Yeesh
United States – Ten year Treasury yields last traded at 1.63- (Five year swap spreads last traded at 15.00bts. The high yield ETF was last at 91.74, the AAA/BAA credit spread was 132bpts, and the JP Morgan Emerging Market debt spread 299.01bpts). The Business Roundtable survey of executives' view of the US economy deteriorated sharply in Q3. The outlook index tumbled to 66 from 89.1 which was the sharpest drop in its decade long history although remained above the critical 50 level separating growth from contraction. CEO's are particularly worried about the fiscal cliff, and in particular the uncertainty that it provides. 34% expect to cut jobs over the next 6 months up from 20% in Q2, while 30% plan to raise capex down from 43%. 58% expect sales to rise down from 75%. A second survey by Deloitte found chief financial officers' view of the economy had also darkened, again with hiring expectations, capital spending and earnings growth expectations all reduced. Obviously these surveys are in contrast to recent consumer data but are consistent with last month's ISM index.
Adding to the CEO's gloom, zerohedge suggests that the markets being made on various election outcomes suggest there is a 50% probability of an Obama victory but with a split government which would mean more fiscal gridlock, and a 15% chance of a Romney win with Republicans controlling the House and Senate which inevitably means spending cuts. Overall therefore it suggests the combined 65% probability of drastic cuts to spending or rises in taxes. I would suggest the figure will be somewhat higher because the market will simply not tolerate the budget deficit continuing to rise at the present rate.
Goldman's CEO Lloyd Blankfein said that the fiscal cliff could jeopardise the dollar's primacy, but so could the alternative that fails to cut America's deficits and slow federal borrowing. With the Eurozone in problems, Japan burdened by excessive debt and China's renminbi not freely convertible, its easy to imagine a new order in which no single currency reigns for global trade and investing. For the last 2 centuries there has always been a leading currency, and Blankfein argues that if this were to go then the cost of hedging would make finance more expensive although originating countries would derive some benefit or seignorage from the international use of their currencies. New currency blocs would emerge and a new gold standard may develop to cut through the confusion. The reality is the international acceptance of the dollar standard – whether from investors, central banks or oil producers pricing oil in dollars) - is simply a reflection of the perceived strength of the US economy and its ability to remain the frontier economy, ie Blankfein's fears about a gradual shift back to the gold standard is a reflection that US productivity and innovation is slowing. As the US economy moves further away from one based on industrial capitalism and real wealth creation to an economy based on financial capitalism and paper wealth then of course the system will gradually move towards a gold standard.
Europe – The Greek bailout issue has moved to another level. The IMF and EU leaders are at loggerheads over how to solve the problem with the IMF adamant that Greece reduce its debt further and that it restructure the debt it owes which would mean the EU taking a loss on nearly EUR200bn of Greek debt according to Reuters which is seen as politically unacceptable. "The problem is not between the IMF and Athens, it's between the IMF and EU" according to a Greek official. "Europe wants more time to see what will happen with Spain and Italy, perhaps even after the German elections in 2013. The IMF wants Europe to come up with a comprehensive solution to its problems now". The IMF says there needs to be debt restructuring to make this work, yet when looking at the details I personally think Greece still has a long way to go until it could stand on its own feet even if the debt was written off to zero, for example whilst its July current account was reported in surplus, this is to a large extent a seasonal aspect and the current account deficit reported at the end of Q2 was still 7.31% GDP which is mainly a trade deficit rather than any income deficit.
China – Baosteel announced it has suspended production at a loss-making steel plant in Shanghai reflecting the intense pressure on the sector from near three year low steel prices. The assistant president of the company said "The government's infrastructure investment may only improve sentiment….but I don't expect a big lift in steel demand". Baosteel posted a 53% drop in H1 profits excluding exceptionals, and expects the price of steel to remain under pressure through the rest of the year. The industry sits on well over USD400bn of debt which like the rest of the economy was taken on when GDP growth was significantly higher. Some 40% of iron ore mines in China have suspended operations as a slump in prices has forced them into losses according to the Metallurgical Mines Association although it does not say how much capacity has been withdrawn.
Bloomberg reports that yields on Chinese shipping company bonds has risen aggressively in recent months. Cosco's 2018 bond has seen the yield rose 46bpts this quarter whilst that on China Shipping Development 2017 paper has risen 176bpts reflecting both the excess capacity but also the slowdown in trade, particularly in raw material imports.
The central bank injected a net CNY365bn into money markets this week bringing the total so far this year up to CNY1.329trn (USD210bn). Based on end of July central bank balance sheet data and the subsequent money market operations, I calculate that the central banks bond holdings have fallen by 25.5% since the end of July to CNY1.334trn and are down 72% since July 2010 meaning that the central bank is exhausting its supply of bond assets and will presumably have to start considering reducing the RRR as the policy tool early next year.
Industrial profits fell 6.2% y/y in August, the 5th straight decline and the fastest pace of decline in those 5 months. Profits in the first 8 months of the year declined 3.1% to CNY3.06trn.
Experts estimate that China will face a pension fund shortfall of CNY18.3trn by 2013 due to accelerated population aging. That figure will obviously soar as the dependency ratio jumps from 12% to 35% by 2030. Longevity is increasing and the labour force shrinking such that Dai Xianglong, chairman of the National Council for Social Security Fund has called on the government to raise the retirement age from 60 to 63 and ask employees to pay pension premiums for 35 years rather than 30 years.
South Korea – Manufacturing business confidence edged lower to 72 in October from 75, which other than a 70 reading in August is the weakest since May 2009. The non-manufacturing index fell from 69 to 67, the lowest level since April 2009 and not far above the all time low of 54.
Chris de RoetthAMC, LLC
617.236.4200
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