12 May 2011.

One of the positives of raising interest rates is that they attract foreign capital. On the surface, this makes complete sense. If U.S. rates are near zero and the European Central Bank raises its main rate to 1.25%, the current level, then anyone with a few functioning brain cells can see there is more cash to be had on European money markets than in America.

12 May 2011.

One of the positives of raising interest rates is that they attract foreign capital. On the surface, this makes complete sense. If U.S. rates are near zero and the European Central Bank raises its main rate to 1.25%, the current level, then anyone with a few functioning brain cells can see there is more cash to be had on European money markets than in America.

In fact, after hinting at more rate hikes to come, European central banking brainiacs might have even hoped for a rise in foreign investment as a pleasant side effect of increased lending costs. That may never happen.

As expected, the ECB held pat on rates last week, but President Jean-Claude Trichet sucker punched salivating investors when he failed to utter the hawkish code phrase “strongly vigilant” about eurozone inflation, thereby deflating hopes for another increase next month. Those who held the euro voted against Trichet’s dovishness with an avalanche of sell orders: The single currency shed some four cents following the rate indecision, a sobering two percent change in sentiment.

So, the ECB has checked fire for the moment, an understandable stance considering its own economic house is ablaze. With Greece imploding – ratings agencies have yet again lowered their grades for the Hellenic republic’s creditworthiness – a hike would make monetary policy makers look callous and could nudge troubled economies in the wrong direction. The edge of Europe still suffers low growth and high deficit spending, and while that’s not going away anytime soon, eurozone inflation ballooned to 2.8 percent in April, well past the ECB’s price stability line in the sand of 2 percent. This raises fears that growth economies like Germany could overheat on a continent flush with cheap cash, at least for those not in danger of defaulting.

The specter of rising consumer prices means the ECB will eventually be forced to resume its rate increases, but foreign investors who want to take advantage of more expensive money may be better off steering clear of anything priced in euros and the currency itself.

Economists at French Bank Crédit Agricole have presented an interesting scenario that should scare away foreign investment despite expected ECB tightening. Focusing on Spain, the number crunchers set out to present an argument that a series of interest rate hikes through 2012 would have limited damage on countries on the periphery partly due to a possible unwillingness of banks to immediately pass on the increased cost of money. The report suggests that the weak economies on the edge of Europe will in fact be stronger at the end of next year than they are now.

This sounds like good news for a world currently fearing a debt crisis in Europe, but what stands out in the report is the predictions the economists used for their models. The Crédit Agricole scenario plots a total ECB interest rate increase of 150 basis points by the end of next year, which would raise the ECB’s main rate to 2.50 percent. With the main U.S. interest rate near naught and the FED giving little indication it will tighten its monetary policy, normally investors would be dropping dollars and other currencies out of planes over the Continent’s posh banking quarters to take advantage of the premium lending rates.

This would be a no-brainer if it were not for the second half of the scenario, which makes investing dollars in Europe akin to dumping them in a shredder. The economists also factored in a fall in the euro/dollar exchange rate to 1.18. Currently, a euro gets you about $1.43, so they are predicting a decline – no, a crash – of nearly 18 percent in less than two years. The report was from last month, when the economist were already forecasting an  “8-10 percent depreciation of the euro in nominal effective terms,” with expectations of a 5 percent decline by the end of this year.

Talk about the “wow” factor.  If the Crédit Agricole prevision holds true, then foreign investors, at least those with dollars, who want to piggyback the higher cost of eurozone credit will be taking a beating when they convert their assets back into greenbacks.

A currency decline at a time of rising interest rates smacks of counterintuitiveness, but that doesn’t mean it can’t happen, especially if investors believe a central bank is debasing its own money. Like, let’s say, by buying Greek and Portuguese bonds that may not be worth anything when they mature.

Eric Culp

EconomyWatch.com

The post Higher Eurozone Interest Rates May Be a Foreign Investment Trap appeared first on Economy Watch.

4 May 2011.

By clicking on this story, you may be a speculator if you thought this information might add value to your knowledge base, or your bank account. The only risk is your time.

Oil and other market speculators basically act in the same way, except they are willing to take monetary chances in exchange for higher profits. For some reason, many politicians and much of the public currently despise that mentality.

4 May 2011.

By clicking on this story, you may be a speculator if you thought this information might add value to your knowledge base, or your bank account. The only risk is your time.

Oil and other market speculators basically act in the same way, except they are willing to take monetary chances in exchange for higher profits. For some reason, many politicians and much of the public currently despise that mentality.

Betting on the future generally receives the stamp of immorality when elected officials and consumers come out on the losing end. President Barack Obama and the European Union both recently announced plans to hound evil profiteers. Brussels has pointed its investigators at the arcane credit default swap. Such a instrument, known as a CDS, allows investors to hedge against the inability of a company or country make its payments, so it is basically bankruptcy insurance. The EU’s probe is of an antitrust nature and based on suspicions that major banks and services may have colluded to control the CDS market. This seems like an attempt to deflect blame from profligate governments and focus public ire on the always opportune target of the money-grubbing banker.

The U.S. investigation has a similar tone, except oil traders are at the center of government scrutiny. Crude futures have been nudging their highest levels in more than 30 months, and anyone who owns a car or consumes goods transported to market with burnt hydrocarbons has felt the pinch hard. Last month, President Obama once again jumped into the blame game. “The problem is … speculators and people make various bets, and they say, you know what, we think that maybe there’s a 20 percent chance that something might happen in the Middle East that might disrupt oil supply, so we’re going to bet that oil is going to go up real high. And that spikes up prices significantly.” The next day, Washington unveiled a task force to investigate energy price fraud.

Before vilifying those who trade oil, one must first examine possible underlying causes for rising prices. It’s easy for the president to tell consumers – i.e., voters – that all is well in the Levant, but companies that need oil have to factor in political and social upheavals in regions that produce fuel. If more people are betting things will worsen and supply could be reduced, such fears – unfounded or not – spur buying and boost prices. Shoot Osama bin Laden in the face, and prices dip on hopes his death signals declining terrorism and more supply security.

Americans and many Europeans may also be thinking locally when oil markets act globally. Weak growth at home should normally reduce demand and price, but if China is running on all cylinders, slaking its thirst sucks up the excess. Chinese oil demand in the month of March rose nearly 11 percent from last year.

When in doubt, blame Washington, an all-too common global reflex which in this case may not be all wrong. Just ask E. Thomas McClanahan, a writer at the the Kansas City Star newspaper.  “If Obama seeks the real roots of this spring of discontent, perhaps he should look across town, toward the tomblike structure housing the Federal Reserve. Inside, Fed Chairman Ben Bernanke probably chuckles every time he hears Obama murmuring about speculators.”

Crude has been priced in American dollars since the first well ran wet in the Pennsylvania backwoods in 1859. For the past couple years, the U.S. virtual printing presses have been creating electronic dollars out of thin air to buy back American debt, making the currency less scarce and therefore less valuable. Bernanke has suggested interest rates will remain near zip for a while, providing little incentive to hold dollar accounts when other currencies offer higher interest rates. This opens up the dollar carry trade, where investors borrow almost free money to buy oil, other commodities, or currencies, driving them even higher.

A comparison of oil prices and the U.S. dollar index – which measures the currency against a basket containing yen, euro and other monies – has shown a strong correlation between greenback weakness and oil strength.

So, Obama may be complaining about a homemade problem. Instead of forming a posse to chase speculators, perhaps he should be chiding Bernanke for devaluing the currency.

Then again, the Oracle of Omaha offers a simpler solution. As investor Warren Buffet told CNBC on Monday, “The real answer to oil prices is to use less oil.”

Eric Culp

EconomyWatch.com

The post Who Are These Pesky Speculators? appeared first on Economy Watch.

27 April 2011.

Standard and Poors’ decision to cut its outlook for US debt to “negative” came as a surprise to many market watchers. The unprecedented move has reaffirmed the role rating agencies have in determining the prospects of national economies, much to the chagrin of many politicians. One main reason the S&P’s pessimism rattled markets was its novelty.

27 April 2011.

Standard and Poors’ decision to cut its outlook for US debt to “negative” came as a surprise to many market watchers. The unprecedented move has reaffirmed the role rating agencies have in determining the prospects of national economies, much to the chagrin of many politicians. One main reason the S&P’s pessimism rattled markets was its novelty.

Since it began issuing reports on the outlook for US bonds in 1989, the agency had not once suggested it could lower the “AAA” rating of the world’s largest economy. Now S&P warns the chances the US will lose its bulletproof credit vest are one in three over the next two years.

According to its estimates, the US debt-to-GDP ratio will range from 80 percent to 90 percent by 2013. The main concern focuses on continued political intransigence in Washington and the divisive nature of US presidential campaigns. Prospective republican candidates are already toeing the political waters and lambasting President Barack Obama even though the election is still 19 months away.

The chance that Republicans and Democrats could remain deadlocked on fiscal policy to reduce the deficit and debt or introduce a plan that will fall short has left the agency no choice but to tell investors that the US may become an unreliable borrower.

During a conference call after the announcement, John Chambers, an S&P managing director and chairman of the sovereign ratings committee, said the downgrade focuses on one thing: “The capacity and willingness of an issuer, in this case, of a government, to pay its debt in full and on time.”

Opinions on the announcement have varied widely. US Treasury Secretary Timothy Geithner took the rah-rah route by saying there is “no risk” of his country’s bonds losing their current status. One of his subordinates said S&P had “underestimated” the ability of US politicians to reach across the aisle and take the necessary steps to reduce overspending and pare what it owes.

Then the private sector weighed in.

Maverick investor Jim Rogers told Investment Week that the US will lose its AAA rating due to the country’s rising debt. Deutsche Bank’s economists suggested S&P may not have gone far enough. In a report, they equated the riskiness of owning US debt “about on a par with the euro periphery.” Based on economic fundamentals, Deutsche Bank says the risk rating for US public debt is higher than Spain’s.

The report even warned that in 2013, the US bond market could face a “Minsky moment.” The term is based on an economic theory that suggests a massive sell-off of certain investment products following a long bull market during which investors take increased risks, and it has happened recently.

The time was April 27, 2010, the place was Greece and the spark was an S&P downgrade of the country’s bonds to non-investment grade, i.e., junk.

It looks S&P made the right call. Eurostat, the European Union statistics office, announced Tuesday that Greece’s 2010 deficit was higher than expected, and the country’s debt last year reached nearly 143 percent of GDP.

The sector needs even more such correct predictions. Agencies have been criticized for overrating a range of corporations ahead of the 2008 collapse of the the US real estate market and a number of US banks, and the economic soothsayers have been trying to regain their credibility ever since.

Their gimlet-eyed views on the prospects of the eurozone periphery have been a boon to investors and the bane of European politicians. One of their most vocal critics in Europe funnily enough also runs the worst debtor in the eurozone. In a statement on a Greek government website late last week, Prime Minister George Papandreou said ratings agencies “are seeking to shape our destiny and determine the future of our children.” 

This was just the latest salvo in his ongoing attacks on the messengers at a time when he should probably be using his time to deal with his country’s out-of-control spending. The EU has weighed in, too. A spokesman said the European Commission does not agree with S&P’s most recent downgrade of Greece, which lowered the country’s rating to BB, two short steps above “highly speculative.”

Unfortunately, ratings agencies may have reached their apex in Europe. The EU is currently finalizing regulations for the industry, and lawmakers are reportedly considering making raters liable for inaccurate downgrades. This could force their exodus and leave European debt an even riskier investment.  

Read The Deutsche Bank report.

Eric Culp

EconomyWatch.com

The post The Return of the Rater appeared first on Economy Watch.