Italy Economy Real Time Data Charts

Edward Hugh is only able to update this blog from time to time, but he does run a lively Twitter account with plenty of Italy related comment. He also maintains a collection of constantly updated Italy economy charts together with short text updates on a Storify dedicated page Italy - Lost in Stagnation?

Friday, October 10, 2008

The Deflation Threat Looms As Consumer and Investment Demand Falls While Oil Turns Year on Year Negative

by Claus Vistesen: Lausanne

Oil prices plunged below $85 a barrel on Thursday, the lowest level in a year, as Opec, the oil exporting countries’ cartel, called an emergency meeting to discuss reducing its crude production to halt the collapse in prices.

This morning it is more of the same, and prices plummeted to a one-year low below $83a barrel in Asia as investor fears of a severe global economic downturn sparked a panicked sell-off of equities and crude. Light, sweet crude for November delivery was down $4.00 to $82.59 a barrel in electronic trading on the New York Mercantile Exchange by midafternoon in Singapore, the lowest since October 2007. The contract overnight fell $1.81 to settle at $86.62.

The US Department of Energy reported this week that the country’s oil demand averaged 18.66m barrels a day last week, down 8.6 per cent against the same period a year ago as the economic downturn takes its toll on oil consumption. High prices during the summer have forced US motorists to cut their mileage, and now the looming recession will mean that they don't simply increase it again as oil prices drop.

Basically this is the point I was raising only one month ago on my personal blog, as to how long we would have to wait for oil prices to turn year on year negative. So now we have the answer, they just did.

Since I am - like everyone else I imagine - basically reeling under the volume of work which all that is happening is generating, I will restrict myself here to reproducing an excellent recent piece from my colleague Claus Vistesen on the issue of global deflation risk.

The Global Economy – Is Deflation the Next Macro Story?

by Claus Vistesen: Lausanne

As the horror story of financial markets continues at full speed it may seem a rather futile endeavor to try to make sense of what is increasingly becoming senseless by the day. Yet, you hardly need to be a financial literate to see that the world of finance and banking has been changed for good. I don’t think this was neither unwarranted nor unexpected. At some point, US authorities had to let someone on the Street fail and it turned out to be Lehman (with Merril Lynch of course coming close in behind as it was snapped up by Bank of America). AIG on the other hand was saved as their role as insurer was deemed too important and systemic to merit a collapse. Then we have Wachovia, the Washington Mutual Trust etc etc …I can understand if many will have a hard time gauging the playbook through which regulatory authorities decide who lives and who dies. As we learned this week that Paulson’s plan was not passed by congress the downside now resembles something of an abyss. It will be interesting to see what happens as the bail-out plan makes its second tour to congress.

Since rumors began of the peril of sub prime mortgages and credit crunch became the new buzz word in the financial vocabulary we have seen some quite eventful weeks not to mention days in which volatility has gone far beyond what any respectable VAR model would be able to foresee. Still the past two weeks must clearly take pole position so far. The numbers flying around and the movement in key market parameters have been extraordinary. That equities were down should not surprise us as we have seen it before this year when Wall Street’s office buildings have been re-shuffled. However, this time it was perhaps a bit different as yield on treasuries fell to almost 0% at one point as investors quit anything with but a faint smell of risky assets. Another specific and most unwelcome side effect of this was the corresponding seizure in credit and liquidity markets which followed. At some point, the cost of borrowing money in the interbank market almost doubled taking the LIBOR rate close to 650 basis points (now running at about 550 bps on the back of the échec of the Paulson plan) as well as the three month spread of LIBOR over the treasury climbed to over 300 basis points. These swings tell an important cautionary tale of the seriousness of this crisis. Especially, the lack of confidence and subsequent seizure of the short term financing market is one of the most tangible and severe effect from this crisis.

Meanwhile and beyond the immediate eye of the storm on Wall Street, Europe is entering its own house of pain as cracks in the banking sector begin to steadily emerge. Add to this that the macro environment is pointing towards a steep Eurozone wide recession and you have the ingredients for a very serious downturn on the European continent. I still hold that the lack of real response on the rate front will not only hurt the ECB’s credibility, but also worsen the inevitable slump.

In emerging market land, things are not looking brighter with the anticipated safe haven flows drastically eroding valuations of asset markets in these economies. Russia seems to be suffering more than most from the recent retrenchment of risk aversion. Now, before people let their thoughts wander back to 1998 and LCTM’s spectacular collapse betting on the wrong side of the Russian debt binge I don’t think that Russia stands before an imminent default. Around $700 billion worth of reserves in the form of foreign exchange and national investment vehicles will keep Russia from any kind of immediate default. However, with trading in the USD denominated RTS index halted twice during the last two weeks due the continuation of outflows from foreign investors, it is difficult to ask the subtle question of whether this time, it might not be a little bit more serious than mere tremors [1] .

On the back of yesterday’s news that congress rejected the bailout plan knitted together by Paulson and Bernanke, the MSCI World Index of 23 developed markets dived 6.8 percent, which was the sharpest decline in the measure's 38-year history according to Bloomberg. In Brazil trading was suspended after the Bovespa fell more than 10% and in India and aforementioned Russia equities were equally pummeled. Stephen Jen and his colleagues from Morgan Stanley (who itself is fighting for survival) have some interesting points on capital flows to emerging markets in the latest edition of the GEF.

What happens next is of course anybody’s guess, but below I would like to point to one plausible and tangible outcome of the wheels that were set in motion back in august 2007 when BNP Paribas announced subprime related losses and thus took the credit crisis to global levels.

Deflation as the Next Macro Story?

The macro themes which have characterized the past year’s eventful period have been fickle. As the Fed decided to let interest rates fall in the end of 2007 decoupling was the name of the game as gold and crude oil reached new highs at one and the same time as the USD was pummeled. However, as it became clear that the US was merely the proverbial canary in the coal mine for a much wider global slowdown the sentiment changed. One main question in this regard was always whether the obvious bout of stagflation, at some point, would turn into deflation; a question I also mused on a couple of months back. As per usual with these things there are arguments for and against. The strongest impediment to a worldwide deflationary slump is the continuing pressure from growth in emerging economies. To be sure, these economies are also going to be run down a notch, but the underlying momentum and the lack of global supply slack in terms of energy resources seem certain to keep headline inflation high as we move forward. [2] However, the crucial point here is exactly that the double barril of imported cost-push inflation at the same time as the economy is contracting may lead to a negative feedback loop that can provoke deflation. Consequently, when I look at the current deterioration in real economic activity across OECD as well as the ongoing tensions in credit markets I believe that deflation is now a fair and probable call in the context of key regions and countries.

Essentially, it is difficult not to notice that something has changed with the recent stream of incoming macro data for Q2 and Q3. In Europe, the Eurozone and key parts of Eastern Europe are likely to be in a recession and also Japan seems to have hit a brick wall. Meanwhile emerging economies also seem to be slowing sharply although recessions in that part of the economic edifice are very unlikely.

All this almost looks like de-coupling in reverse, but the US is unlikely have to have seen the worst yet. Re-coupling does not only work one way and just as the US has enjoyed a windfall from exports in H01 2008 so will the rapid deterioration of the rest of the world feed into US growth rates. It is important to note here that the US’ capacity for domestically induced growth is next to none with a consumer saddled with debt and a financial system in shambles. The US has not yet posted growth rates akin to a recession [3] but that will most likely happen as we come closer to 2009 (Q4 08 and Q1 09 would be my guess, but do go have a look at MS’s Berner and Weiseman for a one stop look at the US economy). In the briefest of versions this small view across the global economic edifice indicates that activity is coming down sharply across the board. In many ways, the effects on the real economy are only about to emerge as we move forward from here and this will be accelerated by the ongoing tensions in financial markets.

However, a sharp de-accelerations in activity need not lead to deflation and even if it does it may, according to some, be the only meaningful end result as well as means for correction for some countries. This begs the question of why am I invoking the deflation ghost and, more pertinently, what kind of deflation I am talking about?

In many ways, the current decline in real activity makes perfect sense as it comes on the back of an extraordinary run in terms of the economic cycle. Some are even talking about the end of one big mega-cycle with some debate on when this cycle is supposed to have started. I will leave this question neatly aside for now and merely conclude that with the added flavor of credit market turmoil and the velocity of the cycle that was (and is now gone), this present slowdown and crisis seem, in many ways, to be quite different than in previous global downturns.

To state that things are different however is scarcely enough to determine whether some parts of the global economy are headed for a sustained deflationary spiral (save perhaps for Japan, but I will touch on that below). However, I would still submit the claim this is actually a real risk at this point. In the following I will argue why.

Stating the Obvious

One key element in my call is a statement of the blatantly obvious. The credit crunch is consequently not just a figment of imagination but a real phenomenon with subsequent real and measurable effects, and what we really ought to be asking ourselves is what it actually means? An almost endless amount of commentary has been devoted to the answer of this question, but I still think that we should try to have a closer look for the sake of argument.

If we begin from the point of view of asset prices, I believe most people can agree that the world as a whole has now entered a prolonged period of asset deflation in key sectors. If we look at an asset such as real estate and housing it seems clear that a substantial amount of deflation lies ahead for many economies before previous imbalances can be corrected. Given the strong and accentuated wealth effect from real estate appreciation due to the possibility for equity withdrawal this is one of the main ingredients in the current crisis. In fact, if we peer across most economies who are now facing serious corrections real estate bubbles was an integrable part of past exuberance.

As regards financial assets we also seem to be in for a period of deflation even though the volatility of such movements makes this an entirely different beast. However, it is interesting in this respect to observe that whole classes of financial assets that were hitherto used to prop up many a financial institution’s balance sheet have now been completely evaporated. This is true not least for many credit products as well as it seem that many debt products backed by mortgages are heading for oblivion (the fascinating tale of the Spanish Cedulas here is a good place to start). [4] In this way, it is perhaps not so much a question of deflation in financial assets but more so about a process by which the asset base is narrowed. I do think this is a critical point to take aboard. This is not just about wealth destruction because risky assets fall in value; it is also about the destruction of entire asset classes and financial business models. If we add to this the general tightening of credit and liquidity provisions we end up with a massive and abrupt shrinkage of the global credit base.

Many would see this as a good and indeed quite necessary byproduct of the incoming slowdown. The past economic cycle was one of easy money and an unprecedented expansion of the credit and liquidity base through, not only through leverage, but also through simple product innovation in the context of financial products. I agree with this narrative, but there is more to this story than meets the eye.

What Does it Mean in a Macroeconomic Context Then?

Two things are important here I think.

One the one hand, economies that have been living well on foreign credit will now have to revert to a different or less extreme version of their previous growth path. Countries such as Spain, the USA, Australia, New Zealand, and many emerging economies in Eastern Europe are amongst the major candidates here. In general, it is clear that across the entire global economic edifice external deficit economies will need to tighten their belts due to the widespread global slowdown.
On the other hand, we also need to look at the credit side since this is not only a story about excessive exuberance on the part of debtor nations. It is also very much about the creditor economies and how they have been living high on foreign economies’ willingness and capacity to absorb the inflows. Now that the capacity for credit absorption is declining, so will creditor nations loose momentum as they are no longer able to tap foreign debtors to the same degree as before.

It is especially within this context that I see the potential for deflation. In particular, I would cut a lateral line through those creditor and debtor nations with distinct demographic profiles in the form of low fertility rates and subsequent high and rapidly rising median ages.

On the credit side Japan and Germany stand out as obvious candidates [5] . We can already see from the data how, absent support from external demand and asset income, headline GDP figures are tanking. Given the persistently depressed situation with respect to domestic demand and the deteriorating global credit conditions, there is a real chance that whatever endogenously generated trend growth path these economies can muster, the ensuing price trend could very well be one of deflation in core as well as key asset prices.

Turning to the deficit nations many commentators have noted how the US may be entering a Japan type of lost decade. I still think this is very unlikely; the amount of liquidity being pumped into the system as well as the much more stable demographic profile will prevent the US from falling under the yoke Japan did in the 1990s. However, I need to concede that the continuation of negative real interest rates at one at the same time as the public debt is being used to funnel corporate’s and household’s liabilities are not helping the US debt position. Without a shred of doubt, the US economy is hit much harder than was initially anticipated and at this point in time it remains to be seen whether the aggressive regulatory arrangements will have the wanted effect. In a more fundamental light I think it is quite obvious that the role of the US economy will change for good which need not be a bad thing but will take some adjustment of mindsets.
Meanwhile, I do see considerable potential for deflationary corrections in Spain, Italy and key parts of Eastern Europe. My rationale is that these economies perhaps stand before the most severe adjustment of all. In Spain the structural break is obvious. 6 years worth of housing booms, deficit spending and high growth driven by massive immigration and negative real interest rates will now need to be corrected. The rub here is however that membership of the Eurozone and a fixed exchange rate make wage deflation almost a certainty if a correction is to be achieved. Coupled with the unraveling of the housing market the downward momentum is extreme, and it should never escape our attention that before 2000 Spain was set to become to oldest society on earth. If she is not able to keep those immigrants the ensuing negative shock to the labour market will be quite severe.

In principal the same argument can be applied to Eastern Europe where the recent period of violent inflation may very well be the initial stages to a slump where wage deflation is the only possible way to correct in light of fixed exchange rate regimes. The greatest threat is that the slowdown becomes so severe that emigration intensifies further. This would have quite important consequences for these economies’ already distorted demographic profiles. One obvious question is the extent to which a prolonged period of wage and asset price deflation would be politically palatable. I would seriously doubt this and then we are back in the viper’s nest where the potential for an abrupt rupture of the Euro peg as well as a severe funding crisis à la Asia 1997.

As for Italy, it has long been my standing position that Italy, at some point, could tumble into a Japan like deflation trap. Whether it will happen during the turn of the current cycle is debatable, but the severity of the slowdown certainly suggests that the possibility is a real one. In passing, I would like to note that the issue of Spain and Italy (and quite possibly other economies in the Eurozone too) will not make life any easier at the ECB and in Bruxelles. The point here is simply that the ECB would not, under the current regime, be able to administer some local version of the Japan ZIRP in Italy and/or Spain. The consequences of this inability may unfortunately now become clear for everybody.

The main manifestation of the potential deflationary correction will be through wage deflation (especially in real terms) as well as a persistent gap between strong headline inflation and core prices. This is an undercurrent in the data I have been highlighting persistently in my analyses. The key point to latch on to is the inability of some economies to muster domestic demand which in turn will tend to have a deflationary effect; especially in the context of an incoming slowdown as we are seeing now.

Much Ado about Nothing?

If you have made it this far, you might ask with some legitimacy whether in fact I am not making much ado about nothing. After all, the means for correction here are pretty standard econ 1-0-1 type processes and deflation need not be an unwelcome thing as long as there is light at the end of the tunnel.

My main thesis however is that many of the economies which now face potential deflationary corrections do so principally because of their demographic profiles. If past experience is anything to go by this should raise more than a few eyebrows since we know how difficult it is to escape from deflation once you are caught in the web. This is the ultimate lesson to draw from Japan’s so-called lost decade. It was never exclusively about incompetent Japanese policy makers. Rather, the crucial question to ask is why Japan did not manage to muster sufficient domestic demand to recover and why Japan is now completely dependent on foreign demand and asset income to attain respectable [6] growth rates.

I believe that the answer to this question resides within the sphere of demographics and it is in this light I am worried that the global economy will see a number of economies join Japan (Germany already has I would argue) on the back of the current crisis.

If this turns out to be true it also highlights a number of crucial questions. The first is simply that if many hitherto net credit absorbers are now to become to net credit suppliers where is the extra global capacity going to come from? From my chair, it is as if everybody is talking about the need for the US to export its way out of trouble, but who the heck are going to take up the slack? Moreover, if I am right in the sense that many former deficit nations have suffered a structural break the re-shuffling of the global economy will not lead to a more balanced flow of funds, but rather the opposite. This would especially be the case if key emerging economies persist on maintaining an open life support to whatever is left of the Bretton Woods II system.
Another way to narrate this predicament would be to ask who will do the saving and, equally as important, who will provide yield for the accumulated stock of capital?

As for the first part of the question one is tempted to say everybody. External deficit nations will now have to work towards grinding down the debt and external surplus economies cannot, for the most part, do much but to cling on to the increasingly smaller batch of growing markets. I am still skeptical here that the unwinding of the Bretton Woods II à la traditionelle with China and Petroexporter et al. holds much promise to bring rebalancing. As for the part of the world actually able to act as buffers (e.g. India, Brazil, Turkey etc), they are clinging on with their nails, not only to prevent a rout on their capital markets as money pours out, but equally so in the context of actually absorbing the flows once the money start coming in again, because trust me, it will. The key point in terms of global capital flows is that the margins are simply getting smaller in terms of living off of one’s accumulated savings (assuming of course that you do not dissave) and that this will hurt economies in the old end of the demographic spectrum in particular.

In conclusion, one of the main forward looking macro themes I am watching at the moment is the potential for deflation. I would especially ascribe this risk to be high in economies in need of serious competitive and debt reducing corrections as well as in economies unable to muster sufficient domestic demand to stay above water when external demand falters. In my rudimentary analysis I use demographics as a yardstick and as such my claim is quite easily falsifiable. The only thing we need to do then is to watch and see what happens.

[1] My colleague Edward Hugh does just that, and I recommend you to go have a look.
[2] Even if it may turn negative y-o-y in 2008 on the back of the accelerated slowdown.
[3] Although most would agree that the US is now firmly in a recession based on the commotion in financial markets and the deterioration of the job market.
[4] The very aggressive expansion of central banks’ balance sheet and the de-facto ability of financial institutions to offload assets on to ”public” books will be an interesting case to gauge for economic policy makers and historians alike.
[5] Japan has obviously never actually escaped deflation.
[6] Respectable here can mean many things, but one simple derivative is the extent to which Japan need a certain degree of headline growth in order to keep on servicing its liabilities.

Thursday, October 09, 2008

The Italian Government Provides Support To Italy's Banks

Italy has committed itself to guarantee bank deposits and provide sufficient funds to stop any lender in the country from failing, according to a statement from Finance Minister Giulio Tremonti.

Italy's ``banking interventions will be on a case-by- case basis,'' according to the statement Tremonti made in the Italian parliament today. ``That's why we didn't give any numbers for the amount of possible interventions. We will do what is enough.''

The Italian government said on Wednesday night it would provide funds for the country's banks if necessary and the newspaper Il Sole-24 Ore said said the plan called for a 20 billion-euro ($27 billion) fund. At the present time we are all very short on details about what the plan will actually involve.

In general terms Italy is going to accept bank shares without voting rights in exchange for capital and act as a lender of last resort. The Bank of Italy will also ease rules on the collateral that lenders are required to deposit with them.

Tremonti stressed that any eventual aid would not jeopardize Italy's commitment to keeping its budget deficit below the European Union limit of 3 percent of gross domestic product. This is the part of the plan I do not understand, unless he is about to announce cuts in public spending of equal magnitude to compensate for the bank support. I think we need to be clear that these measures by governments accross the developed world are simply transfering private bank debt to public debt, so of course there will be public balance sheet implications. The original plan seems to suggest an increase of 1% to 1.5% in public spending, but if they really are intending to "do whatever is necessary" (remember domestic demand in Ukraine and Russia is sinking like a stone at the moment, Kazakhstan has had a "sudden stop", while the Baltics have just had a "hard landing", and these are all areas where Unicredit is quite exposed) then the quantities involved could grow rapidly, and we could move to a threat to Italy's banks to a threat to its sovereign debt in almost a blink of an eye when the dust settles here.

Berlusconi Hits Out At Unicredit

In a move which would seem to be to be at one and the same time ill advised and poorly-informed Italy's prime minister yesterday hit out at Italy's second bank by market capitalisation (and first by assets) Unicredit in the Italian parliament.

While insisting that the Italian banking system was solid and that the state would intervene if problems emerged, Silvio Berlusconi took the advantage of the opportunity offered and uggested that UniCredit had only been facing problems in recent days because of its lending pracices and resulting exposure to the German market.

“There is only one bank which had bought a German bank and that is UniCredit,” said Mr Berlusconi. “UniCredit was called by the Bank of Italy to recapitalise and cover the losses made by this German affiliate. The capital was found in the private market and the problem was solved.”

The Italian prime minister’s comments were seen as part of efforts to reassure Italians that any effects of the international financial crisis came from outside the country and not from the domestic financial sector.

UniCredit’s share price was battered last week by massive selling as investors felt its lack of capital and extensive European business would leave it vulnerable after banks such as Fortis and Dexia collapsed.

Meanwhile Italy's S&P/MIB Index dropped for the fifth consecutive day on Friday morning, losing 1,747, or 8 percent, to 20,124 and taking this week's decline to 22 percent, with Unicredit sinking 32 cents, or 12 percent, to 2.35 euros. Banking stocks dropped in Europe on concern the deepening credit crisis will spur the failure of more financial companies and create a recession. Intesa Sanpaolo SpA (ISP IM) and Banca Monte dei Paschi di Siena SpA (BMPS IM), Italy's other major banks, fell 11 percent to 2.72 euros, and 7.3 percent to 1.52 euros, respectively. Trading in the shares of Intesa Sanpaolo, which is Italy's biggest bank by market value, had been suspended yesterday following excessive declines in Milan trading.

The Milan-based bank lost 18 cents yesterday, or 5.4 percent, to reach 3.12 euros, before being suspended.

Also Italian Finance Minister Giulio Tremonti is reported by Corriere della Sera to be preparing a "Plan B" to give banks more liquidity and guarantee loans. It appears the Tremonti proposal would allow banks that are short of cash to buy guarantees from the government that would enable them to provide financing. According to CdS Tremonti discussed the measure with the Bank of Italy on Oct. 8, and the government is now waiting to see how the European Central Bank's new emergency funding mechanism for bank works before deciding whether to use the plan. As far as I can see this is simply tantamount to the Italian government stepping in and replacing the Credit Default Swap market, with the assumed risk that if the is a major systemic problem in the Italian banking sector, then it will be Italian public finances which suffer the meltdown like the one we have just seen in the US insurance company AIG.

Berlusconi's comments about Unicredit are irresponsible since they are directed to a domestic electorate and not to the international financial community who need reassurance on Unicredit, not verbal castigation of it, and they are ill-informed since while Unicredit does have exposure in Germany via HVB, this is not where the real action is going to be, since the lions share of the losses are likely to be in Eastern Europe, and in part via the Austrian (ie not the German) route, as touched on briefly here.

Industrial Output UP In August

In what amounts - at this point - to a rather trifling detail in all of this, ISTAT announced Friday morning that Italian Industrial production rose month on month in August at the fastest rate in a year - helped by a decline in oil prices and a weaker euro that buoyed exports. Output gained 1.4 percent from the previous month, from a revised decline of 0.5 percent in July, the national statistics office in Rome said today. However, if we look at the situation on a year on year basis (and corrected for working day effects), then output was down 5.3% over August 2007.

The month on month uptick trend seems to follow a European pattern, since the Italian advance mirrored a similar one in Germany - German production also rose in August, advancing the most in 15 years, while French output fell a less-than-expected 0.4 percent in the month from a revised 1.4 percent increase in July.

If we look at the seasonally adjusted monthly index however, we will see that despite the bounce-back, the level of output is still below that acheived in April, and indeed there were only two months between January 2006 and April 2007 when output was lower.

Even before the outbreak of the latest round of financial turmoil Italy's economy was in all probability in recession after contracting 0.3 percent in the second quarter. Confindustria expect the Italian economy to actually contract in 2008, while the Isae Institute yesterday cut its forecast for Italian growth, saying the economy would stagnate this year, putting in the worst performance since 2003. In the short term things can only deteriorate from this position as the shock from the financial sector hit the real economy.

Tuesday, October 07, 2008

Against All Adversity, Unicredit Struggles On

UniCredit SpA, Italy's second biggest bank, fell again in Milan trading this morning after analysts at banks including Citigroup Inc. and JPMorgan Chase & Co. cut their share-price estimates. The bank dropped 14 cents, or 4.8 percent, to 2.78 euros as of 12:52 p.m., after being suspended in earlier trading. Unicredit shares have now fallen 51 percent so far this year. Unicredit lead the charge down, and stock were off by as much as 5.2 percent at one point, although Italy's S&P/MIB Index reversed earlier losses to gain slightly by the close, adding 64, or 0.3 percent, to 23,840.

UniCredit Chief Executive Officer Alessandro Profumo recognised yesterday that the bank had underestimated the scale of the global financial crisis. The Milan-based company has cut its profit forecast and is being forced to raise 6.6 billion euros ($9 billion) in capital, days after saying there was no plan to issue new shares.

JPMorgan cut the price estimate to 4.07 euros from 5.2 euros, while Citigroup today lowered its target for UniCredit to 3.3 euros from 4.1 euros. Analysts at Deutsche Bank AG, Exane BNP Paribas, Keefe Bruyette & Woods, Banca Leonardo and Euromobiliare also reduced their estimates.

As I explained in my lengthier post yesterday, Unicredit shares have been under almost constant pressure over the last week, being down as much as 16 percent at one point in Milan trading yesterday, following a 3 day 24% fall last week.

The most recent share drop follows a capital boost of 6.6 billion euros decided on at an emergency board meeting held Sunday afternoon, where among the exceptional measures decided on to raise the cash was the idea of paying this years dividends to shareholders by giving them more company shares.

The "shares for dividends decision" forms part of a battery of measures which includes significant cost cuts and asset sales in order to try to guarantee that the core Tier I capital ratio, a measure of the banks' financial strength, rises to 6.7 percent by the end of the year, from 5.7 percent now. A core Tier I of 6 percent or higher is generally considered an adequate minimum for banks, while anything below it starts to raise eyebrows.

Among other relevant details in the present drama it is important to grasp that UniCredit is owner of Germany's HVB Group, since one of the issues arising from the first (failed) Hypo bail-out attempt was whether or not UniCredit would be asked to contribute funds, a development which could have negative consequences for Unicredit's capital position. Hypo Real Estate was in fact spun off from the Unicredit owned HVB Group in 2003.

But Unicredit is also exposed due to the extent of its lending in Eastern Europe - which is estimated to amount to one quarter of the banks total lending operations. Unicredit is deeply involved right across Eastern Europe via its ownership ofthe HVB group, as well as via it's ownership of Bank Austria Creditanstalt. Among other issues Unicredit is evidently exposed in the Baltics, given the fact that as of September 1, 2007 ASUniCredit Bank Estonian took over the business of HVB Bank Tallinn. But the extent of Unicredit East European lending is much more extensive than this, and with property markets in one EU10 country after another now likely to "correct" the problem is about to become considerably larger than simply the German Hypo Real Estate one. Unicredit made direct acquisitions in 2007 in Kazakhstan and Ukraine, while extending its position in the Russian banking sector. The first of these counries had a financial "sudden stop" in September 2007, while the latter two are in the process of a major domestic credit "unravelling.

Fitch Ratings last Thursday downgraded the Outlook on UniCredit to Negative from Positive. At the same time Fitch changed the Outlook on Unicredit's main subsidiaries - Germany-based Bayerische Hypo- und Vereinsbank AG (HVB) and Austria-based Bank Austria Creditanstalt AG - to Negative from Positive. Fitch stressed as reasons for the downgrade the poor macroeconomic outlook in Italy and Germany and in particular the less benign outlook for some central and eastern European markets. Fitch also regards UC's current capitalisation (end-H108 Basel 1 core Tier 1 ratio of 5.55%) as tight in relation to its risks especially given thatconditions in the wholesale funding market remain "extremely challenging".

Monday, October 06, 2008

As Europe's Banks Falter, Is There A Risk To The Eurozone?

by Edward Hugh: Barcelona

“We do not have a federal budget, so the idea that we could do the same as what is done on the other side of the Atlantic doesn’t fit with the political structure of Europe,”
Jean-Claude Trichet, commenting last week on the Eupean "summit" in Paris last Saturday

``If you concentrate on California or Florida, it is not at all like Massachusetts or Alaska......It is the same in our case and we have to make a judgment what is good for the full body of the 320 million people'' in the euro area."
Jean Claude Trichet in an interview with Ireland's RTE radio last July, following the controversial decision to raise ECB interest rates to 4.25%

"Europe gives up on a joint rescue plan against the crisis," since the EU "lacks the necessary institutions to respond as the United States has done".
Spain's El Pais yesterday (Sunday 5 October)

For Europe, this is more than just a banking crisis. Unlike in the US, it could develop into a monetary regime crisis. A systemic banking crisis is one of those few conceivable shocks with the potential to destroy Europe’s monetary union. The enthusiasm for creating a single currency was unfortunately never matched by an equal enthusiasm to provide the correspondingly effective institutions to handle financial crises. Most of the time, it does not matter. But it matters now. For that reason alone, the case for a European rescue plan is overwhelming.
Wolfgang Munchau, The Financial Times, Monday 6 October 2008

The euro experienced its biggest one-day drop against the yen in seven years this morning as the deepening credit crisis prompted European governments to pledge bailouts for troubled banks while stopping short of giving any concrete programme of coordinated action. The 15-nation currency declined to a 14-month low against the dollar - hitting $1.3598 at 8:52 a.m. in London - and to its weakest in two years versus the yen after European leaders meeting this weekend avoided announcing any plan that would be equivalent to the U.S.'s $700 billion bailout. And the reason for the euro's fall is clear, the ability of the eurozone countries to apply a concerted startegy to address the problems in the banking and financial system has been called into question, and nowhere is the huge gap between the currency's ambition and its political architecture so evident as it is in the above two quotes from Jean Claude Trichet. When push comes to shove, the US Treasury, as we have seen last week, does not concentrate on the needs of Florida or Massachusetts, but on those of the entire United States, and who, may we ask is in a position to concentrate at this point on the financing needs of the whole 15 member eurozone-area, since trying to manage economies which are one organic whole by splitting them analytically into monetary and fiscal entitites simply isn't going to work, and it never was. Let me expain.

Sunday, October 05, 2008

Italy's Real Economy Trembles Under The Impact Of The Financial Tempest

The condition of Italy's economy continues to deteriorate by the month. Output is down, domestic demand is down, exports are struggling, and unemployment is up. The tumultuous events of late August and early September in the global financial markets are now evidently making their presence steadily felt on the real economy. And new factor emerged in recent days, with the global banking and financial crisis arriving right on Italys doorstep, via the delicate position of the second bank - Unicredit - who saw their shares drop around 25 percent in three hectic days last week, due to concerns about their capital gearing, and their ability to meet their liquidity commitments due to their exposure to the mortgage securities market, especially via their German subsidiary HBV and their involvement in Eastern Euope (which accounts for no less than one quarter of Unicredit business) where conditions, according to global ratings agency Firtch (who downgarded Unicredit outlook rating only last week) are now far from benign. With no effective remedy whatsoever being offered from Euope's core leaders, the worst is, most definitely, still to come. The Unicredit problem now casts a long dark and awesome shadow over Italy's future, since the Italian state - which is already in debt to the tune of over 103% of GDP, is in no position to follow the example of its Irish counterpart and guarantee bank deposits, since should the worst come to the worst, and the state have to assume responsibility for the bank debts, the net consequence would more than likely be simply a shifting of the financial meltdown from the banking sector to Italian sovereign debt.

September Global Manufacturing PMI Shows Sharp Contraction

Italy's manufacturing sector shrank at its fastest pace in at least 7 years in September as output, new orders and employment all fell at a record rate, according to the Markit Economics Purchasing Managers Index out last Wednesday. This result is hardly surprising, since September seems to have been the ultimate "mensis horribilis" for industrial output internationally, with global manufacturing activity contracting for the fourth consecutive month, and output falling to its weakest level in over seven years according to the JP Morgan Global Manufacturing PMI, which at 44.2 hit its strongest rate of contraction since November 2001, down from 48.6 in August (Please see the end of this post for some information about countries included and the JP Morgan methodology).

According to the JP Morgan report the retrenchment of the manufacturing sector mainly reflected marked deteriorations in the trends for production, new orders and employment. The declines in output and new work received were the second most severe in the survey history, while staffing levels fell at the fastest pace for over six-and-a-half years. The Global Manufacturing Output Index registered 42.7 in September, well below the 48.5 posted for August.

The sharpest decline in production was recorded for Spain, followed by the US, Japan and then the UK. Although the Eurozone Output Index sank to its second-lowest reading in the survey history, it was above the global average for the first time in four months. Within the euro area, France and Spain saw output fall at survey record rates, while in Italy and Ireland the contractions were the second and third most marked in their respective series. Germany, which until recently was the main growth engine of the Eurozone, saw production fall for the second month running and to the greatest extent for six years. Manufacturing activity in Japan fell to the lowest in over 6- years with the Nomura/JMMA Japan Purchasing Managers Index declining to a seasonally adjusted 44.3 in September from 46.9 in August.

At 40.8 in September, the Global Manufacturing New Orders Index posted a reading well below the neutral 50.0 mark. JP Morgan noted that the trends in new work received were especially weak in Spain, the UK, France and the US, with the all bar the latter seeing new orders fall at a series record pace (for the US it was the strongest drop since January 2001). The downturn of the sector led to further job losses in September, with the rate of reduction in employment the fastest since February 2002. Conditions in the Spanish, the UK and the US manufacturing labour markets were especially weak.

So basically this is where we get to learn what a global credit crunch means in terms of output and economic growth.

Most Rapid Manufacturing Contraction Since Post 09/11

In fact Italy's manufacturing sector contracted in September at its sharpest rate since the immediate aftermath of the Sept. 11 attacks in the United States, according to the Markit/ADACI. The Markit Purchasing Managers Index fell to 44.4 from August's 47.1.

"Falling domestic and foreign demand were cited as the primary factors that
resulted in a sixth successive decline in manufacturing output during
September," Markit said in its PMI report.

The PMI data simply serve to underline the challenge facing Italy, and illustrate at least one of the reasons why the government has just revised down its 2008 growth forecast to 0.1 from a previous 0.5 . Many economists (myself included) actually fear that Italy's economy may well shrink this year. This view is also taken by the employers organisation Confindustria, who forecast a whole year contraction of 0.1%.

Manufacturing output, like the overall PMI index, hit its lowest point since October 2001 and the new orders sub-index, which had rebounded slightly in August, fell back almost to July's seven-year low.

Even before the global financial crisis intensified at the end of August, Italy's ISAE business confidence survey has been showing declining morale in Italy's business sector, with confidence also falling to its lowest level since October 2001.

Services PMI Continues To Deline, But The Rate Of Contraction Eases Slightly

Italy's service sector contracted for the tenth consecutive month in September, though the pace of contraction was slightly slower than in the previous four months. The Markit Economics Purchasing Managers' Index for services (out last Thursday), and which covers activities from hotels to insurance brokers, rose to 49.4 from August's 48.5, its highest level since April but still below the 50 mark which divides growth from contraction.

Activity and new orders fell, though at a slower rate than in recent months, while employment rose slightly for the first time since June. Business expectations fell from August's level and remained "historically low", the Markit/Adaci report said.

Service providers reported input price inflation accelerating while weak demand left minimal scope for them to raise their charges, keeping a tight squeeze on margins.

JP Morgan Global Manufacturing PMI Methodology

The Global Report on Manufacturing is compiled by Markit Economics based on the results of surveys covering over 7,500 purchasing executives in 26 countries. Together these countries account for an estimated 83% of global manufacturing output. Questions are asked about real events and are not opinion based. Data are presented in the form of diffusion indices, where an index reading above 50.0 indicates an increase in the variable since the previous month and below 50.0 a decrease.

The countries included are listed below by size of global GDP share, and the figures in brackets are the % og global GDP in each case (World Bank Data).

United States (30.5), Eurozone (18.7), Japan (13.9), Germany (5.6), China (4.9),United Kingdom (4.5), France (4.0), Italy (3.2), Spain(1.9), Brazil (1.9),India (1.7), Australia (1.3), Netherlands (1.1), Russia (0.9), Switzerland (0.7), Turkey (0.7), Austria (0.6), Poland (0.5), Denmark (0.5), South Africa (0.4), Greece (0.4), Israel (0.3), Ireland (0.3), Singapore (0.3), Czech Republic (0.2), New Zealand (0.2), Hungary 0.2.