Western Big Shots are ‘officially’ $7.6 Trillion in Debt

by Keith Jenkins
Bloomberg
January 3, 2012

Governments of the world’s leading economies have more than $7.6 trillion of debt maturing this year, with most facing a rise in borrowing costs.

Led by Japan’s $3 trillion and the U.S.’s $2.8 trillion, the amount coming due for the Group of Seven nations and Brazil, Russia, India and China is up from $7.4 trillion at this time last year, according to data compiled by Bloomberg. Ten-year bond yields will be higher by year-end for at least seven of the countries, forecasts show.

Investors may demand higher compensation to lend to countries that struggle to finance increasing debt burdens as the global economy slows, surveys show. The International Monetary Fund cut its forecast for growth this year to 4 percent from a prior estimate of 4.5 percent as Europe’s debt crisis spreads, the U.S. struggles to reduce a budget deficit exceeding $1 trillion and China’s property market cools.

“The weight of supply may be a concern,” Stuart Thomson, a money manager in Glasgow at Ignis Asset Management Ltd., which oversees $121 billion, said in a Dec. 28 telephone interview. “Rather than the start of the year being the problem, it’s the middle part of the year that becomes the problem. That’s when we see the slowdown in the global economy having its biggest impact.”

Competition for Buyers

The amount needing to be refinanced rises to more than $8 trillion when interest payments are included. Coming after a year in which Standard & Poor’s cut the U.S.’s rating to AA+ from AAA and put 15 European nations on notice for possible downgrades, the competition to find buyers is heating up.

“It is a big number and obviously because many governments are still in a deficit situation the debt continues to accumulate and that’s one of the biggest problems,” Elwin de Groot, an economist at Rabobank Nederland in Utrecht, Netherlands, part of the world’s biggest agricultural lender, said in an interview on Dec. 27.

While most of the world’s biggest debtors had little trouble financing their debt load in 2011, with Bank of America Merrill Lynch’s Global Sovereign Broad Market Plus Index gaining 6.1 percent, the most since 2008, that may change.

Italy auctioned 7 billion euros ($9.1 billion) of debt on Dec. 29, less than the 8.5 billion euros targeted. With an economy sinking into its fourth recession since 2001, Prime Minister Mario Monti’s government must refinance about $428 billion of securities coming due this year, the third-most, with another $70 billion in interest payments, data compiled by Bloomberg show.

Rising Costs

Borrowing costs for G-7 nations will rise as much as 39 percent in 2011, based on forecasts of 10-year government bond yields by economists and strategists surveyed by Bloomberg in separate surveys. China’s 10-year yields may remain little changed, while India’s are projected to fall to 8.02 percent from about 8.39 percent. The survey doesn’t include estimates for Russia and Brazil.

After Italy, France has the most amount of debt coming due, at $367 billion, followed by Germany at $285 billion. Canada has $221 billion, while Brazil has $169 billion, the U.K. has $165 billion, China (PRCH) has $121 billion and India $57 billion. Russia has the least maturing, or $13 billion.

Rising borrowing costs forced Greece, Portugal and Ireland to seek bailouts from the European Union and IMF. Italy’s 10- year yields exceeded 7 percent last month, a level that preceded the request for aid from those three nations.

Bad Combination

“The buyer base for peripheral Europe has obviously shrunk at the same time that the supply coming to the market is increasing, which is not a good combination,” said Michael Riddell, a London-based fund manager at M&G Investments, which oversees about $323 billion.

The two biggest debtors, Japan and the U.S., have shown little trouble attracting demand.

Japan benefits by having a surplus in its current account, which is the broadest measure of trade and means that the nation doesn’t need to rely on foreign investors to finance its budget deficits. The U.S. benefits from the dollar’s role as the world’s primary reserve currency.

Japan’s 10-year bond yields, at less than 1 percent, are the second-lowest in the world, after Switzerland, even though its debt is about twice the size of its economy.

The U.S. attracted $3.04 for each dollar of the $2.135 trillion in notes and bonds sold last year, the most since the government began releasing the data in 1992. The U.S. drew an all-time high bid-to-cover ratio of 9.07 for $30 billion of four-week bills it auctioned on Dec. 20 even though they pay zero percent interest.

Tougher Year

With yields on 10-year Treasuries (USGG10YR) below 2 percent, an increasing number of investors see little chance for U.S. bonds to repeat last year’s gains of 9.79 percent. The U.S pays an average interest rate of about 2.18 percent on its outstanding debt, down from 2.51 percent in 2009, Bloomberg data show.

‘Given how well they have done, we don’t think they’re any longer a very good hedge,” Eric Pellicciaro, head of global rates investment at New York-based BlackRock Inc., which manages $1.14 trillion in fixed-income assets, said in a Dec. 16 telephone interview.

The median estimate of 70 economists and strategists is for Treasury 10-year note yields to rise to 2.60 percent by year-end from 1.94 percent at 10:03 a.m. London time. In Japan, the forecast for the nation’s benchmark note yield is 1.35 percent, while it’s expected to rise to 2.50 percent in Germany, from 1.93 percent today.

Central Banks

Central banks are bolstering demand by either keeping interest rates at record lows or reducing them, and by purchasing bonds through a policy know as quantitative easing.

The Federal Reserve has said it will keep its target rate for overnight loans between banks between zero and 0.25 percent through mid-2013, and is now selling $400 billion of its short- term Treasuries and reinvesting the proceeds into longer-term government debt in a program traders dubbed Operation Twist.

The Bank of Japan has kept its key rate at or below 0.5 percent since 1995, and expanded the asset-purchase program last year to 20 trillion yen ($260 billion). The Bank of England kept its main rate at a record low 0.5 percent last month, and left its asset-buying target at 275 billion pounds ($426 billion).

The European Central Bank reduced its main refinancing rate twice last quarter, to 1 percent from 1.5 percent. It followed those moves by allotting 489 billion euros of three-year loans to euro-region lenders. That exceeded the median estimate of 293 billion euros in a Bloomberg News survey of economists. The central bank will offer a second three-year loan on Feb. 28.

‘Flush With Liquidity’

The money from the ECB may be used by banks to buy government bonds, according to Fabrizio Fiorini, the chief investment officer at Aletti Gestielle SGR SpA in Milan.

“The market is now flush with liquidity after measures taken by central banks, particularly the ECB, and that’s great news for risky assets,” Fiorini said in a telephone interview on Dec. 20. “The market will have no problem taking down supply from countries like Spain and Italy in the first quarter. In fact, they should be able to raise money at lower borrowing costs than what we saw in recent months.”

Italy’s sale last week included 2.5 billion euros of 5 percent bond due in March 2022, which yielded 6.98 percent. That was down from 7.56 percent at an auction Nov. 29. It also sold 9 billion euros of bills on Dec. 28 at a rate of 3.251 percent, compared with 6.504 percent at the previous auction on Nov. 25.

‘Phony War’

Investors should be most worried about the period after the ECB’s second three-year longer-term refinancing operation scheduled in February, according to Ignis’s Thomson.

“The amount of liquidity that has been supplied by central banks, with more to come from the ECB in February, suggests the first couple of months will be a sort of phony war as far as the supply is concerned,” Thomson said.

The ECB has bought about 212 billion euros of government bonds since starting a program in May 2010 to contain borrowing costs for Greece, Portugal and Ireland. It began buying Spanish and Italian debt in August, according to people familiar with the trades, who declined to be identified because they weren’t authorized to speak publicly about the transactions.

“There’s a lot of talk that the ECB might have to give more direct support to the governments,” Frances Hudson, who helps manage about $242 billion as a global strategist at Standard Life Investments in Edinburgh, said in a Dec. 22 telephone interview.

Following is a table of bond and bill redemptions and interest payments in 2012 for the Group of Seven countries, Brazil, China, India and Russia, in dollars, using data calculated by Bloomberg as of Dec. 29:

Country    2012 Bond, Bill Redemptions ($)      Coupon Payments
Japan             3,000 billion                   117 billion
U.S.              2,783 billion                   212 billion
Italy               428 billion                    72 billion
France              367 billion                    54 billion
Germany             285 billion                    45 billion
Canada              221 billion                    14 billion
Brazil              169 billion                    31 billion
U.K.                165 billion                    67 billion
China               121 billion                    41 billion
India                57 billion                    39 billion
Russia               13 billion                     9 billion


Hijacking the Stock Market with High Frequency Trading

FT

At an industrial estate on the edge of Tseung Kwan O, a new town connected by road tunnel to Kowloon, work has started on a data centre where traders of stocks, futures, options and currencies will place their computers next to Hong Kong Exchanges’ own systems.

The idea is that by having their equipment only metres away from where the operator of the territory’s securities markets handles the trades, those for whom speed is everything can shave milliseconds off the time it takes for a transaction to be completed. It is a far cry from the days when shares were bought and sold by humans on a trading floor.

The concept – known as co-location – is growing fast. Last week, NYSE Euronext completed the move of trading in thousands of New York Stock Exchange-listed companies to a similar data centre in New Jersey. The Hong Kong facility is being built by the local exchange as one of its “strategic business initiatives”. The same is happening in India, where the National Stock Exchange has rented out racks of computer space for traders. In Australia, ASX plans a centre offering co-location by next August.

The speed with which exchanges are building such facilities is a sign of the global spread of a phenomenon gripping the markets: “high-frequency trading” (HFT). The phrase describes a style of electronic dealing that uses algorithms to dip automatically in and out of markets hundreds of times faster than the blink of a human eye.

The practice is controversial. In the US, HFT has chilling associations with the “flash crash” of May 6, when rapid, computer-driven orders were seen as a main culprit in sending the Dow Jones Industrial Average down by 1,000 points in 20 minutes – a fall unprecedented in its depth and speed.

Ted Kaufman, a US senator for Delaware, where many of America’s listed companies are incorporated, wrote to the Securities and Exchange Commission last month arguing that “excessive messaging traffic, the dissemination of proprietary market data catering to high-frequency traders, and order-routing inducements all may be combining in ways that cast doubts on the depth of liquidity, stability, transparency and fairness of our equity markets”.

Regulators such as the SEC are still puzzling over exactly what caused the flash crash. But what is clear is that it exposed fundamental flaws in the mechanics of today’s markets – and, some maintain, in the rules that govern them. High-frequency traders are by and large privately held, have no clients and trade using their own money. That has led, some believe, to a point where there has been a dangerous breakdown in investor trust in the way markets work.

Christian Thwaites, chief executive of Sentinel Investment Companies, a US asset manager, says: “The mystery and mystique of HFT, the lack of clarity and therefore opacity has meant that retail investors – who have obviously been terribly burned over the last few years – look at this and say: ‘this whole Wall Street thing is just rigged against me’.”

But like an invasive species in the natural world, HFT had grown rapidly before the wider public even noticed. Tabb Group, a consultancy, estimates that HFT now accounts for 56 per cent of all equity trades in the US and 38 per cent by value in Europe. Another sign that Asia is the latest growth spot came this week as traders and technology companies gathered for a Hong Kong conference billed as Asia’s first high-frequency trading event.

At the same time, changing regulations and increasing competition have created a complex matrix in the US of nine exchanges and dozens of other types of venue, including networks run by banks and brokers, and “dark pools” set up to handle large blocks of shares away from public markets. Exchanges now compete not only with each other for their order flow but also with bank and broker networks, including dark pools.

In Europe the same pattern has played out thanks to the Markets in Financial Instruments Directive, a European Commission regulation that broke the national monopolies of exchanges. Mifid allowed the emergence of rival platforms such as Chi-X Europe, fragmenting trading across many venues: the London Stock Exchange now accounts for only 55 per cent of trading in the stocks that comprise the FTSE 100 index.

Such fragmentation has been a driving force behind the growth of HFT, since it produces a variety of trading venues each with slightly different trading systems, speeds and fee schedules. This allows traders to exploit these differences by using computer algorithms to trade back and forth from one platform to another.

Concern is therefore growing that the markets may be morphing into little more than a playground for a specialised type of trading that has minimal economic benefit and contributes little if anything to capital formation – the traditional function of stock exchanges.

Established market users – such as the asset managers that take care of pension funds – say HFT, coupled with the fragmentation of trading across venues, makes it harder to rely on one of the most basic functions of the markets: orderly and fair price formation.

“Because of the predatory nature of some participants we have no incentive to post liquidity,” Kevin Cronin, head of equity trading at fund manager Invesco, told a hearing into the flash crash last month. “There are 40 places where stocks are transacted and none of us has clarity of supply and demand on most [equity] issues. These are fundamental issues as to what the value of a securities market is.”

One worry is the use in HFT of algorithms to direct trades automatically, often to several market centres at once. Not only do such algorithms generate huge volumes of trades, but they can – like any machinery – go wrong. The past six months have brought three cases where an algorithm has run amok – and those are only the ones that have been revealed publicly. The latest came last month when the Osaka Stock Exchange handed an “admonition” to Deutsche Bank for not having “a sufficient degree of control” over an algorithm trading Nikkei 225 index futures.

Mr Cronin is not alone in suspecting that certain kinds of algorithms are actually predatory. Analysts at Nanex, a Chicago market data company, say high-frequency traders may be using algorithms to send unusually heavy traffic to exchanges and other platforms in a deliberate attempt to slow down their data systems.

Knowing that a certain exchange’s system is about to run more slowly gives a trader an opportunity to set up a buy or sell order in advance. The process is called “quote stuffing” and is used in a strategy known as “latency arbitrage” – latency referring to the speed at which message traffic moves through a system.

In its analysis of the flash crash, Nanex managed to plot how the bursts of traffic looked visually on graphs. Many appeared as distinct geometric patterns, such as jagged shapes that Nanex dubbed “Bandsaw II”, and another pattern called the “Boston Zapper”. “There’s no economic justification for it,” says Eric Scott Hunsader, founder of Nanex. “If this is OK by everybody, the market is not going to function in a very short period of time.”

Some go further and suggest outright wrongdoing. “When orders get pinged out to multiple trading venues, there is at least circumstantial evidence that there’s quite widespread use of that information to front-run trades,” Jim McCaughan, chief executive of Principal Global Investors, a large US asset manager, told CNBC last month.

Yet for regulators it is hard to figure out who is behind any of the activity. That is because high-frequency traders can operate with minimal supervision. In Britain, for example, all it takes to set up a HFT operation is a company registration and the necessary technology.

Trading systems can be bought off the shelf from a number of specialist companies. Registration with the Financial Services Authority, the UK markets watchdog, is not needed under a long-standing exemption for people trading on their own account – as high-frequency traders do – unless they present themselves as marketmakers. Similarly, in the US some are registered as broker-dealers but many are not. “Some of the people who are doing the really big volumes are completely unregulated,” says one lawyer familiar with the business. “Now, they have become a potential systemic risk. That’s the issue.”

Many exchanges say they have ­controls in place that can detect unusual trading patterns before they cause trouble. Rolande Bellegarde, head of European execution at NYSE Euronext, says that a month ago the exchange disconnected the algorithm that a trader was using, after software detected that his dealings deviated significantly from the normal pattern the exchange had observed over time.

F  or their part, the few HFT firms willing to show their face in public are at increasing pains to demonstrate that their business is beneficial to markets in providing liquidity and tighter bid-ask spreads.

Firms such as Getco, based in Chicago and formed by a pair of former pit traders, and peers in Europe including Optiver of the Netherlands, argue that high-frequency trading is a label used too loosely to describe almost any kind of rapid electronic trading, whether beneficial to markets or not. Getco and other US firms – excluding the banks and hedge funds that are equally big in HFT – recently formed an association to make their case more coherently.

Getco rejects allegations that high-frequency traders’ interests are at odds with those of ordinary investors. “While the story line may be a compelling narrative, there is no reliable evidence to suggest that this conflict exists. To the contrary, most retail brokers … intentionally route a majority of their customers’ marketable orders to firms that engage in high-frequency trading.”

Some studies back up their assertions. Woodbine Associates, a Connecticut consultancy, found in a study of US equity markets over 2008-09 that HFT had “improved execution quality”. Matt Samelson, a principal at the company, says that if there are any high-frequency traders “gaming the market”, then “we don’t think that constitutes the majority of HFT”.

But many asset managers remain unconvinced that the liquidity high-frequency traders provide is as valuable as they claim. For one thing, many exited the market during the flash crash. That has led to calls for regulators to impose as yet undefined obligations on marketmakers, including high-frequency traders. According to an online poll on FT Trading Room, a section of the Financial Times’ website focused on market structures, a clear majority (56 per cent) favours the move.

Asset managers worry that their interest in depth of liquidity and making long-term bets on company fundamentals is being crowded out by traders interested only in speed – cheered on by exchanges eager to offer incentives to attract such participants in order to stay ahead of rival platforms in the battle for liquidity. Exchanges have little incentive to discourage HFT since, aside from the fees it generates, they have found a new revenue stream in the rent they charge for rack space in data centres such as the ones emerging across Asia.

However, according to Mr McCaughan, investors are being put off by the volatility that phenomena such as HFT can cause. NYSE volumes were the lowest last week since 2006 – a fact that he attributes in part to a loss of trust in US equity market structures. “Our business is Main Street, not Wall Street,” he says, noting that Principal looks after “millions of people’s” pension schemes.

“We want to be able to look them in the eye and say the market is fair. And unfortunately, at the moment it’s quite difficult to do that.”

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As Predicted, Spain on the Brink of Collapse

The tentacles of the international banking cartel are about to envelop the fifth most important economy of the old continent

The Independent

European leaders meet in Brussels today amid growing fears that Spain, Europe’s fifth-largest economy, is preparing to ask for a

The horns of the depression are in Spain's rearview mirror. An aid package is in the works to rescue one more failed State.

bailout which would dwarf the €110bn (£90bn) rescue plan for Greece.

The Spanish government yesterday dismissed reports that it was already in discussions with the European Commission, International Monetary Fund and the US Treasury for a rescue package worth up to €250bn.

Officials in Madrid, Brussels and Paris were forced to deny that a Spanish bailout – which would take the European debt and euro crisis into a potentially dangerous new phase – was on the Brussels summit agenda.

“Spain is a country that is solvent, solid and strong, with international credibility,” said its Prime Minister, Jose Luis Rodriguez Zapatero. The European Commission spokesman said: “I can firmly deny [that a Spanish rescue is under discussion]. I can say that that story is rubbish.”

Brussels diplomats have been at pains to send out feel-good signals ahead of a summit in which Europe’s leaders are supposed to take the first steps towards more disciplined and co-ordinated, control of national finances. Those reforms are meant to restore confidence in the euro and underpin the €750m EU and IMF safety-net, created last month for euroland countries that lose the confidence of the financial markets.

However, it is proving hard to shake off persistent market fears about Spain, which, if it needed a lifeline, would swallow up a large part of the emergency fund. Worryingly for the EU, the doubts about Spain – whether real or driven by speculation – are eerily similar to the gradual seeping away of confidence that sent Greece into a financial death spiral in March and April. The Spanish government’s cost of borrowing hit a new record yesterday. The interest rate gap, or spread, between 10-year Spanish bonds and their German equivalents, rose by more than 0.10 of a point to 2.23 percentage points.

A senior Spanish banker, Francisco Gonzalez, chairman of the BBVA financial services group, confirmed that foreign private banks were now refusing to provide liquidity to their Spanish counterparts. “Financial markets have withdrawn their confidence in our country,” he said. “For most Spanish companies and entities, international capital markets are closed.”

As a result, the European Central Bank is said to have provided record amounts of liquidity to Spanish banks in recent days. The closure of bank-to-bank credit to Spanish institutions recalls to some market commentators the ripple of crisis through the global financial system after the fall of Lehman Brothers in the Autumn of 2008.

The IMF chief Dominique Strauss-Kahn is expected in Madrid tomorrow to see Mr Zapatero – but brushed off speculation of a crisis. “It’s a working visit,” he told reporters in Paris. “I am in France [today] – are there such rumours about France?”

Fears over Spain’s finances checked the recovery of the euro on money markets yesterday. The single currency lost much of the gains it had made in the past seven days.

One of the proposals on the table at the Brussels summit is public “stress tests” to force banks to reveal the state of their books. The Spanish government offered yesterday to open the books of its own private banks unilaterally to prove that they were sound.

Today’s summit in Brussels was intended to be a time for the EU leaders to catch their breath and discuss ways of restoring the euro’s long-term credibility. The threatened Spanish crisis may blow all that out of the water.

Despite an apparent rapprochement between Paris and Berlin this week, President Nicolas Sarkozy and Chancellor Angela Merkel remain deeply divided on how to prevent the currency and debt crisis from dumping Europe back into recession. Mr Sarkozy has agreed to drop his proposals for new institutional machinery for a political “government” of the euro by its 16 member states. Ms Merkel prefers to talk of a vague “governance” of the euro, and European state spending, by all 27 EU governments.

More fundamentally, Paris is deeply concerned that the austerity plans announced by Berlin last week could – on top of budget cuts in other countries – plunge Europe into crisis.

The French fears were echoed yesterday by the billionaire investor, George Soros, who warned that Europe would almost certainly face a recession next year which might generate “social unrest” and the kind of populist nationalism seen in the 1930s. “That’s the real danger of the present situation – that by imposing fiscal discipline at a time of insufficient demand and a weak banking system… you are actually… setting in motion a downward spiral,” he said.

The collapse of Spain’s housing boom has helped fuel a deep downturn which has sent unemployment spiralling to 20 per cent, the second worst in the EU. Mr Zapatero introduced a range of measures last month, including spending cuts of €15bn over two years and reductions in public sector wages and spending. Unions have called a general strike over labour reforms.