Daily Archives: December 7, 2010
As we see continued uncertainty in bond markets the euro is experiencing a volatile run. In order to understand this volatility it is worth considering the basic theory behind government bonds and how the uncertainty we are seeing at present could have an adverse effect on the single currency.
I’m taking a simplistic approach here, but hopefully it will help anyone scratching their head, understand the current situation a little more.
Bond markets are key to a countries ability to borrow money. The government of a given country will issue bonds to investors who receive a guaranteed return on their funds. Returns are low (in comparison to other investments) but risk is also low as historically there has been little or no chance at all of a country/government defaulting on their debt.
The credit crisis has re written the rules on government bonds. Iceland went bust first of all, and we’ve all heard how investors (primarily our councils who had invested tax payer’s money) lost their funds. Then earlier this year Greece almost went to the wire and had to receive emergency funding. Now there are concerns that we could see a similar situation in Ireland, in fact if the recent EU bailout had not been agreed then we may find ourselves in that situation already.
So first off we should examine the reason for this uncertainty. The banks in Ireland put all their eggs in one basket before the subprime crisis (housing crash in the US). They lent huge amounts of money at low interest rates with very little deposit. When these loans, (mainly mortgages) went bad and could not be repaid, the banks only had the houses that were used as guarantees to recoup losses on the loans. Unfortunately due to the property market crash these house were worth less than the loans therefore the banks in Ireland took a huge hit. Couple this with other high risk banking investments that went the wrong way and Irish banks found themselves in real trouble. As a result, in the most basic terms the banks in Ireland are now running out of money.
As news has spread about the problems in Ireland companies and individuals have been withdrawing funds from Irish banks in huge numbers further damaging these banks cash flows. Couple the banking issues with similar problems in government and we have a recipe for disaster. The Government had spent huge amounts in the good times and already had a lot of national debt, when the recessions hit and the tax take fell, the government found the amount of money they had left to pay for their debt was not enough. This has resulted in deep cuts in public spending and increases in the rate of income tax. It is hoped that this will raise more money, but if the economy continues to struggle and unemployment rises you could see income from taxation fall even if taxes rise (as fewer people are earning money to be taxed on).
So to sum up the Irish economy is in real difficulty and even with the austerity measures in order to guarantee their banks can meet their debt and the government can repay theirs, the EU bailout is vital.
So bearing in mind the dire state of the Irish economy, the bond markets take on the role of a ‘confidence indicator’ through the spreads on Irish Government Bonds. Bonds are sold to investors for guaranteed repayment after a period of time e.g.1 year 3 years 10 years. The selling government has to pay interest on those funds that they borrow, so that the investor sees a return. Typically this will be higher for longer term bonds. On top of the interest for the time period there will be a premium or spread for the risk factor (a risk premium). If the country’s economy is stable and there is little or no chance of the funds not being repaid, the risk factor will be low. However, if like Ireland the economy is fragile and investors fear they may not get their finds back they will only buy the bond if the risk premium is high. As a result the government has to pay a huge amount of additional interest in order to borrow money. This has a knock on effect. Ireland has to borrow to keep the economy and banking system going. However, it costs more to borrow, so they spend more on debt and the total amount of debt begins to spiral. This makes it more difficult to reduce debt and please the market, which in turn increases the uncertainty about the economy and pushes up the risk factor again!
So what does this mean for your currency?
In theory if these problems continue the euro could be set to weaken further. The EU have tried to reassure the markets but there is still a long way to go as focus is now turning to Portugal, Spain, Italy Belgium and even France. If fears over France do persist and turn out to be true, we could see some significant euro weakness.
For the US dollar all the euro uncertainty is great news as investors in currency are flooding to the safe haven greenback which has strengthened significantly over the last month against most major currencies.
To find out more about how your particular currency requirements could be affected fill in the form on the right and one of the brokers who write on pound sterling forecast will be in touch. You never know, it may even be me! If you have any questions or comments please feel free to leave a message below.
During this afternoons trading session sterling exchange rates have made reasonable gains against most majors. The pound has hit close to a 2 week high against the USD hovering around 1.5820 as the high and against the single currency the pound has pushed on by 0.4% in the last 3 hours to a high of 1.1871.
Now the reasons behind the pounds gain seems to be on the back of better than expected UK manufacturing data which has shown that our economic recovery is continuing to gain momentum. Figures showed manufacturing output rose 0.6 percent in October twice as fast as forecast Plus we have also had figures from the NOESR state that our estimated GDP in the UK economy grew 0.6 percent in the three months to November. This has reduced the chance that the BoE will have to look at QE over the coming months but you never know what may lurch around the corner.
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Sterling has had a brighter start to the day following reasonably good retail sales figures released overnight.
The Pound is up against pretty much all major currencies, creating some fantastic buying opportunities for those looking to send money overseas in the near future.
The rest of the week brings out Halifax house price data, due at some point todayalong with the NIESR GDP Estimate – This is an estimate by the National Institute of Economic and Social Research and can be quite a market mover should their predicitons be a way off of current Gross Domestic Product estimates.
Tomorrow we see New Zealand announce their interest rate decision, it is widely thought that they will keep rates on hold as Australia did last night however any surprise may lead to a volatile night for GBP-NZD rates.
The Bank Of England also have their monthloy interest rate decision on Thursday at 12:00 and with the last few occasions showing many menbers apparently sitting on the fence to see how the economic battle pans out one would imagine we won’t see any huge movements off of the back of this, however be aware they do like to surprise us now and then.
I feel we may see a reasonably flat week from here forward however that outlook could change considerably so keep an eye on the site for updates later in the week.
If you are buying or selling a property abroad, have business transactions to carry out or simply need to get money overseas for any other reason and want the best exchange rates, just fill in the form on the right hand side and one of the experienced traders that write on this blog will be in touch shortly. Alternatively, if you would like assistance in finding your dream home abroad then feel free to visit www.overseaspropertysearcher.com and let one of our property experts make the hunt much easier for you.