Show me the money

May 3, 2009 — Mitul Kotecha

The long awaited results of the US administration’s stress tests for US bank will be announced on May 7th. There have been various rumours and speculation about the details in terms of the extent that banks will require further capital injections and indeed which banks will need such injections. Ahead of the announcement I thought it would be an interesting exercise to look at the potential equity needed in the global financial sector.

Some light on this was shed by the IMF’s recent release of the Global Financial Stability Report in which the fund increased its total estimates of global writedowns to over $4 trillion. The most recent estimates of financial sector writdowns suggest that institutions are only about one-third of the way there.

In other words there is still a considerable amount of writedowns on toxic debt left to be undertaken. The IMF estimated further writedowns in the US in 2009 and 2010 at $550 billion, $750 billion in the eurozone and $200 billion in the UK.

Moreover, they estimate that financial institutions will require $500 billion of additional capital in the US, $725 billion in the eurozone and $250 billion in the UK just to raise the ratio of common equity to total assets (a measure of leverage) to 6%. Even these estimates may prove conservative. After all, the IMF has raised its estimates of total writedowns several times already and will likely do so again. These figures do not even include the need for other financing which when added amounts to around 60% of Bank’s total assets.

The bottom line is that even with all the money that is being provided to financial institutions at present it will be highly unlikely that they will be able to raise sufficient capital if the IMF’s estimates are anything to go by. Consequently balance sheets will contract sharply and deleveraging will continue.  Governments will be forced to provide support for a long time to come and the end result will be either outright nationalisation or alternatively bankruptcy for some institutions that are deemed not too big to fail.  Worryingly the risks are skewed on the downside, especially if the economic recovery is a weak one which I believe is highly likely to be the case.

Posted in bank rescue, Economics, equity markets, Europe, Financial crisis, UK, US, US administration. Tags: , , , , , , . Leave a Comment »

A taxing time in the UK

April 25, 2009 — Mitul Kotecha

It has been a truly gloomy week for the UK economy.    Firstly there was the shock budget announced by UK Chancellor Darling in which the scale of UK borrowing requirements became worryingly clear.  To summarise briefly the government expects tax revenue to come in at around £175 billion or a whopping 12.4% below public spending in this fiscal year.   What’s more the bulk of this is structural or persistent so will not be erased without adding another layer of taxes. 

It will take several years to reduce the budget gap according to the budget estimates, with the government predicting that the deficit as a percent of national income will drop to 1.2% by 2017-18 but this relies on highly ambitious forecasts.  The scale of government borrowing required and the reliance on government bonds to bridge the gap is worrying enough and has caught the attention of ratings agencies.   It also effectively rules out further stimulus should the economy turn even more sour than expected or if anticipated recovery does not take effect.    

The bigger problem is that the deficit reduction plans bank on highly optimistic and probably downright unrealistic growth growth forecasts.    This was demonstrated by data released shortly after the budget announcement revealing that the economy shrank by a much bigger than expected 1.9% in the first quarter of this year,  the worst growth outurn since the third quarter of 1979.    So much for hopes that the worst was over at the end of last year.   Although the government has said that this does not alter their budget forecasts, as they are based on growth for future months, it does reveal that they vastly underestimated the depth of the recession in the UK.  

Even the forecasts for economic growth in the next few years look highly ambitious with the pace of contraction forecast to ease over coming quarters and stabilise by year end.   Further out, if growth does not pick up as forecast there is a real risk that not only will tax rates not be reduced for several years but that the UK taxpayer is destined for even higher taxes for years to come.     

There has much press on the increase in the high rate of income tax from 40% to 50% but the reality is that this will only bring in a small amount of revenue and will do little to close the gap between spending and tax revenues.   It will require a substantial easing in spending for the government’s plans to have any validity.  It appears that the aftermath of the bursting of the debt fueled consumer spending bubble is still being felt and will continue to do so for years to come, much to the expense of the taxpayer.

Posted in Bond markets, Economics, Financial crisis, UK. Tags: , , . 1 Comment »

Q1 earnings in focus

April 10, 2009 — Mitul Kotecha

Equity markets have continued their ascent albeit with continuing volatility around the Q1 earnings season. Other indicators of market stress have also improved whilst bond yields haved edged higher. Next week will test the markets optimism with a plethora of banks set to release their results for the past quarter. Wells Fargo provided a boost to financials today with its earnings report. Banks will benefit from the changes to mark to market accounting regulations allowing banks more flexibility in valuing their dodgy assets. Although I am somewhat concerned about the political push for the change in these accounting rules it will no doubt ease some of the pressure on banks and their estimates of writedowns.

Meanwhile the economic news continues to be less negative as the bigger than expected narrowing in the US trade deficit reveals. This adds to the run of better than expected numbers over recent weeks that is perhaps showing that the pace of economic deterioration globally is easing. The economic news has also contributed to the better tone to equities and improvement in risk appetite.

Action to prevent the economic and financial crisis from deepening is also creating a floor under markets. The Bank of England left interest rates unchanged but maintained its commitment to conduct asset purchases having done around 1/3 of the planned GBP 75 billion so far, with the remainder to be undertaken over the next couple of months. Elsewhere Japan will provide further fiscal stimulus to boost its flagging economy although the unstable political situation could yet derail such plans. Nonetheless, the picture is clear as policy makers continue their battle to boost sentiment and thaw credit markets.

If markets can get through Q1 earnings without a major set back there maybe hope that the rally really has got legs. I still think there is a whiff of a bear market rally going on but I would happy to be proved wrong.

Posted in Bond markets, central banks, Currencies, Economics, equity markets, Financial crisis, UK, US. Tags: , , , , , , . 1 Comment »

More delay from the ECB

April 3, 2009 — Mitul Kotecha

Once again the European Central Bank (ECB) left markets hanging following its decision to cut interest rates by less than the market expected. Unlike the Bank of England which has been quick and aggressive in cutting interest rates and adopting unconventional policy the ECB has lagged behind due in large part to the difficulty in forging a consensus with so many council members involved in the decision making progress.

The ECB put off a decision to introduce new unconventional monetary policy tools until the May meeting due to the opposing views of various council members which in the end resulted in an unstable compromise. Although ECB President Trichet kept the door open to further easing the room is now limited, with another cut to 1% possible at the May meeting.

This will be less important and less influential on the economy compared to potential new measures that could include purchasing more commercial paper and corporate debt, widening the pool of collateral accepted in market operations and increasing the maturity of loans to banks. Buying government debt still seems unlikely given the technical problems in doing so.

The euro rallied against the US dollar following the ECB’s decision due to the fact that European interest rates remain relatively high compared to the US but a stronger euro will not come as good news for Eurozone exporters who are struggling in the face of a collapse in global demand.

The ECB may have put off the decision to another day but it will not be able to escape forever. The May meeting will be crucial to determine just how quickly Europe’s economy will recover. At the moment the lack of strong action suggests a delay in recovery compared to the US.

Posted in central banks, Currencies, Economics, Europe, UK. Tags: , , . Leave a Comment »

Tough week ahead

March 30, 2009 — Mitul Kotecha

It looked as though it all went wrong today as the bad news just kept on coming. Following reports on Friday that JP Morgan and BoA had a more difficult month in March following a stronger start to the year, reports that UBS would be shedding thousands of staff and would announce billions more in writedowns as well as news of the takeover of a Spanish regional bank by the Bank of Spain hit market sentiment hard. Topping all of this were comments by the US administration that some banks would need more capital in addition to that already provided. The administration also said that bankruptcy may be the best option GM and Chrysler.

This sets up a difficult week ahead, with risk aversion set to rise further and the news unlikely to get any better. Economic news is likely to add to the market’s gloom as US releases such as the ISM manufacturing survey for March and the jobs report will likely reveal further deterioration. Expectations for another hefty drop in payrolls in March could see a total of over 5 million jobs lost so far in the current cycle with many more to go.

The news in Europe will not be much better and as today’s Eurozone sentiment indicators have shown the outlook for the economy remains gloomy. The ECB is likely to cut interest rates but will refrain from embarking on the quantitative easing policies followed by other central banks such as the Fed or BoE. As risk aversion rises the USD is set to continue to strengthen against most currencies this week.

Posted in bank rescue, central banks, Currencies, Economics, equity markets, Europe, Financial crisis, UK, US, US administration. Tags: , , . 6 Comments »
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