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Tuesday, 13 January 2009
Policy Measures Starting to Show Results: Wen
Premier Wen Jiabao says China’s efforts to break out of an economic slump amid global turmoil are starting to show results, with the economy performing better than expected in December, state radio reported.
(BEIJING) Premier Wen Jiabao says China’s efforts to break out of an economic slump amid global turmoil are starting to show results, with the economy performing better than expected in December, state radio reported.
‘The policy measures we have taken have achieved initial results,’ Mr. Wen said, China National Radio reported on its website. ‘Economic conditions in December were better than expected.’
Revenues at some companies are rising, backlogs of unsold goods are falling and power consumption is growing, Mr. Wen was cited as saying during a three-day visit to factories in the eastern province of Jiangsu. The report gave no figures.
Mr. Wen’s comments appeared to be part of efforts to restore flagging corporate and public confidence - a key element in Beijing’s plans, which rely on spurring private investment and consumer spending - and could be a positive sign for hopes China will help to drive a global recovery.
Beijing announced a four trillion yuan (S$870.3 billion) stimulus package in November aimed at reducing reliance on exports by revving up domestic consumption. Effects of the spending are not expected to be seen for several months, but some industries such as steel are stepping up activity in anticipation of revived demand.
‘The early results are not big, but they are strengthening our confidence that we can triumph over adversity,’ Mr. Wen was quoted as saying.
China’s exports fell in November for the first time in seven years and manufacturing activity shrank in December for a third straight month. December trade figures are due to be released today, and analysts expect more weakness amid lacklustre global demand.
China’s 2008 economic growth is expected to fall to about 9 per cent, down from 2007’s 11.9 per cent. Analysts have cut this year’s forecasts to as low as 6 per cent - a worrisome sign for communist leaders who need to satisfy a public that expects steadily rising incomes.
The fall in export demand has triggered factory closures and layoffs in trade-dependent coastal areas in the south.
The government has warned that rising unemployment could fuel unrest and is pressing companies to avoid more job cuts.
Mr. Wen said Beijing will take additional steps, including spending 600 billion yuan on long-term scientific and technological projects, according to the report.
The shortfall at company retirement schemes insured by the Pension Protection Fund soared to more than £200bn in December, setting an unwelcome record as the drop in gilts yields outpaced rising equities markets.
The PPF said the percentage of defined benefit schemes with a deficit rose to 89 per cent of the almost 7,800 plans whose benefits it guarantees – up from 79 per cent in December 2007. The aggregate shortfall of these schemes was a record £209.6bn, up from a high set only last month at £155bn.
About 11 per cent of schemes had a surplus of assets over liabilities, leaving the PPF facing an aggregate deficit of £194.5bn, up from £136bn in November. But the aggregate shortfall is a meaningless number because one scheme’s surplus cannot be used to offset another’s shortfall.
The PPF only insures 90 per cent of promised pensions up to about £28,000 and has limits on annual rises in line with inflation. The value of what is insured is about 70 per cent of that of promised benefits if a solvent employer transferred the assets and liabilities to an insurance company.
The PPF’s role is to step in when an employer becomes insolvent leaving an underfunded pension scheme. But with corporate insolvencies on the rise – Land of Leather yesterday joined a list that includes Woolworths and Waterford Wedgwood – there has been increasing concern about the PPF’s ability to shoulder its financial obligations. So far, Partha Dasgupta, the PPF’s chief executive, has said the nature of the PPF’s liabilities means it can withstand even quite a severe recession.
But the weakened state of some employers has left trustees to press for additional contributions at a time when companies can least afford them.
The PPF publishes its 7800 Index to help keep track of the funding status of UK retirement plans.
In December, much of the increase in the deficit stemmed from a sharp fall in gilts yields, which led to a 10 per cent rise in liabilities. To some extent this was offset by a rise in the FTSE All Share index of 3.5 per cent, but the fact UK pension schemes remain relatively heavily invested in equities makes them particularly vulnerable to shifts in markets.
NEW YORK (AP) — Year after year, the hedge fund industry dazzled Wall Street by delivering "absolute returns" -- outsized profits whether markets rose or fell. Using sophisticated trading models, the pools of managed capital made wealthy people wealthier with eye-popping returns that carried seemingly moderate risk.
Not these days. Blind-sided by a colossal market collapse and the widening Bernard Madoff scandal, hedge funds suffered their worst showing on record last year. And they're bracing for more pain in 2009. The industry's fall proves that even the quantitative brilliance and market wizardry of elite hedge funds are no magic bullet for investors during brutal times.
"Hedge fund managers have always said, 'Look, we know how to make money even in difficult times,' and that turns out to be a fallacy," said Timothy Brog, portfolio manager of New York-based hedge fund Locksmith Capital Management.
Nearly 700 funds -- 7 percent of the industry -- shut down in the first three quarters of 2008, up over 70 percent from the same period last year, according to Hedge Fund Research, a Chicago-based data firm. At that rate, roughly one in 10 hedge funds will have disappeared last year when final numbers are released in coming weeks.
Thousands more are expected to die in 2009 as investors who have been clobbered by losses yank out what's left of their money. Those investor redemptions have forced many hedge funds to liquidate large chunks of their assets, triggering "dramatic" swings in the stock market late last year, Brog said.
"Even if hedge funds make up only 10 percent of the market, it's going to have a big effect if they sell all at once," he said.
Besides the financial crisis and massive losses from Madoff's alleged Ponzi scheme, self-inflicted wounds also haunted hedge funds, experts say. The funds' high-octane investment philosophy, they say, pushed many managers to make big bets with borrowed money despite the dangers.
"We grew into this culture of gunslingers," said Bill Fleckenstein, founder and president of Seattle-based hedge fund Fleckenstein Capital.
For many hedge fund managers, the notion of managing risk through cautious trading was a "recipe for getting fired," he said.
"All anyone really wanted was performance, and managing risk was a drag on performance," Fleckenstein said.
The average hedge fund lost 18 percent of its value in 2008, the industry's worst performance on record and down from an average gain of 9.96 percent in 2007, according to Hedge Fund Research. The only other negative year on record was in 2002. But even then, funds only lost an average of 1.45 percent.
Still, compared with the wider market, hedge funds don't look so bad. The Dow Jones industrial average lost 34 percent in 2008, while the Standard & Poor's 500 index fell 38 percent.
But hedge funds were never supposed to lose money.
The loosely regulated pools of capital burst onto the investment scene in 1990 with $39 billion in assets and quickly ballooned in numbers. Today, there are some 10,000 hedge funds, most of which cater to wealthy investors and promise big returns in virtually any economic climate.
Many hedge funds use complex models to trade crude oil and soybean futures, derivatives and other exotic assets out of reach to ordinary investors. Investors typically are charged a yearly fee equal to 2 percent of assets and 20 percent of profits. That fee structure has reaped eight- and even nine-figure paydays for the most successful portfolio managers.
But not now. Hedge funds' assets hit an all-time peak of $1.93 trillion in June but have since fallen to $1.56 billion, according to Hedge Fund Research. The steep declines mean that most portfolio managers will be taking much smaller paydays in 2009.
Still, not every hedge fund lost money last year.
Chris Wang, founder and portfolio manager of New York-based SYW Capital Management, enjoyed a sizzling 2008 managing $52 million in assets. Using a strategy of "short-selling," or betting that stocks will fall, he managed a return of 80 percent. Wang, 36, said his fund "became ultra-bearish" once the scope of the credit crisis became clear.
"We could see the world coming to an end before our very eyes," Wang said.
Unnerved by losses, many hedge fund investors want their money back. Investors yanked $40 billion out of hedge funds in October, according to Hedge Fund Research.
Those who got their money out were the lucky ones. In recent weeks, dozens of hedge funds have imposed "gates" keeping investors from withdrawing their money, fearing a run on their assets that could drive them out of business.
As troubled funds throw up the gates, investors have little choice but to pull money from healthier funds, which then are forced to sell assets to raise cash.
"It's disappointing," said Robert Romero, manager at Palo Alto, Calif.-based Connective Capital, a $120 million hedge fund that delivered a 3.5 percent return in 2008. He said he expects to lose about 20 percent of his capital from redemptions.
Hedge fund investors are also grappling with the still unknown toll of Madoff's alleged Ponzi scheme, which authorities say bilked investors of billions of dollars. Among the largest victims were investors in "funds of funds" -- capital pools that invested across a number of hedge funds, supposedly limiting risks.
Many funds of funds that were wiped out with Madoff have come under fire for not adequately vetting his trading strategy and for failing to diversify investors' assets. Several have written to frantic investors to reassure them that they're closely monitoring their investments, said Nadia Papagiannis, an analyst at Morningstar.
For many funds of funds, it's too late. There were 3,660 funds of funds listed in Morningstar's database at the end of 2008, a drop of about 12 percent from the previous year.
Fewer funds of funds mean fewer dollars flowing into traditional hedge funds. That will make it harder for many hedge funds to stay afloat in 2009. Barclays Capital strategist Robert McAdie has said that 70 to 80 percent of hedge funds could disappear this year.
Those that survive are likely to undergo sweeping changes, including lower fees charged to investors and a more back-to-basics investment philosophy that will lead to smaller annual returns.
But just because there will be fewer hedge funds and smaller rewards doesn't necessarily mean the high-stakes hedge fund culture will disappear, said Sol Waksman, president of Barclay Hedge Ltd., a Fairfield, Iowa-based research firm.
"Right now, fear is in the driver's seat," he said. "At some point, greed will return."
THE most striking thing about financial markets at the start of 2009 is neither the level nor the valuation of stockmarkets, which are well within historical norms. Nor is it oil prices. Had investors been told two years ago that crude would cost around $50 a barrel, their flabbers would not have been gasted, as Frankie Howerd, a comedian, used to say. What is remarkable is the level of nominal government-bond yields.
Two-year Treasury bonds yield less than 1%. The 30-year bond was, as recently as January 2nd, yielding less than 3%. James Montier of Société Générale cites figures showing that ten-year Treasury yields have averaged just over 4.5% since 1798. Today they offer just 2.5%.
When commentators say that some assets look cheap, they tend to use low government-bond yields as their benchmark. Corporate-bond yields are not that high in historical terms. It is the spread they offer relative to government bonds that is extraordinary. And at 3.3%, the dividend yield on the American stockmarket hardly seems mouthwatering, but it is higher than the long-term Treasury-bond yield for the first time since the 1950s.
All this is occurring when Western governments are conducting an immense economic experiment, with vast fiscal stimuli accompanied by monetary expansion. In the medium term, a sharp rise in inflation is a distinct possibility. Government bonds may be offering “return-free risk”, in the neat phrase of Jim Grant, a veteran newsletter publisher.
One warning sign is that real bond yields (as measured by the inflation-linked market) have risen. Some believe this move has been driven by expectations of low inflation (or deflation) in coming years. But it may also suggest investors think the long-term fiscal position of many governments is not sustainable.
Indeed, nominal bond yields have also moved higher in recent days. Ominously, an auction by the German government of ten-year bonds on January 7th failed to attract sufficient buyers to raise the full amount targeted. The auction was the second-worst on record.
In the near term, bond yields are constrained because they reflect expectations of the future level of short-term interest rates. The Federal Reserve has pegged official rates at 0-0.25% and vowed to keep them low. The Fed has also talked about intervening directly by buying Treasury bonds to hold yields down.
Nor is there any immediate inflationary danger. In both America and Britain there is a chance the headline rate will go negative later this year. Many developed economies are in recession and the consensus expects 2009 to see falling output in America, the euro zone, Britain and Japan.
“Global bond yields are sure to be much higher in five years than they are today, but this does not imply that the market currently is in a bubble,” says Martin Barnes of Bank Credit Analyst, a research group. “The economic backdrop will remain bond-friendly for at least the next six months.”
This leaves investors with a dilemma. In the short term, they may like government bonds for the security they offer. Treasury bonds outperformed the S&P 500 index by an incredible 53 percentage points last year. But if yields are heading back to 4-5% (or even higher) by 2011 or 2012, at what point do they sell? The rational investor would want to get out of the asset class before the herd decides to do so. The logical extension of that argument (assuming most investors are rational) is to sell now.
But what if Japan provides the template? Many people thought Japanese bonds were overpriced when yields fell to 1-2% in the late 1990s. They have stayed around that level for the past decade, despite a vast amount of issuance (at $8.7 trillion, according to Bloomberg, the Japanese government-bond market is the biggest in the world). Even the expected $2 trillion of American issuance this year will leave its debt well below Japan’s.
The crucial difference, however, is that Japan has been running current-account surpluses, not deficits. The Japanese owe the money to themselves whereas the Americans are in debt to foreigners. Such investors could lose twice over: yields could rise and the dollar could depreciate.
For the moment, the balance is maintained by what Nick Carn of Odey, a hedge-fund group, calls “mutually assured destruction”. If overseas investors seek to sell their bonds, they will not only ruin the American economy but the value of their existing portfolios as well.
It is a precarious balance. It may well hold through 2009 and even 2010. But at some point, government bonds will surely suffer a horrendous bear market.
After dotcom stocks, sub-prime mortgages, emerging markets and oil… are government bonds the next big 'bubble'?
Not quite as exciting as some of their predecessors, sovereign debt prices are still a key indicator of where the world economy's heading next. And anyone expecting bad economic news to keep driving prices for these 'safe havens' up - and yields down – will, as usual, be disappointed.
Meanwhile there's another threat looming on the horizon for government bond bulls – a potential 'buyers' strike'…
GDP is expected to keep decreasing in 2009
First, thanks are due to Société Générale's James Montier for a long-term chart of the yield on US ten-year Treasury notes – these are American government debt securities that mature after ten years and are the most often-used benchmark for the 'long-term' cost of global capital.
Going back to 1798, it shows that the current ten-year yield is 2.4%. This is right at the bottom end of the 200+ year range. Indeed the trend has been downward for the last 27 years.
Looking back, since the eighteenth century, the average ten-year yield has usually sat just above 4.5%. This seems reasonable as it reflects the rate of consumer price rises plus the economic growth rate.
But 2.4%? That flags stagnation, says Capital Economics: "We expect GDP to continue shrinking throughout 2009, with annual inflation going negative".
US bond yields point to years of deflation
Though, as Montier points out, all-time low yields aren't necessarily a 'sell'. He cites Japan, where ten-year bonds fell to sub-0.5% in 2003 as the economy tanked, and are still only 1.3%. But he reckons current US Treasury yields "imply inflation will be around 0% over the next ten years", which suggests the States "will follow the Japanese path into grinding deflation".
Will that happen? "I haven't a clue", he says, "and nor has anyone else". But what's very clear is that "bonds simply don't offer any value".
So even if you're in the economic gloom-and-doom camp, the upside for government bonds is starting to look more than a little limited. 'Risk averse' investors have piled into the likes of US sovereign debt simply because virtually everything else looked far too dodgy. So US bonds have got more than a bit frothy.
"Eight weeks ago, Treasuries moved into the 'blow off' stage", says DailyWealth's Tom Dyson, "I believe the bubble's now popped, and it's time to start betting on a rise in Treasury bond rates". Despite a relentless flow of horrible economic news, like soaring jobless claims, plunging car sales, tumbling house prices, the lowest level of manufacturing activity since 1980 and the worst set of new manufacturing orders since 1948, US bond yields have flipped higher.
Bonds have garbage fundamentals
Apart from the value issue, there's another catch. American bonds "have garbage fundamentals", says Dyson, "the US Treasury's about to flood the market with supply. As well as increasing the size of its bond auctions, it has also upped the frequency from eight times a year to 12".
We're talking vast numbers here, as not just the Americans need to raise loads of cash. The US alone is expected to issue $2trn (£1.3trn) of debt this year, says the Telegraph's Ambrose Evans-Pritchard, and the Europeans aren't far behind. "Italy alone must tap the markets for €200bn as it rolls over its huge stock of public debt". Further, ratings agency Fitch has said that Ireland, Greece, Holland and France all face big auction programmes.
And as for gilts, don't ask. Fitch says Britain has a "terrible underlying fiscal picture, by far the worst" of the mainstream countries. That adds up to £145bn of debt – 10% of GDP – just in 2009.
"There are fears the next crisis in the global financial system could to be a rebellion by bond vigilantes, already worried by bubble talk", says Evans-Pritchard, "this would push up rates used to fixed mortgages and corporate bond deals".
This week, even Germany only managed to sell just two-thirds of a €6bn sale of ten-year Bunds, whose yield has plunged to long-term lows of some 3%. "It's very poor", says Monument Securities' Marc Ostwald, "I can't remember the Bundesbank ever being left with a third of the bonds". Nor is confidence likely to be much improved by yesterday's news that the German government is being forced to shell out another €10bn on a second Commerzbank bailout in less than three months.
Meanwhile, the buying power for government bonds could plummet anyway, as the global recession means fewer exports, and so less available cash, from traditionally the largest bond customers – the Japanese and the Chinese.
In short, it's starting to look like a government bond 'buyers strike' could be about to hit the market - the recipe for a major rise in yields and so a plunge in prices. "The bear market in government bonds starts here", says The Independent's Jeremy Warner.
If you own government bonds now, it sounds like time to head for the exit. If you don't, wait…
German Bond Auction Fails to Attract Enough Demand
By Kim-Mai Cutler and Anchalee Worrachate
Jan. 7 (Bloomberg) -- Germany’s sale of 10-year bunds lured the least demand in six months as investors shied away from a flood of government securities, raising the prospect of increased borrowing costs for Europe’s biggest economy.
Investors bid for 5.2 billion euros ($7.1 billion) of the bonds offered today, a level of demand that prompted the Bundesbank to retain 32 percent of the securities, according to the central bank’s Web site. European governments want to raise money to finance more than $96 billion in bank bailouts and stave off the worst of the global recession. France may sell 7 billion euros of bonds tomorrow and Ireland began marketing five-year debt today. Spain is also planning a sale.
“I would call this a failed auction,” said David Keeble, head of fixed-income strategy in London at Calyon, the investment-banking unit of France’s Credit Agricole SA. “This was a very poor start of auction season.”
The yield on the 10-year bund, Europe’s benchmark government security, rose four basis points to 3.19 percent by 5:14 p.m. in London. The price of the 3.75 percent security due January 2019 fell 0.34, or 3.4 euros per 1,000-euro face amount, to 104.70. The two-year yield fell 10 basis points to 1.64 percent. Yields move inversely to bond prices.
Germany sold 4.1 billion euros of its 3.75 percent securities due January 2019 at an average yield of 3.12 percent today, the Bundesbank said. The government planned to sell 6 billion euros of the notes, according to Societe Generale SA and ING Groep NV.
The last time the Bundesbank retained a larger share at an auction was on July 2, when it held 2.384 billion euros, or 34 percent, of a planned 7 billion-euro sale.
‘Geared Up’
Under the German auction system, the Bundesbank retains notes and bonds at sales for the secondary market. Without such a system, three out of the four 10-year auctions held last year would have failed, based on a comparison of planned issuance and bids received.
Today’s “auction wasn’t fantastic,” said Padhraic Garvey, the Amsterdam-based head of investment-grade strategy at ING Groep NV. “The market had been geared up for a successful takedown.”
Euro-region governments will issue about 20 billion euros of bonds every week during the first quarter of 2009, up from 10 to 15 billion euros a week during the past two years, according to Societe Generale SA.
“I don’t think this is the beginning of a big negative trend,” Garvey said. “Investors are starting question whether German yields are too rich. Germany is going to have a give a greater premium for investors to take down some of this paper.”
U.K., U.S. Sales
The U.K. is planning an unprecedented 146.4 billion pounds ($221.1 billion) of debt sales in the fiscal year ending March 31. The government today sold 2 billion pounds of 4.75 percent bonds due in 2038. The securities yielded 3.98 percent and investors bid for 1.72 times the debt offered.
The U.S. sold a record $30 billion of three-year notes today yielding 1.2 percent and attracting bids 2.21 times the amount offered. President-elect Barack Obama said yesterday he expects to inherit a $1 trillion budget deficit and that similar shortfalls are in store “for years to come” as the government grapples with a recession and other spending demands.
Yield Spread
The difference, or spread, in yield between two- and 10- year German notes rose today to 155 basis points, or 1.55 percentage points, the highest level since September 2004, amid speculation the ECB will cut its main refinancing rate at its Jan. 15 meeting.
Investors expect the ECB to cut its main refinancing rate by at least 25 basis points, according to a Credit Suisse Group AG gauge of probability based on overnight index-swap rates. The odds of a reduction of 50 basis points rose to 88 percent today, from 72 percent yesterday.
“Investors are reluctant to sell shorter-dated notes a week before the ECB rate cut while supply will hurt longer-dated bonds,” Calyon’s Keeble said.
Two-year notes gained as stocks fell for the first time in seven days, stoking demand for the relative safety of government bonds. The Dow Jones Stoxx 600 Index lost 1.2 percent.
German bonds returned 12.2 percent last year, compared with 13 percent for gilts and 14 percent for U.S. Treasuries, according to Merrill Lynch’s German Federal Government, U.K. Gilts and U.S. Treasury Master indexes.
Japan’s 10-Year Bonds Fall; Surge in Sales Cools Auction Demand
By Theresa Barraclough
Jan. 8 (Bloomberg) -- Japanese 10-year bonds fell for a fourth day, the longest losing streak since May, as lower demand at today’s 1.9 trillion yen ($20.5 billion) sale spurred concern that increased auctions will overwhelm investor appetite.
The sale drew bids worth 2.33 times the amount offered, compared with a so-called bid-to-cover ratio of 2.9 times at the previous auction last month. The government is stepping up issuance to fund plans aimed at reviving Japan’s economy, which has fallen into its first recession since 2001. The Ministry of Finance said Dec. 20 it will sell 113.3 trillion yen of bonds in the year starting April 1, up from a revised 106.3 trillion yen this fiscal year.
“The auction was not as good as we expected and it can be associated with the government’s package,” said Takashi Nishimura, an analyst at Mitsubishi UFJ Securities Co., a unit of Japan’s largest bank by assets, in Tokyo. “More bond issues are expected, which is basically negative news for bonds.”
The yield on the 1.4 percent bond due December 2018 rose 5.5 basis points to 1.31 percent as of 4:40 p.m. in Tokyo at Japan Bond Trading Co., the nation’s largest interdealer debt broker. The price fell 0.490 yen to 100.790 yen. The yield is at the highest since Dec. 17.
Five-year yields added four basis points to 0.755 percent. A basis point is 0.01 percentage point.
Ten-year bond futures for March delivery lost 0.50 to 138.69 as of the afternoon close at the Tokyo Stock Exchange.
Bond Supply
“Amid expectations of increases in bond supply because of the fall in tax revenue and budget expansion, there is a lot of concern surrounding 10-year notes,” said Akihiko Inoue, an analyst at Mizuho Investors Securities Co. in Tokyo.
Even so, investors should buy Japanese government bonds on speculation growth in the world’s second-largest economy will remain “a lot lower for a lot longer,” according to Principal Global Investors.
The Japanese government’s fiscal stimulus plans will fail to provide sufficient capital to banks to restore risk appetite, said Guthrie Williamson, a portfolio manager for PGI in Sydney. Prime Minister Taro Aso announced a stimulus package of 10 trillion yen on Dec. 12, doubling a 5 trillion yen plan he announced two months earlier.
‘Evaluated Prices’
“Government spending does not substitute for the private sector credit-creation process that has been driving growth for decades,” said Williamson, who helps manage $228 billion worldwide for the unit of Des Moines, Iowa-based Principal Financial Group Inc. “Growth will be lower than the market has priced in, interest rates will stay lower for a lot longer and government bonds will stay at these elevated prices for quite a long time.”
Japan’s economy shrank 2.85 percent in the three months ended Dec. 31, contracting for a third straight quarter, according to a Bloomberg News survey of economists. Gross domestic product is forecast to keep sliding in the first three quarters of 2009, the poll showed.
Declines in bonds were limited after local stocks tumbled, halting a seven-day winning streak, as bigger-than-estimated job cuts in the U.S. rekindled concern the global economic slump is deepening.
The Nikkei 225 Stock Average dropped 3.9 percent after ADP Employer Services said U.S. payrolls shrank by 693,000 jobs, the most since records began in 2001.
“Many people remain bullish about the JGB market,” said Eiji Dohke, chief strategist at UBS Securities Japan Ltd. in Tokyo.
Sentiment among Japanese merchants was the worst ever in November, according to a government survey. The Economy Watchers index, a survey of barbers, taxi drivers and others who deal with consumers, dropped to 21 in November, the lowest since the government started the survey in August 2001.
The survey results for December will be announced in Tokyo on Jan. 13 before a separate report on machinery orders is released on Jan. 15.
Bond scare as German auction fails and British debt hits danger level
Fitch Ratings has warned that Britain's public debt will explode to almost 70pc of GDP by the end of next year, vaulting past Germany to become one of the most heavily-indebted states in the industrial world.
By Ambrose Evans-Pritchard 08 Jan 2009
"In terms of debt dynamics, the UK is by far the worst of the `AAA' club of countries. The underlying fiscal picture is terrrible," said Brian Coulton, head of sovereign rates at the credit agency.
Mr Coulton said it would become increasingly hard for states to raise enough funds in the global bond markets to cover bank bail-outs and big budget deficits at the same time. Britain's bank rescue alone will cost 7pc of GDP.
The danger became all too real yesterday when even Germany failed to sell a full batch of government bonds at its annual `Sylvester Auction', which kicks off the debt season. Investors took up just two thirds of a €6bn (£5.6bn) sale of 10-year Bunds, leading to consternation in the markets. Bund price dropped sharply as the yield jumped 34 basis points to 3.29pc, with copy-cat moves by bonds across the eurozone.
"It's very poor," said Marc Ostwald from Monument Secuirites. "In 20 years covering Bund auctions I can't remember the Bundesbank ever being left with a third of the bonds."
Traders will be watching very closely to see whether today's bond auctions in Spain and France go ahead as planned, or whether the world is starting to see a "buyers strike" as deluge of sovereign debt floods the market.
There are fears that the next crisis in the global financial system could prove to be a rebellion by the bond vigilantes, already worried by talk of a bond bubble. This would push up rates used to fixed mortgages and corporate bond deals. Central banks can offset this for a while by purchasing bonds directly -- "printing money" -- but not indefinitely.
The US alone is expected to issue $2 trillion (£1.3 trillion) of debt this year, and the Europeans are not far behind. Italy alone must tap the markets for €200bn as it rolls over its huge stock of public debt and meets the cost or recession. Fitch Ratings said Ireland, Greece, the Netherlands, and France face a heavy calendar of auctions as maturities fall due.
Britain is expected to issue £146bn this year, or 10pc of GDP. While a £2bn sale of Gilts went smoothly yesterday, the Debt Management Office has warned of possible trouble later this year.
Robert Stheeman, the DMO's chief, says Britain may be nearing the limits of investor tolerance. "I'm not predicting that we will have a failed auction, but I can't rule that out. It's a big amount of debt to be sold. We are in a different world from a year ago," he told Bloomberg News.
As long as Britain keeps its coveted `AAA' rating it should be able to the tap the bond markets at a reasonable price, but this rating is no longer entirely secure. Fitch says the UK will have jumped from 44pc of GDP in 2007 to 68pc by late 2010, a staggering rise for major country. It usually takes a war to do such damage.
A harbinger of things to come, or just an anomaly? To everyone's astonishment, the German government yesterday failed to raise the full €6bn it was looking for from an auction of 10-year bonds.
It's not the first time an auction of German bunds has fallen short, but it was pretty much unheard of before the credit crunch, and as the first big euro debt issuance of the year, it has put the fear of God into governments around the world as they seek to raise record amounts of money from debt markets to fund their anti-recessionary policies. If even Germany, source of possibly the safest form of government debt on the planet, is struggling, what hope for everyone else?
Government bonds were about the only asset class to enjoy a bull market last year, with interest rates plunging to record lows. But the present rush to replace fast-disappearing private debt with public debt promises to produce unprecedented levels of supply, including £145bn from our own Government this year alone.
Barack Obama, the US President-elect, has conceded this year's US budget deficit will break through the $1trillion mark for the first time, and was likely to get even bigger in subsequent years. Germany has announced a €50bn reflationary package, and so on.
All in all, more than $3trillion of sovereign debt is expected to be issued this year, more than three times as much as 2008. Can there really be the appetite for such mountainous quantities of the stuff? The bull market in bonds is driven primarily by fear of deflation. In a deflationary world, it doesn't matter how low the coupon gets, for as long as inflation is negative, the investor will still be getting a real rate of return.
Other, higher-risk asset classes will, meanwhile, struggle to maintain their value. One of the other chief characteristics of a deflationary environment is much higher rates of saving, which, as aggregate demand retreats, we are already seeing in large parts of the world.
More saving equals more money for government debt issuance. Until investors rediscover their appetite for risk, government bonds remain the only game in town. Yet if one investment bubble is always followed inevitably by another, government debt is very definitely taking over from where mortgages left off. Government bonds are showing classic bubble-like characteristics now, with yields having fallen precipitously over the past three months, supported by comments from the US Federal Reserve that it might create money to buy longer dated T-bonds to help keep deflation at bay.
In theory, then, there should be plenty of money around to absorb the eye-popping quantities of government debt awaiting auction, even if, bizarrely, governments themselves become some of the main buyers. Perhaps surprisingly, the British government had no difficulty in getting a £2bn tranche of 30-year gilts away yesterday. The issue was more than 1.7 times subscribed.
Nonetheless, the partial failure of the Germany bund auction suggests that there are limits. Assuming there is no long-term deflation, which is still the consensus view among economists, all this debt issuance is likely eventually to become highly inflationary. Indeed, it almost has to be if governments are ever going to get their finances back into any kind of shape following the present public spending binge.
Britain has never defaulted on its debt, but it has been particularly adept at doing the next worse thing, which is to inflate it all away. On any kind of long-term view, government bonds have thus turned out to be a pretty poor investment. With Britain's history of inflation, gilts have been particularly bad, even if this hasn't been quite so true in recent years.
All this helps to explain what happened to the German bond auction yesterday. January promises to be a heavy month for debt issuance, particularly in euroland. By tradition, Germany is always the first euro bond issue of the year. By shunning it, investors are sending out an important message – in the long term, they expect inflation to climb back up again and therefore won't buy longer-dated bonds on such low yields.
This is, in many respects, a good sign, for it suggests that markets don't expect deflation to take hold. They must be right about this, given the unprecedented quantity of policy action taken around the globe to ease the recession. The bear market in government bonds starts here.
Portugal yesterday became the latest eurozone country to have its sovereign debt put on negative watch by Standard & Poor's because of a deterioration in the public finances, with Spain, Ireland and Greece having already gone the same way. This is obviously not good for the countries involved, for it means they must pay a little bit more for their borrowings, but it hardly presages a break-up of the euro, as many eurosceptics seem to hope.
Virtually all sovereign nations can get a triple-A rating for their debt if borrowing in their own currency. The problem for all euro nations is that borrowing in euros is like borrowing in a foreign currency, because they have only limited control over the central bank and therefore cannot print money to prevent default.
Yet the higher risk of default in these countries as budget deficits mushroom is more than compensated for by the absence of currency risk. Spreads have widened quite a bit within the eurozone over the last year, but not by nearly as much as they have elsewhere in the world as the credit crunch bites home.
If there was any risk of any of these countries being forced out of the euro, the differential would be much more extreme, so as to reflect a likely collapse in the currency once the prop of the German mark had been removed. Reports of the euro's death are somewhat premature, though some countries will undoubtedly be forced into very considerable reductions in relative living standards to stay the course. If wages cannot be deflated through devaluation, they must be adjusted even more brutally still by direct action.
Citigroup, trying to slim down, will combine brokerage business with Morgan Stanley's
Madlen Read January 13, 2009
NEW YORK (AP) -- Citigroup Inc. and Morgan Stanley agreed Tuesday to combine their brokerages in a deal that shows how much Citigroup wants to slim down and build up cash.
Morgan Stanley is paying Citigroup $2.7 billion for a 51 percent stake in the joint venture. Citigroup will have a 49 percent stake.
Citigroup's retail brokerage, Smith Barney, was once the crown jewel in its wealth management business.
The new unit, to be called Morgan Stanley Smith Barney, will have more than 20,000 advisors, $1.7 trillion in client assets; and serve 6.8 million households around the world, the companies said.
Citigroup will recognize a pretax gain of about $9.5 billion because of the deal, or about $5.8 billion after taxes, the companies said. The joint venture is expected to achieve total cost savings for the two companies of around $1.1 billion.
The deal was announced after the market closed. Shares of Citigroup rose 30 cents, or 5.4 percent, to $5.90 on Tuesday, and Morgan Stanley shares rose 7 cents to $18.86.
CEO Vikram Pandit has been saying for months that he plans to sell assets to raise cash, but the executive, according to media reports, is getting ready to announce that Citigroup is abandoning the financial "supermarket" model. That term described the aim of Citigroup -- created over the last couple decades by former CEO Sandy Weill -- to service all of individuals' and businesses' financial needs, from saving to borrowing to investing to deal-making.
Citigroup has fared worse than other banks in recent years, particularly during the recent credit crisis. The New York-based company is expected to post a fifth straight quarterly loss next week. The government has already lent it $45 billion -- more than other large banks received -- and agreed to absorb losses on a huge pool of Citigroup's mortgages and other soured assets.
Some investors believe Citigroup is headed for a larger-scale breakup now that the government is involved and that President-elect Barack Obama is rethinking how to dole out the remaining $350 billion of bailout money.
The new administration could "come to the realization that the whole economy does not hinge on the banks," said Octavio Marenzi, head of financial consultancy Celent. "Banking is important. The banks themselves are not."
William Smith of Smith Asset Management, who still owns shares of Citigroup, has been calling for a breakup of Citigroup for years and believes the government will force that fate, in piecemeal fashion, over the coming year.
"I think within 12 months, Citigroup no longer exists," Smith said. "The new CEO of this company is the government."
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Policy Measures Starting to Show Results: Wen
AP
13 January 2009
(BEIJING) Premier Wen Jiabao says China’s efforts to break out of an economic slump amid global turmoil are starting to show results, with the economy performing better than expected in December, state radio reported.
‘The policy measures we have taken have achieved initial results,’ Mr. Wen said, China National Radio reported on its website. ‘Economic conditions in December were better than expected.’
Revenues at some companies are rising, backlogs of unsold goods are falling and power consumption is growing, Mr. Wen was cited as saying during a three-day visit to factories in the eastern province of Jiangsu. The report gave no figures.
Mr. Wen’s comments appeared to be part of efforts to restore flagging corporate and public confidence - a key element in Beijing’s plans, which rely on spurring private investment and consumer spending - and could be a positive sign for hopes China will help to drive a global recovery.
Beijing announced a four trillion yuan (S$870.3 billion) stimulus package in November aimed at reducing reliance on exports by revving up domestic consumption. Effects of the spending are not expected to be seen for several months, but some industries such as steel are stepping up activity in anticipation of revived demand.
‘The early results are not big, but they are strengthening our confidence that we can triumph over adversity,’ Mr. Wen was quoted as saying.
China’s exports fell in November for the first time in seven years and manufacturing activity shrank in December for a third straight month. December trade figures are due to be released today, and analysts expect more weakness amid lacklustre global demand.
China’s 2008 economic growth is expected to fall to about 9 per cent, down from 2007’s 11.9 per cent. Analysts have cut this year’s forecasts to as low as 6 per cent - a worrisome sign for communist leaders who need to satisfy a public that expects steadily rising incomes.
The fall in export demand has triggered factory closures and layoffs in trade-dependent coastal areas in the south.
The government has warned that rising unemployment could fuel unrest and is pressing companies to avoid more job cuts.
Mr. Wen said Beijing will take additional steps, including spending 600 billion yuan on long-term scientific and technological projects, according to the report.
Pension fund shortfall rises to record £200bn
By Norma Cohen
January 12 2009
The shortfall at company retirement schemes insured by the Pension Protection Fund soared to more than £200bn in December, setting an unwelcome record as the drop in gilts yields outpaced rising equities markets.
The PPF said the percentage of defined benefit schemes with a deficit rose to 89 per cent of the almost 7,800 plans whose benefits it guarantees – up from 79 per cent in December 2007. The aggregate shortfall of these schemes was a record £209.6bn, up from a high set only last month at £155bn.
About 11 per cent of schemes had a surplus of assets over liabilities, leaving the PPF facing an aggregate deficit of £194.5bn, up from £136bn in November. But the aggregate shortfall is a meaningless number because one scheme’s surplus cannot be used to offset another’s shortfall.
The PPF only insures 90 per cent of promised pensions up to about £28,000 and has limits on annual rises in line with inflation. The value of what is insured is about 70 per cent of that of promised benefits if a solvent employer transferred the assets and liabilities to an insurance company.
The PPF’s role is to step in when an employer becomes insolvent leaving an underfunded pension scheme. But with corporate insolvencies on the rise – Land of Leather yesterday joined a list that includes Woolworths and Waterford Wedgwood – there has been increasing concern about the PPF’s ability to shoulder its financial obligations. So far, Partha Dasgupta, the PPF’s chief executive, has said the nature of the PPF’s liabilities means it can withstand even quite a severe recession.
But the weakened state of some employers has left trustees to press for additional contributions at a time when companies can least afford them.
The PPF publishes its 7800 Index to help keep track of the funding status of UK retirement plans.
In December, much of the increase in the deficit stemmed from a sharp fall in gilts yields, which led to a 10 per cent rise in liabilities. To some extent this was offset by a rise in the FTSE All Share index of 3.5 per cent, but the fact UK pension schemes remain relatively heavily invested in equities makes them particularly vulnerable to shifts in markets.
Hedge funds, battered in '08, brace for more pain
By STEVENSON JACOBS
January 12, 2009,
NEW YORK (AP) — Year after year, the hedge fund industry dazzled Wall Street by delivering "absolute returns" -- outsized profits whether markets rose or fell. Using sophisticated trading models, the pools of managed capital made wealthy people wealthier with eye-popping returns that carried seemingly moderate risk.
Not these days. Blind-sided by a colossal market collapse and the widening Bernard Madoff scandal, hedge funds suffered their worst showing on record last year. And they're bracing for more pain in 2009. The industry's fall proves that even the quantitative brilliance and market wizardry of elite hedge funds are no magic bullet for investors during brutal times.
"Hedge fund managers have always said, 'Look, we know how to make money even in difficult times,' and that turns out to be a fallacy," said Timothy Brog, portfolio manager of New York-based hedge fund Locksmith Capital Management.
Nearly 700 funds -- 7 percent of the industry -- shut down in the first three quarters of 2008, up over 70 percent from the same period last year, according to Hedge Fund Research, a Chicago-based data firm. At that rate, roughly one in 10 hedge funds will have disappeared last year when final numbers are released in coming weeks.
Thousands more are expected to die in 2009 as investors who have been clobbered by losses yank out what's left of their money. Those investor redemptions have forced many hedge funds to liquidate large chunks of their assets, triggering "dramatic" swings in the stock market late last year, Brog said.
"Even if hedge funds make up only 10 percent of the market, it's going to have a big effect if they sell all at once," he said.
Besides the financial crisis and massive losses from Madoff's alleged Ponzi scheme, self-inflicted wounds also haunted hedge funds, experts say. The funds' high-octane investment philosophy, they say, pushed many managers to make big bets with borrowed money despite the dangers.
"We grew into this culture of gunslingers," said Bill Fleckenstein, founder and president of Seattle-based hedge fund Fleckenstein Capital.
For many hedge fund managers, the notion of managing risk through cautious trading was a "recipe for getting fired," he said.
"All anyone really wanted was performance, and managing risk was a drag on performance," Fleckenstein said.
The average hedge fund lost 18 percent of its value in 2008, the industry's worst performance on record and down from an average gain of 9.96 percent in 2007, according to Hedge Fund Research. The only other negative year on record was in 2002. But even then, funds only lost an average of 1.45 percent.
Still, compared with the wider market, hedge funds don't look so bad. The Dow Jones industrial average lost 34 percent in 2008, while the Standard & Poor's 500 index fell 38 percent.
But hedge funds were never supposed to lose money.
The loosely regulated pools of capital burst onto the investment scene in 1990 with $39 billion in assets and quickly ballooned in numbers. Today, there are some 10,000 hedge funds, most of which cater to wealthy investors and promise big returns in virtually any economic climate.
Many hedge funds use complex models to trade crude oil and soybean futures, derivatives and other exotic assets out of reach to ordinary investors. Investors typically are charged a yearly fee equal to 2 percent of assets and 20 percent of profits. That fee structure has reaped eight- and even nine-figure paydays for the most successful portfolio managers.
But not now. Hedge funds' assets hit an all-time peak of $1.93 trillion in June but have since fallen to $1.56 billion, according to Hedge Fund Research. The steep declines mean that most portfolio managers will be taking much smaller paydays in 2009.
Still, not every hedge fund lost money last year.
Chris Wang, founder and portfolio manager of New York-based SYW Capital Management, enjoyed a sizzling 2008 managing $52 million in assets. Using a strategy of "short-selling," or betting that stocks will fall, he managed a return of 80 percent. Wang, 36, said his fund "became ultra-bearish" once the scope of the credit crisis became clear.
"We could see the world coming to an end before our very eyes," Wang said.
Unnerved by losses, many hedge fund investors want their money back. Investors yanked $40 billion out of hedge funds in October, according to Hedge Fund Research.
Those who got their money out were the lucky ones. In recent weeks, dozens of hedge funds have imposed "gates" keeping investors from withdrawing their money, fearing a run on their assets that could drive them out of business.
As troubled funds throw up the gates, investors have little choice but to pull money from healthier funds, which then are forced to sell assets to raise cash.
"It's disappointing," said Robert Romero, manager at Palo Alto, Calif.-based Connective Capital, a $120 million hedge fund that delivered a 3.5 percent return in 2008. He said he expects to lose about 20 percent of his capital from redemptions.
Hedge fund investors are also grappling with the still unknown toll of Madoff's alleged Ponzi scheme, which authorities say bilked investors of billions of dollars. Among the largest victims were investors in "funds of funds" -- capital pools that invested across a number of hedge funds, supposedly limiting risks.
Many funds of funds that were wiped out with Madoff have come under fire for not adequately vetting his trading strategy and for failing to diversify investors' assets. Several have written to frantic investors to reassure them that they're closely monitoring their investments, said Nadia Papagiannis, an analyst at Morningstar.
For many funds of funds, it's too late. There were 3,660 funds of funds listed in Morningstar's database at the end of 2008, a drop of about 12 percent from the previous year.
Fewer funds of funds mean fewer dollars flowing into traditional hedge funds. That will make it harder for many hedge funds to stay afloat in 2009. Barclays Capital strategist Robert McAdie has said that 70 to 80 percent of hedge funds could disappear this year.
Those that survive are likely to undergo sweeping changes, including lower fees charged to investors and a more back-to-basics investment philosophy that will lead to smaller annual returns.
But just because there will be fewer hedge funds and smaller rewards doesn't necessarily mean the high-stakes hedge fund culture will disappear, said Sol Waksman, president of Barclay Hedge Ltd., a Fairfield, Iowa-based research firm.
"Right now, fear is in the driver's seat," he said. "At some point, greed will return."
Yielding to none
The dilemma facing investors in government bonds
The Economist
Jan 8th 2009
THE most striking thing about financial markets at the start of 2009 is neither the level nor the valuation of stockmarkets, which are well within historical norms. Nor is it oil prices. Had investors been told two years ago that crude would cost around $50 a barrel, their flabbers would not have been gasted, as Frankie Howerd, a comedian, used to say. What is remarkable is the level of nominal government-bond yields.
Two-year Treasury bonds yield less than 1%. The 30-year bond was, as recently as January 2nd, yielding less than 3%. James Montier of Société Générale cites figures showing that ten-year Treasury yields have averaged just over 4.5% since 1798. Today they offer just 2.5%.
When commentators say that some assets look cheap, they tend to use low government-bond yields as their benchmark. Corporate-bond yields are not that high in historical terms. It is the spread they offer relative to government bonds that is extraordinary. And at 3.3%, the dividend yield on the American stockmarket hardly seems mouthwatering, but it is higher than the long-term Treasury-bond yield for the first time since the 1950s.
All this is occurring when Western governments are conducting an immense economic experiment, with vast fiscal stimuli accompanied by monetary expansion. In the medium term, a sharp rise in inflation is a distinct possibility. Government bonds may be offering “return-free risk”, in the neat phrase of Jim Grant, a veteran newsletter publisher.
One warning sign is that real bond yields (as measured by the inflation-linked market) have risen. Some believe this move has been driven by expectations of low inflation (or deflation) in coming years. But it may also suggest investors think the long-term fiscal position of many governments is not sustainable.
Indeed, nominal bond yields have also moved higher in recent days. Ominously, an auction by the German government of ten-year bonds on January 7th failed to attract sufficient buyers to raise the full amount targeted. The auction was the second-worst on record.
In the near term, bond yields are constrained because they reflect expectations of the future level of short-term interest rates. The Federal Reserve has pegged official rates at 0-0.25% and vowed to keep them low. The Fed has also talked about intervening directly by buying Treasury bonds to hold yields down.
Nor is there any immediate inflationary danger. In both America and Britain there is a chance the headline rate will go negative later this year. Many developed economies are in recession and the consensus expects 2009 to see falling output in America, the euro zone, Britain and Japan.
“Global bond yields are sure to be much higher in five years than they are today, but this does not imply that the market currently is in a bubble,” says Martin Barnes of Bank Credit Analyst, a research group. “The economic backdrop will remain bond-friendly for at least the next six months.”
This leaves investors with a dilemma. In the short term, they may like government bonds for the security they offer. Treasury bonds outperformed the S&P 500 index by an incredible 53 percentage points last year. But if yields are heading back to 4-5% (or even higher) by 2011 or 2012, at what point do they sell? The rational investor would want to get out of the asset class before the herd decides to do so. The logical extension of that argument (assuming most investors are rational) is to sell now.
But what if Japan provides the template? Many people thought Japanese bonds were overpriced when yields fell to 1-2% in the late 1990s. They have stayed around that level for the past decade, despite a vast amount of issuance (at $8.7 trillion, according to Bloomberg, the Japanese government-bond market is the biggest in the world). Even the expected $2 trillion of American issuance this year will leave its debt well below Japan’s.
The crucial difference, however, is that Japan has been running current-account surpluses, not deficits. The Japanese owe the money to themselves whereas the Americans are in debt to foreigners. Such investors could lose twice over: yields could rise and the dollar could depreciate.
For the moment, the balance is maintained by what Nick Carn of Odey, a hedge-fund group, calls “mutually assured destruction”. If overseas investors seek to sell their bonds, they will not only ruin the American economy but the value of their existing portfolios as well.
It is a precarious balance. It may well hold through 2009 and even 2010. But at some point, government bonds will surely suffer a horrendous bear market.
It's time to sell government bonds
By David Stevenson
Jan 09, 2009
After dotcom stocks, sub-prime mortgages, emerging markets and oil… are government bonds the next big 'bubble'?
Not quite as exciting as some of their predecessors, sovereign debt prices are still a key indicator of where the world economy's heading next. And anyone expecting bad economic news to keep driving prices for these 'safe havens' up - and yields down – will, as usual, be disappointed.
Meanwhile there's another threat looming on the horizon for government bond bulls – a potential 'buyers' strike'…
GDP is expected to keep decreasing in 2009
First, thanks are due to Société Générale's James Montier for a long-term chart of the yield on US ten-year Treasury notes – these are American government debt securities that mature after ten years and are the most often-used benchmark for the 'long-term' cost of global capital.
Going back to 1798, it shows that the current ten-year yield is 2.4%. This is right at the bottom end of the 200+ year range. Indeed the trend has been downward for the last 27 years.
Looking back, since the eighteenth century, the average ten-year yield has usually sat just above 4.5%. This seems reasonable as it reflects the rate of consumer price rises plus the economic growth rate.
But 2.4%? That flags stagnation, says Capital Economics: "We expect GDP to continue shrinking throughout 2009, with annual inflation going negative".
US bond yields point to years of deflation
Though, as Montier points out, all-time low yields aren't necessarily a 'sell'. He cites Japan, where ten-year bonds fell to sub-0.5% in 2003 as the economy tanked, and are still only 1.3%. But he reckons current US Treasury yields "imply inflation will be around 0% over the next ten years", which suggests the States "will follow the Japanese path into grinding deflation".
Will that happen? "I haven't a clue", he says, "and nor has anyone else". But what's very clear is that "bonds simply don't offer any value".
So even if you're in the economic gloom-and-doom camp, the upside for government bonds is starting to look more than a little limited. 'Risk averse' investors have piled into the likes of US sovereign debt simply because virtually everything else looked far too dodgy. So US bonds have got more than a bit frothy.
"Eight weeks ago, Treasuries moved into the 'blow off' stage", says DailyWealth's Tom Dyson, "I believe the bubble's now popped, and it's time to start betting on a rise in Treasury bond rates". Despite a relentless flow of horrible economic news, like soaring jobless claims, plunging car sales, tumbling house prices, the lowest level of manufacturing activity since 1980 and the worst set of new manufacturing orders since 1948, US bond yields have flipped higher.
Bonds have garbage fundamentals
Apart from the value issue, there's another catch. American bonds "have garbage fundamentals", says Dyson, "the US Treasury's about to flood the market with supply. As well as increasing the size of its bond auctions, it has also upped the frequency from eight times a year to 12".
We're talking vast numbers here, as not just the Americans need to raise loads of cash. The US alone is expected to issue $2trn (£1.3trn) of debt this year, says the Telegraph's Ambrose Evans-Pritchard, and the Europeans aren't far behind. "Italy alone must tap the markets for €200bn as it rolls over its huge stock of public debt". Further, ratings agency Fitch has said that Ireland, Greece, Holland and France all face big auction programmes.
And as for gilts, don't ask. Fitch says Britain has a "terrible underlying fiscal picture, by far the worst" of the mainstream countries. That adds up to £145bn of debt – 10% of GDP – just in 2009.
"There are fears the next crisis in the global financial system could to be a rebellion by bond vigilantes, already worried by bubble talk", says Evans-Pritchard, "this would push up rates used to fixed mortgages and corporate bond deals".
This week, even Germany only managed to sell just two-thirds of a €6bn sale of ten-year Bunds, whose yield has plunged to long-term lows of some 3%. "It's very poor", says Monument Securities' Marc Ostwald, "I can't remember the Bundesbank ever being left with a third of the bonds". Nor is confidence likely to be much improved by yesterday's news that the German government is being forced to shell out another €10bn on a second Commerzbank bailout in less than three months.
Meanwhile, the buying power for government bonds could plummet anyway, as the global recession means fewer exports, and so less available cash, from traditionally the largest bond customers – the Japanese and the Chinese.
In short, it's starting to look like a government bond 'buyers strike' could be about to hit the market - the recipe for a major rise in yields and so a plunge in prices. "The bear market in government bonds starts here", says The Independent's Jeremy Warner.
If you own government bonds now, it sounds like time to head for the exit. If you don't, wait…
German Bond Auction Fails to Attract Enough Demand
By Kim-Mai Cutler and Anchalee Worrachate
Jan. 7 (Bloomberg) -- Germany’s sale of 10-year bunds lured the least demand in six months as investors shied away from a flood of government securities, raising the prospect of increased borrowing costs for Europe’s biggest economy.
Investors bid for 5.2 billion euros ($7.1 billion) of the bonds offered today, a level of demand that prompted the Bundesbank to retain 32 percent of the securities, according to the central bank’s Web site. European governments want to raise money to finance more than $96 billion in bank bailouts and stave off the worst of the global recession. France may sell 7 billion euros of bonds tomorrow and Ireland began marketing five-year debt today. Spain is also planning a sale.
“I would call this a failed auction,” said David Keeble, head of fixed-income strategy in London at Calyon, the investment-banking unit of France’s Credit Agricole SA. “This was a very poor start of auction season.”
The yield on the 10-year bund, Europe’s benchmark government security, rose four basis points to 3.19 percent by 5:14 p.m. in London. The price of the 3.75 percent security due January 2019 fell 0.34, or 3.4 euros per 1,000-euro face amount, to 104.70. The two-year yield fell 10 basis points to 1.64 percent. Yields move inversely to bond prices.
Germany sold 4.1 billion euros of its 3.75 percent securities due January 2019 at an average yield of 3.12 percent today, the Bundesbank said. The government planned to sell 6 billion euros of the notes, according to Societe Generale SA and ING Groep NV.
The last time the Bundesbank retained a larger share at an auction was on July 2, when it held 2.384 billion euros, or 34 percent, of a planned 7 billion-euro sale.
‘Geared Up’
Under the German auction system, the Bundesbank retains notes and bonds at sales for the secondary market. Without such a system, three out of the four 10-year auctions held last year would have failed, based on a comparison of planned issuance and bids received.
Today’s “auction wasn’t fantastic,” said Padhraic Garvey, the Amsterdam-based head of investment-grade strategy at ING Groep NV. “The market had been geared up for a successful takedown.”
Euro-region governments will issue about 20 billion euros of bonds every week during the first quarter of 2009, up from 10 to 15 billion euros a week during the past two years, according to Societe Generale SA.
“I don’t think this is the beginning of a big negative trend,” Garvey said. “Investors are starting question whether German yields are too rich. Germany is going to have a give a greater premium for investors to take down some of this paper.”
U.K., U.S. Sales
The U.K. is planning an unprecedented 146.4 billion pounds ($221.1 billion) of debt sales in the fiscal year ending March 31. The government today sold 2 billion pounds of 4.75 percent bonds due in 2038. The securities yielded 3.98 percent and investors bid for 1.72 times the debt offered.
The U.S. sold a record $30 billion of three-year notes today yielding 1.2 percent and attracting bids 2.21 times the amount offered. President-elect Barack Obama said yesterday he expects to inherit a $1 trillion budget deficit and that similar shortfalls are in store “for years to come” as the government grapples with a recession and other spending demands.
Yield Spread
The difference, or spread, in yield between two- and 10- year German notes rose today to 155 basis points, or 1.55 percentage points, the highest level since September 2004, amid speculation the ECB will cut its main refinancing rate at its Jan. 15 meeting.
Investors expect the ECB to cut its main refinancing rate by at least 25 basis points, according to a Credit Suisse Group AG gauge of probability based on overnight index-swap rates. The odds of a reduction of 50 basis points rose to 88 percent today, from 72 percent yesterday.
“Investors are reluctant to sell shorter-dated notes a week before the ECB rate cut while supply will hurt longer-dated bonds,” Calyon’s Keeble said.
Two-year notes gained as stocks fell for the first time in seven days, stoking demand for the relative safety of government bonds. The Dow Jones Stoxx 600 Index lost 1.2 percent.
German bonds returned 12.2 percent last year, compared with 13 percent for gilts and 14 percent for U.S. Treasuries, according to Merrill Lynch’s German Federal Government, U.K. Gilts and U.S. Treasury Master indexes.
Japan’s 10-Year Bonds Fall; Surge in Sales Cools Auction Demand
By Theresa Barraclough
Jan. 8 (Bloomberg) -- Japanese 10-year bonds fell for a fourth day, the longest losing streak since May, as lower demand at today’s 1.9 trillion yen ($20.5 billion) sale spurred concern that increased auctions will overwhelm investor appetite.
The sale drew bids worth 2.33 times the amount offered, compared with a so-called bid-to-cover ratio of 2.9 times at the previous auction last month. The government is stepping up issuance to fund plans aimed at reviving Japan’s economy, which has fallen into its first recession since 2001. The Ministry of Finance said Dec. 20 it will sell 113.3 trillion yen of bonds in the year starting April 1, up from a revised 106.3 trillion yen this fiscal year.
“The auction was not as good as we expected and it can be associated with the government’s package,” said Takashi Nishimura, an analyst at Mitsubishi UFJ Securities Co., a unit of Japan’s largest bank by assets, in Tokyo. “More bond issues are expected, which is basically negative news for bonds.”
The yield on the 1.4 percent bond due December 2018 rose 5.5 basis points to 1.31 percent as of 4:40 p.m. in Tokyo at Japan Bond Trading Co., the nation’s largest interdealer debt broker. The price fell 0.490 yen to 100.790 yen. The yield is at the highest since Dec. 17.
Five-year yields added four basis points to 0.755 percent. A basis point is 0.01 percentage point.
Ten-year bond futures for March delivery lost 0.50 to 138.69 as of the afternoon close at the Tokyo Stock Exchange.
Bond Supply
“Amid expectations of increases in bond supply because of the fall in tax revenue and budget expansion, there is a lot of concern surrounding 10-year notes,” said Akihiko Inoue, an analyst at Mizuho Investors Securities Co. in Tokyo.
Even so, investors should buy Japanese government bonds on speculation growth in the world’s second-largest economy will remain “a lot lower for a lot longer,” according to Principal Global Investors.
The Japanese government’s fiscal stimulus plans will fail to provide sufficient capital to banks to restore risk appetite, said Guthrie Williamson, a portfolio manager for PGI in Sydney. Prime Minister Taro Aso announced a stimulus package of 10 trillion yen on Dec. 12, doubling a 5 trillion yen plan he announced two months earlier.
‘Evaluated Prices’
“Government spending does not substitute for the private sector credit-creation process that has been driving growth for decades,” said Williamson, who helps manage $228 billion worldwide for the unit of Des Moines, Iowa-based Principal Financial Group Inc. “Growth will be lower than the market has priced in, interest rates will stay lower for a lot longer and government bonds will stay at these elevated prices for quite a long time.”
Japan’s economy shrank 2.85 percent in the three months ended Dec. 31, contracting for a third straight quarter, according to a Bloomberg News survey of economists. Gross domestic product is forecast to keep sliding in the first three quarters of 2009, the poll showed.
Declines in bonds were limited after local stocks tumbled, halting a seven-day winning streak, as bigger-than-estimated job cuts in the U.S. rekindled concern the global economic slump is deepening.
The Nikkei 225 Stock Average dropped 3.9 percent after ADP Employer Services said U.S. payrolls shrank by 693,000 jobs, the most since records began in 2001.
“Many people remain bullish about the JGB market,” said Eiji Dohke, chief strategist at UBS Securities Japan Ltd. in Tokyo.
Sentiment among Japanese merchants was the worst ever in November, according to a government survey. The Economy Watchers index, a survey of barbers, taxi drivers and others who deal with consumers, dropped to 21 in November, the lowest since the government started the survey in August 2001.
The survey results for December will be announced in Tokyo on Jan. 13 before a separate report on machinery orders is released on Jan. 15.
Bond scare as German auction fails and British debt hits danger level
Fitch Ratings has warned that Britain's public debt will explode to almost 70pc of GDP by the end of next year, vaulting past Germany to become one of the most heavily-indebted states in the industrial world.
By Ambrose Evans-Pritchard
08 Jan 2009
"In terms of debt dynamics, the UK is by far the worst of the `AAA' club of countries. The underlying fiscal picture is terrrible," said Brian Coulton, head of sovereign rates at the credit agency.
Mr Coulton said it would become increasingly hard for states to raise enough funds in the global bond markets to cover bank bail-outs and big budget deficits at the same time. Britain's bank rescue alone will cost 7pc of GDP.
The danger became all too real yesterday when even Germany failed to sell a full batch of government bonds at its annual `Sylvester Auction', which kicks off the debt season. Investors took up just two thirds of a €6bn (£5.6bn) sale of 10-year Bunds, leading to consternation in the markets. Bund price dropped sharply as the yield jumped 34 basis points to 3.29pc, with copy-cat moves by bonds across the eurozone.
"It's very poor," said Marc Ostwald from Monument Secuirites. "In 20 years covering Bund auctions I can't remember the Bundesbank ever being left with a third of the bonds."
Traders will be watching very closely to see whether today's bond auctions in Spain and France go ahead as planned, or whether the world is starting to see a "buyers strike" as deluge of sovereign debt floods the market.
There are fears that the next crisis in the global financial system could prove to be a rebellion by the bond vigilantes, already worried by talk of a bond bubble. This would push up rates used to fixed mortgages and corporate bond deals. Central banks can offset this for a while by purchasing bonds directly -- "printing money" -- but not indefinitely.
The US alone is expected to issue $2 trillion (£1.3 trillion) of debt this year, and the Europeans are not far behind. Italy alone must tap the markets for €200bn as it rolls over its huge stock of public debt and meets the cost or recession. Fitch Ratings said Ireland, Greece, the Netherlands, and France face a heavy calendar of auctions as maturities fall due.
Britain is expected to issue £146bn this year, or 10pc of GDP. While a £2bn sale of Gilts went smoothly yesterday, the Debt Management Office has warned of possible trouble later this year.
Robert Stheeman, the DMO's chief, says Britain may be nearing the limits of investor tolerance. "I'm not predicting that we will have a failed auction, but I can't rule that out. It's a big amount of debt to be sold. We are in a different world from a year ago," he told Bloomberg News.
As long as Britain keeps its coveted `AAA' rating it should be able to the tap the bond markets at a reasonable price, but this rating is no longer entirely secure. Fitch says the UK will have jumped from 44pc of GDP in 2007 to 68pc by late 2010, a staggering rise for major country. It usually takes a war to do such damage.
Record issuance is bad news for bonds
Jeremy Warner
8 January 2009
A harbinger of things to come, or just an anomaly? To everyone's astonishment, the German government yesterday failed to raise the full €6bn it was looking for from an auction of 10-year bonds.
It's not the first time an auction of German bunds has fallen short, but it was pretty much unheard of before the credit crunch, and as the first big euro debt issuance of the year, it has put the fear of God into governments around the world as they seek to raise record amounts of money from debt markets to fund their anti-recessionary policies. If even Germany, source of possibly the safest form of government debt on the planet, is struggling, what hope for everyone else?
Government bonds were about the only asset class to enjoy a bull market last year, with interest rates plunging to record lows. But the present rush to replace fast-disappearing private debt with public debt promises to produce unprecedented levels of supply, including £145bn from our own Government this year alone.
Barack Obama, the US President-elect, has conceded this year's US budget deficit will break through the $1trillion mark for the first time, and was likely to get even bigger in subsequent years. Germany has announced a €50bn reflationary package, and so on.
All in all, more than $3trillion of sovereign debt is expected to be issued this year, more than three times as much as 2008. Can there really be the appetite for such mountainous quantities of the stuff? The bull market in bonds is driven primarily by fear of deflation. In a deflationary world, it doesn't matter how low the coupon gets, for as long as inflation is negative, the investor will still be getting a real rate of return.
Other, higher-risk asset classes will, meanwhile, struggle to maintain their value. One of the other chief characteristics of a deflationary environment is much higher rates of saving, which, as aggregate demand retreats, we are already seeing in large parts of the world.
More saving equals more money for government debt issuance. Until investors rediscover their appetite for risk, government bonds remain the only game in town. Yet if one investment bubble is always followed inevitably by another, government debt is very definitely taking over from where mortgages left off. Government bonds are showing classic bubble-like characteristics now, with yields having fallen precipitously over the past three months, supported by comments from the US Federal Reserve that it might create money to buy longer dated T-bonds to help keep deflation at bay.
In theory, then, there should be plenty of money around to absorb the eye-popping quantities of government debt awaiting auction, even if, bizarrely, governments themselves become some of the main buyers. Perhaps surprisingly, the British government had no difficulty in getting a £2bn tranche of 30-year gilts away yesterday. The issue was more than 1.7 times subscribed.
Nonetheless, the partial failure of the Germany bund auction suggests that there are limits. Assuming there is no long-term deflation, which is still the consensus view among economists, all this debt issuance is likely eventually to become highly inflationary. Indeed, it almost has to be if governments are ever going to get their finances back into any kind of shape following the present public spending binge.
Britain has never defaulted on its debt, but it has been particularly adept at doing the next worse thing, which is to inflate it all away. On any kind of long-term view, government bonds have thus turned out to be a pretty poor investment. With Britain's history of inflation, gilts have been particularly bad, even if this hasn't been quite so true in recent years.
All this helps to explain what happened to the German bond auction yesterday. January promises to be a heavy month for debt issuance, particularly in euroland. By tradition, Germany is always the first euro bond issue of the year. By shunning it, investors are sending out an important message – in the long term, they expect inflation to climb back up again and therefore won't buy longer-dated bonds on such low yields.
This is, in many respects, a good sign, for it suggests that markets don't expect deflation to take hold. They must be right about this, given the unprecedented quantity of policy action taken around the globe to ease the recession. The bear market in government bonds starts here.
Euroland's widening credit spreads
Jeremy Warner
14 January 2009
Portugal yesterday became the latest eurozone country to have its sovereign debt put on negative watch by Standard & Poor's because of a deterioration in the public finances, with Spain, Ireland and Greece having already gone the same way. This is obviously not good for the countries involved, for it means they must pay a little bit more for their borrowings, but it hardly presages a break-up of the euro, as many eurosceptics seem to hope.
Virtually all sovereign nations can get a triple-A rating for their debt if borrowing in their own currency. The problem for all euro nations is that borrowing in euros is like borrowing in a foreign currency, because they have only limited control over the central bank and therefore cannot print money to prevent default.
Yet the higher risk of default in these countries as budget deficits mushroom is more than compensated for by the absence of currency risk. Spreads have widened quite a bit within the eurozone over the last year, but not by nearly as much as they have elsewhere in the world as the credit crunch bites home.
If there was any risk of any of these countries being forced out of the euro, the differential would be much more extreme, so as to reflect a likely collapse in the currency once the prop of the German mark had been removed. Reports of the euro's death are somewhat premature, though some countries will undoubtedly be forced into very considerable reductions in relative living standards to stay the course. If wages cannot be deflated through devaluation, they must be adjusted even more brutally still by direct action.
Citigroup, Morgan Stanley merge brokerages
Citigroup, trying to slim down, will combine brokerage business with Morgan Stanley's
Madlen Read
January 13, 2009
NEW YORK (AP) -- Citigroup Inc. and Morgan Stanley agreed Tuesday to combine their brokerages in a deal that shows how much Citigroup wants to slim down and build up cash.
Morgan Stanley is paying Citigroup $2.7 billion for a 51 percent stake in the joint venture. Citigroup will have a 49 percent stake.
Citigroup's retail brokerage, Smith Barney, was once the crown jewel in its wealth management business.
The new unit, to be called Morgan Stanley Smith Barney, will have more than 20,000 advisors, $1.7 trillion in client assets; and serve 6.8 million households around the world, the companies said.
Citigroup will recognize a pretax gain of about $9.5 billion because of the deal, or about $5.8 billion after taxes, the companies said. The joint venture is expected to achieve total cost savings for the two companies of around $1.1 billion.
The deal was announced after the market closed. Shares of Citigroup rose 30 cents, or 5.4 percent, to $5.90 on Tuesday, and Morgan Stanley shares rose 7 cents to $18.86.
CEO Vikram Pandit has been saying for months that he plans to sell assets to raise cash, but the executive, according to media reports, is getting ready to announce that Citigroup is abandoning the financial "supermarket" model. That term described the aim of Citigroup -- created over the last couple decades by former CEO Sandy Weill -- to service all of individuals' and businesses' financial needs, from saving to borrowing to investing to deal-making.
Citigroup has fared worse than other banks in recent years, particularly during the recent credit crisis. The New York-based company is expected to post a fifth straight quarterly loss next week. The government has already lent it $45 billion -- more than other large banks received -- and agreed to absorb losses on a huge pool of Citigroup's mortgages and other soured assets.
Some investors believe Citigroup is headed for a larger-scale breakup now that the government is involved and that President-elect Barack Obama is rethinking how to dole out the remaining $350 billion of bailout money.
The new administration could "come to the realization that the whole economy does not hinge on the banks," said Octavio Marenzi, head of financial consultancy Celent. "Banking is important. The banks themselves are not."
William Smith of Smith Asset Management, who still owns shares of Citigroup, has been calling for a breakup of Citigroup for years and believes the government will force that fate, in piecemeal fashion, over the coming year.
"I think within 12 months, Citigroup no longer exists," Smith said. "The new CEO of this company is the government."
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