Credit Writedowns

Recent Bulgarian developments are worth discussing. Austerity just brought down another European government, as Prime Minister Borisov and his cabinet resigned this week amidst rising popular protests against his policies. But the story goes even deeper than just austerity, with corruption allegations and higher electricity prices added to the mix as well. In fact, protests against higher electricity prices went hand in hand with power distributor CEZ having its license revoked due to allegations that it routinely broke procurement rules.

By Win Thin Recent developments in Iran are worth discussing.  We feel that with Middle Eastern political risk on the rise lately, Iran is more likely to have the largest impact on global markets, while escalating tensions between Syria and Turkey are unlikely to have as much lasting impact.  News outlets have been carrying countless stories this past week about [...]

The economy remains in solid shape, with exports, IP, retail sales all holding up well despite the sharper US slowdown. GDP rose 4.6% y/y in Q1, and is tracking at a similar rate for Q2. Manufacturing PMI rose to 55.7 in June from 54.3 in May, the highest since 2006. New orders component surged to 62.9, the highest level since 2004. Clearly, there is some strong momentum in the Mexican economy, and is likely to keep the central bank in wait and see mode for now.

People’s Bank of China today cut the 1-year lending rate by 31 bp to 6% and the 1-year deposit rate by 25 bp to 3%. It also widened the allowable discount that commercial banks can offer on loans from 20% to 30%. This gives the PBOC rate cut more bang for the buck, as banks can cut their loan rates by even more than the PBOC’s 25 bp cut. There was no change to reserve requirements, as one newswire erroneously reported. After PBOC started the cycle back in December with a 50 bp cut in the reserve requirement to 21%, it followed up with another 50 bp in February and another 50 bp in May to 20% currently. Today’s rate cut follows the first outright rate cut in this easing cycle back on June 7, and so we think this recent change in pace marks the beginning of the more aggressive easing cycle that we have long been expecting.

We must stress that opening talks does not mean that a deal is going to be easy. In our view, Hungary did the bare minimum to get the EU back to the negotiating table, and that difficult negotiations remain ahead. On a separate but related note, Hungary still faces a decision by the EU on an Excessive Deficit Procedure. The government has sent a convergence plan to Brussels this week, which Hungary hopes will be enough to close the procedure. If not, then Hungary would likely lose some EU funds.

A look at the fundamentals shows why Fernandez is engaging in such visible theatrics, which also includes recent vitriol regarding the Falkland Islands. Simply put, we think economic stresses are intensifying. How deep the stresses will get is yet to be determined.

Fitch has not been as aggressive as the other two agencies, keeping Austria and France at AAA up until now. As such, its negative comments about the Netherlands are noteworthy and likely signal a harder line by Fitch in the coming months. As a result, we think both Austria and France are likely to come under negative scrutiny by Fitch as well, as we view both as inferior credits to the Netherlands.

We stress again that the loss of AAA is not the end of the world, and one could make the case that AA is indeed the new AAA. However, the Moody’s news comes a time when markets are nervous about Greece, and so some limited fallout to the euro and EM FX appears likely near-term. The fallout for GBP may be longer-lasting, since it was expected by most to retain its AAA rating.

FX intervention is certainly in the air this week for Latin America. Brazil stands out as the most aggressive, of course, as the central bank intervened in the forward market Friday and in the spot market Monday.

Given what we see as a basically hands off policy with regards to the exchange rate when MXN is appreciating, we see more potential upside for MXN compared to, say, BRL, where Brazilian authorities are clearly going to work against further currency strength. Others in Latin America are concerned with currency strength, including Colombia. As such, going long MXN vs. BRL or COP would be a good alternative too. On the other side, Banxico has installed circuit-breakers to help boost peso liquidity during times of stresses as part of an effort to prevent disorderly downside movement in the peso.

We think markets are getting too bulled up on the IMF headlines today. As the saying goes, “Show me the money!” Until then, we remain skeptical that the IMF will be able to obtain the extra funding it desires. Even if the IMF does get the extra financing, will it make a material difference? IMF/EU programs for Greece, Ireland, and Portugal have not been able to halt the crisis.

With the long-awaited euro zone downgrades by S&P now out of the way, we thought it would be useful to assess just how close current ratings are now to our own sovereign ratings model.