Deleveraging Pains

Even as we approach the biggest football game of the year, the market seemed to have preferred baseball on Friday and took three strikes on its way to a 2.28% down day and a 5.08% slide after reaching a new post crash high of 1150.23 on the first trading day of last week.

The first of the three pitches was China’s renewed efforts to rein in the effects of its stimulus fueled growth after GDP grew 10.7% in 4Q09, up from 9.1% in 3Q09 and up 8.7% YoY. The growth is having an affect on prices in the Middle Kingdom as CPI rose 1.9% in December after a rather benign 0.6% rise a month earlier. PPI rose 1.7% YoY over 3 times the 0.5% expectation and a dramatic reversal from November’s 2.1% decline.

While Chinese Premier Wen Jiabao’s statement that they will maintain “reasonable and ample” money and credit in the first quarter of 2010 sounded friendly enough, he also said, “We must…closely watch changes in supply and demand in the market, form an accurate judgment of the situation and increase the precision and effectiveness of macroeconomic policy” which was a little more than the market needed to hear. Especially since the Premier also said the government would “curb speculative housing purchases.”

Chinese monetary policy was not the only thing weighing on the markets last week as Greece’s fiscal woes continued to pressure prices on the country’s sovereign debt with default protection rising as high as 350bps on Thursday and the yield spread between Greek and German 10-year paper growing to 308bps. “Greece is looking for alternative ways of financing its huge deficit in 2010,” Ioannis Sokos with BNP said. The Greek government was said to be considering issuing a “popular bond” aimed at retail investors as part of its strategy.

The Euro suffered from the Grecian situation as well falling to as low as 1.4084 on Thursday after trading as high as 1.4513 on 1/11 and 1.5134 on 11/25/2009. And Greece is not alone as Markit, the economic research firm, said last week that its flash composite purchasing manager’s index for the euro-zone fell to 53.6 in January from 54.2 in December. Jean-Claude Trichet, the ECB’s President, expressed his view that the “euro-zone recovery is likely to be bumpy and cautioned against hopes that fiscal-stimulus programs could spur more vibrant activity.”

This occurred after Germany, the EZ’s largest economy, said that GDP shrank 5% in 2009 after stagnating in 4Q09, a more rapid contraction than economists had predicted and possibly a result of inventory drawdowns. “Inventory changes are leading to volatile quarterly numbers, but we expect the recovery to continue in early 2010,” was how Andreas Rees, an economist at Uni-credit in Munich put it.

Greece is not the only member of the group known as the PIIGS with problems. Portugal (the “P”) is facing a deficit of 8% of GDP and the European Commission has given the country until 2013 to bring that down to 3%. “They have seen what happened to Greece, so that might encourage more austerity measures in the budget plan,” said Sean Maloney, a strategist at Nomura in London said. Moody’s recently lumped the tow countries together saying they risked a “slow death” as their debt payments rise. Portugal’s sovereign CDS closed at 151bps on Friday and the spread between its debt and that of Germany stood at 108bps.

All of the budget problems in the European Union might also have an effect on Bulgaria, which surprisingly enough posted the smallest deficit of the 27 member state group. Although the newest (2007) and smallest member of the group it is expected to be the only one with a balanced budget in 2010. Prime Minister Boyko Borisov has received international accolades for his fiscal conservativeness but there are still risks that it might not be enough to allow Bulgaria to join the 16 nation euro-zone when the opportunity arises in 2013. “We hope that the authorities respect the admission criteria as we’ve worked hard to get here”, Boyko said, while also voicing concern that “the debt crisis in newer euro-zone countries might negatively affect us.”

Debt and deficits are a recognized problem but removing them also carries risks as the McKinsey Global Institute recently revealed. The report issued by the think tank of the world renowned consultancy said that “efforts to reduce very high debt levels in the U.S. and other big economies will likely force widespread belt-tightening and bring about very slow growth over several years.” Among those nations in the deleveraging process, McKinsey Global expected the U.K., U.S. and Spain to be affected the most out of the world’s 10 largest economies. “There is still a long process ahead of us as we unwind from the great credit bubble,” the London economist, Charles Roxburg, who led the study said.

Enjoy the week.