Daily: Why Bill Gross and others are now buying Spanish and Italian sovereign debt
Bill Gross has admitted that he has started buying Spanish and Italian debt. That’s quite a turnaround given he had been saying earlier that he wouldn’t touch their sovereign debt with a ten-foot barge pole. So the question is why. And the answer is pretty simple. I told you why about a year ago when I wrote why Investors will buy Italian bonds after ECB monetization:
To sum up, the euro zone is in an existential crisis, brought on by fiscal, private sector and current account, imbalances in a fixed exchange rate environment lacking a lender of last resort. The morality of the economics of this situation are only relevant in regard to the economic nationalism to which these kinds of morality plays give rise. On the other hand, this arrangement necessarily means that some countries within the fixed exchange rate imbalance will eventually suffer a sovereign debt crisis due to the imbalances. Without a lender of last resort, such a crisis becomes existential as default is inevitable without at least an implicit backstop from the central bank. And sovereign default would inflict huge losses on sovereign creditors, cascading the insolvency down the line to the banks.
My conclusion: the ECB will backstop Italian (and Spanish) debt. What that means for Portugal, Ireland, and Greece, I don’t know.
The likely impact of this kind of action is an increase in expected nominal GDP in the euro area. If these expectations don’t include an increase in future real GDP within the euro area, monetisation would lead to a rise in the euro-denominated gold and silver price, currency depreciation more generally, and increased inflation expectations. So, in that case, this could be considered a beggar thy neighbour economic policy – competitive currency devaluation, if you will. It may invite reactions from the US and other currency areas.
Is this kind of monetisation sustainable over the medium-term? 100%.
If a central bank guarantees investors credibly that they can invest in certain debt instruments and not suffer principal or interest repayment risk, but only currency and inflation risk, some investors are almost definitely going to buy the debt instruments with the greatest yield pick up. Put another way, the only reason not to buy Italian debt at 2 or 300 basis points over Bunds, or Greek debt at 3 or 400 basis points over Bunds is because those governments are not credibly backstopped by the ECB.
I should add that that is exactly why investors were in these bonds in the first place. It was only when the solvency issue came to a head that yields began to climb. Investors believed in convergence. They believed that Portugal, Ireland, Italy, Greece and Spain all had implicit backstops just as they believed Fannie Mae and Freddie Mac had them in the United States. In the US case, investors were right.
Does the ECB want to lose its trump card in dealing with Italy? No. That’s why they aren’t offering an explicit backstop. But if they don’t backstop Italy, Italian yields will remain elevated, Italy will default, all of the German and French banks with those bonds will be insolvent, and we will have a Depression. Italy is too big to fail.
If the ECB does backstop Italy credibly and fully, then yields will fall and investors will pile in again. However, this is nothing more than a temporary patch, a medium-term liquidity solution only. Clearly, the issue for the Dutch and the Germans is that Italy would have no reason under this arrangement to make reforms or move to fiscal consolidation. They fear Italy (and Portugal and Greece) would become permanent ‘free riders’, mooching off of Germany and the Netherlands’ fiscal probity, making the euro a weak currency. The right way to deal with that fear is to choose between greater fiscal integration or breaking the eurozone up at some point in the medium-term (say 2-5 years).
My conclusion: the ECB will eventually move to a lender of last resort role. The question is how much damage will be done before they do so.
That’s exactly what has happened here. The ECB is going to write the check. And now Bill Gross and the world’s largest bond fund is piling, just like I told you they would. That’s how bond market vigilantes work. Don’t let people fool you that somehow it’s about fiscal irresponsibility or anything like that. At the end of the day, it’s about getting the safest bond at a specific yield or getting a higher yield for the same risk. That’s all. Now that the risk in Spain and Italy has fallen, investors are buying. It really is that simple.
The question now is what kinds of strings are attached and how long before these strings unravel.
“After fretting about the euro zone’s debt crisis for months, Bill Gross, manager of the world’s biggest bond fund, is going through a change of heart toward the region’s sovereign debt.”
“Prepaid debit cards just keep on getting better — ever closer, that is, to the holy grail of essentially replicating the free checking account of yore. Checking was never actually free, of course: it was basically a bait-and-switch, where people thought that they were getting free checking but then got hit with huge unexpected fees when they could least afford them.”
“the household survey also shows 582,000 of those new jobs were involuntary part-time positions. Workers told the Labor Department they took part-time work (usually 35 hours of less) because of slack business conditions or because it was the only job offered. Part-time jobs now account for 6% of all jobs, double their share before the Great Recession.”
“In September, the number of those 65 and over who were employed was up 21% from the same month in 2008, while broad workforce employment was down almost 1.4%. The size of the retirement-age labor force has also increased 23% during the past four years, while the broader labor force is up less than 0.4%. The group’s average labor participation rate this year is on track to increase 0.55 percentage point compared with 2011 and 1.35 percentage points from 2010 (unadjusted), while the broader participation rate is heading for 0.40 percentage point and one percentage point drops compared with those respective periods.”
“While the Participation Rate trend is certainly down, and down was expected, most of the decline in participation rate since the start of the recession is due to economic weakness, not demographics.”
“although I think some of the decline in the overall participation rate is due to the recession, it appears most of the recent decline in the participation rate is due to changing demographics.”
“Almost half of people in the industrial town of Reading – 58% of whom are Latino – live below the poverty line. Why has Obama not done more to get Reading back to work?”
“GE’s revenues grew 385% under his watch, but the company’s market cap grew 4000%. How did that happen? GE increased earnings over the years, and with stunning regularity, managed a quarterly profit beat.”
“Let’s take this with a grain of salt. The household survey numbers are extremely volatile, and September’s gain in part merely makes up for two large drops in prior months; reality is somewhere in between. Moreover, the gains in payroll employment, for a change, got a big hand from government; state and local jobs have climbed a relatively hefty 72,000 in the last three months. That’s a welcome reversal from the shrinkage of previous months, but not as solid a sign of revived animal spirits had the gains all come from the private sector, a point that Mr Romney’s camp will no doubt make.”
“For Ms Nyberg, returning to the workforce at the age of 60 was like getting a new lease of life.
A scheme called Return to Work, run by the state of New Hampshire, helped Ms Nyberg get her old job back, initially as a six-week unpaid placement, which was followed by an offer of a permanent job.
“It was a great feeling, knowing I would have a job at the end of it all,” she says.”
“Companies cut their orders from US factories by 5.2 per cent in August, the biggest decline since January 2009, the US commerce department said on Thursday. The figures mirrored data last week showing a sharp drop in demand for long-lasting goods largely because of a fall-off in volatile demand for aeroplanes.
The latest numbers were slightly better than the 6 per cent decline forecast by analysts. August’s fall followed a downwardly revised 2.6 per cent increase in July.”
Credit and banking
“In some sense you’re an idiot to give money to a risky company, charge them 8.5% interest, and then let them not pay you that interest if things get tough. But in a broader sense, it’s a great idea: if things get tough, Petco is more likely to survive, because (1) their interest rate is relatively low versus historical CCC levels and (2) they don’t have to pay it. Similar things can be said about the continued weakening of covenants: if you don’t have covenants that throw you into bankruptcy when you run into financial trouble, you can run into financial trouble while still avoiding bankruptcy. Part of why high-yield investors are stretching to buy these bonds is that recent and expected default rates are low; easy terms – and expected easy refinancing with low rates forever – are part of why you can expect default rates to remain low.”
“America could become addicted to loose monetary policy, with an extended period of QE3 leading to excessive risk-taking by some investors, policymakers at the Federal Reserve have warned.”
“Last year, nearly 90% of all new mortgages originated went to households with high credit scores; before the financial crisis, it was about half, according to Moody’s Analytics and Equifax Inc., a credit monitoring service.”
“TIPS returns are based on CPI inflation, not the Fed’s PCE inflation target. I find it hard to believe that Bullard does not understand the distinction. Putting the Fed’s inflation target on this chart is comparing apples to oranges.
The second reason this is disingenuous is the length of the time series. Bullard begins his chart at the beginning of this year, leaving the audience to believe that these high inflation expectations are a new phenomenon. Again, deliberating misleading the audience. “
“Registered voters’ preferences for president are evenly split in the first three days of Gallup tracking since last Wednesday’s presidential debate. In the three days prior to the debate, Barack Obama had a five-percentage-point edge among registered voters.”
“Mitt Romney has jumped out to a slight national lead among those likeliest to vote on Nov. 6, according to a new poll from the Pew Research Center.
Pew, which in mid-September showed Romney trailing President Obama by eight points, now shows him leading the president by four points among likely voters — the first time Romney has led by that much. The poll has Romney at 49 percent and Obama at 45 percent.”
“Catalans prepare to unveil huge flag and chant for independence as Spain’s economic woe causes rise in nationalist sentiment”
“The Central Bank of Ireland has urged Dublin to fast track planned austerity measures and cut public sector wages ahead of its December budget, warning that the economy will grow slower than expected due to a weakening global economy.
The bank forecasts Ireland’s gross domestic product will grow by 0.5 per cent in 2012, down from a forecast of 0.7 per cent issued three months earlier. It also trimmed its 2013 growth forecast to 1.7 per cent, down from 1.9 per cent, citing a marked slowdown in the international economy.”
“Mr. Phillips and Vlingo are among the thousands of executives and companies caught in a software patent system that federal judges, economists, policy makers and technology executives say is so flawed that it often stymies innovation.
Alongside the impressive technological advances of the last two decades, they argue, a pall has descended: the marketplace for new ideas has been corrupted by software patents used as destructive weapons.
Vlingo was a tiny upstart on this battlefield, but as recent litigation involving Apple and Samsung shows, technology giants have also waged wars among themselves.”
“A network that allows mobile access to the internet as fast as a desktop PC’s will be live in weeks – if a little underused”
“as their networks are incompatible, they will have to convince MetroPCS customers to move to T-Mobile’s network with the aim of shutting down the MetroPCS network by the end of 2015. And T-Mobile USA has to upgrade its network with high-speed services to catch up to bigger competitors, the companies said.
“This all adds up to a hugely complex and challenging migration that will take significant time and investment, and which is a major risk for derailing the benefits of the deal,” said Mike Roberts, principal analyst at research firm Informa.”
“South Korean technology giant claims quarterly operating profit up 25% sequentially due to strong sales of smartphones”
“Samsung is reporting a record quarterly profit of $7.3 billion in earnings guidance ahead of its full Q3 report. Reuters notes the figure is nearly double the amount of profit the Korean electronics giant made in Q3 2011, bolstered by strong sales of its Galaxy range of smartphones and high end TVs.”
Same theme on innovation here. Samsung is really doing stuff now. They’re not just copycats.
“although I originally thought only specific Samsung apps would be eligible for multi-window use, I was wrong. I’ve installed several third-party apps and they appear in the dock as well. So I can browse the web in the top half of the screen while my Twitter client shows tweets in the bottom, for example.”
“Last night we reported that Google was opening up their Nexus program to any OEM, as long as they adhered to a set of hardware and software standards. We know that LG is making a Nexus phone, but other rumors have pointed to Samsung, Sony, Motorola, and HTC.
Today Digitimes quoted some industry sources that claim Samsung, Sony, LG, and HTC were all “potential partners” in the Nexus program. All of these manufacturers have been previously rumored to make a Nexus device, but we have only seen evidence of the LG Optimus G Nexus.”