United States: We believe that there is an increasing risk that the 2 August "deadline" will pass without agreement being reached to raise the debt ceiling. However, if that were to happen, we think market pressure would likely encourage a rapid resolution (Issue #1).
Eurozone: With agreement over a second Greek bail-out seemingly imminent, we expect a period of relative calm in the eurozone. But, with fundamental challenges still to be addressed, this is likely to prove short-lived (Issue #2).
MENA: Events remain consistent with our view that there will be a protracted period of political turmoil and uncertainty across the region, which is proving supportive of the oil price despite the recent IEA intervention (Issue #3).
Thailand: The 3 July general election has been greeted by markets with an uptick in sentiment. However, we judge that significant political risks remain which could result in downside shocks (Issue #4).
North Korea: Tensions appear still to be rising on the Korean peninsula (Issue #5).
“Both the United States and the European Union have public finances that are out of control and political systems that are too dysfunctional to fix the problem. America and Europe are in the same sinking boat.”
Gideon Rachman, Financial Times, 5 July 2011
This abbreviated interim report updates our Mid-Year Review for 2011 published on 10 June 2011.
The most significant change relative to the Mid-Year Review is the promotion of the United States from third in our rankings to first, principally reflecting both the apparent continuing impasse in Washington over raising the US debt ceiling and the prospect of an admittedly brief period of relative calm in the eurozone with agreement over a second Greek bail-out seemingly well on track. That said, as this report explains, we expect financial markets‘ focus to return principally to the eurozone by September, barring unexpected events.
In the aftermath of the outcome of its general election last month (see Turkey: The paradox of Turkish elections, Nomura Emerging Market Research, 6 June 2011), Turkey has dropped out of our ―top ten‖ in favour of Argentina, which is due to hold presidential and parliamentary elections on 23 October (see Issue #10).
As always, the order of the ten featured "issues" reflects our subjective judgment of the current importance of each issue to market participants. The number in brackets in the issue heading is the ranking of each in our Mid-Year Review. The final section of the report is an updated calendar of what we see as important "set piece" political events through the remainder of this year and in 2012.
1. United States: Hitting the ceiling
“...anyone looking at Congress should hope that the markets start to focus on the [debt ceiling] issue sooner rather than later. Increasingly it looks like the only thing that will forcean increase...is a painful financial shock.”
Richard McGregor, Financial Times, 30 June 2011
In our Mid-Year Review, we set out the case for why we believed that agreement on raising the US debt ceiling before the US Treasury‘s 2 August "deadline" was not, in our view, a foregone conclusion – even though markets have yet to price in a significant risk of such. All but four weeks later – and less than four weeks away from 2 August – agreement appears no closer despite the personal involvement since late June of President Barack Obama.
On the plus side, we believe it has always been likely that negotiations would go "to the wire." Furthermore, with Greece and the eurozone now less dominant on its radar screen (see Issue #2 below), financial markets may increasingly focus on the debt ceiling, putting more pressure on all relevant parties – especially if (as it has warned) Moody‘s fires another warning shot across Washington‘s bows on 15 July.
Nevertheless, for the time being at least, as Richard McGregor states in the article quoted above, markets seem still to judge that:
“Barack Obama will do a deal with the Republican leadership to lift the country‟s borrowing limits in time for the early August deadline...”.
However, we note that Mr McGregor continues with the following view – with which we agree:
“The trouble with this reassuring scenario is that it appears to be unravelling. Finding the numbers in Congress to pass any deal – whatever the President and John Boehmer, the Republican House Speaker, agree on – is looking perilous.”
On the one hand, the many Tea Party members in the House of Representatives remain adamant that they will not support any deal which involves any increase in taxes and possibly not even an increase in the debt ceiling under any circumstances. On the other hand, a significant number of House Democrats appear reluctant to support any deal that does not involve lifting revenues.
Thus, we believe that the possibility is growing that no agreement will be reached by 2 August. That said, at this stage we still judge that the balance of probabilities remains in favour of agreement before then.
Furthermore, even if 2 August passes without agreement, it is not clear to us that the US would immediately be in technical default since sovereign bond redemptions do not fall due until some days thereafter. On this basis, rather as happened with TARP in 2008, we would expect market reaction to the passing of the deadline to be such that an agreement would likely follow very quickly. This would allow the US to fulfil its obligations in the bond market even though other payments (eg social security) could be delayed and parts of the government closed down (i.e. in a repetition of similar circumstances in 1995).
Nevertheless, as things stand we cannot totally rule out the possibility of technical default.
2. European Union: “Summer of our discontent” Act 4 – See you in September
“The vote in Greece‟s parliament...that approved the government‟s austerity plans is far from the end of the story. As the EU and IMF will have to agree every three months to release further Greek bail-out money, investors are braced for heightened volatility at the end of each quarter.”
Richard Milne, Financial Times, 2/3 July 2011
“Argentina on the Aegean” (Alan Beattie, Financial Times)
Short-term market concerns over Greece abated somewhat at the end of June after the Greek parliament passed two votes deemed essential for agreement of a second EU/IMF bail-out package. The IMF is now expected to sign off on the package on 8 July, allowing the fifth tranche of aid from the first package to be released by 15 July (i.e. in time for Greece to avoid default on its sovereign debt) even though some details of the second package remain to be determined.
According to the Financial Times, in principle EU finance ministers reportedly hope to finalise those details, which revolve largely around the extent and nature of private sector bondholders‘ participation, in time for their next meeting on 11 July. However, it appears likely that final agreement – described in the same report as "technical blips" – may take longer to finalise. One potential stumbling block may, in our view, be the challenge of ensuring that any private sector involvement is not deemed by the ratings agencies to amount to a technical and/or selective default – n.b. S&P‘s warning of 4 July. In that event, the ECB has said that it may no longer be willing to accept Greek sovereign debt as collateral against its provision of liquidity to Greek banks. However, a senior finance official was quoted in the Financial Times on 4 July as saying that the Bank would wait for all four major ratings agencies it uses to downgrade Greek debt to "D" or "SD" before acting.
As for Greece itself, it is uncertain whether civil unrest and strike action will ease now that the relevant bills have passed in parliament, and, if they do, whether the reprieve will last only until September when austerity and privatisation measures laid down in the second bail-out agreement should be implemented.
We have argued since the publication of our original report, EU: Now is the summer of our discontent (3 May 2011), that restive electorates in the periphery are putting the leaders of those countries under increasing pressure. As things stand two months later, we sympathise with the views expressed by Alan Beattie in a recent article in the Financial Times:
“...in some respects those handling Greece are replicating the Argentine crisis. One, there are grave doubts over its depth of determination to take difficult actions. Two, the eurozone-led rescue mission eschews not just substantial restructuring of sovereign debt but even holding a sensible conversation about it.... Implementing an austerity programme demands not just the ability to force bills through parliament...but the administrative and political stamina to fight thousands of day- to-day battles with recalcitrant tax-payers, truculent spending ministries and infuriated public sector workers.”
Thus, despite the government‘s success in pushing through the requisite legislation at the end of June, we believe that the prospect of continuing – and, possibly, intensifying –public pressure presents a non-negligible threat to the implementation of the programme and the longevity of the present government (whose term of office is not due to expire until September 2013). In the event of an early general election, opinion polls currently point to a hung parliament which could lead to a protracted – and potentially damaging – period of political uncertainty.
Furthermore, we note that respected commentators are openly expressing doubts aboutGreece‘s future prospects of remaining in the eurozone, even though few question the determination of Europe‘s leaders to hold firm on eurozone membership or see any evidence as yet on the streets of Athens of support for exiting.
An additional political risk lies in the possibility of a parliamentary backlash in the eurozone‘s Triple-A economies if Greece fails to keep its side of the agreement – a risk on which we have reflected in previous reports.
In short – and as Mr Beattie put it – “The EU...is in serious danger of creating an Argentina on the Aegean.”
Even before the recent spate of protests began in Greece, large numbers of demonstrators had taken to the streets of Spain in the run-up to the May municipal elections, in which the ruling PSOE suffered heavy defeats across the country. Those protests are continuing, with a number of marches from all parts of the country expected to converge on Madrid around the end of the month.
In the immediate aftermath of the May elections we suggested that the government would probably manage to remain in office until March 2012, by which time a general election has to be held. However, we now think an early election – i.e. before year-end – looks more likely in the face of continuing protests and with the PSOE‘s new leader – Alfredo Pérez Rubalcaba, who will take the party into the election – now in office. Although opinion polls point to a clear victory for the main opposition Partido Popular (PP) – an outcome which we believe would be welcomed by financial markets – the popular Mr Rubalcaba may provide PSOE with a boost and, at this stage at least, we do not rule out the possibility of the next election following the pattern of Spain‘s two most recent ones and resulting in a hung parliament.
Meanwhile, recent renewed market jitters over Spain have calmed in parallel with progress on the second Greek bail-out package. Nevertheless, the proposed flotation of the Madrid caja, Bankia, later this month is widely seen as a key litmus test of market sentiment towards Spain. And an uptick in concern about Greece in September could yet risk renewed contagion into other peripherals.
As for Portugal, the new right-of-centre government has a relatively strong hand in implementing the terms of the EU/IMF bail-out agreement. Nevertheless, we expect protests and industrial action there too as the programme begins to bite.
Some key upcoming dates for Europe
- 8 July: IMF due to sign off on the release of further financial aid to Greece.
- 11 July: Meeting of EU finance ministers – aimed at finalising the bail-out package.
- 13 July: Outcome of the second round of bank stress tests.
- Late July: Proposed launch of the Bankia IPO.
- 4 Sept: Regional elections in Mecklenburg-Vorpommern.
- Mid-Sept: Possible date for finalisation of Greece‘s second bail-out package.
- 18 Sept: Regional elections in Berlin.
3. MENA: Protests, potentates and petroleum
“Each country is different, while references to a wave of change are simplistic. A range of political outcomes are likely to be reached, taking divergent paths.”
Richard Haass, Financial Times, 9 March 2011
For our latest full assessment of current events in, and prospects for, the Middle East and North Africa, please see MENA: A Long and Winding Road, Nomura Fixed Income Research, 27 May 2011.
We judge that in recent weeks markets have increasingly accepted continuing turmoil in the MENA region as the "new normal". The so-called "Arab Spring" has proved, as we have consistently forecast, to be protracted and far from linear in its progress (a situation we expect to persist for several years). However, even though events may now be slower moving than was the case earlier in the year, there have been significant developments in the past month or so.
From a broad financial market perspective, we believe that the most significant development in the past month was the International Energy Agency‘s (IEA) surprise intervention on 23 June in oil markets, in which it announced the release of two million barrels per day from strategic oil reserves over the following 30 days. The price of Brent crude fell by around 10% following the announcement. However, Brent has since drifted back into the $110-120/bbl range we identified in our 27 May report, to which it appears to have gravitated since the beginning of the conflict in Libya in late February and which we believe continues to imply a persistent perceived political risk premium around events in the MENA of 10-15%.
We see the following as significant country-specific developments since publication of our 27 May report and our Mid-Year Review (in alphabetical order):
Bahrain: al Wafiq, the main opposition party in Bahrain, has agreed to take part in national reconciliation talks proposed by King Hamad bin Isa al-Khalifa. However, al Wafiq leader, Sheikh Ali Salman, has also expressed solidarity with more hard-line Shia leaders, including Hassan Mushaima who was recently sentenced to life in prison for allegedly attempting to overthrow the monarchy.
Progress of the talks may be aided by the king‘s surprise 29 June announcement of the establishment of an independent commission to investigate the violent unrest which occurred earlier this year. This has been widely welcomed. The head of the commission, Cherif Bassiouni, has publicly expressed the view that its work should help bring about national reconciliation while acknowledging that Bahrain “seems very close to almost total polarization – the king and the people have to be aware of the danger and pull back from the precipice”.
However, these steps have failed to prevent a resumption of street protests.
Egypt: The reasoning behind the transitional administration‘s initial request for and subsequent rejection of IMF assistance is unclear but may have been driven in part at least by current reluctance to trim food and fuel subsidies. Nevertheless, we believe that Egypt will require more economic support from the international community, although this may now have to await the conclusion of legislature elections set for September (but increasingly likely, in our view, to be postponed) if not the presidential ballot due before year-end.
Lebanon: Prospects for Lebanon revolve, in our view, around two recent developments.
First, as we explain below we see an increasing possibility of regime collapse in Syria, with significant implications for Lebanon in general and for Damascus-backed Hizbollah in particular.
Second, at the end of June the UN Special Tribunal on Lebanon (STL) issued the long-awaited indictments and warrants for the arrest of four individuals charged in connection with the murder of former Prime Minister Rafiq al-Hariri in 2005. All four of those indicted are believed to be members of Hizbollah, which dominates the recently formed cabinet of Prime Minister Najib Mikati. It is by no means clear that the current Lebanese government will be willing or able to carry out the arrests, which could bring it into confrontation with the international community (as the STL was set up under Chapter 7 of the UN charter) as the latter looks to bring pressure to bear on Hizbollah.
Libya: Despite growing concern about the length of time that has elapsed since the international coalition first intervened in late February, we believe that the Qaddafi regime looks increasing likely to fall – especially as the rebellion in the Nafusa region just 100km to the southwest of Tripoli seems to be gathering momentum.
Morocco: Tensions appear to be deepening after the authorities claimed a 72% turnout for the 1 July constitutional reform referendum and 98% support for the proposed reforms. Pro- democracy protestors took to the streets in major cities on 3 July – as did reportedly smaller numbers of pro-government protestors – to challenge the outcome and demand more radical changes than those proposed in the referendum motion. Further pro-democracy demonstrations are planned for the coming days. Nevertheless, we see no pressing demand at this stage for regime change rather than regime evolution towards a more constitutional monarchy.
Sudan: Southern Sudan is set to declare its independence from the north of the country on 9 July under an international agreement brokered in 2005. However, despite the efforts of the African Union and the UN – and, perhaps, of China in particular – recent outbreaks of conflict in disputed enclaves in the new border region have raised concerns about a possible renewal of civil war. As we have previously noted, civil war could pose a direct threat to Sudan‘s oil output of close to 500,000bpd (of which around 75% comes from the south). Less dramatic but still potentially endangering oil exports, according to a report in the Financial Times, Khartoum has unofficially blocked exports of diesel to the south (which buys 85% of its supplies from the north). This could, in turn, stifle oil output from the south to international markets.
Syria: Despite the continuing crackdown by the regime, protests are reportedly still escalating in both numbers and geographical spread – even though major anti-regime demonstrations have yet to take place in the two main cities of Damascus and Aleppo. In our view, what appears to be a diminishing ―fear factor‖ among protestors is gaining ground over the "fear factor" evident within the regime of the consequences of its ousting. As a result we think the regime is increasingly likely to collapse in the foreseeable future though it is still far from inevitable. However, for now at least, it remains hard to assess the immediate or medium-term consequences of regime collapse either within Syria or for the country‘s neighbours.
Yemen: It appears increasingly unlikely that President Ali Abdullah Saleh, seriously injured in an explosion last month, will return to Yemen from Saudi Arabia where he is undergoing treatment. However, the Saleh regime is clinging on in Sana‘a as secessionist pressures mount in the south of the country and Islamist militias, which the US authorities believe to be aligned with al Qa‟ida in the Arabian Peninsula (AQAP) tighten their grip in some areas.
4. Thailand: Back to the future?
“Neither assumption – that the new government will still be around after a few months in office, and that it will honour its promises – is entirely sound.”
Lex, Financial Times, 5 July 2011
Although Puea Thai‟s (PT) victory in Thailand‘s 3 July general election should have come asno surprise (see Thai election: Sister Act, Nomura Global Economics, 28 June 2011), the scale of it, i.e. an outright majority of 265 seats in the 500-seat lower house, was. Thus party leader and prime minister-elect, Yingluck Shinawatra, has not only managed to continue the run of election victories for parties associated with her brother, former premier Thaksin Shinawatra, dating back to 2001, but has exceeded expectations by securing an apparently clear mandate for her policies.
To judge from the bounce in both the Thai stock market and the baht as the scale of PT‘s win became clear, financial markets appear to judge the outcome as a positive. Such sentiment was likely bolstered by the endorsement of the result by the defeated prime minister, Abhisit Vejjajiva, and (perhaps more importantly still) outgoing defence minister, General Prawit Wongsuwon. Additionally, Ms Yingluck‘s stated intention of forming a coalition with four smaller parties has also been broadly welcomed, being seen as potentially adding to the new government‘s stability and indicative of PT‘s willingness to work with other parties – both of which we see as essential if Ms Yingluck is to make progress on one of her main stated goals, reconciliation.
For all that, both history and the current situation suggest that one should be cautious about the prospects for political stability in Thailand in the foreseeable future. Notably:
- In the 79 years since the end of absolute monarchy only one prime minister, Mr Thaksin himself from 2001 to 2005, has served out a full term of office. Over the same period the military has staged 18 coups – 11 successfully – the most recent of which resulted in the ousting of Mr Thaksin in 2006.
- Perhaps especially after the turbulent period since the 2007 election, Thai society remains deeply divided, and reconciling the aspirations of her electoral base while building a working relationship with Thailand‘s elite is likely to test Ms Yingluck‘s abilities severely.
For the time being, the two main focal points are likely to be:
(a) economic policy: in particular, whether Ms Yingluck can finance – in a non-inflationary way – a wide range of expansionary (and sometimes populist) election promises; and,
(b) political amnesty: early moves towards an amnesty, which would probably be seen as an effort to pave the way for her brother‘s return to Thailand, would likely trigger an adverse reaction from the elite.
However, a third issue could, in our view, prove to be even more contentious, i.e. if Ms Yingluck were to try to push through amendments to the 2007 constitution which expert opinion sees as the ultimate safeguard of the elite‘s grip on Thailand governance and which remains anathema to many supporters of Mr Thaksin.
Given the sensitivities, we expect that, initially at least, both sides will move cautiously once the new government has been sworn in (which is expected to be before month-end). There will likely be the usual investigations of alleged electoral malpractice resulting in some deputies being disqualified; but these are very unlikely to be sufficiently numerous to shift the balance of power in the legislature given the size of PT‘s majority.
However, as the dust settles over the election outcome we would not be surprised to see a repeat of the sort of actions which followed the 2007 general election, notably any or all of the following: (a) re-energising of the so-called "yellow shirts" and a re-run of the protests which played a key role in bringing down the Phak Palang Prachachon (PPP, the predecessor party to PT) government in 2008;
(b) pursuit of Ms Yingluck herself in the courts in connection with allegations of perjury arising from the sale of her brother‘s telecommunications company five years ago; and
(c) a possible attempt to ban PT itself – the fate which befell both its predecessor parties.
That said, financial markets remained remarkably calm around the violence which besetBangkok itself in April/May 2010. Taking that together with the reaction to the election outcome, we therefore conclude that markets will likely focus more on Ms Yingluck‘s economic policies for the time being than on possible downstream political risk.
5. North Korea: The calm before another storm?
“What is really frightening about the Kim family...is that not even mighty China can tell it what to do.”
The Economist, 1 July 2011
Although we consider there to have been no major political developments on the Korean peninsula of significance to financial markets since the publication of our Mid-Year Review on 10 June, we believe that tensions between North and South Korea have continued to deepen despite the efforts of Beijing and Washington in particular to ease the situation.
6. Pakistan: Overshadowed by Osama?
We consider there to have been no major political developments in Pakistan of significance to financial markets since the publication of our Mid-Year Review on 10 June.
7. Taiwan: A return to cross-strait tensions?
We consider there to have been no major political developments in Taiwan of significance to financial markets since the publication of our Mid-Year Review on 10 June.
8. China/US: Two “Indispensible Powers”
We consider there to have been no major political developments in China/US relations of significance to financial markets since the publication of our Mid-Year Review on 10 June, although we believe that the visit of the Dalai Lama to Washington later this month could lead to some additional friction.
9. Russia: Will he, won’t he?
We consider there to have been no major political developments in Russia of significance to financial markets since the publication of our Mid-Year Review on 10 June.
10. Argentina: The lady is for burning
“Argentina is the only economy where all six [of the Economist‟s overheating] indicators are on red.”
The Economist, 2 July 2011
Argentina is due to hold presidential and parliamentary elections on 23 October withincumbent Cristina Fernández de Kirchner currently favourite to win the former.
With personal opinion ratings above 50% and the economy – superficially at least – performing well since 2003 and currently achieving near to double-digit growth, Ms Fernández also stands to benefit from a sympathy vote following the death of her husband, former president Néstor Kirchner, in October 2010. She could also benefit from of the apparent disarray of the opposition parties. Indeed, opinion polls currently place her over 30 percentage points ahead of her nearest rival, Ricardo Alfonsín, in the province of Buenos Aires, which is home to around 40% of voters, suggesting that she might even secure a first- round victory.
Despite the overheating-related risks highlighted by The Economist earlier this month, we see no real likelihood of any significant shift in economic policy at this stage in the election cycle. Furthermore, we remain cautious about the prospects for a second Fernández administration voluntarily changing course significantly given Argentina‘s economic track record over the course of the Kirchner era
Some important dates 2011-12 (updated 4 July 2011)
16 July: Tibet – Visit of the Dalai Lama to Washington
4 Sept: Germany – Mecklenburg-Vorpommern state elections
18 Sept: Germany – Berlin State elections
24-26 Sept: IMF – Annual Meeting (in Washington)
September: Egypt – Legislature elections (prov)
13 September: UN – UN General Assembly sixty-sixth session
23 Oct: Argentina – Presidential and parliamentary elections
23 Oct: Switzerland – Parliamentary elections
23 Oct: Tunisia – Election of a constitutional assembly
31 Oct: Eurozone – J-C Trichet steps down as ECB president
October: Poland – Parliamentary elections
12 Nov: Denmark – Deadline parliamentary elections
26 Nov: New Zealand – Parliamentary elections
November: G20 – Summit (in Cannes, France)
November: G20 – Mexico takes over the G20 presidency
4 December: Russia – Parliamentary election
December: Egypt – Presidential election
1 Jan: EU – Denmark assumes EU Council presidency
14 January: Taiwan – Presidential and legislature elections
29 March: Iran – Parliamentary elections
March: Russia – Presidential election
March: Spain – Deadline for parliamentary elections
15 Apr: North Korea – 100th anniversary of the birth of Kim Il-sung
22 April: France – Presidential election (1st round)
April: South Korea – Parliamentary elections
6 May: France – Presidential election (2nd round – if required)
May: Serbia – Parliamentary elections
June: France – Legislature elections
1 July: EU – Cyprus assumes EU Council presidency
1 July: Mexico – Presidential and congressional elections
September: Hong Kong – Legislative Council elections
28 October: Ukraine – Parliamentary elections
October: China – Chinese Communist Party 18th Congress
October: Czech – Parliamentary elections
6 Nov: United States – Presidential and congressional elections
November: G20 – Summit (in Mexico)
December: Kazakhstan – Presidential election
December: South Africa – ANC elective conference
December: South Korea – Presidential election
December: Venezuela – Presidential election