Confusion over Spanish bailout seniority and evidence of slowing in US and China

Note: Before I begin today’s summary, I should note that my schedule will be very spotty over the next three weeks as I am on a working vacation. That means I will not be at work but I will be posting to the blog from time to time. I also have a few weekly themes I want to get out.

Two topics today: Spain and global economic growth.

On Spain, yields for Spanish bonds are well over 7% now. Spanish 10-year government bonds are now just off a record high of 7.284% from earlier today after opening at 7.040%. It’s clear now that Spain is in a Greek death spiral that means it will need to formally ask for a bailout, which will mean EFSF monetisation. FT Alphaville noted this morning that there has been confusion about the German Bundestag’s copy of documents for the Spanish bank bailout. The master agreement contains details on Spain paying off EFSF loans, events of default and so on. Alphaville notes as well:

Because it’s a master doc, it contains provisions authorising financial assistance beyond what Spain is actually getting so far (the bank recap loans). This includes bond-buying by the EFSF. But every new bit of financial assistance needs Spain to agree “Specific Facility Terms” with the EFSF, i.e. a new agreement. The Bundestag documents also contain the “Specific Facility Terms” for the bank recap loans, for example.

The end result has been confusion about whether the Spanish bank bailout will be senior to existing loans to the Spanish government. As such, it is understandable that yields on existing binds are shooting up because the prospect of new debt, senior to the old debt makes the old debt worth less in the event of a restructuring that entails haircuts. This obviously creates a self-reinforcing negative doom loop for existing bond yields. And that’s what we are seeing today.

On the slowing in the US and China, the July Philly Fed survey was out yesterday and the data were poor. The good news is that they were not as poor as June. But the bad news is they show contraction in the manufacturing sector in the Philly Fed region of the US (eastern PA, Delaware and southern NJ). My view is that we are not in recession yet but the data are pointing that direction. The retail sales data were a real eye opener. And jobs data seem to be softening to the point where we might get a negative non-farm payrolls in the next month or two. For example, the tech sector is bleeding jobs right now. The June ISM manufacturing survey was still 49 where recession is 42.5. But the new orders component was the weakest of the major subcomponents, suggesting further weakening ahead. To me, this points to slowing into recession but no outright recession yet.

In China, the two data points I want to highlight are credit growth and iron ore inventories. Credit growth is expected to be soft for June despite the increase in loans by China’s four largest banks which account for 40% of loans. Apparently, the Chinese government’s stimulus is being channelled through those groups but the rest of Chinese banks are not growing their loan book. Below is a China Daily story that shows iron ore inventory at record levels as industrial demand in China has become slack. This is yet another sign of weakening growth in China.

The nexus of weakening in these three areas, Europe, the US and China, suggests that we are headed for choppy waters economically. Higher risk, higher beta plays could be hit hard as the Chipotle story below implies.

FT Alphaville » Spain, a bailout master doc