The U.S. Treasury yield curve is flashing warning signs on the economy, pointing to a less optimistic prediction for longer-term economic growth at the same time as Federal Reserve officials are adopting a more aggressive tone on raising interest rates.
A flattening yield curve is often interpreted as a negative economic indicator as it shows concerns about the future pace of growth and inflation, because buyers of long-dated debt would demand higher yields if they expected higher costs.
“The Fed’s optimism has no real counterpart in any of the data that we’ve seen so far,” said Aaron Kohli, an interest rate strategist at BMO Capital Markets in New York “The presumption of weak economic growth is fairly firmly rooted and you can see that in the long-end of the curve.”
Dallas Federal Reserve Bank President Robert Kaplan on Tuesday said that the yield curve showed the market expected sluggish growth ahead; however, New York Fed President William Dudley said this week that the flat yield curve reflects low overseas inflation and borrowing costs and not a weakening U.S. economy.
The yield spread between five-year Treasury notes and 30-year Treasury bonds on Wednesday flattened to 95 basis points, the narrowest since December 2007.
The gap between two-year note and 10-year note yields also declined to 80 basis points, just above 10-year lows of 73 basis points reached in mid-2016.
The yield curve reflects the extra interest investors require to buy bonds of a longer maturity. When they demand higher payments for shorter-dated bonds than for longer-dated ones it shows that they are more concerned about nearer-term risks.
The flattening is not yet near an inversion, which is typically seen as a harbinger of a recession.
The curve flattened this week after Fed officials including Dudley and Boston Fed President Eric Rosengren took a more aggressive view to rate hikes, which sent shorter-dated bond yields higher.
That came despite recent data that shows inflation retreating from Fed targets and weakening retail sales and housing data.
Still, there is not widespread alarm of the risk of a recession. Economists at Deutsche Bank said earlier in June that the chances of a U.S. recession in the next 12 months are remote. Jeffrey Gundlach, chief executive officer at DoubleLine Capital, said the flatter curve would start being a concern “when two- and three-year U.S. Treasuries yield about the same.”
An economic downturn would be a setback for U.S. President Donald Trump who during his campaign had vowed to lift annual GDP growth to 4 percent, though administration officials now see 3 percent growth as more realistic. First-quarter economic growth disappointed.
Irrespective of economic predictions, investors say demand for high-quality assets is also helping to flatten the U.S. yield curve, as there are few other options that generate returns.
“The market is starved for product and starved for yield and has to be invested. We are still one of the highest-yielding bond markets on the planet,” said Gennadiy Goldberg, an interest rate strategist at TD Securities in New York.
CONDITIONS STILL LOOSE
The flattening yield curve may further loosen financial conditions despite the Fed’s attempts to tighten them, giving an additional boost to risk assets like stocks regardless of the strength of the economy.
That’s because long-dated debt is heavily influenced by pension funds, hedge funds and other participants that lend across the economy, often known as the “shadow banking” industry, and not the U.S. central bank.
“The Fed doesn’t have control over the monetary base because the pile of money represented by shadow banking is so much bigger than what the Fed has under its control,” said Lou Brien, a market strategist at DRW Trading in Chicago.
The Chicago Fed’s National Financial Conditions Index shows that economic conditions have in fact loosened from a year ago even though the Fed has raised rates three times since then.
As the flattening yield curve forces investors to chase higher returns to meet investment objectives, the curve could become even flatter, according to Brian Reynolds, chief market strategist at New Albion Partners in New York.
But history suggests it would be some time before the curve inverts, and even longer before stocks take a turn for the worse, he said.
When the yield gap between two-year and 10-year notes was similar to current levels in 2005 at around 80 basis points, it took 11 months for the yield curve to invert, after which stocks gave an annualized return of 14.8 percent before the bear market began 21 months later, Reynolds said.
In 1994, the yield curve took an additional three and a half years to invert from current levels and in that instance stocks returned 21.6 percent on an annualized basis after the inversion before the bull market ended 22 months later, Reynolds said.
Source: Reuters (Additional reporting by Jennifer Ablan; Editing by Megan Davies and Andrea Ricci)
The European Central Bank made a play for power over London’s lucrative clearing industry, cranking up the pressure on an issue that has become a flash point in the Brexit talks that began this week.
The Frankfurt-based ECB is pushing for a change to the European Union law that provides the legal basis for its monetary policy. It seeks “clear legal competence in the area of central clearing” of euro-denominated financial contracts, giving it more control over non-EU clearinghouses — including those in the U.K. after Brexit — that are deemed systemically important to the bloc’s financial markets.
The ECB has mounted an increasingly aggressive campaign in recent weeks for control of clearing, a business dominated by London-based firms led by London Stock Exchange Group Plc, majority owner of the world’s largest clearinghouse, LCH. Bank of France Governor Francois Villeroy de Galhau said on Thursday that the power to force major non-EU firms to move their clearing business into the EU is the “only viable mechanism” to ensure the ECB can manage risks to financial stability.
Austrian Chancellor Christian Kern said on Friday that the ECB under President Mario Draghi “has saved Europe,” so “it makes a lot of sense to give them more means to do the job.”
The ECB’s move is part of a broader overhaul of clearing rules in the EU begun earlier this month by the European Commission, which proposed a two-tier system for non-EU clearinghouses. Smaller firms would carry on operating under existing rules, while those deemed systemically important to EU financial markets would face stricter scrutiny and, ultimately, could be forced to move clearing of EU derivatives inside the bloc.
The proposal on Friday “would pave the way for the Eurosystem to exercise the powers that are foreseen for central banks issuing a currency” in the commission’s plan, according to the ECB.
Clearinghouses stand between the two sides of a derivative wager and hold collateral, known as margin, from both in case a member defaults. About 75 percent of trading in euro-denominated interest-rate swaps takes place in the U.K., according to Bank for International Settlements data from April 2016.
The ECB claimed power over clearing back in 2011, including the right to require firms that clear euro-denominated derivatives and other contracts to set up shop in the currency zone. The U.K. challenged this claim in court and won. In a 2015 judgment, the EU’s General Court ruled that the ECB lacked this authority.
The court said that if the ECB considered this power necessary, it could ask the EU legislature to amend the central bank statute to add “an explicit reference to securities clearing systems.” That’s what the ECB did on Friday.
Kerion Ball, counsel at law firm Ashurst, said the increased powers proposed by the commission are what the ECB has been pushing for since it lost that court case.
The legal amendment could also “give some comfort that there would be a legal basis for the continued provision by the ECB of liquidity swap arrangements that could be used as a funding back-stop in the event of failure of major U.K. central counterparty that clears euro-denominated financial instruments,” Ball said.
The commission took note of the ECB’s recommendation and will issue an opinion, spokeswoman Vanessa Mock said. In particular, the commission will “assess the proposed modification from the perspective of its proposal of June 13.”
The topic of whether euro clearing can stay in London, which dominates the business, after Britain leaves the EU has become a key point of tension in Brexit talks, with thousands of jobs at stake. The ECB insists that it needs oversight of activities that can affect its monetary policy, while the U.K. says fragmenting the industry will push costs up for everyone.
The Bank of England responded to a request for comment on the ECB’s recommendation by referring to a speech this week by Governor Mark Carney, in which he said fragmentation by jurisdiction or currency would reduce the benefits of central clearing.
A spokeswoman for LSE said she couldn’t immediately comment on the ECB’s statement. LCH handles over 90 percent of cleared interest rate swaps globally and 98 percent of all cleared swaps in euros.
The proposed amendment was sent to the European Parliament and to EU member states for adoption.
Jakob von Weizsaecker, a German lawmaker in the EU assembly, said the ECB’s proposal “is a welcome recognition of the key role that central banks play as provider of liquidity in their own currency to CCPs, especially in times of crises.”
Since this month’s election, many British voices have joined a debate on how or even if Brexit may happen; on Thursday, one EU executive added that of John Lennon, sparking a round of more and less musical replies.
Donald Tusk, the former Polish prime minister chairing a summit of EU leaders in Brussels attended by British Prime Minister Theresa May, spoke of the revival of discussion in Britain since May lost her parliamentary majority on June 8.
“We can hear different predictions, coming from different people, about the possible outcome of these negotiations: hard Brexit, soft Brexit or no deal,” he told reporters, referring to talks on Brexit that began in Brussels this week.
“Some of my British friends have even asked me whether Brexit could be reversed, and whether I could imagine an outcome where the UK stays part of the EU. I told them that in fact the European Union was built on dreams that seemed impossible to achieve,” he said, before turning to the late Beatle to clarify.
“So, who knows?,” said Tusk, citing Lennon’s “Imagine”. “You may say I’m a dreamer, but I am not the only one.”
Asked later if it was not an “illusion” to imagine halting Brexit, the 60-year-old Pole insisted: “Politics without dreams would be a nightmare”. Recalling his own past as a dissident who saw Soviet communism collapse, he told reporters: “Miracles do happen. Some of my political dreams have come true.”
Several other leaders at the summit took up the theme of Lennon’s 1971 hit about an end to war and national divisions.
“Yeah, we all have that dream. I hate Brexit from every angle,” Dutch Prime Minister Mark Rutte said of stopping a move Britons voted for last year. “But this is a sovereign decision by the British people and I can’t argue with democracy.”
His Belgian neighbour Charles Michel was more cautious about even raising the prospect of Britain staying in the Union: “I am NOT a dreamer and I’m not the only one,” Michel told reporters.
“It’s time for action and certainty. Not for dreams and uncertainty,” the Belgian premier tweeted in response to Tusk.
Many EU leaders assume Brexit is now inevitable and see talk of a U-turn, which would need EU consent, as a distraction.
Lithuanian President Dalia Grybauskaite joined in the pop lyrics fun by suggesting that even after Britain’s “divorce”, its European allies could still be counted on as friends.
Quoting a Motown classic where the singer tells an ex-lover “If you need me call me”, Grybauskaite, a master of the pithy one-liner, tweeted: “#Brexit: ain’t no mountain high enough.”
Source: Reuters (Additional reporting by Gabriela Baczynska, Philip Blenkinsop and Charlotte Steenackers; Editing by Louise Ireland)
The U.K. cannot hope to retain its financial passporting privileges if it pursues a so-called “hard Brexit” that involves a withdrawal from the European Union’s single market, according to Valdis Dombrovskis, the vice president of the European Commission.
“The issue is quite clear. EU passports are linked to the EU single market. So if the intention of the U.K. is also to leave the single market then indeed U.K. financial institutions cannot have EU passports,” declared Dombrovskis, who is also the European commissioner for the euro and social dialogue, speaking from Brussels to CNBC on Thursday.
“Those things indeed come together, so then the question is basically if you can rely on equivalence in certain sectors or establish sufficient presence within the EU to maintain an EU passport,” added the former Latvian prime minister.
So-called passporting rights allow financial services firms within the EU to run operations and offer services throughout the European Economic Area (which consists of the EU member states as well as Norway, Iceland and Lichtenstein).
During 2016, financial and insurance services contributed £124.2 billion ($157.46 billion) in gross value added (GVA) to the U.K. economy, which amount to 7.2 percent of the total, according to official government data published by the House of Commons. 51 percent of the GVA was generated in London. The sector also provides over 1 million jobs throughout the country.
Given the industry’s importance, the question of what becomes of the U.K.’s passporting rights once it leaves the EU is high on the agenda as a key discussion topic for exit negotiations.
Dombrovskis’ comments echo those of Luc Frieden, former finance minister of Luxembourg, who recently asserted that while the U.K. will remain an important financial services center, its exit from the EU would necessitate a reconfiguration of the status quo.
“‘Out’ is not ‘in’ and therefore I think the United Kingdom must know that it’s not going to benefit anymore over the passporting rights it used to have,” Frieden told CNBC last Friday in Luxembourg.
Large amounts of business investment is being postponed because of uncertainty over the future outcome of Brexit negotiations so Britain should seek clarity as early as possible over a transition arrangement, Chancellor Philip Hammond said.
“There would be a sigh of relief from business if we were able to get an early agreement on a transition arrangement,” Hammond told Sky News on Thursday.
“There is a large amount of business investment that is being postponed until business can see more clearly what the likely outcome of these discussions is. The earlier we can give business that reassurance the more quickly we will get businesses investing again,” he said.
Hammond said the British people wanted a Brexit that protected their jobs and their standard of living. Hammond said he was not at odds with other ministers in government over his approach to Brexit.
Source: Reuters (Reporting by Guy Faulconbridge, editing by James Davey)
While the United Kingdom’s exit from the European Union is an “unfortunate” event, it presents several opportunities to strengthen the latter and also location benefits to Frankfurt, the German Finance Ministry said Thursday.
The Brexit offers “an opportunity to strengthen Germany as a business location and, in particular, the financial center Rhein-Main,” the ministry said in its latest monthly report.
“As the future relationship with the United Kingdom is still unclear and the market access of London is not secured, the location question for many financial services companies is already present.”
The same is true of British universities that are considering opening up branches in the other Member States in order to continue to benefit from EU research programs and to remain attractive to European students, the report added.
“Germany is a stable and attractive location,” the ministry said in the report.
“The role of Frankfurt as the center of banking supervision in Europe could be further strengthened and completed by a shift of the European Banking Supervisory Authority, which is still based in London,” it added.
Germany stiffened its opposition to a proposed revamp of global bank capital standards, renewing a confrontation with the U.S. and putting at risk a deal on rules intended to help prevent another financial crisis.
After opening the door earlier this year to an agreement in the Basel Committee on Banking Supervision, Germany has changed tack and closed ranks with France, the staunchest critic of proposed measures to stop banks gaming the rules known as Basel III, according to people with knowledge of the matter who asked not to be identified because the talks are private.
The shift reflects German concern over the viability of international rules after the U.S. Treasury recommended delaying implementation of two standards the Basel Committee has already completed, one person said. The German government is also keen to show solidarity with France and its new president, Emmanuel Macron, the person said.
The last big sticking point in the talks is a so-called output floor, which limits how much lower banks’ estimates of asset risk generated by their own statistical models can go compared with those produced by standard formulas set by regulators. This risk assessment is part of the process for determining a bank’s capital requirements.
Stefan Ingves, the Basel Committee’s chairman, is pushing for a deal under which the floor would begin to phase in at 45 percent in 2021, rising to 75 percent in 2027. A transitional maximum risk-weight cap is also proposed for residential real-estate exposures, a major concern for many European banks. This plan is backed by the “vast majority” of Basel members, he has said.
Bank of France Governor Francois Villeroy de Galhau said last week that 75 percent is unacceptable “because it would mean that this floor, and thus the standardized approach, would be the constraint for half of the international banks.”
France, with four global banking behemoths led by BNP Paribas SA, has been the staunchest opponent of the proposed floor, while the U.S. has been its most outspoken advocate.
Germany’s central bank had been leaning toward accepting the compromise, three of the people said. In response, the French took their case to the government in Berlin and found a receptive audience, one person said.
While governments aren’t represented in the Basel Committee, their support is crucial because the global standards only become binding when they are converted into national law or regulations.
Spokespeople for the Basel Committee and the Bundesbank declined to comment on the talks.
After years of strained relations between France and Germany, Macron wants to reset the partnership to improve growth across the region and counter the populist fervor that triggered the U.K.’s decision to withdraw from the European Union. He and German Chancellor Angela Merkel have pledged to create a new “road map” for medium-term cooperation and reviving the EU.
With Germany and France pushing for the floor to be set below 75 percent, and the U.S. unlikely to soften its position further, a deal before the summer break probably isn’t in the cards, the people said. The Basel Committee is also discussing steps that could be taken to make either level more acceptable to all members, one person said.
European Banking Federation head Wim Mijs said on June 20 that the regulator’s meeting in Sweden last week “made clear that their negotiations are still deadlocked, and that it may take months at least before an agreement could be possible.”
“I sincerely hope that the EU Member States — finance ministers and central bankers — will remain united in their approach towards the Basel Committee,” he said.
Economic data points to solid growth in the euro zone in the second quarter and indicates a rebound in global growth after a rough patch, the European Central Bank said in a regular economic bulletin on Thursday.
Inflation will hover near the current level in the coming months and while there is still no convincing upswing in consumer prices, there are early signs of pipeline price pressures in the production and pricing chain, the ECB added.
“Overall, incoming data point to solid growth in the second quarter of 2017,” the ECB said in a bulletin that is largely consistent with the outlook presented after its June policy meeting. “Domestic demand is expected to be buoyed by a number of favourable factors.”
“Very favourable financing conditions and low interest rates continue to promote a recovery in investment in the context of rising profits and lower deleveraging needs,” the ECB added.
Source: Reuters (Reporting by Balazs Koranyi; Editing by Angus MacSwan)
Europe is slowly turning a corner as a wave of anti-European Union movements peters out, Donald Tusk told EU leaders in a letter published before he will chair their two-day summit starting on Thursday.
Countries including Austria, the Netherlands, France and Italy have seen a sharp rise in popularity of parties with eurosceptic, often anti-immigration policies, but in recent months these have suffered decisive defeats in elections.
Tusk, the president of the council of EU heads of states and governments, said the bloc was now again starting to be perceived as a solution, rather the problem, and that recent difficulties had served to strengthen it.
“It is fair to say that we will meet in a different political context from that of a few months ago, when the anti-EU forces were on the rise,” Tusk wrote.
“The current developments on the continent seem to indicate that we are slowly turning the corner. In many of our countries, the political parties that have built their strength on anti-EU sentiments are beginning to diminish,” he said.
In Britain, the Conservative government of Prime Minister Theresa May lost its majority in parliament earlier this month, scuppering May’s stated aim of bolstering her mandate for negotiating Britain’s exit from the EU.
In France, Emmanuel Macron decisively won presidential and parliamentary elections on a agenda of support for the EU and reforms, soundly beating Marine Le Pen’s far right National Front, which for the first time in its history reached a second round in a presidential vote.
“We are witnessing the return of the EU rather as a solution, not a problem. Paradoxically, the tough challenges of the recent months have made us more united than before,” Tusk said.
Apart from Brexit, the EU is also facing a major immigration challenge which, though abated, is still fuelling anti-EU sentiment. Some blame the EU for not acting fast enough to stop the inflow of migrants arriving from the Middle East and Africa.
A series of attacks by Islamist militants in Britain, France, Sweden, Germany and Belgium, in which hundreds were killed, have added to concerns.
To further stem migration flows, Tusk said the EU should give more money to support Libyan Navy Coastguards to help stop people being smuggled into the EU by sea.
There is also discontent over unfettered global trade, perceived as a threat to jobs in Europe.
“Therefore, during the upcoming European Council, I want us to move further on our policy response in these three areas,” Tusk said in the letter to the leaders.
He said that while the EU could not replace governments in fighting home-grown militants, it could put pressure on technology firms to act against “content that spreads terrorist material or incites to violence.”
Europe should also set up joint defence capabilities to improve security, Tusk said, and he also called for better instruments to defend EU trade against unfair competition and “uncontrolled globalisation”.
Source: Reuters (Reporting By Jan Strupczewski; editing by Philip Blenkinsop and Raissa Kasolowsky)
The European Central Bank will ignore government complains about rising borrowing costs when it eventually tightens policy and will not help any particular country, the ECB’s chief economist said, according to the German magazine Spiegel.
Countries on the periphery of the 19-member euro zone worry that when the ECB ends its 2.3 trillion-euro (2.03 trillion pounds) bond-buying scheme, yields will rise. The higher financing costs could curb growth and would disproportionately hurt indebted countries such as Italy, Spain or Portugal.
“If the spreads for a particular country rise, that’s not a monetary policy problem,” ECB Chief Economist Peter Praet said in an interview published in Spiegel on Thursday. “We are not singling out particular countries and neither are we there to ensure governments have favourable financing conditions.”
The ECB gave up its bias towards more rates cuts earlier this month in a small step towards normalisation. It will decide this autumn whether to extend or wind down its bond buying.
“When the day comes, we will look at inflation and act accordingly, regardless of whether governments complain,” Praet said. “We forewarned them and they clearly understood that.
“I have just read a commentary by the Italian Minister of Economy and Finance, Pier Carlo Padoan. ‘When the bond purchases come to an end, we are on our own’, he writes. And he’s right,” Praet said.
The bond purchase scheme is set to run until the end of the year, but even if the programme is wound down, it would be reduced over a period several months.
Although many market analysts expect another extension of the programme, the scarcity of government debt to buy could limit the ECB’s ability to continue buying.
Source: Reuters (Reporting by Balazs Koranyi; Editing by Maria Sheahan, Larry King)
French President Emmanuel Macron said Thursday his new government is working “hand in hand” with Germany to build a European Union that can help protect the bloc’s citizens.
“We will work on the fight against terrorism, the topics of migration, the topics of defense,” he said on arriving at his first summit of EU leaders.
“We are working hand in hand with Germany…During the Council, we will speak with one voice,” he said.
Mr. Macron said he wants to see the EU remain open on international trade but must “modernize” its trade defense instruments to protect the bloc from unfair trade practices.
France and Germany are pushing for the EU’s executive, the European Commission, to look into ways that member states can better screen investments in sensitive sectors, such as national security.
Speaking a few minutes later, German Chancellor Angela Merkel said greater Franco-German contribution can help the whole bloc.
“We will for the first time have the new French President with us,” she said. “I look forward to the cooperation, I think that right now, creativity and new impulses from France, and also Germany, can do everyone good.”
In Turkish President Recep Tayyip Erdogan’s hunt for domestic enemies, even the invisible hand of the marketplace is getting cuffed.
With elections just over two years away and his approval ratings dipping below 50 percent, Erdogan isn’t leaving his political fate to the vagaries of the free market. Instead, he’s risking his country’s future stability by flooding the economy with credit to engineer short-term growth, analysts say.
“Turkish economic policy is all about politics—and politics is all about Erdogan and his AKP party winning decisively in 2019,” said Nigel Rendell of Medley Global Advisors in London. “Nothing else matters.”
Since last year’s foiled coup, which triggered emergency rule, Turkey has expanded state guarantees to rush about $50 billion of lira loans to almost 300,000 businesses with little transparency over how the money is spent. The government has also pooled about $200 billion of assets into a wealth fund. That’s so it can borrow against its stakes in companies like Turkish Airlines and Turk Telekom to build popular big-ticket infrastructure that will further swell a budget deficit that’s already projected to be the highest since 2010.
Officials have even proposed letting banks securitize their total loan book of $515 billion to finance more lira lending, though they’ve already dispersed 50 percent more than all deposits in the national currency, the most of any major economy. While a 22 percent surge in credit since the failed putsch is helping fuel 5 percent headline growth, which Erdogan has trumpeted as a vindication of his policies, it’s also threatening to prolong double-digit inflation.
The immediate downside of the credit boom has been an increase in the price of money. To attract savings from a population that’s more reluctant than most to park cash, lenders have raised deposit rates to as high as 15 percent, which means they have to charge even more for lending to be profitable.
Melis Metiner of HSBC Holdings Plc says Erdogan and his allies are trying to bypass the structural, “supply-side constraints” of the economy, including low savings rates, poor education results and skill shortages—all while shielding inefficient industries with some of the most protectionist policies in emerging markets. This neglect, together with the debt buildup, risks making Turkey even more vulnerable to external shocks after the elections, she said.
“The government’s priority appears to be to keep domestic activity as strong as possible for as long as possible by leveraging the public- and banking-sector balance sheets,” the London-based economist said in a research note.
Recep Tayyip Erdogan.
Finance Minister Naci Agbal said in an interview in March that most of the government’s recent measures related to taxes and credit are one-time in nature and their impact on the budget will disappear by 2020.
“As long as the budget gap is at manageable and controllable levels, a certain amount of increase will not hurt the perception of fiscal discipline,” he said.
The Credit Guarantee Fund, which the government created in 1991 but drastically expanded last November, lets commercial banks share some of their lending risks with the treasury, which covers 7 percent of any losses—enough for lenders to approve many clients with borderline creditworthiness.
Metiner and other economists have criticized the fund for creating a “debt spiral,” adding another element of fragility to the economy. They argue that while it allows companies to restructure debt and receive fresh loans with maturities of up to 10 years, it does nothing to improve credit quality and encourages excessive borrowing that can require even more loans to service.
Business owners like Alper Akmaner, who makes and distributes the Cire Aseptine brand of Swiss beauty products, say they would’ve had difficulties surviving, let alone expanding, without the guarantee program.
The Anthemis Cosmetics chairman, like legions of other entrepreneurs, imports raw materials for dollars and was thus ravaged by the lira’s 21 percent plunge last year. Turkey is particularly sensitive to U.S. currency swings because its current account deficit is set to be the biggest relative to output of the 20 largest economies this year and its imports are priced mostly in greenbacks.
“When I started my company, banks avoided me,” Akmaner said in an interview in Istanbul, where he employs 14 people. “Now they’re calling me.”
Akmaner, who borrowed 750,000 liras ($213,000) from two different banks under the mechanism, said the “huge cash injection” has provided “undeniable relief” for thousands of firms. It should be extended to achieve sustainable results, “otherwise, in terms of growth, it’ll be a one-off and then we’ll be back where we started,” he said.
Deputy Prime Minister Nurettin Canikli said so far the fund has backed about 180 billion liras of credit out of a maximum of 250 billion liras, after which the program will be wound down. That’s the main reason officials are considering allowing banks to bundle their loans and market them to investors, said Trieu Pham, a credit analyst at MUFG Securities in London.
“That could reduce the upward pressure on deposit rates and free up some breathing room for further loan growth,” Pham said.
For Erdogan, who’s presided over the firing and jailing of civil servants by the tens of thousands since a rogue army faction tried to topple him, prolonging the credit spree is a double-edge sword. He’s seeking a popular mandate for greater powers after pushing through a disputed referendum in April on moving from a parliamentary system to an executive presidency. Elections for both offices are scheduled for November 2019, but he can call either one early, a decision that may depend on the health of the economy.
“The risk is to face an over-leveraged economy right after elections,” said Inan Demir, Nomura International Plc’s London-based economist. “An external financing shock could lead to accelerating inflation, higher unemployment and stagnant activity right after the transition to the executive presidency.”
Even supporters of the debt and restructuring frenzy who’ve benefited from the government’s largesse are worried it may have gone too far.
“This isn’t sustainable,” said Mehmet Erdogan, chairman of Sezon Pirinc, an agriculture producer based in Istanbul that filed for bankruptcy protection two years ago. “We can’t get anywhere by borrowing and restructuring,” said Erdogan, who isn’t related to the president.
Maybe not, but don’t expect the Turkish leader to stop trying, according to Atilla Yesilada, an adviser to GlobalSource Partners, a consultancy in Istanbul.
“Voters are extremely uncomfortable with the purges and clampdowns,” Yesilada said. “Erdogan can only hold the system together by pumping in enough money to keep growth high, so he’s not going to hit the brakes.”
The International Monetary Fund has resurrected an old technique — commonly used in the 1980s during the Latin American debt crisis — that would allow Greece to avoid a payment default next month on debt owed to European creditors.
The reprieve also gives the IMF and its European partners time to sort out their technical differences on the struggling country’s growth and budget outlook. But the Fund’s elegant compromise still leaves Greece under the shadow of an enormous debt overhang; reducing it requires that Europe find a way to set aside national politics and act on the basis of economic logic and necessity.
Europe and the IMF have been unable to reconcile two views of Greece’s debt sustainability, with the two sides’ differences spilling over into the public domain. Guided mainly by a cash-flow analysis, European authorities argue that low interest rates and long maturities have made the nation’s debt sustainable. But the Fund notes that, at almost 200% of GDP, Greece’s stock of debt deters investment and capital inflows. For the IMF, meaningful debt reduction is critical for generating the confidence and credibility needed to break Greece out of a prolonged period of impoverishment.
This is not the only area of disagreement between Greece’s two major creditors. They also differ on the realism of some key economic projections, including the important nexus between growth and the government budget, with Europe adopting a much more optimistic perspective.
For those of us who have been following the Greek economic tragedy for many years, much of the European view continues to defy economic logic — and for a simple reason: European politicians worry about the domestic political consequences of granting Greece debt relief, especially ahead of Germany’s federal election in September. Offering debt relief, it is feared, could undermine the credibility of governing parties and provide a boost to extremist movements.
To be sure, debt forgiveness is tricky, raising complicated issues of fairness and incentives. Yet, in some cases, there comes a time when refusal to forgive debt is more damaging. European officials know as well as the IMF does that Greece has long been at this stage, turning the country into a permanent “ward of the state” within a eurozone that does not accommodate this outcome well. But they seem unable to act.
With Europe and the IMF failing to agree, Greece has been robbed of the additional funding it needs to clear domestic arrears and meet its rather large external debt-service payments in July. Meanwhile, growth is languishing once again, despite the pickup in European economic performance as a whole. To overcome this bottleneck, the IMF has compromised, by reviving the practice of approving a financing program “in principle.”
An approval in principle signals the Fund’s endorsement of a country’s economic policy intentions. This can unlock other funding (in this case, from Europe). But the IMF refrains from actually disbursing its own loans, pending a more satisfactory outcome on overall financing assurances (in this case, proper debt relief for Greece).
It is a short-term compromise that acknowledges Europe’s political calendar and constraints, helps Greece avoid a summer default, and safeguards the IMF’s resources. The arrangement would shift more of the financing burden to Europe, where it properly belongs. And it even provides a signal of unity, despite the important disagreements that remain.
But this is nothing more than yet another temporary solution — or, to be less generous, the continuation of what has come to be known as the “extend and pretend” approach. While the immediate funding issue is indeed addressed, not enough is being done to put Greece on a realistic path of medium-term growth and financial viability. It also risks exposing the IMF to even heavier political pressure, accentuating legitimate questions about the uniformity of its treatment of member countries.
Having compromised, the IMF should now stick to its guns and refuse to make its arrangement for Greece operational until it is satisfied on both debt relief and technical assumptions. And, rather than declare victory, as they were inclined to do in a mid-June statement by eurozone finance ministers, European officials should treat this compromise as the next step in softening its increasingly untenable stance on Greek debt.
In the meantime, both sides would be well advised to undertake a careful analysis of previous experiences with programs that were approved in principle, rather than becoming immediately operational. When defined well, including by specifying a short period for the prospective shift to being fully operational, such programs can serve as a catalyst and conduit for relaxing a binding constraint on growth and financial viability. They need to be part of a constructive process. They do not work as standalone solutions.
Notwithstanding some bumps along the way, the succession of such programs in the 1980s helped avoid disruptive defaults, and culminated in meaningful reductions of debt and debt-service obligations, which helped several Latin American economies restore high growth and financial viability. A few years later, the process was repeated successfully in the debt-reduction programs for low-income countries under the HIPC (Heavily Indebted Poor Countries) initiative.
The grudging short-term compromise between the IMF and Europe comes after months of sometimes acrimonious discussions. For the sake of Greece, and for the credibility of their own future interactions, they should view it as a stepping-stone to the (long-delayed) definitive resolution of Greece’s economic and financial malaise. Greek citizens have waited, and suffered, long enough.
That’s how McKinsey & Co. consultant Walter Baker describes the plight of corporate salespeople doing battle with purchasing managers in the U.S. today.
The vendors want to charge more for the in-demand products they’re selling but are deathly afraid of losing the sale. The buyers, armed with sophisticated tools and in-depth knowledge of the competitive landscape, see no danger in refusing to pay up.
The lopsided tug-of-war goes some way to explaining why Federal Reserve Chair Janet Yellen and her colleagues are having such a hard time lifting inflation to their 2 percent goal. For companies from arts-and-crafts retailer Michaels Cos. to industrial giant ABB Ltd., the focus is on cutting costs, not raising prices.
“If you were to look inside a company you’d see more resources, more assets, software, tools, more senior folks focused on procurement than on pricing,” said Baker, co-author with two other McKinsey experts of the book “The Price Advantage.” The reason, he added, is simple: “No company ever worries about going to any of its vendors asking for a discount. The opposite is true for companies that try” to increase prices.
An increasingly ingrained corporate mindset sees pricing power as a relic of the past after years of minimal inflation. The brave new world is one dominated by stiffer competition from technological breakthroughs and globalization, and downsized demand from a slower-growing and aging population.
In spite of that, Fed policy makers are pressing ahead with plans to tighten credit by raising interest rates and reducing the central bank’s bond holdings. They’re betting that a scarce supply of workers will force companies to pay employees more and then boost prices to protect their profits, in line with a theory called the Phillips Curve that’s about six decades old.
Many companies, though, still think they can’t push through price increases, even after eight years of economic expansion. In fact, more firms lost pricing power in the past six months than gained it, according to the Institute for Supply Management’s latest semiannual survey of about 700 purchasing managers at manufacturers and service providers.
“We run the business assuming the price pressure is going to continue indefinitely,” John Flannery, president of General Electric Co.’s health-care business, told an investor conference on June 1. “It’s a core mindset.”
“So our response has to be the cost side of the equation,” added Flannery, who takes over as GE’s chief executive officer on Aug. 1.
That’s got to be of some concern to the Fed. If companies are convinced they can’t raise prices, that could turn into a self-fulfilling prophecy, leaving inflation permanently depressed and the U.S. in greater danger of falling into a deflationary funk during a recession. Chicago Fed President Charles Evans said Tuesday that he’s nervous inflationary pressures won’t build as policy makers expect.
Businesses’ “long-run inflation expectations appear to have come down” over the last five years, Brent Meyer, an economist at the Atlanta Fed, said in an email.
An April survey by the bank found that more companies believe the Fed is willing to tolerate inflation below target than above it — a perception the central bank has been trying to fight by stressing that its inflation target is “symmetric.”
It’s no wonder. Since policy makers adopted their 2 percent goal in January 2012, inflation has been below that more than 90 percent of the time. In April, prices were 1.7 percent higher than a year ago.
3M Co., the St. Paul, Minnesota-based producer of everything from Post-it notes to stethoscopes, expects its U.S. selling prices “to be approximately flat” in 2017, Chief Financial Officer Nicholas Gangestad told analysts on April 25.
Companies’ perceptions of their ability to raise prices will influence how they’ll respond to the bigger wage increases the Fed is trying to engineer. At a 16-year low of 4.3 percent in May, the jobless rate was below the level policy makers reckon will fan price pressures.
“If you look at wage inflation, we expect that we recover our wage increases in productivity gains,” said Greg Scheu, president of the Americas region for Zurich-based ABB, a maker of engineering products including power grids and robots. “So if wages in the U.S. are averaging, say, 2 percent, which is about where it’s been, we expect to drive productivity to be able to handle that” rather than attempt to raise prices, he said in an interview.
In trying to ascertain where inflation is headed, policy makers frequently exclude food and energy costs because they’re supposedly inherently volatile. Yet downward pressure in both those areas may prove to be more persistent than expected, the result of technological advances and globalization.
Within energy, it’s all about shale oil worsening the global supply glut. Shale drillers in the U.S. are staging the longest drilling ramp-up on record, pushing prices lower.
In food, it’s about online shopping — think Amazon.com Inc. — and the entry of foreign rivals that spells even fiercer price wars at grocery chains.
Amazon, which is acquiring Whole Foods Market Inc., is expected to cut headcount and change inventory to reduce prices as it steps up competition with Wal-Mart Stores Inc. and other big-box retailers. German discounters Aldi and competitor Lidl are adding to the fray with plans to open a combined 1,000 stores in the U.S.
It’s not just groceries. Heavy discounting has become an almost permanent part of the retail landscape in general.
The arts-and-crafts business “is incredibly promotional,” Michaels CEO Chuck Rubin told analysts on a June 15 conference call. “Over the past many years, our customers as well as our competitors’ customers have grown to rely on discounts in this industry.”