperinflation as a monthly rise in consumer prices of 50 per cent or more; the 20th century, he says, witnessed 29 such hyperinflations involving “elastic money.” Mr. Schlichter thinks that the collapse of U.S., European and Japanese currencies will be the worst in history. It will be a collapse “of epic proportions.”
Mr. Schlichter does not recommend an investment strategy for “the coming monetary breakdown.” And gold, he insists, should not be regarded as an investment. Gold, rather, is simply money, a medium of exchange – and the most successful form of it in history. But the cash in your pocket doesn’t pay interest or dividends and the gold in your pocket doesn’t, either.
“A collapse of paper money will be a momentous event,” he writes. “It will produce a transfer of wealth of historic proportions.” But it does not mean the end of civilization. All wealth is not illusion. And real wealth will survive.