Posts Tagged ‘Risk Exposure’
Five Banks Account For 96% Of The $250 Trillion In Outstanding US Derivative Exposure; Is Morgan Stanley Sitting On An FX Derivative Time Bomb?
Saturday, September 24th, 2011
The latest quarterly report from the Office Of the Currency Comptroller is out and as usual it presents in a crisp, clear and very much glaring format the fact that the top 4 banks in the US now account for a massively disproportionate amount of the derivative risk in the financial system. Specifically, of the $250 trillion in gross notional amount of derivative contracts outstanding (consisting of Interest Rate, FX, Equity Contracts, Commodity and CDS) among the Top 25 commercial banks (a number that swells to $333 trillion when looking at the Top 25 Bank Holding Companies), a mere 5 banks (and really 4) account for 95.9% of all derivative exposure (HSBC replaced Wells as the Top 5th bank, which at $3.9 trillion in derivative exposure is a distant place from #4 Goldman with $47.7 trillion). The top 4 banks: JPM with $78.1 trillion in exposure, Citi with $56 trillion, Bank of America with $53 trillion and Goldman with $48 trillion, account for 94.4% of total exposure. As historically has been the case, the bulk of consolidated exposure is in Interest Rate swaps ($204.6 trillion), followed by FX ($26.5TR), CDS ($15.2 trillion), and Equity and Commodity with $1.6 and $1.4 trillion, respectively. And that’s your definition of Too Big To Fail right there: the biggest banks are not only getting bigger, but their risk exposure is now at a new all time high and up $5.3 trillion from Q1 as they have to risk ever more in the derivatives market to generate that incremental penny of return.
At this point the economist PhD readers will scream: “this is total BS – after all you have bilateral netting which eliminates net bank exposure almost entirely.” True: that is precisely what the OCC will say too. As the chart below shows, according to the chief regulator of the derivative space in Q2 netting benefits amounted to an almost record 90.8% of gross exposure, so while seemingly massive, those XXX trillion numbers are really quite, quite small… Right?
…Wrong. The problem with bilateral netting is that it is based on one massively flawed assumption, namely that in an orderly collapse all derivative contracts will be honored by the issuing bank (in this case the company that has sold the protection, and which the buyer of protection hopes will offset the protection it in turn has sold). The best example of how the flaw behind bilateral netting almost destroyed the system is AIG: the insurance company was hours away from making trillions of derivative contracts worthless if it were to implode, leaving all those who had bought protection from the firm worthless, a contingency only Goldman hedged by buying protection on AIG. And while the argument can further be extended that in bankruptcy a perfectly netted bankrupt entity would make someone else whole on claims they have written, this is not true, as the bankrupt estate will pursue 100 cent recovery on its claims even under Chapter 11, while claims the estate had written end up as General Unsecured Claims which as Lehman has demonstrated will collect 20 cents on the dollar if they are lucky.
The point of this detour being that if any of these four banks fails, the repercussions would be disastrous. And no, Frank Dodd’s bank “resolution” provision would do absolutely nothing to prevent an epic systemic collapse.
Lastly, and tangentially on a topic that recently has gotten much prominent attention in the media, we present the exposure by product for the biggest commercial banks. Of particular note is that while virtually every single bank has a preponderance of its derivative exposure in the form of plain vanilla IR swaps (on average accounting for more than 80% of total), Morgan Stanley, and specifically its Utah-based commercial bank Morgan Stanley Bank NA, has almost exclusively all of its exposure tied in with the far riskier FX contracts, or 98.3% of the total $1.793 trillion. For a bank with no deposit buffer, and which has massive exposure to European banks regardless of how hard management and various other banks scramble to defend Morgan Stanley, the fact that it has such an abnormal amount of exposure (but, but, it is “bilaterally netted” we can just hear Dick Bove screaming on Monday) to the ridiculously volatile FX space should perhaps raise some further eyebrows…
Tags: 5tr Cds, Bank Holding Companies, Bank Of America, Biggest Banks, Chart Below Shows, Citi Bank, Commercial Banks, Comptroller, Derivative Contracts, Derivative Time, Derivatives Market, Distant Place, Gold, Gross Exposure, Interest Rate Swaps, Morgan Stanley, Occ, Risk Exposure, Swells, Time Bomb, Trillion
Posted in Gold, Markets | Comments Off
Tuesday, June 14th, 2011
In my previous column, Examining portfolio risk, we discussed ex-ante risk, ex-post risk and how both measures can provide greater understanding of portfolio risk. In this column I would like to discuss the options that are available to a pension fund manager that discovers excessive risk concentration in a fund through ex-ante risk reports.When a pension fund utilizes the services of multiple investment managers, there is potential for overlap of risk, causing excessive concentration of risk. Excessive risk concentration can be found in exposure to a single company, a sector of the economy, or a currency among others. If the pension fund manager receives ex-ante reports on risk which aggregate all investment manager portfolios, he or she may recognize an exposure as excessive prior to a potential blow-up.
There are three potential approaches to managing aggregate risk concentration created by multiple asset managers:
- immediate reduction of risk,
- use of an overlay portfolio, and
- the establishment of trigger points for risk reduction.
The optimal approach may vary, depending on the organizational structure of the pension fund. No matter how a pension fund manages the issue of risk concentration, ex-ante risk reports provide valuable information to the pension fund manager with respect to aggregate fund risk exposure and risk concentration.
I thank Jonathan for sending me this excellent comment and I want to expand on it a little. Jonathan correctly states if the pension fund manager receives ex-ante reports on risk which aggregate all investment manager portfolios, he or she may recognize an exposure as excessive prior to a potential blow-up.
Here is the problem: those ex-ante reports have to aggregate risk from all investment portfolios, which include both public and private markets. This sounds easy and straightforward but it isn’t. In private markets (real estate, private equity, and infrastructure), you run into stale pricing due to infrequent valuations And in some absolute return strategies, risk aggregation can be very deceptive, especially if it’s an illiquid strategy when a crisis hits.
Take a Canadian pension fund that is invested in the commodity and energy heavy TSX, then does private equity ventures in oil and gas, invests in commodity trading advisors (CTAs), in hedge and long-only funds, in commodity futures index, emerging markets, and is long the Canadian dollar. Risk aggregation could be a nightmare if it’s not done properly across all portfolios, leaving a fund vulnerable to serious downside risk.
And as far as overlay strategies, you need a CIO responsible for all investment portfolios, internal, external across public and private markets to make the calls and reduce overall risk at a fund. To do this properly, the CIO needs to have excellent risk aggregation reports but that’s not enough. This person needs to have a central research team that focuses on leveraging off all sources of information, including the pension fund’s external and internal investment managers (knowledge leverage), to produce high quality quantitative and qualitative research for all investment portfolios. This research group acts like the central nervous system of the pension fund and needs to be staffed by senior investment analysts from all groups. Importantly, they need to work well together and work well under pressure, always focusing on total fund risk.
Long gone are the days where risk is only quant oriented. More and more large pension funds in Canada are leveraging off their external partners to add in-depth qualitative research based on rigorous economic and financial analysis. In this environment, you got to think like a Bridgewater. And the bigger you are, the more important this becomes because you have to react quickly, be nimble and be able to take advantage as opportunities present themselves (go back to read my comment on OTPP’s Neil Petroff on active management).
Finally, concerning my personal portfolio, I can tell you excessive risk concentration can be very painful when you’re concentrated in a certain stock or sector and it’s going against you. I’ve had a wild ride making and losing money with a Chinese solar stock called LDK Solar. Just check out the price action over the last year, and pay attention to the last three months and days (ticker is LDK; click on image to enlarge):
LDK and Trina Solar (TSL) both got whacked on Tuesday, down on heavy volume after Trina guided lower on margins (click on image to enlarge):
OUCH! Talk about a sunburn! Should have listened to Jean Turmel’s wise advice! Now, to be truthful, I’ve traded this stock enough and seen many crazy periods before. I tripled down on LDK when it double bottomed at $5 last year, and I’m getting ready to add to my position (already started and got burned today so now I am waiting).
Chinese solar stocks are not for the feint of heart. When they move, they move abruptly in both directions. You got to buy them when they’re way oversold (or wait for them to base after huge down moves on big volume) and sell them when they explode up. A lot of big hedge funds are accumulating and manipulating these stocks, as I will show this weekend when discussing 13-F filings for elite funds in Q1 2011 (I will cover all sectors, not just solars).
Excessive risk concentration matters. It matters for your personal portfolio and it really matters when you’re managing other people’s money, which is what pension funds are doing. And to properly understand excessive risk concentration, these pension funds need strong quantitative and qualitative analysis across all investment portfolios in public and private markets. While this sounds straightforward and easy, most pension funds lack the tools, systems, external partner relationships and most importantly, investment professionals on the inside who are thinking properly about risk aggregation across all investment portfolios. It’s total fund risk that ultimately matters, which is why a lot of large institutional managers got killed in 2008.
One senior pension fund manager sent me this comment, which sums it up well:
Seeking to manage this risk on some sort of systematic data capture basis seeks false precision, and turns investment management into a giant IT project. What is needed is simply one person, even in a large organization, to stay on top of broad goings on, and on occasion commission staff to do special ad hoc analysis. We used to call this person of experience a chief investment officer…
And Jonathan Jacob added this comment:
Your commenter has a point – it can be difficult to obtain quality data from custodians and that data must be run through a quality assurance process. My article was not so much directed at those large pension funds with significant systems and employee resources but more toward those funds that are severely understaffed (2-3 employees) and who outsource the investment management function to external managers.
Copyright © Pension Pulse
Tags: Advisory Firm, Aggregate Risk, Asset Managers, Blow Up, Canada Article, Canadian, Canadian Market, Excessive Risk, Forethought, Fund Risk, Infrastructure, Investment Manager, Investment Managers, Investment Portfolios, Optimal Approach, Pension Fund Manager, Portfolio Risk, Private Markets, Risk Exposure, Risk Reduction, Risk Reports, Single Company, Trigger Points
Posted in Canadian Market, Infrastructure, Markets | Comments Off
Wednesday, March 23rd, 2011
The carry trade – borrowing in currencies with low interest rates and investing in currencies with high interest rates – has been a surprising hit for decades. This column provides empirical evidence suggesting that the mysteriously high returns this generates can actually be explained as compensation for the volatility risk undertaken.
The “carry trade” is the most popular trading strategy in currency markets. Traders borrow in currencies with low interest rates (negative forward premium) and invest in currencies with high interest rates (positive forward premium), profiting from the margin. Yet according to the uncovered interest parity this strategy should not work. If investors are both rational and risk-neutral, then exchange-rate changes will eliminate any gain arising from the differential in interest rates across countries. It is well documented, however, that exchange-rate changes do not compensate for the interest-rate differential. If anything, the opposite holds true empirically – high-interest-rate currencies tend to appreciate while low-interest-rate currencies tend to depreciate. As a consequence, carry trades form a profitable investment strategy, violate the uncovered interest parity and give rise to the “forward premium puzzle” (Fama 1984).
Considering the very liquid foreign-exchange markets, the dismantling of barriers to capital flows between countries, and the existence of international currency speculation during this period, it is difficult to understand why carry trades have been profitable for such a long time. A simple and theoretically convincing solution for this puzzle is the consideration of time-varying risk premia. If investments in currencies with high interest rates deliver low returns during “bad times”, then carry trade profits are merely a compensation for higher risk-exposure by investors. However, the empirical literature has serious problems to convincingly identify risk factors that drive these premia until today.
What is the risk in carry trades?
In a recent paper we suggest a resolution (Menkhoff et al. 2011). We start by sorting currencies into portfolios according to their forward premium (or, equivalently, their relative interest-rate differential versus US money market interest rates) at the end of each month, as first proposed in academic research by Lustig and Verdelhan (2007). We form five such portfolios. Investing in the highest relative interest-rate quintile, i.e. portfolio 5, and shorting the lowest relative interest-rate quintile, i.e. portfolio 1, therefore results in a carry-trade portfolio. This carry trade leads to large and significant average excess returns of more than 5% even after accounting for transaction costs and the recent market turmoil. These returns cannot be explained by standard measures of risk (e.g. Burnside et al. 2011) and seem to offer a free lunch to investors.
We argue that these high returns to currency carry trades can indeed be understood as a compensation for risk. Finance theory predicts that investors are concerned about variables affecting the evolution of the investment opportunities and wish to hedge against unexpected changes (innovations) in market volatility, leading risk-averse agents to demand currencies that can hedge against this risk. We test whether the sensitivity of excess returns to global foreign-exchange volatility risk can rationalise the returns to currency portfolios in a standard asset-pricing framework. We find that high-interest-rate currencies are negatively related to innovations in global foreign-exchange volatility and thus deliver low returns in times of unexpectedly high volatility, when low interest rate currencies provide a hedge by yielding positive returns.
To prove this point, we carry out the empirical analysis using data for spot exchange rates and 1-month forward exchange rates versus the dollar over the sample period from November 1983 to August 2009, obtained from BBI and Reuters (via Datastream). The total sample consists of 48 countries, but we also study a smaller sub-sample consisting of only 15 developed countries with a longer data history.
From these data, we construct carry-trade portfolios and examine their excess returns. We also construct a proxy for global foreign-exchange volatility, which is simply the cross-sectional standard deviation of volatility across all currencies in the portfolio, calculated month by month from daily data. Figure 1 shows cumulative returns for the carry-trade portfolio for all countries and for the smaller sample of developed countries. Shaded areas correspond to NBER-defined recessions. Interestingly, carry trades among developed countries were more profitable in the 80s and 90s; only in the last part of the sample did the inclusion of emerging markets’ currencies improve returns to the carry trade. Also, the two recessions in the early 90s and 2000s did not have any significant influence on returns. It is only in the last recession — that also saw a massive financial crisis — that carry-trade returns show some sensitivity to macroeconomic conditions. By and large, most of the major spikes in carry-trade returns (e.g. in 1986, 1992, 1997/1998, 2006) seem rather unrelated to the US business cycle. The graph also shows our proxy for global foreign-exchange volatility and its innovations, which appears to pick up obvious times of turmoil, including the recent financial crisis.
Figure 1. Cumulative carry trade returns
Figure 2 provides a graphical analysis to illustrate our point (we carry out extensive tests to establish our results in our paper). We visualise the relationship between global foreign-exchange volatility risk and currency excess returns. To do so, we divide the sample into four sub-samples depending on the value of global foreign-exchange volatility innovations. The first sub-sample contains the 25% months with the lowest realisations of foreign-exchange volatility risk and the fourth sub-sample contains the 25% months with the highest realisations. We then calculate average excess returns for these sub-samples for the return difference between portfolio 5 and 1. Results are shown in Figure 2 for the sample of all countries and for the smaller sample of 15 developed countries.
Figure 2. Distribution of global foreign-exchange volatility
Bars show the annualised mean returns of the carry-trade portfolio. As can be seen from the figure, high-interest-rate currencies clearly yield higher excess returns when volatility risk is low and vice versa. Average excess returns for the long-short portfolios decrease monotonically when moving from the low to the high-volatility states for the sample of developed countries, and almost monotonically for the full sample of countries. While this analysis is intentionally simple, it intuitively demonstrates a clear relationship between global foreign-exchange volatility innovations and returns to carry-trade portfolios.
How well does this risk explain the returns to carry trades?
The answer is: surprisingly well. In fact, we can explain over 95% of the variation in the cross-section of our sorted portfolios. This point can be seen visually in Figure 3, which shows the mean excess returns from the five portfolios (the actual data) and the corresponding mean excess returns predicted by the asset pricing model based on our global volatility risk variable. Essentially, we obtain almost a 45 degree line, indicating that the volatility-risk proxy captures almost fully the variation in portfolio returns.
Figure 3. Realised mean excess returns
We propose a measure of global foreign-exchange volatility innovations as a systematic risk factor that explains the returns from carry trades. There is a significantly negative co-movement of high-interest-rate currencies (carry-trade-investment currencies) with global foreign-exchange volatility innovations, whereas low-interest-rate currencies (carry-trade-funding currencies) provide a hedge against unexpected volatility changes. Further analysis shows that liquidity risk also matters for the cross-section of currency returns, albeit to a lesser degree. These results also extend to other cross-sections of asset returns such as individual currency returns, equity momentum, and corporate bonds.
Burnside, C, M Eichenbaum, I Kleshchelski, and S Rebelo (2011), “Do Peso Problems Explain the Returns to the Carry Trade?”, Review of Financial Studies, forthcoming.
Fama, EF (1984), “Forward and Spot Exchange Rates” , Journal of Monetary Economics, 14:319-338.
Lustig, H and A Verdelhan (2007), “The Cross Section of Foreign Currency Risk Premia and Consumption Growth Risk” , American Economic Review, 97:89-117.
Menhoff, L, L Sarno, M Schmeling, and A Schrimpf (2011), “Carry Trades and Global Foreign Exchange Volatility”, Journal of Finance, forthcoming. CEPR Discussion Paper 8291.
Tags: Carry Trade, Currency, Currency Markets, Currency Speculation, Emerging Markets, Empirical Literature, Exchange Rate Changes, Foreign Exchange Markets, High Interest Rate, High Interest Rates, Interest Parity, International Currency, Low Interest Rates, Lucio Sarno, Lukas Menkhoff, Maik Schmeling, oil, Profitable Investment, Risk Exposure, Risk Premia, Schrimpf, Trade Profits, Volatility Risk
Posted in Energy & Natural Resources, Markets, Oil and Gas | Comments Off
Friday, June 4th, 2010
Euro-contagion has spread to Hungary. Parity for the euro may come sooner than anyone expected. Here are notes and analysis from a variety of sources on the unfolding euro/Hungarian meltdown, Round 2:
Hungary CDS Offerless, 100 Wider At 430 bps, from ZeroHedge.com.
To all those who listened to Hugh Hendry’s recommendation to panic a week ago, congratulations- you are well ahead of the market today. Hungary CDS is now offerless as investors are shocked, shocked, that the country (and continent) is actually really bankrupt, as opposed to just make believe. IMF’s comments yesterday that it does not have the funds to rescue all of Europe are not helping. Hungary CDS is now essentially bidless last seen 120 bps wider, around 430/460 with the bid/ask spread at 30bps, and only dealers daring to take on any risk exposure as the risk off brigade has kicked the optimists out of the building. The one thing up today so far? Gold. NFP better be north of 100 million or else the stick save today will be a tad problematic.
Europe Tremors Resume: Spain Bund Spreads At All Time Wides, China Exporters Ditch Euro As CHF Surges, from ZeroHedge.com.
Another horrendous day shaping up for Europe. Spanish Bund spreads have surged to all time highs just south of 200 bps, Hungary confirms that it was not exaggerating comments about chances of (not) avoiding Greek situation, pushing its CDS even wider, the EURCHF has dropped to under 1.40 and the SNB has not intervened yet, while the EURUSD is down to 4 year lows below 1.21. The nail in the euro coffin is a report by Reuters that a growing number of Chinese exporters turn down euro payment, flatly refuting anything SAFE may be saying officially.
Chinese exporters who made a big push only a year ago to bill in euros are increasingly turning their backs on the wounded European currency and demanding dollars instead.
By contrst, Beijing last week said a report it was reviewing the euro portion in its mountain of foreign exchange reserves was groundless and it calmed markets by saying that Europe remained a key investment market.
But Chinese exporters and the local governments that oversee them are less confident. They are trying to keep a wider berth from the euro, at least for now.
Oh, and now the French PM is quoted as saying that he only sees good news in parity between the dollar and the euro. Too bad none of his bank share the sentimentm realizing all too well none of them will exist in that situation.
Add Hungary to the PIIGs List, from Big Picture.
The market needs a new acronym to replace PIIGS to include Hungary as a spokesman for the PM of Hungary said their economy is “in a grave economic situation” and the possibility of default is “not an exaggeration.” Markets rolled over after the comments and the euro fell to a new 4 year low vs the US$. Hungary 5 yr CDS is higher by 15 bps to 323 bps, the highest since July ‘09. Hungarian stocks are lower by almost 4% and European banks are all lower. With respect to the US jobs data, it’s not the headline number that will matter but what’s under the hood as census workers may add 500k+ to the figure. The private sector is expected to add 180k jobs and that is the only thing that matters as the census workers will be off the gov’t rolls by Sept. The birth/death model will also contribute as 186k jobs were added in May ‘09. The unemployment rate is expected to tick lower by .1% to 9.8%.
Now it’s Hungary’s Turn, from TraderMark.
Well this one came out of the blue. Looks like they pulled a Greece in their statistics department. Hmm, governments worldwide fudging the numbers to create an alternate sense of reality? Whodda thunk!
- Hungary’s is in a “grave situation” because the previous government “manipulated” figures and “lied” about the state of the economy, said Peter Szijjarto, spokesman for Prime Minister Viktor Orban. The forint fell for a second day, dropping as much as 2.1 percent against the euro.
- A fact-finding panel will probably present preliminary figures on the state of the economy this weekend, Szijjarto said today at a news conference in Budapest. The government will publish an action plan within 72 hours after the committee reports its findings, he said.
- “It’s clear that the economy is in a very grave situation,” Szijjarto said. “We need a clean slate to formulate our economic action plan, and the fact-finding committee will provide just that.”
- “It’s no exaggeration” to talk about a default, Szijjarto said today.
- Hungary needed a 20 billion-euro ($24 billion) international bailout to avert a default in 2008. Orban, who took over May 29 after winning elections by pledging to cut taxes and stimulate the economy, yesterday failed to get European Union approval for looser fiscal policy.
- “Investors are losing their patience,” Gyorgy Barta, a Budapest-based economist at Intesa Sanpaolo SpA, said in a phone interview. “This is part of a communications strategy that wants to tell voters one thing and the markets another. It’s getting too complicated, and the government now needs to come clean and present a convincing plan of fiscal consolidation.”
Oh well, nothing a hundred or two billion euro won’t fix. Get to work US taxpayer… err IMF.
Biggest Hungarian Commercial Bank Trading Halted On Budapest Stock Exchange, from ZeroHedge.com.
All trading in shares of OTP Bank, Hungary’s largest commercial bank, has been halted on the Budapest stock exchange after a plunge greater than 10%. Nothing to see here, go back to reading Goldman’s spin on things, and why everything all of this really should be priced in already.
Austria Next On The Implosion Radar; German, France CDS Blow Out, from ZeroHedge.com.
Austria, the country most exposed to weakness in Central and Eastern Europe, is back on the radar. After having avoided skeptical investor scrutiny even as the bulk of Europe was collapsing all around it, the country is today’s top CDS widener, yet still stunningly trades inside of France and Belgium. Look for this spread to blow out over the next week. Then again, the biggest CDS wideners are precisely the countries formerly seen safe: Austria, France, Germany and Belgium are all the top movers in CDS. So much for the whole North vs South division in Europe.
Goldman Sachs’ Desperate Attempt at Hungary Damage Control, courtesy of ZeroHedge.com.
Goldman Sachs to save the day…
Hungary – Greek-like crisis has already happened; Fidesz tries to free itself from campaign promises
Yesterday’s comments by Fidesz vice-president Kósa alleged that Hungary stands on a brink of a sovereign default due to its very precarious budget situation and continuously appearing ‘skeletons’ in the fiscal accounts while Michaly Varga, a deputy PM, claimed again that the ‘true’ 2010 budget deficit is closer to 7%-7.5% of GDP rather than the 3.8% assumed in the IMF-led program or 4.3%-4.5% forecasted by the NBH. Given the seriousness of the situation, Kósa declared that within a week the new government will announce a two-year crisis management plan that would include deep constitutional and structural reforms. Nevertheless, Kósa did not withdraw the plans to lower taxes which was one of the key election promises. He also declared that countries that were successful at crisis management ‘rejected the requirements of the World Bank and the IMF’ and expected the European Union to foot the bill for a potential external rescue of Hungary.
On the same day, European Commission President Barroso urged the new Hungarian government to speed up fiscal consolidation and implement structural reforms that would help maintain long-term fiscal sustainability and support economic recovery.
The Hungarian PM, Victor Orban, followed with declarations that the new government is committed to restoring fiscal stability and that the new economic plan, to be published within 72 hours after revealing the budget report, will include structural measures to boost growth and competitiveness as well as significant tax cuts.
IMF mission chief is due to arrive in Budapest for informal talks with the government. His visit is not a part of a formal review mission, which was postponed because of the parliamentary elections.
COMMENT: We believe that yesterday’s dramatic comments were intended for domestic consumption and were used to build a dramatic backdrop that would let Fidesz backtrack on a large share of its campaign promises and broadly continue with the fiscal policies of the previous government, as well as preparing the ground for another round of IMF talks. Exaggerating the state of public finances left by the previous government, pretty common as it is (the incoming UK government used very similar tactics), supports the arguments against fiscal expansion and, in the future, will back up the claims that the crisis management plan was successful in reducing public deficit. The party faces local elections in October and not following up on the election promises risks alienating the voters, while blaming the ‘imminent crisis’ and ‘fiscal skeletons’ helps it save its face. At the same time, inflating the deficit forecast gives it space for negotiations with the international lenders and increases the chances that the potential new program will allow for some fiscal loosening in 2010 and 2011.
The claim that the country is on a brink of sovereign default and risks following the Greek path does not hold up against the facts. Hungary has already faced a crisis and asked for IMF and EU assistance in late-2008. In this context, Hungary is some 18 months ahead of Greece. Next, Hungary is not an EMU member and by having its own currency and domestic and external debt benefits from having a captive investor base. Finally, Hungary still has access to the undisbursed tranches of the IMF/EU loans. Our analysis (New Markets Analyst 10/04) shows that under the current policies debt stock is stable and that the country will be able to rollover its maturing debt without a problem.
It seems that Fidesz has taken a major decision on the path of macroeconomic policy and is now preparing the stage for its announcement – first, by revealing the ‘true’ size of the deficit and, second, by following up with the two-year plan. We believe that the ‘good scenario’ is more likely, namely a new agreement with the IMF and the EU and broad continuity of the fiscal consolidation plans, although with some loosening due to the cost of the yet to be announced structural reforms and to accommodate some of the election promises. We continue to believe that a stabilization program is the most likely outcome, which should significantly reduce the perception of the Hungarian sovereign risk (for more information, please see New Markets Analyst 10/05).
The risk here is that the new government attempts to follow the Ukrainian and Romanian examples, leading to protracted and rocky discussions. The other risk is that the new government is too confident in its ability to influence the Forint (in earlier comments, Fidesz said that weaker currency will support Hungary’s competitiveness) and may be careless in its communications (as shown by yesterday’s comments from Kósa). The punishment from the market may come quickly and weakening of the currency beyond the pain level of banks and households (about EURHUF of 300) – which hold significant amounts of FX debt – would serve as a warning to the new government. Our research shows that among CE3 countries, Hungary is most exposed to risk sentiment and the widening of risk premia would hurt Hungary’s growth.
The ‘negative scenario’ in which the new government abandons the IMF program and lets the fiscal situation get out of control would actually help fulfil the claims that the country is indeed unable to access financing; we find that unlikely, though.
The news that the IMF mission chief will hold informal talks with the new government is neutral. Such a visit had to happen regardless of the course of Fidesz’s macroeconomic plans. IMF needs to learn more about these plans and both sides need to decide how they want to proceed. This should clarify the situation and help us know whether the next program is going to happen. We expect some follow-up news within the next couple of days.
Tags: All Time Highs, Bps, China, China Exporters, Chinese Exporters, Coffin, Contagion, Ditch, ETF, Eurchf, Eurusd, Gold, Hugh Hendry, Imf, Lows, Meltdown, Optimists, Parity, Reuters, Risk Exposure, Snb, Surges, Tremors
Posted in ETFs, Gold, Markets | 1 Comment »
Sunday, February 28th, 2010
- Taiwan’s GDP grew 9.2 percent year-over-year in the fourth quarter of 2009, exiting a recession which started in late 2008. Not only were exports and investment on the rise, but private consumption registered the strongest quarterly increase in the last 20 years.
- Thailand’s fourth quarter GDP rose 5.8 percent from a year earlier, accelerating from a 2.7 percent contraction during the third quarter. The change came as private consumption and government spending more than offset still anemic investment constrained by political uncertainty.
- January wireless data for Brazil indicated net additions of 1.6 million and a 16 percent year-over-year increase in total subscriber base. Vivo accounted for 43 percent of new subscriber additions, followed by Claro (América Móvil) with 25 percent and Telecom Italia Mobile with 24 percent. Brazil wireless penetration currently stands at 92 percent compared with 76 percent in Mexico, 116 percent in Argentina, 98 percent in Chile, 81 percent in Colombia and 68 percent in Peru.
- Unemployment in Brazil rose to 7.2 percent during January, up from 6.8 percent in December due to a seasonal effect but was better than the market expected.
- According to Troika Dialog metals and mining analysts, Russian gold mining companies boast output growth that is among the highest on the global landscape, while appearing attractive on valuation grounds.
- Initial public offerings launched by Chinese companies in the U.S. during the fourth quarter declined 4.8 percent on average in the first month of trading. The loss deteriorated to 6.7 percent for IPOs in January and February, the longest slump in five years, as investor continued to trim risk exposure and sentiment remained weak.
- Results from Brazilian toll road operator Companhia de Concessões Rodoviárias (CCR) came in weaker than anticipated due to higher costs.
- Murray and Roberts, the largest engineering firm from South Africa, provided a murky outlook for its operations. While the company was positive about its long-term outlook, its short-term future is foggy—particularly with respect to operations in the Middle East.
- Price expectations for residential buildings in Czech Republic remain stagnant even after a significant recession, according to Citi research. The chart shows realized prices significantly below offer prices, while expectations from a business survey point to further weakness.
- Expanded urbanization and regional development are expected to be confirmed as a major policy focus in China in the upcoming annual plenary session of the National People’s Congress. Supportive policies may be created to empower local governments to develop infrastructure and attract capital because of the role urbanization plays in promoting consumption. Indeed, even global luxury brands have spread their presence beyond coastal China into second- and third- tier cities to position for tomorrow’s growth.
- As uncertainty related to global policy actions in both the developed and emerging worlds continues to rise, Russia could become a spot of relative stability, according to Bank Credit Analyst research. The chart shows that equity valuations are still low compared with the emerging market universe.
- Domestic sugar prices in China have been on the rise so far this year as drought in southern China affected cane production. There are also news reports about labor shortages, especially in the Pearl River Delta area where some migrant workers chose not to return to work after the Chinese New Year because of unattractive wages compared with inland regions. There could be inflation going forward if these developments persist.
- Although an announcement of higher bank reserve requirements in Brazil had been expected, some market participants may view it as ambiguous with respect to the impact on the banks’ top and bottom lines. We do not expect a detrimental impact on the profitability of Brazil’s banks because they will still be earning interest on the reserves at the SELIC rate—the overnight lending rate set by Brazil’s central bank.
- Political tensions in Turkey have escalated this week following new arrests related to an alleged 2003 military coup against the ruling Justice and Development party. The uncertainty related to the outcome of a likely referendum on controversial judiciary reform may also contribute to further market volatility.
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