jueves, 14 de agosto de 2014

Whew! An inflow into high yield bond funds

Reports say investors put US$0.68 billion into high yield bond funds in the week ending August 13. That's a welcome relief after the US$7.1 billion outflow of the prior week.

Meanwhile, though, other worrying trends in the financial markets have Fed officials and bankers on edge. Liquidity is not as abundant in the "repo" market as it was. "Repos" are repurchase agreements in which borrowers sell government bonds (principally) for cash to a third party at the same time they promise to repurchase the bonds at a slightly higher rate in the future.

That some banks are reported to be reducing their role as middlemen in the repo market is important because financial institutions like banks and hedge funds use repos for funding. Repo markets froze up in the 2008 crisis, threatening the international financial system.

No one is suggesting that repo markets are on the verge of a 2008-style seizure. However, two Fed regional presidents  expressed their concern about repo markets this week. 

viernes, 8 de agosto de 2014

Investors pulling out of junk bonds...

In the week ended August 6, investors yanked a record US$7.1 billion out of junk bond funds, the Wall Street Journal reports. The prior record of US$4.6 billion was set in June 2013. The week ending August 6 was the fourth straight week in which investors cut their holdings in junk bond funds and a marked contrast to steady inflows early in the second quarter.

At the same time, yields on US treasuries have been declining.

The funds flows out of junk bonds are another reason to believe that portfolio investment flows are behind the recent depreciation of the peso.

viernes, 1 de agosto de 2014

Why has the peso jumped? There's Argentina...

On August 1, the International Swaps and Derivative Association (ISDA) “resolved that a failure to pay credit event occurred in respect of the Argentine Republic”. What does that mean? It means that any institution holding a credit default swap (CDS) insuring against a default by Argentina can collect. 

CDS are written by private parties. Banks and insurance companies (remember AIG?) developed a lucrative fee-generating business line by writing CDS. The notional value of the CDS written can -- and often does -- far exceed the nominal value of the debt being covered by the CDS. Estimates of the value of the CDS written on the defaulted bond issue are not widely known, if they are known with any exactitude.

By triggering the right to collect, the ISDA resolution opens up a can of worms. Over the coming days, we'll see how much exposure to the Argentine default there really is in the international financial system and which financial institutions are most heavily exposed. The issue isn't really who holds the actual bonds. It's which institutions bet that Argentina wouldn't default and they value of the CDS they wrote  based on that belief. 

The background:

Argentina entered into a technical default when it failed to make a debt payment to foreign creditors on June 30. The technical default became a real one a month later. It’s not that the country didn’t have the money to make the payment or even that it didn’t want to pay. The funds are sitting in a US bank awaiting transfer.

The situation is the consequence of a June 16 US Supreme Court’ decision that it would not accept an appeal of lower court rulings requiring Argentina to pay bondholders who refused to participate when the country restructured its debt earlier this decade as well as the holders of the restructured bonds. The US Supreme Court ruling also upholds lower court decisions that permit bondholders to issue subpoenas to banks to trace assets held abroad by Argentina.

The rulings are a major victory for those “vulture investors” who often bought the bonds at discounted rates in the secondary market and turned to the courts to enforce their right to payment in full. Be that as it may, the rulings will greatly complicate any future debt restructurings since the rewards for holding out have just soared.

jueves, 31 de julio de 2014

Why has the cost of a dollar jumped?

The answer may well have to do with the hefty US$4.8 billion loss Portugal's largest bank (in terms of assets), Banco de Espirito Santo, reported on July 30. Losses could be even higher, up to US$5.7 billion. The US$4.8 billion loss was 72% higher than had been expected earlier in the month when Portugal's central bank -- based on information provided by KPMG, the Espirito Santos's group's auditors -- stated on July 11 that Banco de Espirito Santo had enough capital to weather possible losses.

The central bank not only ordered the bank to raise more capital, it also forced the suspension of voting rights of three Board members of the Espirito Santo family and ordered the  bank's auditors replaced. Last week, the family patriarch, Ricardo Espirito Santo, was arrested in connection with an investigation of money laundering and tax evasion. An outsider replaced him as head of the bank.

The damage had already been done, though. Extensive lending to prop up weak companies in the family empire took its toll when those family companies failed anyway. Three family holding companies have filed for bankruptcy protection this month.

What does this have to do with Mexico? Portfolio flows... If the effective failure of Portugal's largest bank were to cause investors to become more concerned about risk, they will pull back from investments in emerging markets. Economex does not think it's a coincidence that the fix rate peso jumped from $13.06 on July 29 to $13.23 on the 31st.

And then, of course, Argentina's default doesn't help.

miércoles, 23 de julio de 2014

A poor year for US growth...

The IMF has again reduced its expectations for growth in the US. Now, the Fund is projecting a 1.7% growth rate for 2014. That's bad news for Mexico, for whom exports to the US are so important to its own growth.

It's not all bad news, though: the damage was done in the first quarter, when GDP contracted 2.9%. The rest of the year should be quite decent: the IMF expects the US economy to grow 3% - 3.5% in what remains of 2014.

The IMF has reservations about US growth over the longer-term, putting the growth rate at 2%, tops, unless there are major reforms, "including tax and immigration changes, more investment in infrastructure and job training, and the provision of childcare assistance, which could help lure more Americans into the workforce" (July 23 New York Times). The Fund even went so far as to argue there is a "strong case" for more government spending to support the recovery, provided there's a plan to tackle entitlement spending later.

The need for structural reforms to boost the economy's sustainable long-term growth rate isn't confined to Mexico.

jueves, 3 de julio de 2014

Bubbles? Not the preserve of monetary policy says the Fed...

Federal Reserve (Fed) Chairperson Yellen reiterated her view on expansive fiscal policies and asset bubbles in a speech at the International Monetary Fund on July 2. Dr. Yellen accepts that maintaining financial stability is a primary responsibility of the Fed but argued that is best done through macro-prudential regulation. Acknowledging the challenges to regulating successfully that the substantial shadow banking sector poses, she made it clear, however, that she hasn’t eliminated monetary policy as a tool to rein in financial excesses.

Not all policymakers are as sanguine that low interest rates and expansive monetary policy don’t pose a threat to financial stability. Perhaps the perception of a threat depends on whether the size of the economy relative to the size of capital flows… As RaboBank put it, although the “approach is arguably an improvement on the Greenspan/Bernanke-era “Let Them Eat Bubbles” policy stance, it still does not seem to address the issue that in today’s global, interconnected markets central banks will presumably have to be regulating left, right, and centre to try to prevent bubbles from forming somewhere”. 

domingo, 29 de junio de 2014

A sobering analysis by the world's central bankers...

The Bank For International Settlements (BIS) is the central bankers' bank. Its Annual Report is an ideal forum in which central bankers can voice concerns they aren't able to express as openly as individuals. The BIS's just published 2014 Annual Report makes for sobering reading. Here are some of the major concerns...

--New asset bubbles are forming -- and the global economy hasn't even fully recovered from the excesses of the financial crisis! With interest rates at record lows, investors aren't paying much attention to risk. Consequently, weak borrowers are able to issue debt at surprisingly low rates, given their underlying fundamentals.
   Does this remind you of the heady days before the PIIGS crisis? The head of the BIS's monetary and economic department said "There is a disappointing element of deja vu in all this... The signs of financial imbalances are there." According to the Annual Report, debt levels in many emerging markets and in Switzerland "are well above the threshold that indicates potential trouble."

--It could be a few more years before the the world recovers from the financial crisis. Europe could experience an especially slow recovery because of high debt levels: "During the boom, resources were misallocated on a huge scale and it will take time to move them to new and more productive uses", according to the text of a speech by the General Manager of the BIS, Jaime Caruana, a former Governor of Spain's central bank. 

--Governments need to take measures to improve their economies, including improving labor mobility. The governments of countries that are growing rapidly need to watch out for overheating.

--There were admonitions for the private sector as well. Banks should raise more capital, both as a cushion against risk and to deal more quickly with portfolio problems. That corporates haven't taken advantage of the boom in stock prices to increase investment is one reason productivity gains have slowed in most developed economies: "Instead of adding to productive capacity, large firms prefer to buy back shares or engage in mergers and acquisitions." 

The BIS sends this message: "...a growth model that relies too much on debt, both private and public, ... over time sows the seeds of its own demise."