Jim O’Neill Bets The (Horse) Farm On Chinese Decoupling All Over Again

Monday, September 12th, 2011

Like a Swiss watch, Goldman’s Jim O’Neill, who refuses to acknowledge that decoupling between the US and the BRICs not only never existed, but was always a flawed premise to begin with, has released his latest dose of Kool-Aid, in which he bets the horse track on, you guessed it, Chinese decoupling…. Sigh. Then again what can one expect: just like Bernanke will keep trying QE until QE succeeds (it won’t) or the market breaks; and just like the Krugmanites will keep pushing for an ever bigger fiscal stimulus (because the last one is never big enough, regardless of how big it is), why should one expect the latest addition to Goldman’s biggest loss leader (GSAM) be any different. And what makes this particular episode not only tragic but very much comic, is that the former “Red Knight” now sees the Chinese launch of a fully convertible and floating Yuan by 2015 as the panacea to the US stock market, and Goldman bonus doldrums (because when one cuts to the chase, that’s really what it’s all about). Little does it bother the BRICer that the advent of a new reserve currency would have a devastating impact not only on existing risk markets, but on so-called risk free ones as well. Remember that 0.000% yield on last week’s 4 week bond auction? Yeah… that would not come back. Ever. Anyway, with the upcoming week sure to provide significant tears, especially to European readers, here is at least some comic relief (yes, O’Neill does in fact “applauds” the move by the pegging move by the SNB – apparently loading up the asset side of your balance sheet with toxic paper which may or may not exist post the Greek expulsion is considered prudent when one is a Goldman partner) to start it off with.

From Goldman’s Jim O’Neill

THE ST LEGERS TO THE RESCUE – OR NOT?

Another tumultuous week comes to an end, coinciding with the 10 year anniversary of 9/11 adding to a weekend mood of reflection on the past decade.

There have been a remarkable number of things happening this week, especially on the policy front. Unfortunately, this has not included major policy developments on the European front, which continues to be the biggest source of disturbance to world markets. Worryingly, the hole in which the Euro Area seems to be slipping into is getting broader and the scale of the solution is getting tougher.

That being said, Saturday saw the Doncaster annual horse race, the St Leger. I think it was a little bit earlier in the month than usual. Perhaps someone knows markets need that extra helping hand…….( those who are more baffled than usual by my comments , there is a famous phrase re markets in the UK, “ sell in May and  Go Away, Come Back on St Leger’s Day”. As we all know too well, the May part worked rather well this year.

CLEAR, BUT CONTROVERSIAL STEPS IN THE US.

The US economy had a slightly better week for data with the services ISM for August and the July trade data positively surprising. After reducing forecasts of coincident GDP growth, a number of people are now talking about possible upside risks. To me, it looks as though the US may be growing in the vicinity of 2 pct.

At our latest internal CIO call at GSAM, I hosted a discussion of our views and stance on the US with our fixed income and equity portfolio managers. The above views of the economy reflected the broad stance of views offered from a macro perspective. The equity teams offered their views based on very up-to-date readings from many US companies across many sectors. Their conclusion had a similar flavor to the message from the Fed’s latest Beige Book: an economy with modest momentum but, importantly, no real signs of a downward shift. When it translated into a discussion of the US equity market, the general conclusion was that the market is – pending external events – more likely to rise than fall.

The major US highlight of the week was Thursday’s speech by President Obama to Congress where he unveiled a larger than expected proposed fiscal stimulus, aimed at targeting job growth and infrastructure spending. According to the GS Economics Department, if implemented, the proposal would take fiscal policy from a 1.5 pct  of GDP reduction to a 0.5 pct stimulus. Put together with a clear bias to explore additional ways of monetary stimulus from the Fed, it is tough for me to see the big downside risks to the US economy, at least cyclically.

Of course, somebody that had arrived back on earth from a few weeks in Jupiter might ask, “Is this stimulus being proposed by the same country that was berating credit rating agencies at the start of August for regarding its fiscal stance as not credible?”

I raise this because one of the most interesting aspects of post Obama market trading was how unenthusiastic the market response was. Whether this is because investors doubt its effectiveness, doubt the likelihood of it being supported by Congress, because markets rose in advance on leaks of most of the content, or probably, in my view, bigger negative concerns elsewhere, it will no doubt have added to concerns of the US contingent coming to Europe for the Marseille G7 meeting.

CHINA IS THE STILL THE BIGGEST TRUE HOPE FOR EXCITEMENT.

I had an odd past two days, as I have become more and more concerned about aspects of the Euro mess, which I discuss below, but this was more than offset by excitement over a Bloomberg story Thursday suggesting that senior Chinese policymakers have been giving out signals that they are now aiming for full convertibility  of the Yuan by 2015.

This is hugely important, not least as I don’t recall a specific close timetable being cited before. It is unlikely that such a major initiative would be unveiled without being announced by the leadership. But according to some of my conversations, this notion is certainly not being dismissed. It follows a growing feeling I have had since early August that Beijing is definitely in a mood to accelerate RMB and other reforms. It also comes a few weeks after the French G20 hosts announced that a working group had been established to develop a plan for RMB inclusion in the SDR basket.

I cannot emphasize enough as to how important, and positive, such a development would be. 2015 is not much more than 3 years away. To reach and achieve this goal, a whole host of parallel developments would be likely. These would range from less accumulation of FX reserves, steps to develop the Shanghai stock market including the listing of many non Chinese multinationals, and major development of the domestic bond market. It would also move in-step with successful efforts to adjust the economy’s leadership from exports to domestic – consumption led – demand.

It is no surprise to see stories of more central banks talking about diversifying into the RMB with this week, with both Chile and Nigeria giving some such signals.
To add to the flavor of the opening up of the RMB, on Thursday, Chinese officials issued a joint press release with the UK to announce that London would be allowed to undertake offshore RMB trading.

Friday brought the important news that CPI inflation in China slowed from 6.5 to 6.2 pct. It is very likely to have peaked for the year, and base effects alone suggest a move down to 5 pct or less by early next year. I said to some G7 policymakers I saw in London yesterday that this is something they should all be embracing instead of berating the Chinese about the RMB this weekend. For the massive challenges facing the US and most of Europe, lower inflation in China (and other Growth Markets) represents the most likely escape from years of weak growth, as it would allow strong increases in personal consumption to occur.

Further good news appears to have come this weekend with the August trade data surprising on the downside as a result of stronger imports. I continue to be amazed by the lack of awareness of how much the Chinese trade balance has improved. This week I appeared at the UK Treasury Select Committee, along with Gerard Lyons  of Standard Chartered, and the members seemed to have similar views to most I come across. I also participated as a panelist at a Chatham House event on the Global Economy on Friday where the new head of the IMF repeated a comment I have seen written by Fund staff that improvement in global imbalances has stalled. This is simply not true. After the August trade data, we now have 8 months of the 2011 year. And, the 12-month running total trade surplus is around $182.7 bn, down from last month and about 2.5 pct of GDP. Moreover, the trend of import growth is quite strong. Year to date annualized they have risen by around $ 350 bn.
So if all of this is such good news, why did Chinese equities not rally? I don’t know, but I suspect it is because the CPI improvement was smaller than hoped for, and without an “all clear” regarding the inflation outlook from the Chinese leaders, investors are nervous about jumping the gun. But it certainly seems to me the ingredients for a big Chinese rally are improving.

EUROPE. CAN THE SWISS RUN EMU PLEASE?

What another staggering week in Europe. The more it progressed, the more “emergency” calls I was asked to join for clients all over the world about the deteriorating dynamics of European Monetary Union (EMU). Major institutional investors, large private equity firms and big international corporate were all asking the same underlying question, “How can this thing survive?”

Jonathan Bayliss from our Fixed Income team this week led a 2-day onsite offsite about the future for the Euro Area and we will be providing clients with a flavor of these discussions. Many different outside experts were invited to contribute. It seems as though “the muddle through” path is the one that most see as the most realistic one ahead, with more and more thinking ultimately we get “more Europe” with tighter, clearer fiscal rules and genuine Euro bonds. The depth of market fragility questions whether time will allow for such a long road There are lots of key event risk factors coming up this month, but the vicious circular mood that has taken hold means that, not only does it seem as though something “big” has to happen with Greece pretty soon, but something “big” needs to happen for European bank capital, the clarity and determination of ECB policy making and, most importantly, where Germany wants to lead EMU.

I can’t help concluding that it actually isn’t as difficult as many European leaders seem to think. Bang in the heart of Europe is Switzerland, and having seen their competitiveness potentially devastated by the mess that surrounds them, this week the Swiss National Bank (SNB) went ahead and announced the extraordinary step of putting a formal, temporary floor under the Franc at 1.20 against the Euro. It seemed to me pretty obvious this was coming and, within minutes of the announcement, the Franc fell by over 8 pct, which I think has to perhaps be the single fastest large move of a major currency since floating markets commenced in the 1970’s. I applaud the SNB for such a bold step, and find myself amused at the tons of people who have suggested to me that it won’t work. When a central bank uses words like “unlimited” and puts a new currency arrangement at the core of its monetary policymaking, especially when they are trying to turn a grossly misaligned currency, my experience suggests it should be followed. Moments such as these in foreign exchange are all too rare and they are usually the ones that distinguish currency investors.

When quizzed about the SNB move, predictably, the ECB stated that while they were made aware, it was a solo act of the SNB. While this is obviously the case, the tone of that statement sums up for me many of the shortcomings of Euro Area policymaking. Is it that most of them lives in some kind of time warp? Or is the more subtle interpretation that the key actors know the really powerful decisions need an appearance of real crisis before the German electorate can be persuaded to support them?

At least there has been some spectacular Premier League football especially from a certain team this weekend.

Jim O’Neill

Chairman, Goldman Sachs Asset Management

Tags: Bond Auction, Bonds, BRICs, Comic Relief, Decoupling, European Readers, Fiscal Stimulus, Free Ones, Gold, Goldman Bonus, Horse Track, Infrastructure, Kool Aid, Loss Leader, Market Breaks, O Neill, Outlook, Red Knight, Reserve Currency, Risk Markets, Snb, St Legers, Swiss Watch, Us Stock Market
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Hungary Meltdown – Euro Contagion Spreading

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:

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.

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