A Few Last 2013 Developments

In the last full trading session of the year, the US dollar is little changed against the major currencies and a bit softer against many of the freely accessible emerging market currencies. 

Asian equities mostly firmed, with the MSCI Asia-Pacific Index gained a little less than 0.5%, while the Dow Jones Stoxx 600 is little changed as its consolidates its gains to 6-year highs.  

In the debt market, we note that the 10-year JGB yield has quietly crept up to new 3-month highs, while European bond yields are mostly softer.  The US 10-year Treasury yield is hovering just below the 3% threshold.  

The US economic calendar is light.  Pending home sales and the Dallas Fed manufacturing report will be released.  These rarely move the market, even in the best of times.  

There are four developments to note:  

1.  France's Constitutional Court approved the government's revised effort to use tax policy to discourage high salaries.  For this year and next, employers will pay 50% income tax on the portion of salaries over 1 mln euros (~$1.37 mln).  Others taxes and levies will bring the effective tax rate to 75% (capped at 5% of the company's revenues).    Earlier this year, the Hollande government sought to apply the tax on individuals.  The Court disallowed it on grounds that it was applied to individuals rather than households.  This new iteration is payable by a company or organization.

It is largely symbolic, though a costly symbol for artists and some athlete, who may be the most vulnerable.  It is expected to raise a few hundred millions euros at most, but in terms of the government's budget is minuscule. Moreover, the tax is only for 2013 and 2014.  It will generate a weak revenue stream and the temporary nature duration speaks to the lack of sustainability.  

It is mostly thunder, with little rain.    Some observers play up the potential emigration by wealthy and successful people.   But this more an example of tax arbitrage.  The emigration itself is a largely symbolic too as all that really changes is the taxing authority.  There could be a high profile case or two, but this type of behavior appears to be very limited.    Integrating immigrants appears to be a more pressing issue that emigration.  

Hollande claims his budget, which includes 15 bln euro spending cuts and new taxes will cut the country's deficit to 3.6% from an estimated 4.1% for this year.   Hollande may be able to influence the distribution of the pain and moderate the pace a bit, but cannot escape the ordo-liberal agenda (which Draghi himself has noted is embodied in the ECB).   The crux of the matter is straight forward.  France has among the extensive role government and its services.  The French tax burden is already 46% of GDP, which is among the highest among the OECD. 

The Socialist Hollande, like UMP's Sarkozy before him, is  embracing the ordo-liberal agenda reducing the budget deficit to 3% and, over time, balanced.    There are symbolic differences, but resistance to ordo-liberalism is not to be found in the main stream parties.  Instead, one must turn to the far right.  Le Pen's National Front, which appears poised to do well in the spring elections, defends the large role of the state, but thinks this is only possible outside of ordo-liberalism, which means, outside of the EMU.   The costs of exit could be minimized if, under French leadership, a bloc of other countries, including Spain and Italy, would leave in a coordinated fashion. 

2.  Many Italian economic officials in the government and central bank may miss New Year's celebrations as Italy's third largest bank, and the oldest bank in the world,  may have to be nationalized.  The key investor, a charitable banking foundation, with reportedly close ties with local politicians (and a 33.5% stake) has delayed the bank's proposal to dilute its stake through a new 3 bln euro equity offer in January 2014 (to after May 12).  

Monte Paschi is required to pay back the 4.1 bln euros in state aid received earlier this year to avert nationalization.  It is highly unusual for the Chairman and CEOs to be over ruled by the largest shareholder (who has veto power) and may resign over the dispute.  A decision is expected next month.  If the bank is nationalized, a new management team would likely be named.  

It is possible that if a banking union was in place, Monte Paschi could face the immediate prospects of nationalization.  However, the Italian government does not seem so inclined.  In fact, it appears to be hoping that Monte Paschi can still raise the capital. Shares were limit down today (2%), though the overall stock market was posting small gain at midday.   As 2014 unfolds, many European banks, prompted by new capital requirements and the pending stress test, may also be trying to raise capital. 

Italy did sell 5- and 10-year debt today.  The results were mixed, with the former rising and the latter slipping from the previous auctions.  Thinness of market conditions contributed to the results.  

3.  Stepped up intervention and some reports of easing tension between the government and judiciary has seen the Turkish lira bounce back and equity recovery.  The central bank indicated it would sell $600 mln today, the most since July, and will sell $3 bln in daily auctions in January. The lira rallied about 1.1% against the dollar at its best, before easing a bit.  It is still up about 0.75% on the day.  It has fallen by about 15% since the political crisis began on December 17.  

The local equity market is up a little more than 3%, recouping about 1/5 of its recent losses.     Yet, the debt market seems less sanguine.  The (generic) 2-year yield is up 8 bp to 10.0%, which represents a new high and the 5-year credit default swap has also continued to rise.  

4. China reported the results of its first audit of government debt in 2-years.  The audit puts local government debt at CNY17.9 trillion (~$2.95 trillion) as of June.  This represents a 2/3 increase from the last audit, though it includes CNY4.3 trillion of debt that is regarded as contingent, in the sense that local governments may not be legally obligated to cover.   

The results had been expected in October and the Chinese Academy of Social Sciences, a government think tank, has estimated local government CNY19.9 trillion).   The government has already moved to curb the growth of local government debt, but dealing with the current stock of debt, in a slowing economy, will be an ongoing issue.