Irrational Bond Markets

This post was written by

The post hoc attribution of market movements to specific events is always a bit speculative. But Thursday’s release of weak Q2 national accounts (Economy Shrinks Shock!) was headlined in Irish and international media and appears to have unsettled the secondary market in Irish government bonds. The 10-year closed around 6.65 on Friday, the worst close of the crisis to date and cue panic stations.

This makes sense if

(i) The prospective growth rate in 2011 and later is critical for fiscal sustanability, which is reasonable, and

(ii) A sensible person would have revised their expectations on the basis of Thursday’s release, which I think is not reasonable at all.

So far as I know, there have been just three technical studies of the Irish quarterly data since the CSO commenced publication in 1997 and which are relevant to this discussion.

In this paper, the conclusion here is that the Irish quarterly GDP and GNP numbers are very volatile, and considerably more so than is the case in other OECD countries, including smaller ones.

This study concludes that the seasonal adjustment procedure used by CSO is (probably) not the best, and that this can make a difference, in the sense that an alternative, and preferable, procedure can give results which sometimes alter the qoq % changes quite a lot.

The final study shows that revisions to the first-shot estimates, while no greater than elsewhere, can be substantial.

The economy sank like a stone through 2008 and 2009. The last three qoq % changes in real GNP, using the CSO’s seasonal adjustment, were -1.9, then -1.2 and just -0.3 for the most recent Q2 number. Using the alternative (indirect) seasonal adjustment, the most recent number was -0.1. A reasonable headline in either case would have been ‘Economy Now Flat’.

The reason for the Shrinking! headlines was the GDP numbers. The last three qoq changes read -2.5, +2.2 and -1.2. These are the qoq changes, not annualised. At seasonally adjusted annual rates (saar) the decline in real output in Q4 was -9.6%. It then grew at a saar of +9.1% in Q1 of 2010, relapsing to a saar of -4.7 in Q2. If you really believe this, maybe you could make it as a bond dealer.

The gyrations in the quarterly numbers are just not credible. Various people including Garret FitzGerald and Robbie Kelleher have speculated that real output measurement in the MNC sector is mainly responsible for the extreme volatility. There may be a bit of informal smoothing practiced by other countries too.

Forecasts of GDP growth for 2011 seem to be mostly in the 2% to 3% range. My point is not that these forecasts are likely or plausible. The point is this: given what we know about the behaviour of the Irish quarterly macro aggregates, whatever your figure was on Wednesday, there was no good reason for changing it on Thursday morning.

96 Responses to “Irrational Bond Markets”

  1. David O'Donnell Says:

    @Colm McCarthy

    On Q-volatility agree re MNCs (not sure on ins_an_outs re IFSC; not getting into explanations here): message to economists :pls figure out this ‘speculation’ into research output by next week.

    ‘…whatever your figure was on Wednesday, there was no good reason for changing it on Thursday morning.” (I agree)

    Blind Biddy says Hi: ‘It’s not me figure he’s admirin!
    Do’D: What kind of figure do you think he’d mind?
    Blind Biddy: ’bout 90 Billion from de bleed! blind’.

    Great to see your use of the ‘sensible’ as the rational comes under increasing pressure due to the aesthetic turn.

  2. OAC Says:

    Is there any likelihood of gov’t or academics releasing an estimated revised Q figure in parallel with the “normal” (inaccurate) quarterly calculation?

    Is there any hope of them releasing monthly figures, as the 3rd paper linked above (2006) mentions that monthly records are kept?

    It is hard to imagine how Q figures could be taken that seriously, if they only consider data submitted by half-way through the previous quarter (if I understood the 2006 paper correctly).

  3. colm mccarthy Says:

    OAC: Monthly figs for national accounts are not produced anywhere to my knowledge. Would be even more volatile?

  4. Bond. Eoin Bond... Says:

    @ Colm

    in fairness, the yields had gone somewhat crazy even before the GDP figures were released, mainly on the back of the misunderstood comments/articles on Anglo sub debt losses (basically the FX and equity boys, who aren’t the sharpest on the difference between sub, senior, g’teed senior and sovereign, seized on the comments and all hell broke loose before people could get the factual info out there, and then the GDP figures meant there was no point even trying to right the wrong story).

  5. hoganmahew Says:

    @CmcC
    The problem is the government box themselves in every time they proclaim the economy has turned a corner. Everyone expects that they have access to more and better ‘real-time’ information; they themselves claim to have their finger on the pulse of the economy. While it might be more accurate for them to admit that they wait for the CSO quarterly figures themselves, it would expose many of their intervening pronouncements as spoof.

    Every time I hear “the economy is recovering” or “has turned a corner” based on on datapoint, I shudder. The economy is no longer contracting at the pace it was, it may even have bottomed out, exports may be growing, but at this stage, we just don’t know. Announcing a direction to the markets is a fools game. Changing your forecast from a perhaps too pessimistic -1% to a perhaps too optimistic +1% because of a single quarter datapoint is likely amateur.

    Better to pleasantly surprise the markets that you have underestimated growth, than shock them that you have overestimated it. If you don’t know what is happening, keep your mouth shut, otherwise you have more chance of proving yourself a fool than not (2-1, I reckon…).

  6. hoganmahew Says:

    @Eoin
    Rumours around that it has little to do with either the Anglo sub debt or the GDP figures. I think those rumours would fit into the “sell the rumour” category.

  7. Bond. Eoin Bond... Says:

    @ Hoggie

    pls tell sir!

    All i know if that everyone was talking about the Anglo stuff well before the GDP, and you always know something iffy is up when the FX sales guys are the first to start asking, ditto the CDS moving way before there was any action in the cash bonds. We don’t call these “spiv FX rumours” for nothing…

  8. LorcanRK Says:

    Colm, it is reasonably well understood that quarterly data is more of a barometer than a benchmark – hence the ‘revisions’ that national statistic offices globally tend to give some time after initial results are given.

    But.

    I think you might be mistaking causality. Yields are at record highs on Friday, but it is hard to see how much of that price was caused by the GDP numbers.

    The effects of the confusion caused, as outlined by Mr. Bond above, had a lot more to do with our yields.

    From my experience (nothing personal Eoin) bond traders tend to be very boring people who hate nothing more than a shock. Were the quarterly numbers a shock? Certainly not.

    They care about getting their money back, and anything that might threaten that isn’t good for our yields. Of course, our yields hanging around 6.5% reduces the chances of them getting their money back, so they may well charge us more the next time (etc etc)

    Your argument seems to be that the GDP numbers aren’t as accurate as they could be. That may well be true. My argument is that blaming them for the bond yield spike may not necessarily be accurate either.

    There are, of course, political considerations. Tonights possible defection of another government TD may cause more trouble come Monday.

  9. colm mccarthy Says:

    Eoin et al: Sure the market slid well before the GDP figs came out, but some of your colleagues are saying that they had an additional impact on Thursday and Friday. Maybe ascribing market movements to specific factors is just a mug’s game, sellers don’t have to fill in a form listing motives.

    Agree Hogan that governments boxing themselves into forecasts is unsmart. If your macro policy bombs whenever your GDP forecast is off by a couple of points, it’s going to bomb fairly regularly.

    Whether bond dealers are more boring than equity dealers is one of the really big unresolved questions. In my experience, bond dealers occasionally slip people free tickets for Croker, equity dealers never. How boring is that?

  10. Brian O' Hanlon Says:

    @ Colm McCarthy,

    What is really going on in the Irish Economy today?

    The measurement of the slump in the Irish economy of late, makes an awful lot of sense to me. Because if you look at the ‘grain’ of the economy in 2010, it is now radically different from that which it was in 2008. What I notice, from day to day interactions with people, is that many large companies have broken up – and as a means of keeping active in some shape or form – many younger people (and many older folk too), have simply set up shop as small sole traders. Whether this is very sustainable or not is open to huge speculation I think. Because many of these new small traders aren’t bringing anything new to the table, at the moment. But, on balance, I would say this movement, or phase shifting in the Irish economy, at a quite deep level – is necessary for one reason. Society and the economy in the Ireland, which I grew up in, was comprised of many leading authorities in all kinds of specialism’s. You could call them household names. They were the traders and brand names one could rely on. Many of the first wave of young Irish people who had the benefit of higher education in Ireland, left their school-ing days behind, to go and work for well established names in most industries. What followed of course, was the Celtic Tiger boom, which we all know about. A period during which the established names in many industries could glean the benefit from of hiring from a local talent, home grown talent pool.

    The trouble was, the talent which had left education, didn’t have enough room to grow inside of the established, named institutions in Ireland – both public and private. What we are witnessing today in Ireland, is the wholesale disintegration of the household names in all of our industries. They are crumbling right, left and centre. What has happened as a result of that, is the wholesale shedding of all that human resources at once. They have no option but to set up as sole traders at the moment, usually on a shoe string. Therefore, their productivity has fell like a lead baloon. I don’t know what authority in Ireland attempts to measure ‘productivity’ in the various industry sectors – Ibec? ? ? But if you looked at that graph, you would see a night and day relationship between 2008 and 2010. It is all, the most ‘productive’ kinds of people – who are totally un-productive, in 2010. Which makes it even more exaggerated. If some CSO measure, somewhere, didn’t pick up on this trend, I would be really surprised. BOH.

  11. Brian O' Hanlon Says:

    @ CMcC,

    A useful scientific and visual metaphor for the process I tried to describe above, is that of condensation. At certain times of the year, the weather is such that we get very high humidity levels, as the atmosphere is able to absorb a huge constituent of water vapour. Then as day turns to evening, and you have the additional element of a very clear night sky, we find this air-bourne water vapour creates a pattern of visible moisture in all sorts of places. What we are seeing in the Irish economy in 2010, is such an effect in terms of the utilisation of human resources. We have gone from water vapour back in dew saturation. BOH.

  12. hoganmahew Says:

    @CmcC
    “If your macro policy bombs whenever your GDP forecast is off by a couple of points, it’s going to bomb fairly regularly.”
    As I say, you want to be on the right side of wrong. You have two options and you should use both of them:
    1. Conservative forecast – aim to beat it – works for quoted companies…
    2. Stick to your original forecast. “We are not in the business of stuffing our forecast”. Then you can claim it was made a long way out and clearly there is a margin for error.

    There should only be good news on GDP numbers versus estimate. Being right is not important. Being on the right side of wrong is what matters.

  13. seafoid Says:

    @Eoin

    What sort of trading volumes are you seeing on the 10 year bond and on CDS ? Do bond yield tend to follow CDS prices or is it the other way around ?

  14. Cormac Lucey Says:

    An aspect of recent bond market developments which has escaped much comment is that Irish and Portugese bond yield movements have been pretty closely related.

    So while Irish bond yields have escalated, vis-a-vis German yields, they have been relatively steady compared to Portugese yields. This would suggest that the recent drop in Irish bond prices / increase in Irish yields may have been part of wider Eurozone development.

    Those who might suggest that last December’s budget achieved little in terms of our credibility in bond markets should consider that last December it was about +1% (Irish yields being higher) while it is now about +0.1% (Irish yields now only slightly higher).

    My own view is that market participants may be anticipating a breakup in the Eurozone on the grounds that the debt-deflation policies required now of the periphery countries are not politically sustainable in the long run. If the Euro were to break up the fear of bond holders would be that their bond payments would come in the form of devalued Punt Nuas, rather than in Euros.

    Given that sterling, with the UK having fewer and lesser problems than us, has dropped by 30% against the Euro since 2007 a Punt Nua might drop by 40-50%. That might explain the difference in bond prices. Looking at the closing yields on Friday night (Germany 2.34%, Ireland 6.47%) would imply approximate bond prices on a bond with a 4% coupon of Germany €115 and Ireland €82.

    German governments are valued at 40% more than Irish government bonds of the same maturity! That is simply extraordinary. I don’t see how (a) the possibility of Ireland defaulting on its government debt or (b) the likely extent of haircuts were we to default, can justify bond price differences of that order.

    If a possible Irish default were the only fear which markets were discounting, then the current gap in values between Irish and German bonds would appear very difficult to justify and Irish bonds would therefore appear to be a Strong Buy.

    But an exit from the Euro could start to justify the gap in prices (and consequently in yields). It would also explain the startling rise in German bond prices as a Deutschemark Nua could be expected to appreciate in value post EMU breakup.

    Are markets beginning to bet on a break-up of the Eurozone?

  15. tull mcadoo Says:

    @Cormac,
    Our bonds are denominated in euros and the coupon & principal payments are to be paid in euros so if the common currency broke up and the new punt depreciated as you suggested we would have a real debt service problem or we could default.
    There is an ongoing capitualtion trade. The sellers are dumping Irish and Portuguese bonds for the simple reason that they fear that somehow they will not get their money back.
    Part of the reason we are at these yield levels is due to the fact that we have decommissioned our indigenous asset management industry. In previous crises up to 50% of the Irish Bonds were held (largely to maturity) in the vaults of Irish Life, New Ireland, Hibernian, Prudential, BIAM etc. Some of these have gone the way of the dodo while the remainder have reduced their Irish holdings for portfolio reasons. This is good for their Irish policy holders but not neccessarily great for the NTMA.

  16. hoganmahew Says:

    @tull
    “This is good for their Irish policy holders but not neccessarily great for the NTMA.”
    You’re comedy gold this morning. A bit congested? :D

    The reason bond holdings have collapsed is because there’s never been a better time to buy shares in Irish companies or US banks. Look at any default investment strategy and the bond element is near zero. You have to fight your way through “green tech funds”, “mining and metals”, “web 2.0″ marketing spiel before you can convince a pension manager that you want a boring bonds only fund.

    I agree with you it is portfolio theory that is at work; I totally disagree that it has been good for Irish policy holders.

  17. tull mcadoo Says:

    Hogan,

    Very narrow point.
    Irish bond managers would have steadily reduced their bond holdings over the last 5 years through sales and redemptions. Irish bonds have widened in spreads v other European alternatives ergo fallen in capital value. By not owning these bonds, Irish bond holders have avoided these mark to market losses. Instead they have been bourn by overseas investors & a very large bank in Frankfurt.

    As Mary Couglan allegedly said during the weak. You have may “alma mater” to discuss this matter further.

  18. hoganmahew Says:

    @tull
    But there is no obligation to mark to market all of a bond portfolio, is there? The Zurich long bond fund is up 13% to date and has an average return of nearly 10% over the last three years.

    Irish equities average fund annual return over three years? -28%…

    Not picking on Zurich in particular, just saying. Provided bonds remain at investment grade, you can hold them at, eh, LTEV. No?

  19. Cearbhall O'Dalaigh Says:

    PAUL KRUGMAN

    So what will happen? In the end, I’d argue, what must happen is an effective default on a significant part of debt, one way or another.

    The default could be implicit, via a period of moderate inflation that reduces the real burden of debt; that’s how World War II cured the depression. Or, if not, we could see a gradual, painful process of individual defaults and bankruptcies, which ends up reducing overall debt.

    And that’s what is happening now: ……….. the main force behind the gratifying decline in consumer debt appears to be default rather than thrift.

    So basically, we can do this cleanly or we can do this ugly. And ugly is the way we’re going.

    http://krugman.blogs.nytimes.com/2010/09/25/default-is-in-our-stars/?src=twt&twt=NytimesKrugman

  20. Brian Lucey Says:

    Cormac
    No doubt some people are betting on a breakup of the euro. Some are betting on it remaining as it is, and some on further integration.
    What I have never had convincingly explained, by anyone pro-con the “leave the euro/break up the euro” is the question of HOW. What are the practicalities and processes that would lead to this happening?
    As far as I can see the only practical way would be for the core european strong currencies to do a solo run and institute a new currency. However, the euro and its tentacles are so deeply embedded in the entire governance and political structure of the EU that to do so would be to in effect break up the EU. And I dont see political will for that anywhere serious.
    So, maybe they are so betting – but its like betting on Lindsay Lohan having space alien babies by Elvis. HOW?

  21. tull mcadoo Says:

    Hogan,

    If they are held in a unit linked or pension fund they are marked to market on a daily/weekly/monthly basis. In theory you can walk into the Zurich and say, gimme my money back now.

    For the record, the Eurozone over 10 year bond index is up 9% ytd while the Irish over 10 year is down -8%. So clearly your man in Zurich is a good steward of your capital. Judging by his performance, I would guess he has very little irish exposure. I think that rahter proves my point.

  22. hoganmahew Says:

    @tull
    “Judging by his performance, I would guess he has very little irish exposure. I think that rahter proves my point.”
    Ah, fair enough. That was why I chose it in early 2008… :oops:

  23. Cearbhall O'Dalaigh Says:

    WSJ – Secret Committee to Save the Euro

    BRUSSELS—Two months after Lehman Brothers collapsed in the fall of 2008, a small group of European leaders set up a secret task force—one so secret that they dubbed it “the group that doesn’t exist.”

    Its mission: Devise a plan to head off a default by a country in the 16-nation euro zone.

    http://online.wsj.com/article/SB10001424052748703467004575464113605731560.html?mod=e2tw

  24. Brian O' Hanlon Says:

    Cormac Lucey says:

    My own view is that market participants may be anticipating a breakup in the Eurozone on the grounds that the debt-deflation policies required now of the periphery countries are not politically sustainable in the long run. If the Euro were to break up the fear of bond holders would be that their bond payments would come in the form of devalued Punt Nuas, rather than in Euros.

    Looking at it from a political perspective, it is away more lightly the political instability will arise in the core Franco-German regions. Think about this. Those dead beat peripheral nations are never going to bother to try and change the system. Rather, the core EU states will try to carry the peripheral ones for as long as they can. Namely, to the point at which the concern amongst the citizens of the core EU states becomes so great, that they are carrying the can, too much, for the peripheral states – that political instability in France and Germany, is what wrenches them away from the Euro. This is a scenario I could envisage happen. In that situation, it is highly probable – for all the reasons outlined above, that the Euro will remain as a de-valued currency, to be used by the non-core EU states – and that the bond holders of these peripheral states, will get paid in due course, in a de-valued Euro note – rather than in a Punt Nua.

    As I stated before on the Irish Economy blog, what Ireland, Portugal and many other peripheral states tried to do in the 1990s, was to go from being Albania, to being more like France, Germany, and other wealthy European states. That was guaranteed to overheat markets in Ireland and elsewhere, but we could have done something to quench the overheating, if Ireland and other states like Portugal were only playing catch-up, to the rest of Europe. On the contrary, were playing catch-up, and at the same time, locking ourselves into pro-Germany interest rate policy. The Irish economy, and those of Spain, Portugal, Greece and Italy may have been able to adjust itself along one dimension – the catching-up part. But when the interest rate policy tool was removed at the same time, it was playing catch-up then, all kinds of weird and wonderful distortions were made possible. It wasn’t the Celtic Tiger boom, or the ECB interest rate policies which resulted in our indebted-ness today. It was the interaction of those two things which ultimately resulted in our ruin. BOH.

  25. Cormac Lucey Says:

    @Tull
    You wrote “Our bonds are denominated in euros and the coupon & principal payments are to be paid in euros so if the common currency broke up and the new punt depreciated as you suggested we would have a real debt service problem or we could default.”

    Sovereign states can legally determine their own currencies and redenominate assets and liabilities subject to domestic law. This has happened here twice in your and my lifetimes: 1979 when we swtiched from sterling to punts and 1999 when we switched from punts to the Euro.

    Read “Mann on the Legal Aspects of Money” for details of the legalities of a country changing its currency. You can buy it on Amazon for a mere £232.75. http://www.amazon.co.uk/Legal-Aspect-Money-Charles-Proctor/dp/0198260555/ref=sr_1_1?ie=UTF8&s=books&qid=1285517102&sr=8-1

    @ Brian Lucey
    “You wrote “No doubt some people are betting on a breakup of the euro. Some are betting on it remaining as it is, and some on further integration. What I have never had convincingly explained, by anyone pro-con the “leave the euro/break up the euro” is the question of HOW.”

    I agree with you that the practicalities of a Eurozone break-up are very difficult to envisage for reasons discussed in detail on this website in the past.

    But the WSJ reports that in early May “French Finance Minister Christine Lagarde told her delegation the euro zone was on the verge of breaking apart, according to people familiar with the matter.”

    http://online.wsj.com/article/SB10001424052748703467004575464113605731560.html?mod=WSJ_hpp_LEFTWhatsNewsCollection

    If key policy makers who support the Euro can envisage the possibility of a Eurozone breakup, I suggest that so should we.

  26. Cormac Lucey Says:

    @ Brian O’Hanlon

    The WSJ article referred to above tends to confirm your hunch about Franco-German political tensions.

  27. Brian Woods II Says:

    @Cormac

    I don’t think break up of the euro can have anything to do with it. It is a fear of default. Your suggestion would only make sense if there was in prospect some seamless transition from euro denominated bonds to depreciated punt nua bond. This would be contrary to international law and would be a default. So there is no prospect of a “soft” currency related default. It is hard default/restructuring or not.

    But you are of course right 40% discount on German bonds way overstates the risk in pure risk neutral mathematical terms but not, as I argue elsewhere, on a risk averse basis.

    The people who traditionally invest in sovereign debt for these amounts are extremely risk averse, at least so far as this aspect of there portfolio is concerned. They might be banks or insurance companies, for example. You and I might be prepared to live with a risk of a 20% write down. For a bank/insurance company this could be fatal. And the key point is this default risk cannot be diversified. If Ireland defaults so most likely will the other PIGS.

    As a result these risk averse players need increasing risk premia to persuade them to invest. One might posit for example that a 50% default risk would be so unacceptable that there would be no takers. My guess is that risk aversion is extremely elastic as the risk is perceived to increase.

    It is impossible to quantify these things but let me suggest a plausible scale:

    1 in 200 year perceived risk – 50bp or 5% over 10 years will suffice, i.e. almost risk neutral

    1 in 50 years risk – 40% might suffice, i.e. a 200% risk premium, that is probably where we are at the moment.

    1 in 20 year risk – No takers at any reasonable price. This is probably where Greece is. And you can see the good sense in the EU bailing them out because they do not require a risk premium. Furthermore they are in a very good place to actually minimise that risk.

  28. Brian Lucey Says:

    Cormac
    The WSJ is as fond of the Euro as the Torygraph. Caveat alert when your read anything there about the Euro

  29. tull mcadoo Says:

    Cormac,
    If I recall correctly, the NTMA bought back all the old punt debt and issued shiny new Euro debt with new coupons at the Euro/IEP conversion rate of 0.787964. Presumbly, we would do the same but at what rate. If its 1.0 then we stuff the lenders with IEP debt at an overvalued exchange rate. If we did it at the exchange rate on d+1, I assume we get stiffed.

    There is also the small problem of secrecy. Any hint of exit and you have massive capital outflows out of the banks. Moreover, bank external borrowings will be in currencies that appreciate against the euro. Result, a liquidity and a solvency event. Perhaps you could post a watch on the CB printing centre in Sandyford to see if there is a sudden increase in truck traffic. A large whirring sound at night might also give the game away.

    @B Lucey
    It is interesting though that Lagarde pointed out to the Germans the obvious outcome if they refused to sanction the EU bail out of Greece and the first round of intervention in sovereign bond markets. The German government and the BUBA do not seem wedded to the concept of the euro.
    This is a well sourced story, albeit a bit hyperbolic.

  30. Cormac Lucey Says:

    @ Brian Woods II

    The Irish authorities, as those of a sovereign state, have the power to redenominate our currency and to thus redenominate all liabilities and assets i.e. they would be within their rights, as a sovereign state, to legislate so that your €5,000 deposit with AIB on Friday becomes a IR£Nua5,000 deposit on Monday.

    The question of Irish bonds would be a matter of the governing law of the underlying contract. If the law is that of Ireland, then it could be redenominated by the Irish authorities. If the law is that of London, then Euro liabilities would remain Euro liabilities as changes in Irish law would not stretch to London in their effect.

    I do not advocate our exit from EMU. I am persuaded that the practicality of exiting the Euro, without causing an unstoppable bank run, is close to impossible. And there is the considerable question of what would be the knock-on effects on our relations with the EU. But, while exiting the Euro may not be an attractive policy option for Ireland, others could cause the entire system to break up. It is this latter danger which may be influencing market prices.

    The heading of this discussion is “Irrational Bond Markets.” If there is no prospect of the Euro breaking up or of Ireland exiting the Euro, then it would appear to me that markets are drastically, and possibly irrationally, underpricing Irish bonds. But, if there is such a prospect, then market prices may not be quite so irrational.

  31. simpleton Says:

    The question posed by CMcC is a good one. I would put it slightly differently. Proper investors try to figure out what’s priced into asset valuations and whether or not there is some disagreement with that narrative. If we think that narratibe is wrong we have a mis-priced asset. Does happen, if not as often as we like to think. Investors then have to decide whther the mispricing is likely to be corrected and, if so, on what time scale. Me, I’m happy to take on the equity markets any time – plenty of dumb money driving mis-pricing; plenty of subsequent exploitable mean reversion. Forex markets rarely and briefly mean revert; it’s all dumb money, forever irrational. Bond markets, however, are truly scary: it’s usually wise to listen to what they say, rather than deliver lectures to them.

  32. Brian Woods II Says:

    @Cormac

    By irrational you seem to be fixated that “rational” means mathematically risk neutral i.e. €1 bet on the toss of a coin has the exact same value as €1 kept in your pocket.

    I haven’t made this up, most practitioners state that the market for sovereign bonds is anything but risk neutral at the moment, it is highly risk averse. Even to the point that if the mathematical risk rises to say 50% over 10 years the bond markets won’t touch the stuff at all.

    The topic is “are bond markets irrational?” The bond markets are most definitely not risk neutral. They require far greater odds than even money on the toss of a coin. Is that irrational? No, it is simply not risk neutral. It is perfectly rational, or at least understandable, to be averse to risk and demand a premium over and above its mathematical value.

  33. AMcGrath Says:

    @Brian Lucey, Cormac
    It is surprising to say the least, that this “secret task-force” was undetected and unsuspected on this side of the pond for the last two years.
    Incidentally Cearbhall (above) was in just ahead with the link to that WSJ article. No doubt if there is substance to the claim it should emerge over the next few days

  34. AMcGrath Says:

    @Colm McCarthy
    Speaking of irrational bond markets – what do you make of IMF executive Michael Casey’s claim in Friday Innovation supplement of IT that rge swing to Labour support added at least 100 basis points to the Irish Sov bond yields:

    So far a deafening silence on this in here – is this a widespread perception? Anybody?
    http://www.irishtimes.com/newspaper/innovation/2010/0924/1224279238140.html

  35. tull mcadoo Says:

    AMcGrath

    If truth be told, it was probably the Garglegate & the FG letter to Almunia that added to the spread. The initial reaction was that FG would shortly take power, leading to a default by a nationalised bank on senior debt which was then tantamount to a sovereign default. In addition, Anglo became AIB as the story travelled. Now the truth is way more subtle than that & most people here would not agree with this characterisation.

    Who said “a lie would get round the world before the truth got its boots on”

  36. Joseph Says:

    @AmcGrath – “that rge swing to Labour support added at least 100 basis points to the Irish Sov bond yields”

    Tosh.

  37. colm mccarthy Says:

    Cormac, I am open to correction, but I don’t think we redenominated anything in 1979 since we did’nt introduce a new currency. We simplyabandoned one exchange rate policy (a unilateral no-margins peg to sterling) for a new policy, an adjustable peg to, in effect, the DM. We had to re-denominate in 1999 since we abolished the currency of the state.

  38. tull mcadoo Says:

    @Joseph,

    what Casey meant to say is that the Gnomes of Frankfurt will take one look at Eamonn and shake their heads & SELL. Anybody with some cash left should probably do the same and move their money offshore. Now if only the leader of the Labour part was a true Labour man such as Ruairi Quinn.

  39. Brian Lucey Says:

    Tull
    Yes, lets all blame it on Labour. It makes a change from me, or twitter, or, oh anything apart from the lamentable state of our finances.
    “Who said “a lie would get round the world before the truth got its boots on””
    Sam Vimes?

  40. AMcGrath Says:

    @tull
    To be fair to Casey he doesn’t say he agrees with the perception. On the contrary as the piece makes clear he considers the markets “hysterical”:
    The quote in it’s context:

    “The recent opinion polls have also played a part in Ireland’s high cost of debt. Rating agencies and markets put great store in political factors. The massive swing to Labour probably accounts for up to 100 basis points of the high yields we have to pay. This is the tyrannosaurus rex in the room. Someone should tell the markets the Labour party in Ireland is almost as rightwing as the other main parties. And if they coalesce with Fine Gael, the Government so formed will be well right of centre.

    Whether we like rating agencies or the hysteria-prone markets, we have to live with them. Germany has put forward ideas for clipping their wings but unless the US takes a lead role, nothing much will happen. Markets are enormously powerful nowadays; the sheer weight of money makes them much more influential than the Federal Reserve System or even the US Government. One has the image of spoiled, excitable children equipped with fully loaded automatic weapons. They can cause enormous damage and they ignore regulation because the penalties involved are trivial in relation to their profits. “

  41. Celtic Phoenox Says:

    One question guys, in a situation where over a weekend the Brians decided it best to bring back punts, how would it work with the banks? I mean, would all bank deposits, in all banks operating in the state have to implement such a conversion or could the foreign owned avoid the switch?

  42. tull mcadoo Says:

    @BL,

    I am sorry if I left you out. Ok, it was Kenny’s letter, Cowen’s boozing, Gilmore’s unreconstructed communism, the ADHD sufferers in the bond markets, twitter & your good self. Dan Boyle must be away.

    It is a quote from Churchill according to the internet.

  43. AMcGrath Says:

    @Tull, BL
    Neither – it was Mark Twain (Sam Clemens would also get full marks) Typical Churchill claiming the credit. You can’t believe half the lies he told!

  44. Michael Hennigan - Finfacts Says:

    @ Cormac Lucey

    “Sovereign states can legally determine their own currencies and redenominate assets and liabilities subject to domestic law.”

    Citizens of EU states have a right of appeal to the European Court of Justice and a contract in euros cannot be arbitrarily changed to another currency.

    @CMcC

    The 1999-2007 narrow spreads are now seen as irrational and in July 2007, Irish 10-year yields were below the German bund equivalent.

    As to national accounts, the CSO relies on business surveys for various data streams but how reliable is this given that businesses that can be tracked, generally would regard CSO form filling as a nuisance without a serious sanction? I don’t know if there is a crosscheck with tax data as that is likely to be the best source for business activity data.

    As regards the MNC sector, monthly industrial production data is very volatile — as if the chemical companies cannot provide work-in-progress estimates.

    Tracking IFSC activity must be difficult and changes in tax haven activity can also have an impact.

    When Microsoft has a big product launch like Windows 7, the staff at the law firm Matheson Ormsby Prentice have more numbers to crunch for the Microsoft subsidiary, Round Hall One, which it houses and hey presto, our exports go up.

    The company collects licensing fees from more than 30 EMEA countries on software code that has largely originated in the US and it is one of Ireland’s biggest companies. Before being converted to unlimited status (to keep its financials private) it had gross profit of $9bn in 2004 and assets of $16bn.

  45. Cearbhall O'Dalaigh Says:

    .
    The WSJ has a follow-up to its Friday story.
    .
    ‘Currency Union Teetering, ‘Mr. Euro’ Was Forced to Act’
    .
    http://online.wsj.com/article/SB10001424052748703904304575497871279626904.html?mod=googlenews_wsj

  46. Ribbit Says:

    Another point that regularly seems to get forgotten in the debate on Irish growth is the endogeneity of growth and deficit spending.

    It is neither wise nor possible to find a floor in the Irish recession until we have stabilised the deficit.

    This is because the deficit spending is providing an (unsustainable) stimulus to growth, which has to be factored out before we can realistically assess our ability to pay these bond guys back. (i.e. what is the multiplier on G?)

    As in: Wimpy earns $10 a week and borrows $15 a week.
    He is spending $25 dollars a week on hamburgers.
    He owes $200 but don’t worry keep lending to him, because with his weekly income of $25 he earns back that debt in only 8 weeks…..but only if you keep lending his income to him!

  47. Cormac Lucey Says:

    @ Colm McCarthy

    You are quite right about 1979. We changed exchange rate policy rather than currency.

    @ Michael Hennigan

    I accept that there are many practical and serious objections to Ireland exiting the Euro, including the prospect you raise of citizens litigating to the European Court of Justice.

    But I do not accept that a Eurozone breakup is an utter impossibility.

    Given the likelihood of a weaker Eurozone member precipitating a bank run if it were to contemplate Eurozone exit, I find it hard to see how it would be in the interests of a “weaker” Eurozone member to exit. But that particular concern would not constrain a “stronger” Eurozone member such as Germany.

    According to recent polls, a majority of Germans would rather have the Deutschemark back. And they are unwilling – and currently constitutionally constrained – from turning EMU into a fiscal union.

    So EMU, at best, is likely to remain under severe strain for some years as policy-makers hope that underlying economic growth resumes in weaker peripheral countries thus enabling us (Greece, Ireland and Spain) to cope with our mountains of public and private sector debt.

  48. Brian Woods II Says:

    @Cormac

    “The Irish authorities, as those of a sovereign state, have the power to redenominate our currency and to thus redenominate all liabilities and assets…”

    Cormac, we haven’t got a currency. We owe money in sterling, dollars, euro etc. We can no more redenominate our euro liabilities than we can of any other currency. You seem to be labouring under some illusion that there is an Irish euro with an exchange rate of parity with German, French, Spanish etc. euros.

    Of course the government can do whatever it wishes in redenominating internal contracts/assets/liabilities, but international law states that an external liability denominated in an international currency cannot be redenominated without constituting a default.

  49. Michael Hennigan - Finfacts Says:

    @ Cormac Lucey

    I agree that a Eurozone breakup could happen but given the importance the European project has been to Germany as an anchor of the postwar period and also the economics as an exporter, it will no choose isolationism

    @ Cearbhall O’Dalaigh

    Nothing special here from the WSJ.

    It of course needs to jazz up an almost 5-month story!

  50. Bryan G Says:

    A good article on the international tax dodge known as the “Double Irish” can be found here.

    http://www.bloomberg.com/news/2010-05-13/american-companies-dodge-60-billion-in-taxes-even-tea-party-would-condemn.html

    The money flows from these and similar schemes could both be distorting the GDP/GNP figures and making them more volatile.

    These tax dodges smart financial planning schemes may be on the increase on the basis of some recent promotional advertising from our friends at Matheson, Ormsby Prentice:

    “Ireland has recently taken significant and focused steps to further enhance Ireland’s position as a leading jurisdiction for the development and holding of intellectual property. The scope of Ireland’s exemptions from withholding tax for patent royalties have been expanded. The categories of IP for which tax depreciation can be claimed has been extended. The R&D tax credit has been broadened. Taken together (and in the context of Ireland’s low 12.5% rate of corporation tax), these steps provide further tangible benefits to businesses seeking to develop, exploit or manage IP in Ireland.”

  51. dreaded_estate Says:

    While real GNP/GDP growth is the best measure of growth of an economy. Isn’t nominal growth far more important to Ireland right now.

    Tax revenues and the debt burden are much more closely linked to nominal growth in the economy and at the moment isn’t that what really matters

  52. The Alchemist Says:

    The final ‘bill’ for the banks isn’t on the table yet. It is not irrational in that context to look for an additional premium. The government has played ducks and drakes for so long on the costs that its credibility is on the floor. The news this morning that BoI will loose €36 million on a loan of €42 million again raises questions about the generosity of the discount applied by NAMA.

  53. EWI Says:

    Now if only the leader of the Labour part was a true Labour man such as Ruairi Quinn.

    Brother of Lochlainn. Interesting to see what Tull considers a “true Labour man”.

  54. tull mcadoo Says:

    EWI

    Guilt by association?

  55. Paul Hunt Says:

    There may be reluctance to blow his trumpet too loudly, but Colm has expanded on the original post here:
    http://www.sbpost.ie/commentandanalysis/its-now-time-to-outline-just-how-we-will-cut-the-deficit-51849.html

    There is also an interesting take on the economic literacy (or lack thereof) of politicians which should provoke some comment:
    http://www.sbpost.ie/commentandanalysis/politicians-live-or-die-by-economics-they-dont-even-understand-51852.html

  56. Brian J Goggin Says:

    See also John McManus in today’s IT:

    http://www.irishtimes.com/newspaper/finance/2010/0927/1224279760272.html

    bjg

  57. Hugh Sheehy Says:

    @Colm
    While you may be correct that well-proven volatility in the Irish GNP/GDP quarterly numbers makes conclusive interpretation of the recent set of numbers both impossible and inappropriate, that isn’t necessarily what bond traders are trying to do or able to do.

    Their aim is just as likely to be to update a vague assessment of where the Irish economy may be going (U or W), what other traders will think of Ireland, and to imagine where the perceptual dynamics might lead.

    In addition, just because you’ve done the work to prove that Irish stats are notoriously volatile doesn’t mean that they have read it or understood it, or even that they’d care if they had read it and understood it. They’d also have to assume that other traders had read and understood it…..which they probably know isn’t the case.

    Business people – if you’ll allow me to call bond traders that – often have no choice other than to act on data that they intellectually understand isn’t dependable, or where the appearance of a trend has to be acted on even though they know very well that it may be an illusion. Sometimes brave managers (or traders) can evade this problem by setting out a longer vision of what’s happening, but often they can’t. Sad, but true.

    Oh, and if managers or traders defy the apparent trend then they’d better be right almost every time. People don’t get fired for buying IBM, but they do get fired for defying an apparent trend and being wrong.

  58. Enda F Says:

    BNP actually sent out a piece last week confirming Colm Mc Carthy’s stance. They said that while the numbers looking disappointing, the volatility in Irish GNP/GDP numbers made looking at the numbers in isolation made little sense. They used average numbers and saw growth in GDP and the lowest contraction in GNP in over two years so were moderately postitive on the figures with the usual caveat that we are exposed to global growth.

  59. Cormac Lucey Says:

    @ Brian Woods II

    I suggest that you read the chapter in Mann’s “Legal Aspects of Money” (OUP) on the legal implications of a breakup of the Eurozone. The library in TCD has a copy as that is the edition which the library of Chartered Accountants Ireland borowed for me to consult.

    Or you can pay Amazon > £200
    http://www.amazon.co.uk/Legal-Aspect-Money-Charles-Proctor/dp/0198260555/ref=sr_1_1?ie=UTF8&s=books&qid=1285517102&sr=8-1

    My comments on the Irish government’s authority to designate its own currency – and to redenominate domestic contracts into that currency – are based on a close reading of that chapter.

    Fears of an ultimate Eurozone breakup would fit the recent pattern of price movements in bond markets where Irish and Portugese bonds yields have kept pace with each other but have shot up relative to German bond yields.

    If I thought current bond yields were, as the title of the post suggests, “irrational” then I would trade against that irrationality. But I am not so sure.

  60. Bond. Eoin Bond... Says:

    @ Cormac

    i think all everyone has to do to avoid the re-denomination would be to put their money into National Irish Bank, Nationwide UK, or RaboDirect – all of these would legally not be “Irish” and so would remain as Euro. As soon as word got out about a potential redenomination everyone would simply shovel their money in there.

  61. Hugh Sheehy Says:

    @Eoin
    IIRC there was a discussion previously and someone had checked and discovered that RaboDirect, etc., would not be shelters from a redenomination.

  62. Bond. Eoin Bond... Says:

    @ Hugh

    really? Oh, i thought i had heard differently. I thought that if the institution was a full branch of the foreign entity, rather than just a subsidiary, than technically in terms of the balance sheet your deposit is actually housed in the foreign entity’s main domicile. This is why, amongst other things, those banks are regulated by their home regulator and not the Irish one?

  63. EWI Says:

    @ tull mcadoo

    Guilt by association?

    This from the person who just informed us that Gilmore is an “unreconstructed communist”?

    Zounds.

  64. hoganmahew Says:

    @Eoin
    “eally? Oh, i thought i had heard differently. I thought that if the institution was a full branch of the foreign entity, rather than just a subsidiary, than technically in terms of the balance sheet your deposit is actually housed in the foreign entity’s main domicile. This is why, amongst other things, those banks are regulated by their home regulator and not the Irish one?”
    It’s not what the banks themselves are saying.

    They’re all regulated as deposit-taking financial institutions by the Irish Central Bank. Some of them have signed up to the Irish deposit scheme, some not.

    The word from Rabo Ireland is that they would have to consider the position in the event of a mandatory currency changeover and won’t prejudge (or give any guarantees) until then. Some of the other banks were equally non-commital.

    Let’s just tap our ruby slippers together and hope it doesn’t come to that, eh? Cheer up, there’s reason to be optimistic. The Tanaiste is off to see the wizard and this time, she doesn’t have that annoying hairy terrier in tow…

  65. tomc Says:

    @ cormac

    portugal + irish bond yields are breaking away from the ”core periphery” of italy and spain. eur now much higher against the usd than when we last had the may/june ”euro crisis”. i would suggest that this is pricing a much lower chance of a euro break up. what it really suggests is that the market expects that portugal and ireland are at much higher risk of needing multi lateral support over the next 12-18 months than a spain or an italy. the death of the euro is over exagerated. still think we need a thread on what a likely ersf/imf funding programme would looklike for ireland. it could shape the political and economic landscape for a long time to come.

  66. JohnTheOptimist Says:

    @Colm McCarthy

    Whatever your figure was on Wednesday, there was no good reason for changing it on Thursday morning.

    JTO again:

    I agree. But, I would go further and say:

    Whatever your figure was on Thursday, there was good reason for revising it UP on Friday morning.

    What happened on Friday morning was that the July trade figures were published. These confirmed that growth in the volume of exports in 2010 is likely to be much higher than either the Central Bank or ESRI have forecast to date (as I predicted in a post here in early July). I hope that both these organisations will produce more realistic forecasts for export growth in 2010 in their next quarterly bulletins. The July trade figures also highlighted the extreme volatility in Ireland of the net exports/imports volume ratio, which is the key determinant of quarterly fluctuations in GDP about their trend (I look at this further below).

    In their summer 2009 bulletins, the Central Bank forecast that the volume of exports would fall by -1.3% in 2010, while ESRI forecast that the volume of exports would fall by -1.4% in 2010. I rubbished these forecasts here at the time. By their summer 2010 bulletins, the Central Bank had revised its forecast to a +3.3% rise in the volume of exports in 2010, while ESRI had revised its forecast to a +5.0% rise in the volume of exports in 2010. Again, I said at the time that these forecasts were far too low, and I predicted a +8% to +10% rise in the volume of exports in 2010. Its beginning to look as though I was too pessimistic.

    Look at exports in the first half of 2010:

    in 2010 Q1, UP by 6.1% on 2009 Q1
    in 2010 Q2, UP by 7.4% on 2009 Q2

    combining these:

    in 2010 H1, UP by 6.7% on 2009 H1

    So, not only is exports volume growth above forecasts, it is accelerating.

    The July trade figures showed it accelerating further.

    Add in:

    The volume of exports fell in the second half of 2009, compared with the first half of 2009 – so, even if the volume of exports in the second half of 2010 shows no rise on the first half of 2010, the full-year rise in 2010 over 2009 will be +7.2%.

    But, the July trade figures published on Friday showed the volume of merchandise exports in July almost 6% higher seasonally-adjusted than the average for the first half of 2010. So, just on that account alone, the full-year rise will be a lot higher than +7.2%.

    Add in:

    The number of foreign tourist arrivals was extremely depressed in the first half of 2010, due to the arctic weather last winter and the volcanic ash cloud in April and May. Media reports suggest a large rebound in the second half of 2010 and, although the CSO figures lag a few months behind, their figures for June seem to support this.

    So, I think we are looking at a rise in the volume of exports in 2010 at 10% minimum. If the July tend in merchandise exports is maintained, it could reach 12%. At any rate, far above the 3.3% forcast by the Central Bank and the 5% forecast by ESRI in July 2010 (which in turn were massive upward revisions to their forecasts for 2010 made the previous July).

    Going back to the Q2 GDP figures, these showed domestic demand rising for the first time since 2007 (mainly higher investment). Even if it doesn’t rise further in Q3 and Q4, the full year fall in 2010 over 2009 will be -4.3%.

    In July 2010, the Central Bank forecast that GDP would rise by +0.8% in 2010, on the back of a fall of -4.3% in domestic demand and a rise of +3.3% in the volume of exports. It looks as though their forecast for domestic demand will be very accurate, but their forecast for the rise in the volume of exports is way out. As I showed above, a rise in the region of 10% to 12% is now more likely.

    So, if the fall in domestic demand is much as the Central Bank forecast in July (even if the Q2 rise proves a one-off and there is no further rise in Q3 and Q4), and if the rise in the volume of exports is turning out to be 3 to 4 times what they forecast in July, then by any yardstick they ought to be revising UP their forecast of GDP growth in 2010 from the +0.8% rise that they forecast then.

    How does all this tally with the GDP fall in Q2?

    It is quite a mouthful, but the explanation lies in the following: the extreme and random volatility in Ireland of the net exports/imports volume ratio.

    Ireland has an exceptionally open economy. Exports and imports are both the size of GDP. For each 1% by which export growth exceeds import growth in any quarter, GDP growth is increased by 1% from what would be indicated by domestic activity. For each 1% by which import growth exceeds export growth in any quarter, GDP growth is decreased by 1% from what would be indicated by domestic activity. Other countries don’t have anything like this volatility, because their exports and imports are much smaller as a percentage of GDP.

    Consider the 2010 Q1 and Q2 GDP figures for Ireland:

    in Q1, domestic demand fell by -2.8%, but GDP rose by +2.2%, because the +7.1% rise in exports, combined with the +3.7% rise in imports, meant that the net exports/imports volume ratio rose by +3.3%

    in Q2, domestic demand rose by +1.5%, but GDP fell by -1.2%, because the +1.6% rise in exports, combined with the +4.5% rise in imports, meant that the net exports/imports volume ratio fell by -2.8%

    So, economic activity on the ground in Ireland was significantly higher in Q2 than in Q1, but GDP fell because of the fall in the net exports/imports volume ratio.

    I’m not suggesting that there is anything wrong at all with the GDP figures that the CSO published. GDP did rise in Q1 and fall in Q2, even though domestic demand did the reverse in both quarters. I’m certainly not criticising the CSO as some have. They report what happens and the fall in the the net exports/imports volume ratio has to be taken into account when calculating GDP. So, the GDP figures reported by the CSO are correct. Rather, I’m saying that, because of the extreme and random volatility in Ireland of the net exports/imports volume ratio. the Q2 GDP figures were freakishly bad, and the Q3 GDP figures will be freakishly good.

    Of course, if the Q2 trend was to be a permanent feature of the economy, it would be bad news. If every rise in GDP was accompanied by a much larger rise in imports than in exports, then that would be consistent with stagnant or falling GDP. But, that isn’t what is happening. We can see this by looking at the merchandise trade volume figures, which are available up to July, and so beyond Q2. They give the first indication as to what will happen in Q3.

    These are the merchandise export and import volume figures from Oct 2009 to July 2010 (indices to base 1990 = 100.0):

    Oct 2009: exp: 440.9 , imp: 231.1
    Nov 2009: exp: 444.7 , imp: 247.6
    Dec 2009: exp: 413.4 , imp: 232.9
    Jan 2010: exp: 486.7 , imp: 229.7
    Feb 2010: exp: 456.4 , imp: 229.8
    Mar 2010: exp: 452.8 , imp: 252.1
    Apr 2010: exp: 458.9 , imp: 275.3
    May 2010: exp: 475.8 , imp: 237.9
    Jun 2010: exp: 455.1 , imp: 256.5
    Jul 2010: exp: 491.9 , imp: 233.6

    To make any sense of the figures, re-calculate the 3-month moving averages and rebase to 2009 Q4 =100.0:

    Oct 2009-Dec 2009: exp: 100.0 , imp: 100.0 (2009 Q4)
    Nov 2009-Jan 2010: exp: 103.5 , imp: 99.8
    Dec 2009-Feb 2010: exp: 104.4 , imp: 97.3
    Jan 2010-Mar 2010: exp: 107.5 , imp: 100.0 (2010 Q1)
    Feb 2010-Apr 2010: exp: 105.3 , imp: 106.4
    Mar 2010-May 2010: exp: 106.8 , imp: 107.5
    Apr 2010-Jun 2010: exp: 107.0 , imp: 108.2 (2010 Q2)
    May 2010-Jul 2010: exp: 109.5 , imp: 102.3

    Next, calculate the net exports/imports volume ratios:

    Oct 2009-Dec 2009: 100.0 (2009 Q4)
    Nov 2009-Jan 2010: 103.7
    Dec 2009-Feb 2010: 107.3
    Jan 2010-Mar 2010: 107.5 (2010 Q1)
    Feb 2010-Apr 2010: 99.0
    Mar 2010-May 2010: 99.3
    Apr 2010-Jun 2010: 98.9 (2010 Q2)
    May 2010-Jul 2010: 107.0

    These figures are for merchandise exports only. The GDP figures include services exports. But, they follow the same trend and show clearly what has been happening to the GDP figures. The net exports/imports volume ratio rose from 100.0 in 2009 Q4 to 107.5 in 2010 Q2, but fell back to 98.9 in 2010 Q2. The reason was the very large rise in merchandise imports in April, combined with no increase in exports, on top of a similar combination in March. This depressed the net exports/imports volume ratio for any 3-month period in which April occurs (clear from the above tables). Once April drops out of the 3-month period, the net exports/imports volume ratio goes back up again. So, it was back up to 107.0 in May-July.

    What does all this mean?

    (a) there is clearly a large element of random volatility in the monthly net exports/imports volume ratio

    (b) if GDP was measured for each 3-month period, rather than just Q1, Q2, Q3 and Q4 (this does happen in a few countries), GDP would have shown a large increase between Feb-Apr and May-July, because the net exports/imports volume ratio rose from 99.0 to 107.0 between those teo periods, and this would have overwhelmed any small change in domestic demand likely to have occured between those two periods (indeed, its quite likely that any change in domestic demand would have been positive)

    (c) barring a collapse in the the net exports/imports volume ratio in August and September, it is likely to be much higher for Q3 than for Q2, resulting in a freakishly good GDP growth rate in Q3

    The above analysis only deals with merchandise exports and imports because monthly figures are not published for services exports and imports. But, merchandise are a sufficiently large proportion of total exports and imports for the above analysis to hold.

    There is an additional factor relating to services imports to complicate matters still further. No less than two-thirds of the total rise in imports in Q2 was due to a rise in royalty payments, which counts as a service import. This rise was out of line with all previous quarters and on its own knocked almost 3% off GDP in Q2 through its effect on the net exports/imports volume ratio. Minister Lenihan has called this a ‘spike’ and said it would not be repeated in Q3. As I know nothing about this matter, I have no idea if his forecast will prove correct. If it does, there will be a double boost to the net exports/imports volume ratio in Q3: the one resulting from the rise in the net exports/imports volume ratio for merchandise trade that I described above and the one resulting from the spike in royalty payments coming out of the accounts, as Minister Lenihan has predicted. If both these occur, there will almost certainly be a very large, although mostly freakish, rise in GDP in Q3. Even if Minister Lenihan is talking nonsense, and the spike in royalty payments does not come out of the accounts in Q3, the rise in the net exports/imports volume ratio for merchandise trade should result in GDP growth similar to or larger than that which occurred in Q1 (as, unlike Q1, it is unlikely that domestic demand will fall in Q3).

  67. JohnTheOptimist Says:

    Oops, an error in my post – should have said:

    If every rise in domestic demand was accompanied by a much larger rise in imports than in exports, then that would be consistent with stagnant or falling GDP.

  68. JohnTheOptimist Says:

    Oops, yet another error – should have said:

    The net exports/imports volume ratio rose from 100.0 in 2009 Q4 to 107.5 in 2010 Q1, but fell back to 98.9 in 2010 Q2.

  69. Joseph Says:

    @JtO – even for you, that was a long post. Didn’t get to the end of it.

    Is it true that what really spooked the markets about Ireland was that Bertie had said some time ago that he wouldn’t draw his pension while still sitting in the Dail…. but figures released recently show that he has been drawing it? They have to send it round in a Seuricor van it’s draing the public finances that badly.

    All those public sector pensions….. they’re going to have to stop you know.

  70. Ray Says:

    @JTO

    The improvement in farm output and prices particularly in milk and grain will feed into the third quarter accounts which should have an impact on GNP and to a lesser extent GDP in exports. You only need to have visited the Ploughing Championships in Athy last week to realise how much there is a good feeling in farming and the farmers are spending on new machinery again and if we can believe it AIB were lending to farmers. The GNP of Ballsbridge next saturday should rise significantly when Munster Rugby comes to town.

  71. Sporthog Says:

    @ Joesph,

    It would be fairer to distinguish between the Upper and Lower civil service when mentioning pensions.

  72. EWI Says:

    It would be fairer to distinguish between the Upper and Lower civil service when mentioning pensions.

    Not to mention the “upper, upper” rarefied world of the McCreevey’s and Sutherlands of this world.

  73. Pat Donnelly Says:

    rIBBIT

    a VERY SANE RESPONSE!

    Not likely to be taken seriously, though.

  74. Eamonn Moran Says:

    A few people here have theories on why the price of bonds have been shooting up on various days. Labour going up in the polls, Fine Geal might default on anglo debt etc.But what about the reports of Hedge funds shorting Irish Bonds in the Indo on Monday. Is this not the most likely reason for the large daily fluctuations?

  75. Enda F Says:

    Oh great, time to blame those damn hedge funds and short sellers again.

  76. Eamonn Moran Says:

    @ Enda
    I am just asking the question because I saw the story in both the Indo and the Belfast Telegraph.
    I also see the EU are planning legistlation in this area so maybe they are making hay before the sun goes down
    BTW 10year has shot up again this morning towards 6.8%
    Personally I blame the moons gravitational pull on this latest jump.

  77. Enda F Says:

    @Eamonn

    I wasn’t having a go. There is just no evidence to suggest that shorting through the CDS market is a major problem. There never was even at the height of the crisis.
    Whatever about the 10 year, the short end of the curve also spiked this morning which is more worrysome. S&P opened their big mouths again saying their €35 billion cost of Anglo could be exceeded. Why they couldn’t wait before Lenihan made his statement on Thursday is beyond me. Ireland and Portugal are now in serious trouble. The problem is the banks can’t go to market until we see a big change in sentiment towards Ireland. Thursday is make or break day. If Lenihan doesn’t convince the markets, it could be all over. At this stage, I would bring some budget announcements forward as well.

  78. Eoin Says:

    @ Enda

    whats truly bizarre is that those S&P comments were actually made around 10 days ago, and they’re really angry at the way RTE released them into the market this morning as some sort of ‘breaking news’ announcement from S&P. Domestic media here needs to understand that they need to be careful about how they release these sort of comments so close to the Anglo announcements.

  79. Enda F Says:

    @Eoin

    I didn’t realise that! It was picked up by the newswires.

  80. Eoin Says:

    @ Enda

    i know. Its actually unbelievable the way the comments were put out, as if it was a live interview with the S&P analyst this morning. The comments are part of an interview forming a larger Primetime show tonight on (i assume) the whole Anglo bailout. S&P have obviously been getting a lot of grief about it today.

  81. Enda F Says:

    I see RTE have changed the story to say that the S&P analyst will make the comment on Prime Time tonight. So he is basically just rehashing what they said in their last analysis piece. Shocking journalism.
    Strange that a S&P analyst is willing to go on Prime Time on such a politically sensitive subject I have to say.

  82. Enda F Says:

    Now Fitch are at it according to Reuters.

  83. Eamonn Moran Says:

    @Enda
    “There is just no evidence to suggest that shorting through the CDS market is a major problem. There never was even at the height of the crisis.”

    Unless the following report is wrong from the Belfast telegraph then isn’t this report evidence that Shorting through CDS bets is a major problem?

    “Wall Street hedge funds are thought to be leading the campaign to “short sell” Irish government bonds, making vast profits in the process.

    US hedge funds Groveland Capital and Corrientes Advisors are thought to have taken major positions against Irish debt. Giant €60bn asset-manager Pictet also revealed that it had earlier bet against Irish government bonds. JP Morgan is also thought to have taken a bearish position on Irish debt.

    The International Monetary Fund estimated that up to €3bn of Ireland’s debt was being targeted by speculators through the uses of derivatives.

    This practice is likely to have increased in recent weeks over growing fears that Ireland may default on some of the Anglo debts.”

    And if the hedge funds are making huge profits who are making the losses?

  84. podubhlain Says:

    Is it time to look at the suggestion of Eoin that we buy back some bonds. The NPRF could get a yield to maturity of 6.72 as of now. A better return than they have managed since inception. The volume appeared thin yesterday with only 5.65m of 5%10yr and 65m of the 4.5% so a buyback programme could have an effect on yields before we go over the cliff.

  85. Eoin Says:

    @ podubhlain

    you’d have a funding issue which would constrain the total amount the NPRF could do – but it’d work much better for either the Irish banks (funded via ecb repo) or the EFSF (440bn warchest to do it).

    In theory you could turn the NPRF into a massive new SIV, using the 25bn as the equity stake, and use private bank repo….but even i think that’d be a step too far!!

  86. David O'Donnell Says:

    @Eoin

    Worth keeping all options open – even your massive SIV, …. bring in a few more, turn around, and take on the global (-;

  87. podubhlain Says:

    @Eoin
    I was not suggesting a massive operation- say 3b – the amount allegedly in play by the hedge funds would do wonders if executed properly. considering the daily volume it should be possible. The bans as you say could repo these at the ECB and it remains a mystery why they are not visibly in the market.
    BTW RTE reporting 6.95% this evening but this is at variance with Bloomberg at 6.726%. If we let it drift over 7% we are toast.

  88. Enda f Says:

    The problem is no longer government debt. We don’t need to issue till next year. Problem is the banks. They need to get to Market to prove they are open. If sentiment does not change after Thursday, I don’t think we will have option but to tap the EU stability fund. We are fast running out of time and options. Still 300,000 jobs in the next 5 years is good news!

  89. Brian Lucey Says:

    The yield difference may be down to bberg giving trade prices and Rte whom I know have Reuters using closing bids.

  90. podubhlain Says:

    @Brian Lucey
    thanks. that explains it.

    @Enda F
    If we (the sovereign) are at 6.9% this evening then we are effectively shut out of the market. Likewise the banks. With AIB at 50 cent I cannot see a right issue taking off for them – but it might be good for the State converting those prefs

  91. tomc Says:

    ok. so from whats i’ve heard, a pretty big short base is building in irish govt bonds and anglo and aib senior bonds. not sure what we get on thursday but i reckon whatever number or statement comes out, we get a sharp reversal in spreads. i’ve heard stuff over the last 2 days that suggests the famous smart hot money actually believes the confused and clueless spin in the irish media. we have issues, big issues but they will not be crystalised or accelerated this week or this year.

  92. Bryan G Says:

    @Eamonn M

    And if the hedge funds are making huge profits who are making the losses?

    My understanding is that CDS trades are a zero-sum game – for every short position there is a corresponding long position, so presumably there are other hedge funds or investment banks on the other side of the trades.

    My model is that it is like a group of people betting between themselves on what the weather will be like tomorrow. The fact that people are making bets does not cause the weather to get better or worse. Maybe this model is overly simplistic or plain wrong (and I would be happy to be corrected), but wheeling out the “evil foreign hedge fund managers are the cause of the problem” line seems a bit like the last refuge of the desperate. I’m also not sure why those who short are always more vilified than those who sell – in both cases there’s a view that the outlook is negative.

  93. Niall Says:

    Haven’t we being here before blaming the short sellers.

    If I remember correctly wasn’t it short sellers who forced down Anglo’s share price.

    At that stage we shot the messenger (i.e. banned short selling) rather than asking why were they short selling.

    The answer was that the bank was insolvent and therefore not suitable for a guarantee to help overcome ‘temporary’ liquidity issues.

    Correct me if I’ve got this in the wrong order (timewise).

  94. AMcGrath Says:

    @Bryan G
    “My model is that it is like a group of people betting between themselves on what the weather will be like tomorrow. The fact that people are making bets does not cause the weather to get better or worse.”

    WolfGang Munchau argued for banning “naked” CDS thus:

    “A naked CDS purchase means that you take out insurance on bonds without actually owning them. It is a purely speculative gamble. There is not one social or economic benefit. Even hardened speculators agree on this point. Especially because naked CDSs constitute a large part of all CDS transactions, the case for banning them is about as a strong as that for banning bank robberies.”

    To my mind the speculative aspect of CDS is not the real problem – the problem is the opportunity for mischief for unscrupulous financial institutions. If the instititutions is in the postition where it can influence both sides then (although they like to claim chinese walls are erected) they can actually help precipitate the disatster which they seek to make money from – sometimes even getting paid by the victim for advice.

    The most striking description I have seen is comparing it to allowing multiple arsonists to buy fire insurance on your house.

    At the risk of offending some posters in here – the Greek crisis is a possible example.
    http://www.thefirstpost.co.uk/59812,business,greek-crisis-investors-fooled-by-goldman-sachs

  95. Niall Says:

    Can we identify a difference then between CDSs and Short sellers?

    And can we say that short sellers have a neutral effect on price – i.e. in every contract there must be a short seller matched to a long buyer? The only thing that could drive the price is if the unmatched volume is know.

    CDS are flawed instruments, I can’t but insurance on someone’s house but I can insure a bond that I don’t own.

  96. AMcGrath Says:

    @Niall
    Not an expert – but earlier you mentioned that short sellers were being blamed for forcing down Anglos share price. True and later the Gov banned short selling of bank shares. That was definitely an overreaction and probably caused problems rather than solved them. Normal short selling of shares as I understand it can not drive down the price of a companys shares. It will be the underlying value of the company which will eventually cause the share price to fall. There is though something called “naked short selling” where the shares are sold short without first borrowing them. I don’t know if this type of transaction is possible for small traders but I believe it can be difficult to detect and may because of the sheer volume cause problems like driving down the share price. For this reason it is illegal in the US and othe countries. Maybe they suspected something like this was going on,
    But as I say – I am no expert but I am sure you will find lots of info online

Leave a Reply