SEP: Someone Else’s Problem – until...

Mint – Bill Blain’s Morning Porridge  -   March 11 2013

SEP: Someone Else’s Problem – until suddenly it’s not and becomes your problem

As anticipated, Friday’s strong US employment data Friday put markets in a tizz. US Treasuries recorded a returns bursting collapse. The blogosphere is buzzing with speculation about further equity strength and 101 technical reasons for stocks to rally further. On other hand, interesting to read on wires how Norway’s Sov Wealth Fund has been buying treasuries, bunds and JGBs, and dumping OATs and gilts.

While not everyone believes the US is on the road to boom recovery, the Nikkei remains on a roll. Yen’s resumed weakening against the resurgent dollar and the potential of real economic growth has been boosted by stock-specific stories like Mitsubishi Aircraft posting gains from weaker yen on recent plane sales, and the potential of bullet train sales to India. New BoJ head-elect Kuroda says he may consider quick easing! That trade – buy Nikkei, sell Yen continues apace..

Stocks and Japan aside, the usual sense of European going-nowhere fast misery pervades markets. It feels likely to be a typical thin Monday is in prospect with European markets digesting last week’s positive peripheral tightening, German exports up but worrying European growth, EU summit later this week and Cyprus, Italy and whatever else.

Cyprus has been unfixed too long. If the intention had ever been to bail in depositors to catch Russian money – they missed it. Perhaps the EU’s lack of decision-making was deliberate – to give Russians time to get out so as not making a complex situation more difficult. Instead, we hear Russians are contemplating buying Cypriot banks in the expectation of rescue! That really will not make giving the island any easier.

Where has all the money gone? – out of Cyprus that’s for sure. Meanwhile, a bail-in may not prove smooth. The defences are up. Bonds have been actively trading and are now held by the very people you would rather not be holding distressed bonds if you were the issuer. Any bond bail-in is going to have to be combatitive at this stage and could prove a legal gold mine. .

Italy’s late downgrade by Fitch on Friday shouldn’t cause too many ructions – like who cares any more. Fitch wins a “No Sh*t Sherlock” award for spotting “increased political uncertainty and non-conducive backdrop to further structural reform…” in Italy. Market hardly notices in terms of Spain tightening further (although as we warned we do expect the Spain Italy spread to keep tightening in Spain’s favour). The recent moves suggest the market doesn’t much care about Italy – until they have to. We still reckon Italy may look, but its potentially still a massive crisis coming.

Quite a lot of feedback and responses to my rant about cutting US military spending possibly benefiting the US economy. Most of it suggested I am apparently an idiot for thinking its remotely possible - which set me thinking over the weekend.

The aligned vested interests of consumers (the military), manufacturers, vote-dependent legislators (politicians unwilling to see bases or factories close), the visibility of programmes, and workers’ reluctance to lose jobs, means there is simply no constituency  or power with the strength to restrain spending.

This suggests the more inter-connected and aligned parties are in any spending decision, the less likely the programme is to be cut. The only things states can cut are spending programmes with the fewest power alignments underlying them. So it’s easier to cut discrete programmes like health, age and disability programmes than institute major labour programmes or otherwise control spending. Moral issues might have a feel-good factor, but when the English clergy say they will oppose benefit cuts, no-one does much except pay it lip service.

There must be some obscure economic or political science theory that shows this? I must ask some of the academics who read the porridge for their thoughts on spending alignments, and how closely linked political parties and organised labour makes spending cuts less likely. Ie the greater difficulties economies with a strong state intervention and director of the economy, like in southern Europe have relative to more laissez faire governments? It would certainly seem to be the case in France where the high degree of state intervention in industry and the enarch culture makes it less likely French managers and politicians can force through difficult spending cuts.

The ease with which economies can quickly shift resources from inefficient subsidies to more stimulating programmes is a critical one for choosing losers and winners in the European sov space. For instance: compare and contrast the swiftness with which the US has created a new energy paradigm with shale gas and fracking with the inability of France to rationalise its car industry or the failure of Italy to address endemic corruption. Very interested in reader comments on this “political science” aspect of markets.  

Out of time…

Bill Blain

0207 786 3877

[email protected]

[email protected]