tony's blog

Thursday, July 26, 2012

Clouds on the horizon

Following the disappointment of UK GDP figures released this week registering a 0.7% drop, I was heartened to think that third quarter GDP will see an improvement. The bounce back in the third quarter will relate in part to the positive impact of the Olympics and the likelihood of an increase in private sector pay deals which will outstrip RPI inflation for the first time since 2009. So with more money in our pocket, that’s great news as the assumption is that we will spend more and drive the economy back into positive territory.

However trawling through economic news today I was disheartened by news from the US department for agriculture that has warned that food prices are likely to rise in the US next year due to a drought gripping large parts of the Midwest. It reported that this is the worst seen since 1956 and prices are expected to rise by between 3% and 4% in 2013. Corn and soybean price have already soared recently as fields dried out and crops withered.  Richard Volpe of the US department for agriculture told Reuters that ‘the drought is really going to hit food prices next year’ adding that the pressure on food prices would begin to build later this year.

So why should we be concerned? Well the US is the world’s largest exporter of corn, soybeans and wheat and a rise in prices will impact economies worldwide.

In June, UK food inflation fell to 3.5% from 4.3% - its lowest level in almost two years. However if the drought in the US doesn’t end, prices could once again rise. Colin O’Shea, head of commodities at Hermes Fund Managers said: ‘If we do not get rain in the near term then corn prices and related crops will continue at these elevated price levels. As a result the Governor of the Bank of England many not get the falling inflation numbers that he so desires’.

The last thing we need is for inflation to become a problem once again. Let’s pray for rain! In the US at least….

Thursday, July 12, 2012

What now for the Brics?

Of all the recent economic statistics to come out, the numbers that concern me most are those coming out of a recent report from HSBC which suggests that growth is slowing in the four big Bric countries - Brazil, Russia, India and China. These have been some of the fastest growing economies of the past ten years, and have been largely responsible for keeping the global economy moving forward. Yet now they are facing a sustained slowdown which has largely been blamed on the euro crisis and deterioration in the US economy.

Let’s look at these two issues. Well sadly I predict that the euro crisis is set to run for some time. Even Sir Mervyn King seems despondent accusing EU leaders of failing to tackle the fundamental causes of the crisis and adopting a policy of ‘kicking a can down the road’. He suggests that ‘there is a great black cloud of uncertainty hanging over businesses’ and until they know how things are going to pan out, ‘they are holding back from investment and spending’. His comments seem to make sense albeit will do very little to instil confidence in the UK.

I think economic data from the US is a little more encouraging, after all statistics suggest that the US trade deficit narrowed in May with exports to Europe rising. Yet analysts have warned this may not last suggesting it is ‘unlikely to be sustained in the coming months’. I am however encouraged that the Federal Reserve will act to provide further stimulus if things get worse although I can’t see a rapid return to growth in the US.

So going back to the Brics. Of all the emerging economies, China in particular has responded rapidly to a slowdown with its government easing the curbs it imposed back in 2010 which at the time were brought in to cool an overheating economy and curb inflation. Beijing has cut interest rates twice since the start of June and announced various additional stimulus measures. These measures initially appeared to do some good but with external influences affecting demand for China’s commodities, forecasters have now put back prospects of a rebound until at the earliest later this year.  

I fear we will have to wait some time until the world’s second largest economy, along with other Brazil, Russia and India, once again drive global markets.

Thursday, July 5, 2012

LIBOR and Barclays - the real world

If you look at the British Bankers Association website you will see that each contributing bank to the LIBOR rate setting has to answer the question: “At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11 am?”

So BBA LIBOR is not necessarily based on actual transactions. This is an important point.

It seems to me that the latest scandal to hit the markets is little understood by most of the vociferous market spokesmen and commentators.

I am not condoning wrongdoing that Barclays have owned up to but we do need to get this in perspective. First of all LIBOR is not some mathematically computed number which is always accurate to within fractions of a basis point. It is a number derived by dealers in prime banks talking to each other having observed the yield curve and the latest supply and demand for money in the markets and for them at that moment. It is a matter of opinion.  

Even if Barclays were a sole outlier in the LIBOR rate setting, the effect would have been eradicated. Every BBA LIBOR rate is calculated using a trimmed arithmetic mean of all rates submitted to them. Once all rates are received the rates are then ranked in descending order and the highest and lowest 25% of submissions are excluded - this is the trimming process. 

Looking at the second of the two breaches by Barclays; that they rigged the LIBOR rates between September 2007 and May 2009 by making LIBOR submissions which took into account concerns over the negative media perception of Barclays’ LIBOR submissions.

In other words they were looking to mask any Barclays’ specific problems.

Well I well remember this time vividly and as someone who has operated in the sterling money markets since the 1970’s I can assure you that what was happening at that time was far from normal. We were seeing major banks worldwide finding difficulty with raising money in the markets to cover their liquidity positions. The first major warning sign of the credit crisis that I observed was a movement in 6 month LIBOR in excess of 65 basis points above Bank Rate and with no yield curve cause. In other words it wasn’t that banks thought that rates would rise, it was simply that banks were struggling to fund themselves and would pay “whatever it cost” to cover funding positions. Very scary! There were rumours abounding about ‘major banks being in difficulties’. In this market it must have been tricky for any bank to fix a normal LIBOR setting for the BBA. To signal that your bank had a worse position that others and therefore had a problem must have been a real cause for concern.

I could quite understand in fact why it may have been prudent to agree with the Bank of England that a ‘normalised’ LIBOR rate should have been quoted and to take out the peaks and troughs of a far from normal market. But this does not appear to have been the case based on Bob Diamond’s evidence yesterday. Let’s see what Paul Tucker has to say. I’m not trying to make excuses for others and certainly have no axe to grind with Barclays but in relation to the LIBOR fixings in extreme markets maybe we need to reflect on just what was happening in a very hostile real world.

Just as an afterthought however, Bob Diamond’s letter to Andrew Tyrie ahead of the meeting said The interventions in question were typically on the short term one and three month rates relevant to the wholesale markets and not the longer term rates used to set, for example, retail mortgages.What planet has Bob Diamond been on? Mortgage rates are set relevant to short dated LIBOR rates such as 1 month and 3 month and not 6 or 12 months.

Sorry but this just doesn’t add up! Get a grip Mr Diamond.