Market Watch from Redmayne Bentley at Legal and Financial 100

Whilst the communiqué following on from the G20 summit had words for each individual nations population, markets were left unimpressed as the US pressed for further stimulus and Europe felt that budget containment and austerity, however painful in the shorter term, offered the longer term sounder policies, although The G20 gathering ended with all countries agreeing to half their deficits by 2013 and stabilise the ratio of debt to gross domestic product by 2016.

 

Following on from the meeting the Bank for International Settlements warned on Monday that central banks might need to raise interest rates even before their respective economies are clearly on the road to recovery and on Thursday Sweden raised its key interest rate by a quarter percentage point to 0.5pc, making Sweden’s central bank the second Western European bank after Norway to tighten interest rates since the global financial crisis began.  In its annual report the BIS said that low interest rates inflate prices, increase risk taking, delay the recognition of losses, discourage saving and distort investment decisions.  It also acknowledged that banks remain vulnerable to further losses as a number have not yet recognised all their bad debt loans.  The report highlighted the fact that the recent upturn in banking profitability remains very vulnerable as the banks have relied heavily over the last couple of years from soaring commodity prices and fixed income products.  The banker for central banks also warned of unsustainable Sovereign debt levels and that countries should slash their large deficits and introduce structural reforms regardless of the consequences.  “Such measures may have adverse effects on output growth in the short term but the alternative of having to cope with such record low interest rates aimed at spurring economic growth have stopped households and banks from reducing the huge debts that led to the credit crunch” the bank stated.  Other parts of the review are encouraging for the UK. The "average maturity" of the UK's debt is 14 years the best of the leading industrial countries. The US and Germany, have maturities of under 9 years. It also highlights countries' dependence on overseas finance. "Non-residents" hold approximately 70% of Greek government debt, just under 50% for US government debt, and below 30% of UK government debt, which means we are not as dependent on the whims of foreign investors as others. We are however increasingly depending on overseas investors and this makes us much more vulnerable to the actions of others. The BIS report shows the trajectory of UK public debt to be the most worrying other than Japan, which has significantly more savings than the UK and the world's second biggest foreign exchange reserves. Even if the UK government spends only along the "austerity" lines now being proposed, retaining current plans for the next 30 years, our national debt gets near to 300pc of GDP by 2040 largely due to demography as the "baby boomers" born after the Second World War move into retirement and old age. When they retire the "boomers" become extremely expensive in net terms as they draw state pensions, become more reliant on health care and start paying much less tax. The report also highlights the fact that low interest rates make it easier for banks to engage in “ever greening” the term the BIS uses to describe the practice of rolling over debt to non-viable businesses that can continue with interest payments at low rates but cannot afford to pay the original capital back.  The report concluded that the necessary restructuring not only in the financial sector but also in other inefficient industries is therefore being delayed and the BIS forcibly argued that making changes to the financial system had acquired an even greater urgency after recent events and that banks should continue to bolster their balance sheets by holding more reserves, although banks and Governments have been reluctant to do this as this would further curtail lending.  The requirement for increased reserves is backed by international regulators based in Basel Switzerland who have urged a move to double what is termed core capital or tier 1 from 2 to 4pc.  The results are expected next month from the European Bank stress tests and there is a growing recognition that up to 20 of Europe’s largest banks could be forced into cash calls as a result of the stress tests, with analysts suggesting that up to €30bn in fresh equity may be required.  Publication of the European wide tests is rumored to have been delayed by a week to July 23rd as the scope of the testing has been expanded from 26 to 100 banks.  Two thirds of the €30bn is expected to be required from public sector banks with the remaining €10bn spread across the private banking sector.  The BIS warned that European banks have yet to come clean over bad loans and may struggle to refinance short term debt unless the regions that bond the crisis subsides shortly. Stress tests done last year in the United States were credited with turning around its crippled banking sector, allowing them to raise capital and stabilize the banking system. Ten of the largest lenders were instructed to raise tens of billions of dollars. In the euro zone, it is the German banks that are thought most exposed to bad loans, with a  new study by PricewaterhouseCoopers saying that some €213-billion ($282-billion) of non-performing loans sat on the balance sheets of Germany’s banks in 2009, up 50 per cent from the previous year. Most of the troubled loans were made to the real estate sectors in Greece and Spain, where property prices have plunged and unemployment has soared. Analysts expect some of the smaller German banks to merge after the stress tests are published.

 

The number of job losses arising from the austerity budget has been a hot political debate in the week particularly following a leaked report in the Guardian that suggested that an official unpublished Treasury Report suggests that 1.3m jobs will be lost across the economy over the next five years.  The assumption in the document is that between 500,000 and 600,000 jobs will be lost in the public sector whilst 600,000 and 700,000 will disappear in the private sector by 2015.  On top of this the Treasury is assuming that growth in the private sector will create an additional 2.5m jobs over the five years to compensate for the spending squeeze, although this number in my opinion looks excessively high.  The Office of Budget Responsibility believes that overall employment will pick up in every year from now rising from 28.89m to 29.9m by 2015.  This is a net increase of 1.08m even after the impact of the budget is accounted for.  The Office of Budget Responsibility believes unemployment will peak at this year 8.1pc and then fall for each of the four years to reach 6.1pc in 2015. If the Office of Budget Responsibility is right then the economy will be creating jobs at a rate of 400,000 plus on average in each of the next five years.  What makes this assumption so questionable in my opinion is that in the thirteen years of the Labour Government 2.5m jobs were created and this included a housing boom,  700,000 new public sector jobs and a rampant financial sector, and a strongly growing global economy. Whilst one hopes that this number of jobs can be achieved I believe the potential for it to occur is very remote. 

 

At the end of last week fears for the UK economy increased after surveys showed that export growth slowed in June and banks expected to cut mortgage lending in the third quarter.  Whilst manufacturing grew strongly in June according to the Index of Purchasing Managers the export growth element dropped in a sign that the European debt crisis was hitting demand in the biggest market for UK goods.  The Purchasing Managers Index for manufacturing recorded a level of 57.5 in June close to the fifteen year high seen in April and May as Employment in the sector grew at its fastest level since early 1995 in a sign the recovery is helping boost jobs.  In the Bank of England’s credit conditions survey, lenders expect to find it harder to secure funding on the wholesale markets as vendors are beginning to increasingly worry about household’s ability to keep up with monthly mortgage repayments.  The Council of Mortgage Lenders has repeatedly warned of its fears about the mortgage market and is particularly worried about the Bank of England’s £165bn special liquidity scheme which is gradually being withdrawn and will end in October 2012.  The scheme allows lenders to temporarily swap assets that are difficult to trade such as mortgage backed debt for Treasury bills and uses money from the scheme to supply new mortgages.  The Council of Mortgage Lending predicts that there will be just £15bn worth of net mortgage lending this year compared to nearly £110bn in 2007.  The Bank of England also stated that a total of 49,815 mortgages were approved in May down from 59,338 last November when the market peaked.  The total amount of money advanced reached its highest level this year at £12.29bn indicating that the lower end of the property market is under significant duress.  The number of people remortgaging fell during May with 25,759 people switching to new deals and secured lending rose slightly during the month with outstanding debt increasing by £331mn after contracting by £114mn in April.  Within the total, outstanding credit card debt rose by £138m, whilst borrowing through loans and overdrafts rose by £193m.  The Bank of England’s quarterly credit conditions survey continues to show that the credit crunch is firmly with us and like in Europe it has recently intensified as Government emergency actions at the height of the credit crunch are rolled back. According to the authoritative Land Registry house prices in England and Wales fell by 0.2pc between April and May producing an annual price increase of 3.2pc a decline from April’s rise of 8.5pc.  The average property value in England and Wales is now £165,314 according to Land Registry figures.  According to the Nationwide house prices moved ahead by just 0.1pc in June compared to a rise of 0.5pc in May and 1pc in March and April.  According to their numbers the annual rate of house price inflation eased to 8.7pc in June and from 9.8pc in May.  I have for some time said that the recent bounce in property prices was unsustainable and a mirage and evidence is now emerging that prices are likely to be trending downwards for the remainder of the year and any upturn will require more buoyant general economic and credit conditions two scenarios that look some way off yet.  In the week the Office for National Statistics confirmed that UK business investment jumped in the first quarter to its highest level since 1987.  Numbers showed a 7.8pc rise to £29.1bn over the first three months of the year.  Analysts however caution that the sharp bounce should be seen in the context of the sharp fall in investment during the past eighteen months.  The ONS also had to apologise that some of its numbers did not add up and has had to delay the release of the final estimate of GDP in the first quarter of the year for a fortnight after discovering errors in its data.  The new date for release is July 12th and it is an embarrassing delay for the organisation which has increasingly come under scrutiny for the quality of its data releases. Moody’s Investors Service said in the week that the U.K. will retain its top credit rating if the government sticks to its deficit-reduction plan

 

 When the European Central Bank provided European banks with €442bn last summer they knew it would have to be repaid by July 1st 2010, nevertheless the repayment date appeared to catch investors on the hop last week.  The 1,121 euro zone banks were offered a three month loan facility instead and some 171 banks borrowed €131.9bn in three month loans , which although high was less than feared by many who expected that demand would be about €250bn.  Ahead of the auction the Spanish Finance Minister was particularly said to be worried.  On average each of the 171 banks that took part in Wednesday’s offer obtained €771m which was notably higher than the average of €394m in the twelve month loans that were repaid.  The cost of the lending was also higher with the loan rate at 1pc compared to 0.7pc in the open market.  On Thursday the European Central Bank also provided €111bn worth of six day money to 78 banks advancing an average of € 1.4bn.  What this shows is that there is a rotten core of struggling lenders in the euro zone as the market.  The European Central Bank’s generosity means that the borrowing institutions over the week were given a further lifeline but funding concerns will not disappear as the European banking market will continue to face similar flashpoints to those experienced last week, particularly when the three month tender expires in September and when existing one year and six month facilities have to be paid again in October.  On Wednesday night Moody’s credit rating agency warned of a possible downgrade to Spain’s Sovereign debt although the country was successfully able to sell €3.5bn worth of bonds which was covered 1.7 times.  The rate of interest total was very close to the 4pc level at the Euro zone Emergency Stability Fund and indicates that Spain is clearly not out of trouble yet.    Spain's registered jobless fell for a third straight month in June by 2.1 percent from May, the Labour Ministry said on Friday, the sharpest monthly drop in five years and a sign of recovery in the battered labour market. "This new reduction, which puts the number of jobless below 4 million, confirms that job destruction is slowing and that we're getting close to seeing monthly figures comparable to before the crisis," said the head of the Labour Ministry's employment department Maravillas Rojo in a statement. Spanish unemployment has more than doubled in the last two years after the collapse of the construction industry on the back of a burst property bubble and plummeting consumer confidence.

 

The European Financial Stability Facility, A €440bn stabilisation fund for euro zone countries in financial trouble looks likely to be delayed by a couple of weeks because of the new Slovakia’s government, because the country which only joined the euro zone in January 2009 will not ratify the matter until a meeting of the area’s finance ministers on July 12 or later. Slovakia is alone among the euro zone’s 16 nations in raising objections to the fund and is coming under intense pressure from other governments to abandon its resistance. At about €4.4bn, Slovakia’s contribution to the fund is relatively small but the centre-right parties that won its June 12 election and who are in the process of forming a government campaigned on a platform of no euro zone bail-outs. Slovakia’s new government is also determined not to pay the country’s €800m contribution to a €110bn IMF-euro zone rescue plan that was activated in May for Greece although this has not prevented the loan being paid to Athens and whilst legally the European Financial Stability Facility can start operating without Slovakia’s approval, as long as parliaments in other euro zone countries, representing at least 90 per cent of the €440bn commitment, have given their approval. Such a move would send a dangerous signal to financial markets if the facility got off the ground without firm support from all 16 euro area states.  As well as the stability facility’s €440bn, troubled governments will be able to draw on €60bn in EU funds and up to €250bn from the IMF. The prospect of Hungary defaulting on its debts alarmed the financial markets last month and this saw the euro hit a four-year low after a spokesman for the new Hungarian government said that the economic situation was much worse than expected. Under its current plan agreed with the IMF, Hungary is committed to keeping its annual budget deficit to 3.8% in 2010, and then below 3% in 2011 but in the week the government said that next year's target may need to relaxed and it is thought that it  is planning to ask the International Monetary fund and the European Union for a "precautionary" two-year rescue package worth €10bn-€20bn as it continues to try to establish control its finances amid concern that  the European economic situation is deteriorating. The country has an existing IMF/EU rescue package worth $25bn, which was agreed in October 2008 in an attempt to protect it from going bankrupt. That is due to run out this October, but the Hungarian government has already indicated that it will try to extend it until the end of the year.

 

Unemployment in the euro zone fell at the start of the second quarter reversing a two-year trend of increased joblessness, but this was more than offset by an increase in May as the euro debt crisis and the prospect of austerity measures hit the labour market badly. Revised data show the number of jobless in the 16 countries that use the single currency fell in April by 6,000, the first drop since April 2008, according to seasonally adjusted data from the European Union. But the good news was hit by the addition of 35,000 people to the jobless queues in May, to 15.8m, the highest figure since the creation of the single currency a decade ago. The unemployment rate was revised down from 10.1 per cent to 10 per cent for April, and stayed there in May. It stood at 7.2 per cent in March 2008, before 24 consecutive jumps. Official data showed inflation in the 16 nations that use the euro fell to 1.4 percent in June, down from 1.6 percent in May.

 

The head of the European Central Bank has said that EU governments' borrowing levels should be more strictly policed in the future. Jean-Claude Trichet said rules on borrowing needed to be much stricter, with tougher sanctions in place for countries that break the rules. "The ECB believes that a true quantum leap is needed in the framework for surveillance and adjustment of fiscal policies," Mr Trichet told the European Parliament's committee on economic and monetary affairs. Having failed so spectacularly to control overspending nations Brussels in the week added its weight to the argument when it said that European governments could lose farming, fishing and other subsidies from the EU budget if they indulge in profligate public spending under stiff new proposals aimed at entrenching fiscal austerity. The commissioner for economic and monetary affairs said the entire EU budget should be used to penalise fiscal miscreants and forestall the debt and deficit crises that have thrust the euro into its worst crisis. He called for the new regime of penalties to be applied to all 27 EU governments, including Britain, and not just to the 16 countries using the single currency. From January, he wants all governments to supply their budget, fiscal, and macro-economic plans for prior review by Brussels before they are passed by national parliaments and hopes to see the proposals made binding by late September. This has put him in conflict with the British who insist they should not be subject to sanctions from Brussels and who reject any notion of prior scrutiny of British budget planning by the EU. The British government argues that the terms for its opt-out from the euro mean that legally it cannot be included in the punitive new regime.

 

Christian Wulff, the candidate of Germany’s centre-right coalition government to become federal president, was elected on Wednesday night after a two failed votes that saw a damaging revolt against the authority of Angela Merkel, the chancellor. The cliffhanger presidential vote in a specially convened electoral assembly was seen as a vital test of confidence in the coalition, already riven by public disagreements and plunging popularity only nine months after it assumed office. In the event, it demonstrated deep divisions within the ruling coalition. The revolt was intended by many of the rebels to “teach the government a lesson”, admitted Peter Altmaier, chief whip of the CDU in the Bundestag, and a close ally of Ms Merkel. Austerity budgets and German tax payer money being used to bail out other European nations is not bring well received by the electorate. In the week the German Chancellor said that the European Union’s 750 billion-euro ($945 billion) rescue package for the euro is only buying time for governments to cut budget deficits,“ A policy of saving, scaling back deficits that have risen very sharply -- that’s the task we have to accomplish now,”

 

In the US, first quarter growth in GDP was recently revised downwards to an annualised level of 2.7pc further indicating that growth prospects later in the year for the US economy look unattainable. The U.S. economy shed jobs in June for the first time this year and the unemployment rate remained high, both which added to concerns that the pace of the US recovery could slow in the second half. Nonfarm payrolls fell by 125,000 last month, as 225,000 government workers that were hired for the 2010 census in recent months lost their temporary jobs, the U.S. Labor Department said Friday. Only 83,000 private-sector jobs were added last month. In May, nonfarm payrolls had surged by 433,000, boosted by the census hiring. The May figure was revised slightly from a previously reported 431,000 increase. Economists were expecting payrolls to drop by a more modest 110,000 in June. Taking into account revisions to prior months, the U.S. economy added an average of around 150,000 jobs a month in the first half of the year, a level that's still not strong enough to bring unemployment down significantly. The jobless rate, which is calculated using a separate household survey, edged down to 9.5% in June from 9.7% the previous month. Economists were expecting it to edge up to 9.8%. The private-sector jobs gains of 83,000 were less than the 110,000 that were expected and followed a small 33,000 increase in May.  U.S. factory orders declined in May, posting the largest drop in 14 months as transportation related orders tumbled. New orders for U.S. manufactured goods dropped more than expected by 1.4% in May to $413.25 billion, the Commerce Department said on Friday. Economists had expected orders would decrease by 0.8%. The report showed the factory sector performed worse in April than initially estimated as orders were revised down to a 1.0% increase, from the previously estimated 1.2% rise adding to increasing concerns that US growth may slow in the second half of the year. U.S. consumer confidence also fell sharply in June, wiping out the gains posted in the previous two months as Americans worried about their job prospects. Two senior Fed officials on Wednesday gave a poor view of the U.S. economy, saying it isn't yet strong enough to warrant interest-rate increases and that credit growth is likely to be restrained for years. Economic figures out on Thursday pointed to a broad economic slowdown in the U.S., from less manufacturing growth to elevated claims for jobless benefits and declines in home construction and pending sales. Pending US home sales fell sharply last month and although it was expected that home sales would drop once the homebuyer tax credit lapsed at the end of April, the depth of the decrease was shocking. According to the National Association of Realtors, pending home sales fell a huge 30% in May. Their index, which measures signed sales contracts but not closed sales, plunged to 77.6 from 110.9 in April and is off 15.9% from a year ago when the nation was barely emerging from the recession. The figures highlight just how dependent the morbid economy is the stimulus spending.

 

India’s central bank increased interest rates in the week in an unscheduled announcement reflecting policy makers’ concern that inflation will accelerate in the world’s second-most populous country.  The central bank increased the reverse repurchase rate for a third time this year to 4 percent the highest level since March 2009, from 3.75 percent and the repurchase rate was increased to 5.5 percent from 5.25 pc. The government raised gasoline and diesel prices on June 25 adding to inflationary pressures as the $1.2 trillion economy expanded 8.6 percent in the three months to March from a year earlier. The Indian central bank is expected to increase lending rates by another quarter point at its next meeting July 27 and then by “at least” a half point through to the end of the year. The Organization for Economic Cooperation and Development on May 26 forecast that India’s economy will grow 8.3 percent in 2010 and 8.5 percent in 2011.

 

Goldman Sachs has cut its growth forecast for China this year to 10.1 percent from 11.4 percent as government restrictions on lending and real estate slow expansion in the world’s fastest-growing major economy. Shanghai is now firmly in the grip of a bear market, with a drop of 25 per cent since April, as Chinese banks have tightening lending and scrambled to improve the strength of their balance sheets after record lending in 2009.

 

The new Australian government has reached a deal with mining companies over controversial tax plans with the deal being struck just a week after Ms Gillard swept to power and the mining tax had become highly political. Former Prime Minister Kevin Rudd had announced plans for a 40% tax on miners' profits but a compromise agreement negotiated by his successor, Julia Gillard, has now reduced the rate to 30% for coal and iron ore with the new tax being applied from July 2012. The new tax will now only apply to coal and iron ore mine profits and affects 320 companies instead of the 2,500 originally thought. Miners will also be entitled to a 25% extraction allowance that will reduce taxable profits. For tax purposes mines will be valued at market value rather than book value allowing miners to claim against depreciation of their assets. Junior explorers have lost an exploration rebate that was included in the original proposal. The scheme would have allowed small exploration companies to pass on tax losses to investors.

 

Gold prices slid more than $40 an ounce last week as the sell-off in financial markets sparked a bout of profit-taking. it suffered its sharpest daily fall in five months on Thursday, but bounced back on Friday to end the week at $1,210.35 a troy ounce on the spot market, down 3.5 per cent. Oil had a difficult week also as Nymex August West Texas Intermediate fell $6.70, or 8.5 per cent, to $72.16 a barrel oils biggest five-day decline in nearly two months. Still within the $70-$85 trading range it has traded in for the last nine months. According to Reuters Russia's oil production hit a record high in June and remained above 10 million barrels a day for the 10th month in a row. This means Russia remains the world's top oil producer, ahead of Saudi Arabia,

 

Thursday’s Bank of England interest rate meeting is expected to see no change with base rates and when the minutes are released in a few weeks’ time investors will be keen to know if anybody else has joined Andrew Sentence as he voted for a rate increase at the last meeting.  On Thursday official manufacturing numbers are expected to show that the sector is continuing to recover although the increase is only expected to be small.  On the same day the National Institute of Economic and Social Research are expected to report that GDP grew at around trend rate or 0.6pc in the second quarter.  On Friday producer price figures are likely to confirm that inflationary pressures still remain strong as raw material prices continue to increase input prices.  On Monday the Bank of England releases its housing equity withdrawal numbers and these are likely to show that households invested around £4bn more in the housing market than they borrowed in mortgages in the first quarter. This contrasts with the first quarter of 2007 when they withdrew £14bn.  On Friday trade figures are expected to show that imports are continuing to grow faster than exports, which means that net trade is actually depressing overall growth. 

 

Figures in the week showing manufacturing output slowing across large parts of the world, pose further challenges to leading economies as they attempt to shore up shaky fiscal positions without falling back into recession. In Asia the world’s production powerhouse whose economies are still largely dependent on export demand  manufacturing activity indices for China, South Korea, Taiwan, India and Australia all showed weaker activity for June than forecast and whilst the overall level of factory activity still suggests production is expanding it is doing so at a more moderate rate than in recent months. Fears of a slowing global economy gripped investors in the week and with the yield on two year US Treasuries falling to as low as 0.61pc and ten year yields dropping below the psychologically important 3pc level, bond markets are signaling the fact that US growth is unlikely to be in the 3pc region in the second half of this year as is being forecast and could very well move into negative territory over the next twelve months.  I believe that the US economy will fall back into recession and whilst I do not believe this is likely to occur until next year, turbulence elsewhere in the world may bring this date further forward.  One of the major failures of the G20 summit was the inability to tackle the huge Chinese and German trade surpluses which are causing such massive global imbalances and which until they are put right will leave a precariously posed global economy unsustainably balanced.  I believe it is now safe to take the view that the much hoped for V-shaped economic recovery can be forgotten and the return of volatility is a sign that investors are rapidly returning to safe havens as they fear muted growth which will undershoot what they had been hoping for.  Consumers, companies and Governments are increasingly nervous and with no more