Category Archives: General

Here’s Why Draghi’s Inflation Bomb Could Prove to Be a Dud

Bloomberg, Mar 10, 2015

Mario Draghi’s inflation bomb could prove to be a dud.

That’s because the weakness in the euro resulting from the European Central Bank’s 1.1 trillion euro ($1.2 trillion) quantitative-easing program risks being more than offset globally by the deflationary impact of a stronger dollar.

Making that case as the euro trades around its lowest in 11 years against the greenback is David Woo, head of global rates and currencies at Bank of America Merrill Lynch in New York. He’s telling clients that pressure from a rising dollar threatens to rattle emerging markets, undermine U.S. stocks and curb commodities prices.

Here’s how:

First, the higher the dollar goes the more likely investors will flee developing nations; that will make their borrowings in the U.S. currency more expensive, damaging their already-shaky outlook for growth.

As Woo notes, the Turkish lira and Mexican peso have both reached or traded near all-time lows against the dollar in the past few days and Brazil’s real is at its weakest since 2004.

China, which manages the value of its yuan against a basket of other currencies, may be forced to devalue to keep its products cheap in the international marketplace.

Next, because commodities are priced in dollars, the higher the greenback goes the more downward pressure will be applied to oil prices. Bank of America already says the likelihood is greater that crude falls rather than rises.

Finally, Woo estimates the dollar’s rise is starting to undermine profits at home. U.S. companies in the Standard & Poor’s 500 Index get 40 percent of their earnings from overseas and the index has fallen in 19 out of 27 trading days this year in which the greenback gained.

“The obvious implication is that investors are becoming concerned about the ability of the U.S. economy to cope with the strengthening dollar,” Woo said in a report to clients Monday. “The decline of euro/dollar below 1.10 may be less benign than it may appear at first.”

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Is the dollar losing its clout among EMs?

CNBC, March 9, 2015

The greenback’s dominance in the developing world may be under threat as more emerging economies begin to reduce their reliance on the global trade currency.

“Decreasing reliance on the dollar is an important trend that’s going to grow,” said Jim Rickards, chief global strategist at West Shore Funds. “As far as emerging markets, the rise of bilateral trading deals is significant for the dollar’s future as a trade currency.”

Around 80 percent of global trade finance is conducted in dollars, according to January data from SWIFT. But over the past few months, Russia and China have spearheaded a movement to use their domestic currencies for bilateral trade in an effort to distance themselves from dollar-denominated settlements. The countries recently signed a $24 billion three-year currency swaps agreement to double trading.

Meanwhile, Moscow and New Delhi may agree on a currency deal next year, Russian news agency TASS reported two weeks ago. Russia and Egypt are also considering a deal, according to Egyptian media reports last month.

Eye on reserves

It’s not just trade; Russia and China are also taking the lead in a $100 billion currency reserve pool and New Development Bank for the BRICS (Brazil, Russia, India, China, South Africa) group.

Moscow announced a $2 billion commitment to the bank over the next seven years in February, while China’s $41 billion contribution to the currency pool is the largest. The two projects, announced last year, were widely seen by economists as an alternative to Western dominance in international financial institutions.

Last week, Kazakhstan joined the group of countries turning their back on the U.S. dollar. The central bank announced a plan to decrease economy dollarization, reducing the use of dollars as it attempts to strengthen its national currency, the tenge.

The move followed calls by International Monetary Fund (IMF) deputy managing director Naoyuki Shinohara last month for emerging Asian economies to actively engage in de-dollarization.

“In some cases, high dollarization can facilitate trade. But there are drawbacks, such as limiting exchange rate flexibility to mitigate against external shocks, and constraining the central bank’s ability to be the lender of last resort. Under such circumstances, consideration could be given to actively promote de-dollarization,” he said.

Future of the greenback

As the dollar experiences decreased usage in global trade, China’s yuanis slowly climbing the ranks.

The yuan is now among the top ten currencies used in global trade, according to rankings by the Bank of International Settlements and SWIFT. Moreover, trading platform EBS told Reuters earlier this year that the yuan ended 2014 among its top five traded currencies.

Still, the greenback’s status as a global reserve currency remains intact, experts say.

“The dollar is declining as a trade currency, but it remains strong as a reserve currency. Right now, it’s around 61 percent of global reserves, versus 70 percent over a decade ago,” said Rickards.

In the meantime, the euro’s share has risen to around 25 percent from 18 percent when the currency was first introduced in 1999, according to the IMF.

Furthermore, major commodities are still priced in dollars; as long as that’s in place, even if more countries start ditching the dollar for payments, it won’t have a big impact on USD dominance, said Uwe Parpart, managing director and head of research at Reorient Financial Markets.

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German Yields Negative to 2021 as Investors Set for ECB Buying

Bloomberg, March 9, 2015

German government bonds advanced, pushing yields on securities due in as many six years further below zero, as investors prepared for the European Central Bank’s program of sovereign-debt purchases.

Anticipation of the 1.1 trillion-euro ($1.2 trillion) quantitative-easing plan, which is due to start on Monday, has already fueled a debt-market rally that sent yields across the euro region to record lows. The purchases, which are to include public and private debt, will be conducted in the secondary market by national central banks via existing counterparties.

“The ECB may well have to bid bonds aggressively to procure them from their holders, in particular to avoid question marks around the credibility of its QE delivery,” Cagdas Aksu, an analyst at Barclays Plc in London, wrote in an e-mailed report. Yields on the safest euro-area bonds “will remain suppressed,” he wrote. “We also expect the core-periphery spreads of Italy and Spain versus Germany to grind tighter in this environment.”

The yield on German 10-year bunds, Europe’s benchmark sovereign securities, fell three basis points, or 0.03 percentage point, to 0.37 percent at 8:26 a.m. London time. The 0.5 percent security due in February 2025, rose 0.265, or 2.65 euros per 1,000 euro face amount, to 101.305.

Germany’s six-year yield was at minus 0.03 percent. A negative yield means investors buying the securities would get less back than they paid if they held the bonds to maturity.

Yields have plunged across the region on concern the plan may lead to a scarcity of fixed-income assets. Seventy-seven of the 346 securities in the Bloomberg Eurozone Sovereign Bond Index have rates below zero, data compiled by Bloomberg show.

Off Bounds

ECB President Mario Draghi spurred demand for higher-yielding bonds last week when he said securities won’t be purchased under the debt-buying plan if their yields are below the ECB’s deposit rate of minus 0.2 percent.

Only bonds due between a minimum two years and a maximum 30 years and 364 days at the time of purchase will be eligible, and there are other limits on what can be bought to reach the target of 60 billion euros a month.

The trading desks of the euro-area’s national central banks do have some discretion over what they buy and when, the ECB said in a March 5 document.

Italy’s 10-year yield declined two basis points to 1.30 percent and Spain’s decreased two basis points to 1.28 percent.

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China February consumer inflation rebounds, producer deflation intensifies

Reuters, Mar 10, 2015

China’s annual consumer inflation recovered in February, exceeding expectations, but producer prices continued to slide, underscoring deepening weakness in the economy and intensifying pressure on policymakers to find new ways to support growth.

The producer price index (PPI) declined 4.8 percent in February, the National Bureau of Statistics said on Tuesday, extending factory deflation to nearly three years.

China’s statistics bureau attributed the rise in CPI to price rises in vegetables and fruit, while the decline in PPI – which analysts had expected to come in at minus 4.3 percent – was blamed on sliding prices for global commodities, in particular energy, which have undermined profitability at China’s industrial heavyweights.

The risk of deflation is rising for the world’s second-largest economy, as drag from a property market downturn and widespread factory overcapacity is compounded by an uncertain global outlook and falling commodity prices.

Analysts polled by Reuters had expected annual consumer inflation to be 0.9 percent in February, compared with a five-year low of 0.8 percent in January.

Chinese leaders announced last week an economic growth target of around 7 percent for this year, below the 7.5 percent goal that was narrowly missed in 2014.

The consumer price index target was put at around 3 percent for this year. Annual consumer inflation was 2 percent in 2014, well below the government’s target of 3.5 percent.

The People’s Bank of China (PBOC) has cut interest rates twice since November, on top of a reduction in bank reserve requirement ratios (RRR) in February, as regulators show signs of growing concern over lackluster data since the fourth quarter and growing deflationary pressures.

A newspaper owned by the central bank warned last month that China was dangerously close to slipping into deflation, highlighting increasing nervousness in policymaking circles as a sputtering economy struggles to pick up speed, despite a series of stimulus steps.

There could be some distortion caused by the timing of the Lunar New Year as it fell on January 31 in 2014 but fell on Feb 19 this year.

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ECB Starts Buying German, Italian Government Bonds Under QE Plan

Bloomberg, Mar 9, 2015

mario-draghi-raining-euros

The European Central Bank started buying government bonds under its expanded quantitative-easing plan designed to boost price growth in the region.

Central banks bought German and Italian debt, according to at least two people with knowledge of the transactions, who asked not to be identified because the information is private. They also purchased Belgian securities, one of the people said, and a separate person said French notes were being acquired.

Bonds rallied. The yield on Germany’s 10-year bunds fell five basis points, or 0.05 percentage point, to 0.35 percent at 10:30 a.m. London time, approaching the record-low 0.283 percent set on Feb. 26. Italy’s 10-year yield declined three basis points to 1.29 percent.

“The QE purchases are having the expected effect and the market is very positive,” said Michael Leister, a senior rates strategist at Commerzbank AG in Frankfurt. “In the core we’re seeing yields dropping sharply lower led by the ultra-long end so these are very much QE-style moves. Near-term it’s going to stay quite volatile because there are some sellers who did front-run these purchases and now are keen to sell.”

The ECB said in a Twitter post that it had started purchases along with national central banks. The Bundesbank was active in the market from 9:25 a.m. Frankfurt time, a spokesman said by phone.

Tighter Spreads

Anticipation of the 1.1 trillion-euro ($1.2 trillion) plan already fueled a debt-market rally that sent yields in the 19-nation currency bloc to all-time lows. ECB President Mario Draghi said in Cyprus last week that the stimulus will spur the euro area’s fastest economic growth in seven years and help return inflation to the ECB’s goal.

“The ECB may well have to bid bonds aggressively to procure them from their holders, in particular to avoid question marks around the credibility of its QE delivery,” Cagdas Aksu, an analyst at Barclays Plc in London, wrote in an e-mailed report. Yields on the safest euro-area bonds “will remain suppressed,” he wrote. “We also expect the core-periphery spreads of Italy and Spain versus Germany to grind tighter in this environment.”

Belgium’s 10-year yield tumbled six basis points to 0.57 percent and the rate on similar-maturity French debt dropped five basis points to 0.64 percent.

Scarcity Concern

Speculation over the impact of the quantitative easing program has dominated trading of euro-area bonds since it was announced in January. Some holders of government securities have indicated an unwillingness to sell, sparking concern that there will be a scarcity of available debt for the ECB to buy. There’s also a risk that flexibility and limited information on the plan stirs market volatility.

The ECB said last week that the purchases, which are to include public and private debt, will be conducted in the secondary market by national central banks via existing counterparties. That’s in contrast to the Federal Reserve’s approach, which involved a calendar telling dealers what it intended to acquire and when.

While the ECB has said that only securities due between a minimum two years and a maximum 30 years and 364 days at the time of purchase will be eligible, national central banks will have some wiggle room as they carry out purchases within their home markets, allowing them some choice between government and agency debt.

Purchases of bonds will be made roughly in proportion to the capital that each member central bank has contributed to the ECB, though that guideline doesn’t have to be strictly followed every month. There’s also flexibility on what maturity of bonds will be bought by the central banks to reach the target of 60 billion euros a month.

Cautionary Tale

Events in Japan in 2013 may offer a cautionary tale for dealers and central bankers alike. That nation’s government-debt market was rocked as its central bank expanded a quantitative easing program. After yields fell to record lows, they more than doubled in five weeks amid confusion by banks that were supposed to help facilitate trading of the securities, obliging the Bank of Japan to boost the number of operations it held each month to buy the debt.

Borrowing costs in the euro area have plunged on concern the plan may lead to a limited availability of fixed-income assets. The average yield to maturity on the region’s government debt reached 0.538 percent Feb. 26, the least since at least 1995, according to Bank of America Merrill Lynch indexes.

Balance Sheet

About 45 billion euros a month will probably be spent on sovereign debt, a central bank official said Jan. 22. That implies an intention to purchase 14 percent of euro-area government bonds outstanding by September 2016, or 18 percent of securities from Finland, Germany, Luxembourg and the Netherlands, the only nations with two or more AAA ratings from the three major credit-assessment companies.

To rekindle inflation in the euro area, Draghi has said the central bank intends to expand its balance sheet toward 3 trillion euros. Since October, when it announced details of plans to purchase covered bonds and asset-backed securities, the ECB’s balance sheet has grown from 2.05 trillion euros.

It took the Fed almost six years, and three rounds of quantitative easing, to boost its holdings to about 20 percent of U.S. Treasuries.

Buying Competition

Reduced government spending is likewise contributing to a global dearth of sovereign debt. Germany is due to curb the amount of conventional bonds outstanding by 8 billion euros this year. In Spain, where Prime Minister Mariano Rajoy’s People’s Party has implemented the deepest austerity measures in the nation’s democratic history, the net issuance target for 2015 is 55 billion euros, down from net sales of 97 billion euros in 2012.

With austerity measures and ECB buying, the euro-area sovereign-bond market will shrink by 259 billion euros in 2015, Morgan Stanley strategists, including London-based Neil McLeish, Anthony O’Brien and Serena Tang, forecast in a report in February.

Competition for purchases may come from banks requiring bonds to meet regulatory rules, pension funds that need to match their liabilities, passive investors who track debt indexes, and other central banks, which buy European securities as part of their balance-sheet management.

Negative Yields

Draghi added to demand for higher-yielding bonds last week, when he said securities won’t be purchased if their yields are below the ECB’s deposit rate of minus 0.2 percent.

Seventy-seven of the 346 securities in the Bloomberg Eurozone Sovereign Bond Index already have rates below zero, meaning buyers would get less back when the debt matures than they paid to buy them. Germany’s six-year yield was at minus 0.04 percent.

The ECB may have to cut its deposit rate further to ensure enough government bonds are eligible for purchase, according to Standard Bank Plc head of Group-of-10 strategy Steve Barrow.

Portuguese securities probably will fare best under the central bank’s program, according to a survey last week of the 37 banks that deal directly with Germany’s debt agency. Fourteen of the 20 financial institutions that responded on March 2-3 identified them as one of their top picks, saying they were attractive because they had the highest-yields of bonds included in the plan, and the nation’s debt market should be among the most saturated by ECB bids.

Whatever Necessary

The rally in bonds is a boon for the governments in the region because their borrowing costs should fall in international markets. Portugal took advantage of the upswing in demand to sell 30-year securities in January, the longest bond maturity since the country exited an international aid program. The nation’s debt agency has issued almost 60 percent of its 2015 target.

That’s a turnaround from 2011 to 2012, when concern the euro area would splinter under its debt load pushed yields to record highs and Draghi pledged to do whatever was needed to save the currency bloc.

Portugal’s 10-year yield was little changed at 1.75 percent, from a record 18.289 percent on Jan. 31, 2012.

The drop in yields has also helped to weaken the euro as it dimmed the allure of holding the currency and made it more attractive to borrow in the euro region in order to invest where yields are higher. Germany’s 10-year bunds yield about 188 basis points less than similar-maturity U.S. Treasuries, the widest yield discount since 1989, according to data compiled by Bloomberg.

Euro’s Slide

Only Brazil’s real and Denmark’s krone have fared worse versus the dollar this year than the euro among 17 major currencies tracked by Bloomberg. Even after a gain of 0.4 percent on Monday, it has weakened about 10 percent to $1.0891, reaching the lowest level since 2003. It touched the weakest level versus the British pound since 2007 on Friday and a record low against the Swiss franc in January.

The outlook for inflation is reviving as the lower yields and currency boost prospects for growth and exports. The five-year, five-year inflation swap, a market gauge of inflation expectations in the second half of the next decade, climbed to 1.7675 percent on Thursday, the highest this year, and up from a record-low closing rate of 1.48 percent in January. It was at 1.7265 percent on Monday.

The price of Germany’s 0.5 percent bund due in February 2025 rose 0.44, or 4.40 euros per 1,000-euro face amount, to 101.48.

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