The post-Moody’s blues

Not a lot of talk of government bond yields this week but a quick look at the indicative five-year yield on Irish government bonds calculated here shows that the drop in yields that happen on January 20th (after the Moody’s upgrade) has been almost fully reversed for the bond maturing in October 2018.

The yield was around 1.80 per cent on Friday 17th of January and it dropped to close to 1.60 per cent after the Moody’s upgrade.  As can be seen it has been edging back up since then and is now at 1.77 per cent.  Much better than 14 per cent of course.

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Retail sales (volume) did surge this December

Statements from Retail Excellence Ireland provided some contrasting views of the level of retail sales in December.  On December 24th it was reported that:

Retailers see fall in Christmas trade compared to 2012

while just a few days later a report from another REI statement was published under the following headline:

Retailers see strong start to post-Christmas sales

Unlike December 2012 when they got it all wrong, CSO data released today shows that REI’s take on December 2013 was pretty accurate: consumer purchases increased but they waited until the lower prices in the sales to do so. 
Here is the December 2013 Retail Sales Index excluding the motor trades.

The increase in the volume series is pretty clear and the December reading is now higher than at any point going back to mid-2010, seasonally adjusted.  The value series did increase in December but by a much smaller amount.
If we look at the unadjusted series we can see concentration of retail sales in December of each year.

In December 2013 the unadjusted volume series was close to the levels seen in 2006 and 2008, though nine percent below the 2007 peak.  The drop in the December readings for the value series was much more pronounced with a clear gap emerging in December 2009.  The value series in December 2013 was 18 percent below the 2007 peak.
December 2013 volume was 5.5 percent higher than the December 2010 trough but the value series only shows a 3.6 percent increase.  We are beginning to buy more but are not having to spend as much doing so.
Returning to adjusted series here are the annual changes excluding the motor trades.

The annual changes in Q3 were negative but the increases in the latter part of the year pushed them back into positive territory.  It remains to be seen whether the increase in December was a once-off splurge or reflects an emerging frugality fatigue amongst consumers who are going to continue to spend more.  Tweet

The Bundesbank versus the ECB

A wide-ranging interview in The Irish Times today with current Bundesbank president, Jens Weidmann, offers the following:

Derek Scally: The euro zone door to debt write-downs, now open, was held closed by ex-ECB president Trichet for Ireland. Does this argument hold water here?

Jens Weidmann: A The Governing Council then was weighing bail-in versus financial stability risks, and its majority concluded that the latter were more relevant under the concrete circumstances. In that debate the Bundesbank has always considered it important to make investors bear the risks of their investment decisions and already then favoured contributions of investors in the event of solvency problems, especially for banks that are to be wound down. Our common goal is to be able in the future to wind down banks without endangering financial stability.

In 2010 Weidmann was head of Economic Policy in the German Chanellor’s Office of Angela Merkel so this view of the Bundesbank was relayed to him at some stage.

We know that at the time of the negotiations surrounding the EU/IMF programme that burden sharing with the €6 billion or so of senior unsecured (and unguaranteed) bonds that remained in Anglo Irish Bank and Irish Nationwide was  “raised” by then Minister for Finance, Brian Lenihan.

The view expressed by Weidmann today differs from that offered by another German official.  In November 2010, Jorg Asmussen  was a deputy finance minister in the German government but in early 2012 he was appointed to the ECB Executive Board and sat on the Governing Council.  He was in Dublin in April 2012 and delivered a speech which included this:

I know that the decisions concerning the repayment of bondholders in the former Anglo Irish Bank have been a source of controversy. Decisions taken by the Irish authorities such as these are not taken lightly. And the consequences of subsequent actions are weighed carefully. It is true that the ECB viewed it as the least damaging course to fully honour the outstanding senior debts of Anglo. However unpopular that may now seem, this assessment was made at a time of extraordinary stresses in financial markets and great uncertainty. Protecting the hard-won gains and credibility from the early successes in 2011 was also a key consideration, to ensure no negative effects spilled-over to other Irish banks or to banks in other European Countries.

When speaking both Weidmann and Asmussen are giving the views of their employer.  At the time of the decision in November 2010 they did not work for the Bundesbank or the ECB.  The views from with their employers at the time (the German government/civil service) would also be interesting.

If the Bundesbank had German interests at heart why would it favour imposing losses on creditors in failed Irish bank thereby exposing German banks to possible losses?  The answer is that German banks never really had a huge direct exposure to the ‘covered’ Irish banks and it was close to zero even before the end of 2007 (three years before the above mentioned discussions).  See this research letter from the Central Bank.

There have been indirect exposure through the operations of German banks based in the UK but it can be clearly seen that by far the greatest source of the massive external funding used by the ‘covered’ banks was London.

Finally, in this question Weidmann hints that the Promissory Note swap might be a concession to compensate for the decision to force the repayment of the €6 billion of Anglo/INBS unsecured senior bonds in November 2010 (emphasis mine).

David Scally: Was a line crossed that has brought the ECB into a position of political dependency?

Jens Weidmann: As you know, I viewed this transaction with great scepticism. At the end of the day, the central bank (of Ireland) largely has the debt on its books and is refinancing it at the main refinancing rate. This transaction is a blurring of monetary and fiscal policy that, from my perspective, risks being perceived as monetary financing. If the impression arises that monetary policy is handling fiscal problems, this would bring central banks into a situation where monetary stability is dominated by fiscal policy. Some might consider the transaction as a kind of a compensation for the Irish support to its banking system, but in my view such transfers should not be the business of central banks.

A 66% haircut on the €6 billion of bonds would have generated around €4 billion of savings which is a possible figure that arises if one tries to estimate the interest savings from the Promissory Note swap.

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Bond yields tumble; should we refinance debt?

There was much talk over the weekend that the Moody’s upgrade of Irish government bonds on Friday was merely Moody’s catching up with the market.  If that was the case then it would have been reflected in little or no change on the yield on Irish government bonds this morning.  That has not been the case.  Yields have fallen considerably.  Here is a five-day chart of the five-year yield calculated here.

The drop at 8am this morning is pretty apparent.  The reputation of ratings agencies has taken a deserved battering in the past few years but their significance in financial markets seems to have remained.

Any debate about the decision not to go with a Precautionary Credit Line now seems moot.  Although the yields now back the decision the reality is that the PCL was unlikely to be used if it was in place.  Here is chart from an interesting presentation on Portugal.

Ireland’s debt financing needs over 2014 and 2015 was less than 5 percent of GDP which is much lower than Greece, Portugal, Spain and Italy.  At the end of 2013 Ireland had a cash reserve of around 12 percent of GDP which is enough to cover debt and deficit financing until the first half of 2015.  A PCL would have lasted 12 months before it would expire or require renewing.

Of the 5 percent of GDP debt financing needs for 2014 and 2015 about half has already been covered with the maturity of a bond on the 12th of January.  As shown here the only bond currently in issue that matures over the next two years is a €3.6 billion bond that will need to be paid in February 2015, while the one following that is a €10 billion bond that matures in April 2016.

The debt profile shown by the NTMA shows a large EFSM loan that is set to mature in 2015.

The EFSM loans, however, will have their terms extended as agreed by the ECOFIN last June but the actual change will not be determined until closer to the original maturity debt.  As the NTMA note:

EFSM loans are also subject to a seven-year extension that will bring their weighted average maturity from 12.5 years to 19.5  years.  It is not expected that Ireland will have to refinance any of its EFSM loans before 2027. However, the revised maturity dates of individual EFSM loans will only be determined as they approach their original maturity dates.

Ireland’s low refinancing needs have undoubtedly been a factor in the relatively benign move out of the direct funding phase of the EU/IMF programme.  However, given the current level of borrowing rates, it might be better to have slightly more debt to refinance at the current lower rates.  As John Corrigan said on today’s Morning Ireland (reported here):

“each one tenth of one percent of a fall in the interest rate for every billion we borrow represents a saving of about a million per annum.”

Refinancing €10 billion of debt at a one percent lower interest rate would save around €100 million per annum.  The problem with this potential saving is that we don’t have debt to refinance.  We can’t just buy existing debt as that would have to be bought at the current lower yields, i.e. higher prices.  We need existing bonds to mature to benefit from the lower rates.  As we have seen we have less than €4 billion maturing over the next two years. Maybe we should give thought to repaying the EU/IMF loans early.

This seems particularly worthwhile for IMF loans.  These have an average interest rate of around 4.2 percent (almost one percentage point over the current ten-year yield).  Ireland has accessed €22.5 billion of loans from the IMF.  This will amortise in different tranches from 2015 to 2023.

So why not pay off the relatively higher cost IMF loans with the relatively cheaper funding now available from sovereign debt markets?  The problem with this is that one condition of the overall €67.5 billion funding package is that any early repayments must be split in proportion across all the lenders.  The IMF provided one-third of the overall funding.

So if we wished to repay €10 billion of IMF loans then a further €20 billion would have to be repaid to the EU lenders (EFSF, EFSM and UK, Danish and Swedish bilaterals).  Repaying the high-interest, relatively short maturity IMF loans makes financial sense.  Repaying the low-interest, very long maturity EU loans currently does not make financial sense.

Repaying IMF loans early is sometimes used as a positive indication for post-bailout countries. Iceland has done so.  Interest rates are now at levels that mean Ireland would gain financially and reputationally from doing so.  The structure of our EU/IMF funding package means it is unlikely to happen but if bond yields were to continue to tumble…

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The slow improvement in the Public Finances

The successful issue by the NTMA of another 10-year bond is a further small step to normality for our public finances.  They are a long way from being under control but the ability to raise €3.75 billion over 10 years at 3.5 percent indicated that decision makers in government bond markets think they are under control (or at least that they will be).

Getting a handle on Ireland’s public finances is not easy.  There are a plethora of sources and a variety of measures.  There are cash-based and accruals-based accounts.  There is the cross-over and subsidisation of central and local government.  There is the difference between voted and non-voted expenditure.  There is the difference between net and gross expenditure.  There are sinking fund contributions and appropriations in aid.  With all those in mind the following table may be comprehensible!  Click to enlarge.

A fuller spreadsheet with some constituent components of the revenue and expenditure items is available here.  Note though that composition changes have affected some of the items.  For example, on the revenue side, the Health Levy, a departmental receipt for Health, was replaced by the Universal Social Charge and now appears under Income Tax.  On the expenditure side, FÁS, or equivalent, was transferred from Enterprise to Education.  These changes don’t affect the overall totals shown above.

Some comments on the above table are provided above the fold but offers little that we do not already know.  It is little more than a thought-straightening exercise. 

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