WISE MONEY

Back in July, 91 of Europe’s largest banks were required to disclose how much government liability from European countries they held on their balance sheets. Euro regulators said the data showed banks’ total holdings of that debt as of March 31st. At the time, worries about the Banks’ government-debt holdings were fanning fears about the health of Europe’s banking system as a whole.

Release of the bank data was considered the main benefit of the stress tests, which were widely criticized as being lenient overall, but taken as showing that the exposures were not as widespread and extreme as had been feared.

According to an article in today’s Wall Street Journal, “An examination of the banks’ disclosures indicates that some banks didn’t provide as comprehensive a picture of their government-debt holdings as regulators claimed.

Some banks excluded certain bonds, and many reduced the sums to account for “short” positions they held—facts that neither regulators nor most banks disclosed when the test results were published in late July”.

Asian markets, starved of news or data input following the US/Canadian Bank Holiday, seized upon this article and dumped the Euro – especially versus the Yen – on fears that eurozone governments and institutions would accordingly find it difficult to raise new and renew maturing funding with doubts returning over the health of the region’s finance.

The Yen was the favoured recipient on the lack of mention of the strength of the currency in the statement from the Bank of Japan which followed their decision to leave Japanese rates and QE levels on hold.

The Central Bank now seems more confident of strong domestic growth, and the expectation is that lower unemployment and increasing inflationary pressures will prompt the Bank to resume a hike in official rates later this year.

Also this morning, Australia’s Labour Prime Minister, Julia Gillard, finally secured the support of two key Independent MPs which enable her to form a working Government with a majority of 2 over the opposition party.

An unexpected boost in German IFO business sentiment gave the Euro a lift yesterday. The data showed sentiment at a three year high, hitting 106.7 versus a forecast level of 105.5 and reaffirming the positive data flow from Germany over the past month.

However, Irish woes continued with Standard & Poor’s, the ratings agency, downgrading their debt to AA- with a negative outlook.

The huge cost of supporting the Irish banking system will push debt towards 113 per cent of GDP according the S&P estimates, well above the Eurozone average putting increasing demands on the Celtic tiger’s public finances and creating serious headwinds for economic growth.

Irish ministers were understandably furious, but the fear is the austerity measures designed to reduce the government budget deficit may make the job harder because of increasing unemployment and depressing tax revenues.

This fear, applicable to the other indebted Eurozone nations, is once again hanging over the Euro and is allowing Sterling and the Dollar to regain lost ground against it.

Reports today suggest FX analysts are the most pessimistic on the Pound since May 2009, predicting the Chancellor’s cuts will eat into economic growth, the already soft economic recovery is forecast to slow causing Sterling to fall back against both the Dollar and Euro. Median estimates suggest the Pound will drop 8 per cent against the Euro by year end as the recent bullish UK data starts to deteriorate.

The US Dollar rose sharply on Friday against the Euro, Sterling, Aussie and Canadian dollar on the back of risk aversion, while safe haven currencies such as CHF and JPY strengthened against the dollar.

The Fed is perceived by the markets to be in a holding pattern until further directional economic data is released. Weakness in global equities carried through to European markets sending major indices lower while US stocks are lower as the sell off continued.

The Euro fell against a basket of currencies on Friday and remains on the defensive this morning as comments by a senior ECB official fuelled expectations for liquidity to remain a concern for the single currency.

ECB Governing Council member Axel Weber told Bloomberg in an interview published on Friday it would be “wise” to extend unlimited liquidity to banks past the end of 2010. The Euro was further hit after the US Federal Reserve said the US and global economic recovery was losing steam, striking a nerve with investors.

The euro zone is seeing an increasing split not only in banking but in the economy in general. While the euro zone economy improved in the second quarter with Germany setting the tone, southern Europe recorded much more muted growth.

Market analysts believe the ECB may have little option but to keep flooding the money market with cash to help banks and governments in the EU.

In contrast to the UK inflation figures falling yesterday eurozone inflation yesterday hit a 20 month high eu data has shown.
Annual inflation in the 16-nation bloc rose to 1.7% in July, up from 1.4% in June and the highest rate since November 2008, Eurostat said.

The figure was boosted by more expensive fuel costs for transport, and higher alcohol and tobacco prices.

Across all 27 nations in the European Union, prices were up 2.1% in July, compared with a rise of 1.9% in June.

Some countries – Finland, Greece, Spain, Portugal and Romania – raised their rates of VAT in July, which also helped to push prices higher.

On a month-on-month basis, prices in the eurozone fell 0.3% in July, and in the wider EU fell 0.2%.

China is now officially the second largest economy in the world, after the US.The Japanese GDP data out overnight reflected that China has moved into the lead and a number of economists are forecasting that China will take over as Number One by 2027.

Friday was a busy day on the economic data front. First up, we saw figures released showing that the Eurozone economy expanded in the second quarter at the fastest pace in nearly four-years.

The eurozone’s seasonally adjusted preliminary second quarter GDP showed an expansion of 1.0%, compared with the previous 0.2% and the expected 0.7%. The biggest jump in the figures came from Germany’s GDP, with a preliminary reading of Q2 GDP showing extremely robust 2.2% q/q growth, well above expectations of 1.3%.

This was the fastest pace of growth in nearly 20 years since German reunification. Global demand and a weaker Euro helped boost exports during the period, sustaining growth in the area.

Whilst the UK can take comfort from the fact that they can control their own currency, there are still issues. House prices in the UK have taken a bit of a knock for the month of July according to figures posted by Rightmove, the property website.

The figures reflect that people wanting to sell their homes are having to cut prices faster than at any time this year following a flood of properties hitting the market. On a national basis house prices have come in by 1.7% from July to August.

Following the Bank of England cutting its growth forecast on Wednesday and raising its estimate of inflation this housing data has not helped the continued fear around the risk of a double dip recession.

Sterling has just received a welcome boost after the release of positive retail sales figures.Data showed a 0.7% increase month-on-month & 1.3% yoy, the highest monthly figure since April 2008.

The ONS suggested the World Cup boosted consumption of electrical goods, which after England’s performance should see a double whammy when people look to replace the TV’s thrown out of the window after the Germany game.

Bank of England minutes released showed a 7-1 vote in favour on keeping interest rates on hold, with Andrew Sentence, the only dissenter, voting for a rate rise. More interestingly, the minutes showed discussion of an extension to the asset purchase scheme if, as expected, the economic outlook continued to deteriorate.

Sterling continues its recent volatility in light of the comments & also rumour circulating yesterday that the bank has reopened dollar swap lines and low liquidity in the market exaggerates moves.

The Euro continues to tread water ahead of the Stress test results. There is increasing uncertainty around the release of the results, the planned announcement is today at 4.30pm.

Strange that an exercise in reducing uncertainty and restoring credibility is actually having the opposite effect, and that is feeding though to the Euro which now trades lower against both Sterling and the Dollar.

The perceived safe haven of the Swiss Franc has also hit the headlines as the SNB announced a huge FX loss following large bouts of currency intervention earlier in the year. The continuing strength of the Swissy will be a real headache for the central bank as it fights to remain out of a potential deflationary spiral brewing in the Eurozone.

This week is all about the euro and the approaching stress test results which will offer much needed feedback on the health of European banks.
The euro has experienced a significant turn of fortune from its June 4 and half low against the USD gaining over 10 cents to test the 1.30 level.

One reason that the euro has gained is simply that the market was significantly over short in the euro and naturally a lot of these short investors paired their positions leading to a short squeeze higher.

In addition some comfort has come back into the euro approaching Fridays stress test results as comments in the run up from members of the IMF and the ECB have been bullish – we will see!

Recent gains have led to EUR/USD testing the 1.30 level and GBP/EUR falling back into 1.17 territory. The results are due out from 5pm GMT on Friday- good feedback should push EUR/USD over 1.30.

An unnamed bank or banks had lent 380 tonnes of gold to the Bank of International Settlements in return for foreign currencies causing widespread surprise and confusion.
The news that a mystery bank has just pawned the family jewels gave traders a jolt – nervous about the sudden transfer of almost 20pc of the world’s annual gold production and the possibility of a sell-off.

In a tiny footnote in its annual report, the BIS disclosed its unusually large holding of gold, compared with none the year before. The disclosure was a large factor in the correction of the gold price this week, which fell below $1,200 for the first time in more than a month.

Concerns hinged on whether the BIS could potentially sell on this vast cache of bullion in the event of a default, flooding the market with liquidity.

It appears to have raised $14bn for whoever’s been doing the swapping – small fry on the currency markets, but serious liquidity in the gold market.

Denominated in euros, gold has fallen 8pc since the beginning of the month and is now trading at a seven-week low of €937 per troy ounce.

The big gold exchange traded funds (ETFs) – having peaked at record inflows in May – have also been showing net outflows over the past few days.

Meanwhile, economists and gold market-watchers were determined to hunt down which bank is short of cash – curious about who is using their stash of precious metal for what looks suspiciously like a secret bailout.

At first it looked like the BIS was swapping gold with a troubled central bank. After all, the institution is the central bankers’ bank and its purpose to conduct transactions with national monetary authorities.

Central banks in the troubled southern zone of Europe were considered the most likely perpetrators.

According to the World Gold Council, central banks in Greece, Spain and Portugal held 112.2, 281.6 and 382.5 tons of gold respectively in June – leading analysts to point fingers at Portugal, or a combination of the three.

The only other potential monetary authorities with enough gold as the US, China, Switzerland, Japan, Russia, India and Taiwan – and the International Monetary Fund.

This led to musings that the counterparty was the IMF, making sense because the lender of last resort is historically prone to cash shortages and has been quietly selling off gold in the first half of the year.

Renowned gold expert Jim Sinclair adopted this explanation. The panic came when people mistook a lease for a swap, he argues. Far from being a big release of gold into the market, it is simply a commercial arrangement between the IMF and BIS with a favourable rate of interest paid for the foreign currency.

“Gold swaps are usually undertaken by monetary authorities,” he writes on his industry blog, JSMineSet. “The gold is exchanged for foreign exchange deposits with an agreement that the transaction be unwound at a future time at an agreed price.

“The IMF will pay interest on the foreign exchange received. Historically swaps occur when entities like the IMF have a need for foreign exchange, but do not wish to sell the gold. In this case, gold is a leveraging device for needed currency to meet requirements.

“The many reports that characterise the large IMF gold swap as a sale of gold into the markets do not understand the difference between a swap and a lease.”

However, the day after original reports about the swaps, BIS emailed a statement saying that the swaps had not been conducted with monetary authorities but purely with commercial banks.

This did nothing to quell the sense of mystery surrounding the deal or deals. It is almost inconceivable that a single commercial bank could have accumulated so much gold alone. And cynics have suggested that the whole affair still looks like a secretive European bailout that a single country wants to keep quiet.

In this case, one or more of the so-called bullion banks – which act as wholesale market-makers and include Goldman Sachs, Deutsche Bank, JP Morgan, HSBC, Barclays, UBS, Societe Generale, Mitsui and the Bank of Nova Scotia – would have agreed to act on behalf of a monetary authority.

The Bank of England has kept UK interest rates on hold at a record low of 0.5% for the 16th consecutive month and the European Central Bank (ECB) has held eurozone interest rates at a record low of 1% for the 14th month running.
The banks have kept rates low to try and stimulate the economies following the global economic downturn.

Many analysts argue rates need to stay low as governments are cutting back on spending- which undermines growth.

The Bank of England’s Monetary Policy Committee (MPC) also decided not to inject any more money into the economy under its policy of quantitative easing (QE).

The decision had been expected but calls have been growing for an increase in rates to curb inflation.

The National Institute of Economic and Social Research (Niesr) estimated that the economy grew by 0.7% in the three months to the end of June, marking a slowdown from the 0.9% expansion seen in the three months to May.

The minutes of July’s meeting, which will reveal how MPC members voted, will be released in two weeks’ time.

Explaining the ECB’s decision to keep rates on hold, president Jean-Claude Trichet said the eurozone’s economic recovery continued in the first half of the year, adding “we expect the area’s economy to grow at a moderate and still uneven pace, in an environment of high uncertainty”.

The eurozone economy has been in the international spotlight in recent months, with concerns about high government debt levels hitting global stock markets and threatening to derail the economic recovery.

In recent weeks, attention has turned to bank debt, with investors eagerly awaiting the results of stress tests designed to see how well equipped banks are to cope with future financial crises.

Mr Trichet said the tests should “build confidence” in markets as investors learnt how exposed banks were to bad debt. Transparency, he said, would be beneficial.

The results of these tests are due to be published on 23 July.

EU banks have borrowed less than expected from the European Central Bank, easing concerns about liquidity among european financial institutions.
After Tuesday’s sharp falls, stock markets and the euro stabilised on news that the ECB had agreed three month loans worth 131.9bn euros (£108bn). This compared with the 150bn to 200bn euros many had expected.

The euro rose almost a cent against the pound, while European stock markets also made gains. However, eurozone banks are still on welfare support

Banking shares had been under pressure after the European Central Bank confirmed it would be stopping a special 12-month loan facility for euro-zone lenders from yesterday.

Investors were concerned that European banks could face funding problems as a result.

Also this week, the EU has said it is to treble the number of banks that will be subject to public stress tests, as it tries to allay a growing global anxiety over Europe’s finance sector.

The tests are designed to examine how certain banks would perform if there were a repeat of the financial crisis.

The plight of Greece, combined with worries about nations such as Spain and Portugal, means that for the first time the tests would also examine whether institutions could cope in the event of a sovereign-debt default in the eurozone.

The number of those forced to take part in the exercise would expand from the 22 big banks examined last year to include a further 60 to 120 banks, meaning that many not included in last year’s stress-tests will now feature.

They include, for the first time, banks such as German Landesbanken, which are not among the biggest institutions but whose potential weaknesses have contributed to uncertainty in financial markets.

The tests are due to be completed by mid July, with results to be issued on a bank by bank basis.