Today’s commentary
Despite my unease about the secular headwinds of debt, bank balance sheets and wage stagnation, I must admit that many of the recent macro data points globally are pointing to growth. This is true in the US, in Europe, in Japan and in China. Below are a few highlights in Europe specifically.
As European equities hit six-year highs, eurozone industrial production is rebounding sharply. Yesterday, Eurostat released the data showing industrial output in the eurozone block jumping 1.8% in November. The biggest gain on a month-to-month basis was in Ireland where IP was up a staggering 11.7%. German IP was up 2.4% and even France eked out 1.4% growth in industrial production. This should allay fears of weakness, as German Q3 GDP estimates showed a scant 0.4% growth today. Q4 looks a lot better all around. In the European Union as a whole, industrial production was up 1.5% in November. In year-over-year terms, industrial production is up 3% in both the eurozone and the EU.
In terms of economic stress which could retard growth in Europe, I am looking for signs of it in bond yields in particular. And there are no signs of stress there – just the opposite. Last week, I linked to a Bloomberg story on Spanish bonds which gave a good overview:
Spanish government bonds rose for a second week, pushing 10-year yields to a seven-year low, as evidence that the euro-area recovery is gaining momentum boosted demand for the region’s higher-yielding debt.
[…]
Rates on Spanish two- and five-year notes dropped to records as European Central Bank President Mario Draghi strengthened a pledge to keep interest rates low for an extended period. The additional yield investors get for holding Portugal’s 10-year securities instead of Germany’s slid to the least in three years. Yields on similar-maturity Irish bonds fell to the lowest since 2006 as the nation returned to debt markets after exiting its international bailout last month.
[…]
The rate on Spanish two-year notes dropped to 0.953 percent on Jan. 9 and that on five-year notes slid to 2.213 percent, the least since Bloomberg started compiling the data in 1993.
Given the size of the Spanish and Italian economies, lower yields and reduced stress and redenomination risk there means upside potential for growth. In Spain, a lot of this comes from the uptick in house prices as in Ireland. Italy’s 10-year is now trading at 3.88% or 206 basis points over German Bunds. I think this is as close as we are going to get over the near term. But because yields will back up if the economy improves in Germany, Italy could benefit from tightening due to portfolio shifts if Italy lags on the economic front.
I am more interested in Portugal and Greece right now regarding signs of stress because Italy, Spain and Ireland have re-coupled to the core with all three out of bailout programs. Portugal and Greece remain the only two countries in Troika programs within the eurozone.
Now the Irish Independent had an article pointing to investment managers recommending Greece on the premise that default risk has lessened. I am not buying that at all. Default risk in Greece is still immense. A different take that makes sense to me is that the default risk of the Greek sovereign bonds which are trading in the public markets is lower. Yanis Varoufakis gave a compelling account of this view last week on RT’s Boom Bust (videos here and here). What he is saying is that the default risk is now mostly public sector risk i.e. the Troika bonds. He believes that the public market bonds are less risky. In any event, the bonds are trading at a yield of 7.81%, down from a high of 12.84% in April. This is why Greece was the top performer in 2013. I doubt it will be again this year. But there is significant opportunity for re-coupling.
Portugal is where the rubber hits the road. Greece is talking a big game about exiting the Troika program free and clear like Ireland and Spain, but realistically Portugal has a better chance of doing so. Yields are now down to 5.28% for 10-year bonds in Portugal. And we seem to have come full circle on yields now, suggesting that the first wave of crisis is well and truly over. Joseph Cotterill has a great chart of the Portuguese 5-year showing the round trip on interest rates – and he muses about European sovereign convergence redux – paralleling the pre-Euro convergence. Unlike Greece, which has only gone to market with short-dated paper, Portugal has now gone to market with 5-year paper and the bonds were well received.
If the macro data coming out of Europe continue to point to recovery – as I believe it will – we should continue to see yields fall and I believe bonds in Portugal in particular could outperform. Greece, with its primary surplus and still high bond yields offers a huge yield pickup, however, and can’t be overlooked.
The longer-term problems of weak growth prospects because of internal devaluation, a large debt overhang and poor bank balance sheets are ceding ground now to the cyclical upturn in economic prospects. And I expect this dynamic to continue for quite a while. No harbingers of weakness are immediately on the horizon.
More bullish macro data points in Europe
Today’s commentary
Despite my unease about the secular headwinds of debt, bank balance sheets and wage stagnation, I must admit that many of the recent macro data points globally are pointing to growth. This is true in the US, in Europe, in Japan and in China. Below are a few highlights in Europe specifically.
As European equities hit six-year highs, eurozone industrial production is rebounding sharply. Yesterday, Eurostat released the data showing industrial output in the eurozone block jumping 1.8% in November. The biggest gain on a month-to-month basis was in Ireland where IP was up a staggering 11.7%. German IP was up 2.4% and even France eked out 1.4% growth in industrial production. This should allay fears of weakness, as German Q3 GDP estimates showed a scant 0.4% growth today. Q4 looks a lot better all around. In the European Union as a whole, industrial production was up 1.5% in November. In year-over-year terms, industrial production is up 3% in both the eurozone and the EU.
In terms of economic stress which could retard growth in Europe, I am looking for signs of it in bond yields in particular. And there are no signs of stress there – just the opposite. Last week, I linked to a Bloomberg story on Spanish bonds which gave a good overview:
Given the size of the Spanish and Italian economies, lower yields and reduced stress and redenomination risk there means upside potential for growth. In Spain, a lot of this comes from the uptick in house prices as in Ireland. Italy’s 10-year is now trading at 3.88% or 206 basis points over German Bunds. I think this is as close as we are going to get over the near term. But because yields will back up if the economy improves in Germany, Italy could benefit from tightening due to portfolio shifts if Italy lags on the economic front.
I am more interested in Portugal and Greece right now regarding signs of stress because Italy, Spain and Ireland have re-coupled to the core with all three out of bailout programs. Portugal and Greece remain the only two countries in Troika programs within the eurozone.
Now the Irish Independent had an article pointing to investment managers recommending Greece on the premise that default risk has lessened. I am not buying that at all. Default risk in Greece is still immense. A different take that makes sense to me is that the default risk of the Greek sovereign bonds which are trading in the public markets is lower. Yanis Varoufakis gave a compelling account of this view last week on RT’s Boom Bust (videos here and here). What he is saying is that the default risk is now mostly public sector risk i.e. the Troika bonds. He believes that the public market bonds are less risky. In any event, the bonds are trading at a yield of 7.81%, down from a high of 12.84% in April. This is why Greece was the top performer in 2013. I doubt it will be again this year. But there is significant opportunity for re-coupling.
Portugal is where the rubber hits the road. Greece is talking a big game about exiting the Troika program free and clear like Ireland and Spain, but realistically Portugal has a better chance of doing so. Yields are now down to 5.28% for 10-year bonds in Portugal. And we seem to have come full circle on yields now, suggesting that the first wave of crisis is well and truly over. Joseph Cotterill has a great chart of the Portuguese 5-year showing the round trip on interest rates – and he muses about European sovereign convergence redux – paralleling the pre-Euro convergence. Unlike Greece, which has only gone to market with short-dated paper, Portugal has now gone to market with 5-year paper and the bonds were well received.
If the macro data coming out of Europe continue to point to recovery – as I believe it will – we should continue to see yields fall and I believe bonds in Portugal in particular could outperform. Greece, with its primary surplus and still high bond yields offers a huge yield pickup, however, and can’t be overlooked.
The longer-term problems of weak growth prospects because of internal devaluation, a large debt overhang and poor bank balance sheets are ceding ground now to the cyclical upturn in economic prospects. And I expect this dynamic to continue for quite a while. No harbingers of weakness are immediately on the horizon.