Tuesday, December 16, 2014

Fitch downgrades the EFSF euro zone bailout fund's credit rating to AA from AA+. / EFSF: CNBC Explains

EFSF: CNBC Explains

To help solve Europe's sovereign debt crisis, a special organization was set up in 2010 called the European Financial Stability Facility, or EFSF. So what is it and how does it work?
Mike Kemp | Getty Images
CNBC explains.
What is the EFSF?
Basically, the EFSF functions like a bank to provide loans to euro zone members who have economic difficulties.
The euro zone includes the 17 countries and states that use the euro as its currency. They are:
Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, Netherlands, Portugal, Slovakia, Slovenia, and Spain.
The EFSF was formed in May of 2010, emerging out of the debt crisis sweeping through countries such as Ireland, as we'll see later. It's headquartered in Luxembourg City and has a CEO, a board of directors, and a staff of about 12 people. The EFSF receives administrative help from the European Investment Bank.
How does the EFSF help countries with debt problems?
The EFSF issues bonds or other debt instruments to provide loans to the countries who need them. The loans are guaranteed by other states in the euro zone.
It's important to note the the primary goal of the EFSF is to provide loans to countries. However, in certain circumstances, the EFSF charter does allows a country to use the loans to support one of its banks deemed to be in financial trouble.
How does a country get a loan from the EFSF?
There are more than a few steps to get a loan, and other groups—including the International Monetary Fundand the European Commission—get involved.
First, a country in the euro zone applies for the loan after it is unable to borrow money from the international debt markets. Then the country has negotiations with the European Commission and theInternational Monetary Fund, during which those groups "look over the financial books" of the country in need to determine if a loan should be approved.
If, after that, a request has been unanimously accepted by the euro zone states and the other agencies, a deal is done to make the loans. It can take three to four weeks to draw up a loan program.
The EFSF spends several working days raising the necessary funds and disbursing the loan. The majority of the funds raised for the debt are in euros, but other currencies can be used.
The debt instruments are then sold through specific banks to anyone who wishes to buy them, usually large institutional investors and countries.
When was the first EFSF loan given out?
The first bonds of the EFSF were issued for Ireland on Jan. 25, 2011. The EFSF placed its inaugural five-year bonds for an amount of €5 billion as part of the EU/IMF financial support package agreed for Ireland. The €110 billion bailout to Greece of 2010 is not part of the EFSF guarantees; rather it is a separate deal from the EU.
What if a country defaults on the loans?
It's important to remember that the EFSF gives loans, not hand-outs. The loans must be paid back with interest. If a country that receives an EFSF loan defaults on its payments, those who guaranteed the loan are on the hook for the money.
Each country in the euro zone has limits on what it will guarantee to another country that wants an EFSF loan. For instance, Greece would only guarantee 2.82 percent of the loan, while Germany would guarantee 27.13 percent of the loan—but the total from all the euro zone countries would add up to a 100 percent guarantee.
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Charting a Crazy 24 Hours in Global Markets

Charting a Crazy 24 Hours in Global Markets

Shoppers carried a TV in central Moscow on Monday. Russians are feeling the pinch from the falling ruble, but one somewhat paradoxical result has been to unleash a spending spree as consumers snap up electronics, furniture and cars before prices soar. Kirill Kudryavtsev/Agence France-Presse — Getty Images
It has been a hairy 24 hours in global financial markets, particularly for anyone who works in the oil business or has a stake in the health of Russia’s economy. But what is really going on, and what does it mean for the United States?
With the Russian ruble in near free fall, the country’s central bank announced an emergency interest rate increase at 1 a.m. Moscow time on Tuesday, raising its main interest rate 6.5 percentage points to a whopping 17 percent. The idea was to make the ruble more attractive with the very high interest rates it might earn, and thus avert the outflow of capital that has driven the currency down since summer.

The Ruble Keeps Falling

A surprise interest rate increase on Monday night was not enough to arrest a plunge in the value of the Russian ruble.
Rubles per U.S. dollar
70
60
50
40
67.9
Oct.
Nov.
Dec.
Source: Bloomberg
The initial results were promising, with a brief uptick in the value of the ruble. But it didn’t last. After falling about 11 percent Monday, the ruble was down a further 10 percent against the dollar early Tuesday, before rebounding to be down 6 percent around noon Eastern time, 8 p.m. in Moscow.
The central reason for the sell-off is a collapse since the summer in the price of oil, Russia’s leading export. Not helping matters: the geopolitical uncertainty created by President Vladimir Putin’s aggression toward neighboring Ukraine and the resulting international sanctions that have made businesses and investors wary of Russia.

Oil Prices (Keep) Plunging

Price per barrel, West Texas Intermediate Crude
$75
70
65
60
55
50
$54.12
11/18/2014
11/25/2014
12/02/2014
12/09/2014
12/16/2014
One-month forward futures contract
Source: Bloomberg
Russia is stuck in a vicious cycle in which falling oil prices worsen its financial position, which causes a loss of confidence in the ruble. A falling ruble causes high inflation and makes businesses reluctant to invest, and the central bank’s interest rate increase to combat the falling ruble will have a side effect of worsening the economy further.
A simultaneous sell-off of Russian bonds, stocks and currencies on Tuesday suggested global investors think it will all end in tears, perhaps with capital controls restricting the ability to move money out of the country, or perhaps even a debt default like the one Russia experienced in 1998.
The stock market has been relatively stable in both the United States and Europe, suggesting that investors don’t see the troubles in Russia and the continued sell-off in oil affecting corporate profits in the West very much. But things are more interesting in the bond market.
Falling oil prices mean lower inflation. And Russia’s troubles could presage more geopolitical instability. Both these things make United States Treasury bonds (and other safe assets) look more attractive. Sure enough, investors have plowed money into bonds, pushing down their yields.

Long-Term Interest Rates Keep Falling

Yield on 10-year U.S. Treasury bond
%
3.0
2.8
2.6
2.4
2.2
2.0
2.1%
Jan.
Feb.
March
April
May
June
July
Aug.
Sep.
Oct.
Nov.
Dec.
Source: Bloomberg
It reflects a trend that has been underway throughout 2014. Even as the American economy has performed well, and the Federal Reserve has moved toward an era of tighter money, the nation’s longer-term interest rates have been inexorably dropping. This decline reflects both falling global inflation (caused by weak global growth and falling oil prices), and the desire among global investors to put money somewhere safe.
The United States benefits from a paradox: The two things that are driving volatility in global markets right now are both likely to provide a lift for American consumers. Cheaper oil means cheaper gasoline and heating oil. And the boom in Treasury bonds will mean lower mortgage rates. So as hard as this moment is for the Russian economy, there’s little reason to think the United States economy is in imminent danger. Europe has more to lose, with its deeper trade ties to Russia, but that is only one in a long list of Europe’s economic challenges.
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Why Russia’s monster rate hike spells trouble ahead

Why Russia’s monster rate hike spells trouble ahead

The Russian central bank's dramatic rate hike further threatens financial stability in the troubled economy and is thus unlikely to put a floor under the country's currency or stocks, say analysts.
The Central Bank of Russia (CBR) unexpectedly hiked rates by 650 basis points to 17 percent overnight after the beleaguered ruble plunged to a fresh record low. The currency rebounded to 60.00 to theU.S. dollar following the move but has since crumbled during Tuesday's session and hit a fresh all-time low of 72.152 by mid-afternoon London time.
"This is essentially a panic situation, the central bank took the most drastic action they could think of," Uwe Parpart, managing director and head of research at Reorient Financial Markets told CNBC.
Kirill Kudryavtsev | AFP | Getty Images
The rate hike will further tighten domestic liquidity, putting a strain on the domestic corporate sector and reinforcing economic weakness, Parpart noted.
"You can expect credit issues facing various companies and banks, so there's a real issue of financial stability for Russia," he said. "It's a pretty bad situation, the only place worse off is Venezuela."
Oil price stability will be the main determinant of stability in Russian assets, Parpart said. The price of oil - Russia's main export and revenue source - has fallen 46 percent in the past six months due to abundant supply—partly from U.S. shale oil—and low demand growth.
"If oil prices continue to drift lower, the central bank's measures will be overcome by more panic in a matter days."
Further downside
With such uncertainty, it's much too early for investors to gain exposure to Russia, he said.
David Riedel, president and founder at Riedel Research Group says trying to find a bottom in Russian assets is akin to catching a falling knife.
"I think there's a lot further downside in the Russian situation," he said. "I have nothing but sympathy for you if you own a lot of Russian stocks."
On top of the collapse in oil prices, the economy faces the risk of new U.S. sanctions, Riedel notes.
U.S. Congress on Monday sent President Barack Obama legislation setting out further sanctions on Russia. Administration officials say the president is assessing the measure, which would target Russia's energy and defense industries, according to the Associated Press.
Rate hike not enough?
Stan Shamu, strategist at IG does not expect a sustained turnaround in Russian assets on the back of central bank action either.
"Given the sanctions the country is also facing, any recovery in the ruble and domestic assets could be short lived," he said.
Benoit Anne, strategist for Societe Generale, on the other hand, believes CBR's action is a "game changer" in the course of the ruble.
"After weeks of lamenting over the central bank's indecisiveness, I am at last impressed by the policy response," he said. "Game on. The CBR now means business."
Investment opportunity?
Nicholas Ferres, investment director, global asset allocation, says Russian government bonds may warrant another look following the central bank's move to defend its currency.
"Russia has the means to pay their sovereign obligations and even cover the corporate obligations," he said.
"Therefore, following the dramatic collapse in price, the now aggressive central bank action and Russia's ability to pay, sovereign [debt] is very attractive in both the dollar and particularly in local currency terms."
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Retail platform FXCM ceases ruble trade

Retail platform FXCM ceases ruble trade




Retail currency trading platform FXCM halted trading of Russia's battered rouble on Tuesday, saying it expects major traders of the currency to stop pricing the rouble this week in anticipation of the introduction of capital controls.
The rouble fell by up to 25 percent on Tuesday despite Moscow's raising of official interest rates to 17 percent from 11.5 percent overnight, prompting speculation there would be moves to halt a further exodus of capital.
The currency had recovered some ground late on in London trading tostand at around 72 roubles per dollar.
FXCM said it made the move to "protect ourselves and our clients. We just don't know what will happen."
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Oil could drop another $15 from here: Analyst

Oil could drop another $15 from here: Analyst






The plunge in oil prices is "completely disconnected" from what makes any sense economically, and there's no telling how low crude can go, an influential analyst told CNBC on Tuesday.
Stephen Schork, founder and editor of The Schork Report newsletter, said he had thought last month that the $70 to $75 a barrel price range for oil in the U.S. would hold. "It did not," he added in a "Squawk Box" interview. "As soon as it broke, I had to position myself for lower prices. And I'm still positioning for lower prices."
"How low can we go? We are beyond the point of economics … completely disconnected from that because as we've seen with the ruble and as we've seen with the demand issues elsewhere, there's no telling," Schork said, putting the next target for WTI crude at $52 and the one below that at $42. "Will we get there? Absolutely."
Oil prices continued lower in early trading Tuesday, with U.S. crude hitting lows of about $54 not seen since early May 2009, as global currency turmoil and slowing Chinese factory activity added to concerns about demand. In mid-June, oil settled at a high of $106.86 a barrel.
"What is this price decline telling us? Commodity prices don't drive economies. economies drive commodity prices," Schork said. "The United States is the only shining light out there economically. But with a rising dollar at a five-year high ... who are we going to sell our manufacturing exports to?"
"No one can tell you where this [oil] market is going," he continued. "It could have already bottomed or we could still be heading another $15. And that's the scary thing about this. This is 2009 all over again."
Pavel Molchanov, oil analyst at Raymond James, described what happened then and how it relates to current conditions. "As we saw at the beginning of 2009 when oil very briefly touched $30—near-term [here] anything can happen—but let's remember 2009 prices bounced to $60 within a couple of weeks."
The plunge in crude has wreaked havoc on the Russia's oil-dependent economy and in turn its currency, which continued to collapse despite the central bank there hiking interest rates by 6.5 percentage points to 17 percent. The ruble sank as much as 18 percent early Tuesday after suffering its worst session in 15 years on Monday. The Russian stock market also dropped sharply in dollar terms Tuesday. But with the depreciation of the ruble, Russian stocks were higher in ruble terms.
"Forty dollar oil would be lethal to a lot players in the global oil industry in the United States, in Canada, in Brazil, in Russia, and frankly more than half the OPEC countries," Molchanov said. That's why he feels that prices cannot stay at $60 a barrel on a permanent basis. He added that he sees oil in the "bottoming process" right now.
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