Tag Archives: Erik Nielsen

The Last Optimist – Alive and Kicking

There’s an old saying amongst investors that claims that the market bottom is reached only when the last optimist turns pessimistic. Former Goldman Sachs European analyst, now UniCredit chief economist, Erik Nielsen, is a natural-born optimist. And he’s still hanging on, still looking for something positive to tell his clients… God bless his soul!

“While few people like to see their individual benefits being cut, or their individual taxes hiked, the broader sentiment in Southern Europe is that people want core-European quality-institution and stability.”

Erik Nielsen

“Big political changes are now sweeping through the euro zone, putting, at least for now, the many skeptical political observers to shame.  I can’t tell you how often I have been told by investors and economists during this crisis that its only a matter of time before Southern Europe refuses the adjustment medicine and brings into power radical political forces which will eventually take them out of the euro zone, and that Germany will soon refuse to lend any further money to the south.  Interestingly, some 90% of those having predicted this outcome happen to be residing outside the euro zone,” Nielsen points out.

Here’s the rest of Mr. Nielsen’s commentary, published at www.eurointelligence.com today:

The Case for Optimism

Well, so far it is moving in the opposite direction: In Greece, Lucas Papademos was sworn in as prime minister, and Italy is about to hand power to Mario Monti.  And next Sunday when Spain goes to elections, and assuming the opinion polls are remotely accurate, Spain will elect the conservative Partido Popular with a wide absolute majority.

What’s the common picture in these three countries? People want more Europe, not less.  While few people like to see their individual benefits being cut, or their individual taxes hiked, the broader sentiment in Southern Europe is that people want core-European quality-institution and stability. 

Meanwhile, in Germany, Stern magazine rewarded Angela Merkel‘s performance during recent weeks by putting her on the front page – her picture tattooed onto the bicep of a strong arm and with a sub-title of “how Merkel runs Europe”.  Stern’s weekly ranking of politicians sent her top of the group, followed by – equally important – other pro-European opposition politicians, with the more sceptical ones (the Left and FDP) way down.

For us believers in the European project, this is clearly good news. 

But will the market appreciate it?  Well, one day it will, but I am not completely sure that it will get it quite yet.  At the end of the day, we are living through this highly peculiar period where investors will rather buy bunds or gilts with a virtually guaranteed erosion of real wealth, than being paid 6%-7% for an equivalent Italian bond with a virtually certain better outcome in two years.  But with leverage and mark-to-market and a year of generally poor performance, two years is a long time.

Everybody in the asset management industry seems preoccupied with career risk. 

It is a sad reality, sad because when the collective guardians of our savings prefer negative real return rather than maximizing return on capital, then this will come with a cost to long run growth.

What should be the policy response this bizarre state of affairs? 

So far, the European response has been out of the good old text-book, to which I still subscribe:  When you have an excessive fiscal imbalance, then you adjust it as fast as you can, accepting the short-term pain for the longer term gain.  And until very recently, the market subscribed to the same philosophy, discounted the future benefits of the tougher policy, and rewarded the faster adjustment over the slower one.  

Now, however, markets seem to like slower, or no, adjustment over the fast adjustment, predominantly because investors have turned themselves into pseudo political scientists, predicting a demise of the politics in the countries undertaking tough reforms.

So far, the common political “wisdom” on Europe on Wall Street has been wrong.  Will it change now on this latest evidence?  I don’t know.

If it doesn’t, then I would propose the following: if markets do not properly reward fundamentally good adjustment policies in a country, which the Troika deems sufficient and therefore eligible for a credit line, then it would be only reasonable for the ECB to draw a line in the sand and announce a maximum funding cost for that country for a period of time. 

For example, if Italy puts into law the required structural reforms, and the market does not bring funding costs down sufficiently on the back of the prospect for better growth in the future, then – with a Troika approved credit line – the ECB ought to tell the market that during the next year (or two) and so long as those policies remain in place, the 2-5 year sector of the Italian curve shouldn’t be above, say, 4%. 

I suspect that the ECB would not have to spend much money getting that result, if any. 

The parallel is the Swiss National Bank’s decision to change their exchange rate policy “from leaning against the wind” with a clear and defendable floor of 1.20 Swiss Francs against the euro. 

It was a gutsy call by the SNB, which suddenly  everyone agreed with once implemented and successful.

I suspect the same would be true if a member of the European Central Bank‘s executive board were to propose a temporary ceiling on yields of 4%.

This would quickly put to an end the current phase of the crisis – and, almost certainly, the build-up of sovereign debt on the ECB’s balance sheet.

By Erik Nielsen, chief economist of UniCredit.

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Ex. Goldman Chief Economist Comment on European Debt Crisis

Former Chief European Economist Erik Nielsen at Goldman Sachs takes an in-depth look at what’s going on in Europe at the moment, before he’s joining the Italy based bank UniCredit as Chief Global Economist in September. Nielsen is obviously worried.    

“..there is a risk that while the urgency of the economic and financial crisis may be over, a political crisis could be looming..”

Erik F. Nielsen

Finally, the big boys at Wall Street is getting the message: The financial crisis in Europe is about to turn into a political crisis. If that happens, the consequences will be severe and unpredictable. Here’s what former Chief European Economist at Goldman Sachs, Erik Nielsen’s latest thoughts on the subject – entertaining, as always.

The following article is syndicated by www.eurointelligence.com:

The frontlines in the battle over what to do with Greek sovereign debt has shifted, highlighting a new and uncomfortable intra-European split.

The original frontline was drawn between, on the one side, a majority of market participants, academics and commentators, and on the other side, the entire class of European policymakers.

Most market participants and other private sector analysts have long argued that the debt levels are unsustainable under any reasonable set of assumptions for growth and interest rates and that debt relief therefore would be needed. Referring to past debt crises and the first principle of fairness, they concluded that relief should and would be shared broadly among all the creditors, including bondholders, who might suffer a loss of maybe 50% of their claims.

On the other side of this argument stood the united front of policymakers. Originally, they all claimed that there would be no need for debt relief because Greek policy reforms alone would do the trick. They were not persuasive. Through their more recent actions, however, they have since acknowledged the need for debt relief by lowering the interest rate they charge on their own loans to Greece. But they have kept arguing that the bonds would not be restructured.

The casual observer would be forgiven for thinking that the world has turned on its head:  Here is the community of market participants arguing for haircuts on the bonds.  And here are the governments – representatives of taxpayers – insisting that private bondholders be protected at the implicit expense of Europe’s taxpayers.

There is good reason for the official sector’s insistence on avoiding a bond restructuring.

However, there is good reason for the official sector’s insistence on avoiding a bond restructuring. Greek bonds do not include collective action clauses, and they are distributed widely to domestic and foreign holders.  Worse, there is no reliable information on who exactly owns what, including who has bought and who has sold protection on these bonds.  The ECB’s Lorenzo Bini Smaghi has rightly suggested that the aftermath of the Lehman default might look like a walk in the park compared with a forced restructuring of Greek bonds. Some have argued that since about 90% of the bonds have been issued under Greek law, the Greek parliament could simply change the law and impose haircuts on the existing bondholders; a highly questionable preposition since retroactive legislation would run counter to any normal modus operandi in democratically ruled market economies.

The political winds throughout Europe have begun to swing towards fringe parties with a more sceptical – if not outright hostile – attitude to European cooperation.

Left with no practical way of including in an orderly way the private creditors in the burden sharing, the official sector is now contemplating further relief, including via longer maturities and maybe still lower interest rates, while insisting on further measures to speed up the inevitable policy adjustments in Greece.  However, as the political winds throughout Europe have begun to swing towards fringe parties with a more sceptical – if not outright hostile – attitude to European cooperation, the appropriateness of involving the private creditors for a fairer sharing of the burden has now been accepted by several governments, led by Germany.

With a disorderly attempt at restructuring still ruled out, the idea of voluntary participation of bondholders through a maturity extension, possibly under the vaguely defined Vienna Initiative, has been introduced. The Vienna Initiative aims as keeping banks involved in crisis countries. Importantly, while a voluntary maturity re-profiling would be unlikely to provide much,if any, net present value reduction, it might provide sufficient political cover to keep taxpayers involved for the heavier lifting.

I suspect that the ECB has concluded that the generally improved economic and financial outlook justifies a return to normal monetary policymaking. 

Strangely, this reasonable and gentle call for private sector involvement has met strong opposition from the ECB.  Having no explicit vote in the system, the ECB has threatened a practical veto by suggesting that voluntarily re-profiled bonds might not be eligible as collateral under its repo system.  Surely, if that were to be the ECB’s final word, then no bank would voluntarily participate, and the attempt to include even modest private sector participation would end right there.

Why would the ECB now throw a spanner in the wheel for what appears to be a perfectly reasonable compromise to involve most of the bondholders – and recalling that they have before made important exceptions to the treatment of debt in their collateral set-up?  I suspect that the ECB has concluded that the generally improved economic and financial outlook justifies a return to normal monetary policymaking.  Therefore, they now want to send their extraordinary and at times quasi-fiscal measures back to their rightful owners; the governments.  This means that governments need to adjust their policies, and when help is needed for one of the member states, it is to be provided via implicit or explicit tax transfers by other members, not the ECB.

There is a risk that while the urgency of the economic and financial crisis may be over, a political crisis could be looming if additional taxes have to be transferred.

Erik F. Nielsen

I have a lot of sympathy for that argument. But there is a risk that while the urgency of the economic and financial crisis may be over, a political crisis could be looming if additional taxes have to be transferred. And if, God forbid, the financial crisis indeed were to be followed by further political tensions with the potential to drag euro zone member states away from the common good, and towards nationalism, then the ECB could soon find itself back with policies much more uncomfortable than the acceptance of collateral of bonds which the holders have voluntarily accepted in place of their holdings of shorter bonds. Wanting to do the right thing, there is a real risk that the ECB is moving too fast towards the exit door right now.

 

Erik F. Nielsen is the former Chief European Economist at Goldman Sachs. 

He’ll join Unicredit as Global Chief Economist in September.

www.eurointelligence.com

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Even Goldman Sachs Is Confused About Irish Economy

Goldman Sachs‘s European analyst, Erik Nielsen,  is back in London’s prominent Chiswick with an updated view on the regions partly messed up economies. He is, however, confused over Ireland. But he’s not alone. The  whole European financial market were left in a state, described as of “unusual uncertainty” after close on Friday. The main problem is that no one seem to know what’s going on in Ireland. Erik Nielsen at Goldman Sachs is most worried about the contagion effects, thou.

“Whether (or when – if before early summer) the Irish government seeks financial help from the EU and IMF is a purely political decision on the back of an assessment of the broader risk of the spread levels to economic and financial stability.”

Erik Nielsen

Chiswick - Dublin

“To recoup:  the Irish government is fully funded – with no borrowing needs at all – until mid-2011.  They are in the midst of budget negotiations which should be done by December 7.  If they were to breakdown before then, pressure on Irish spreads would surely widen further, putting the country further at risk,” Nielsen writes in a note to clients.


With courtesy of www.zerohedge.com, here’s the latest economic update on Europe from Goldman Sachs’ London-based European analyst, Erik Nielsen:

Happy Sunday,

* I’m back in my beloved Chiswick after having been on the road most of this past week; and what a week it was!  Here’s the way I see it all:

* It’s been a week of scary spread widening for the periphery mostly due to the uncertainties stemming from the stated policy initiative to include private sector participation in future debt workouts.

* On Thursday, European finance ministers – finally – clarified that this initiative will not apply to existing debt, but whether this is enough to put the genie back in the bottle remains to be seen.

* It is being reported that Ireland has started informal talks with Brussels on a rescue package, but so far there has been no formal request.  I summarise my view on how it may all play out.

* French PM Fillon submitted his resignation yesterday; a cabinet reshuffle is likely later today or tomorrow.

* On the data front it was a quiet week generally lending support to our constructive pan-European views.

* Tuesday-Wednesday will see the Eurogroup and Ecofin meetings; an opportunity to express support for the periphery, if that has not happened before then, but formal agreement on a package will take longer.  Also look out for politics in Italy.

* On the data front we’ll get inflation and trade numbers out of the Euro-zone this coming week; not that exciting although we’ll be hitting the ECB’s target of 1.9%.

* The UK also prints inflation this week along with labour market and retail numbers.  And we’ll get the MPC minutes – and loads of MPC talk.

And Switzerland prints inflation – and trade – data this week.


-1     What started as confusion among investors about a sentence in Merkel and Sarkozy’s communiqué from Deauville in mid-October referring to the participation of private creditors in future debt workouts (after the Treaty has been changed by 2013) escalated to real market worries after the Council approved this language in late October.  It was clearly a grand political statement of intentions rather than a concrete proposal taking into considerations the umpteen legal and practical issues involved in marrying such an approach with the need to keep the process orderly, but it spooked the market and raised a lot of unnecessary uncertainty.  I am sure that this problem was being conveyed to the policymakers from many sides.  On Wednesday, I had a piece in the FT highlighting some of the complexities, concluding that “the sooner Van Rompuy and his team – and the rest of the political leadership – clarify these complex practical and legal issues, the sooner premiums on peripheral sovereign issuance will evaporate.  Otherwise the peripheral countries could see their borrowing costs hit levels not seen since the Greek rescue, in effect, shutting them off from commercial borrowing – hence forcing them to rely on the existing rescue facilities.”  When LCH.Clearnet imposed substantial margins on Irish bonds things turned outright scary because of the possible effects of the sovereign spread-widening onto the financial sector.

-3     Ireland is reported to have started informal conversations with the Commission on a support program, and an unnamed German official is quoted today saying that Germany is encouraging Ireland to tap the facility to help further calm markets.  I apologise for not being able to take very many calls (or answer the many emails) Thursday-Friday when I was travelling, but my views on how all this may play out has not changed the last few weeks (i.e. after I realised that our original view on Ireland was too optimistic.)  To recoup:  the Irish government is fully funded – with no borrowing needs at all – until mid-2011.  They are in the midst of budget negotiations which should be done by December 7.  If they were to breakdown before then, pressure on Irish spreads would surely widen further, putting the country further at risk. If the budget gets through, then I suspect the original Irish game-plan was to spend the next couple of months convincing markets that things are back on track before they restart the government borrowing sometime late winter/early spring.  This could include the involvement of some of their domestic resources, but I tend to doubt it.  Given its own strong cash position, the spread widening has no immediate or direct effect on the government, but the part of the private sector with financing needs will be hurt, of course, and this degree of market stress will increase the risk for the financial system as a whole (well beyond the benefits stemming from the weaker euro.)  And it may be fuelling the spread widening for other countries as well.  In other words, whether (or when – if before early summer) the Irish government seeks financial help from the EU and IMF is a purely political decision on the back of an assessment of the broader risk of the spread levels to economic and financial stability.

-3     Ireland is reported to have started informal conversations with the Commission on a support program, and an unnamed German official is quoted today saying that Germany is encouraging Ireland to tap the facility to help further calm markets.  I apologise for not being able to take very many calls (or answer the many emails) Thursday-Friday when I was travelling, but my views on how all this may play out has not changed the last few weeks (i.e. after I realised that our original view on Ireland was too optimistic.)  To recoup:  the Irish government is fully funded – with no borrowing needs at all – until mid-2011.  They are in the midst of budget negotiations which should be done by December 7.  If they were to breakdown before then, pressure on Irish spreads would surely widen further, putting the country further at risk. If the budget gets through, then I suspect the original Irish game-plan was to spend the next couple of months convincing markets that things are back on track before they restart the government borrowing sometime late winter/early spring.  This could include the involvement of some of their domestic resources, but I tend to doubt it.  Given its own strong cash position, the spread widening has no immediate or direct effect on the government, but the part of the private sector with financing needs will be hurt, of course, and this degree of market stress will increase the risk for the financial system as a whole (well beyond the benefits stemming from the weaker euro.)  And it may be fuelling the spread widening for other countries as well.  In other words, whether (or when – if before early summer) the Irish government seeks financial help from the EU and IMF is a purely political decision on the back of an assessment of the broader risk of the spread levels to economic and financial stability.

-4     There has been no official request for help so far, but if the Irish want it, there can be no question that they’ll get it without much trouble; i.e. no need for long negotiations on conditionality.  As I have argued throughout this year, their policy adjustments have been impressive, and apart from the valuations of assets transferred to Nama (which triggered the beginning of the sell-off – but was that really bad for the government balance sheets?), I am not really aware of any material macro or political news that would justify the present spreads.  But that said, if investors are running for the door out of fear of being the last one left behind, then there’ll be a liquidity crisis (as there would be for anyone with a financing need), and they’ll need help. In my book, this is not a solvency crisis, and the government’s policies are surely not far off what the Commission and the IMF would demand in return for a loan (which would eliminate the need for private funding for the next 2-3 years.)  The Commission – and fellow Euro-zone members – will surely ask the Irish to raise their corporate tax rate, but the Irish will resist, although they may end up with some sort of “gentlemen’s agreement” to move in that direction over the medium term.  IMF programs (and surely EU-IMF programs as well) do not set specific detailed fiscal policy measures, but more general frameworks.  That said, the Euro-zone will need towards greater tax harmonization, and while Ireland has fought this for a long time, the power is naturally now shifting to those providing the bail-out.  Importantly, with or without a facility to include private creditors in a debt workout in the future, this would not apply to a liquidity crisis like the Irish.

-5     Portugal is quite different from Ireland.  The 2011 budget is further ahead (and the deficit is smaller), but their financing needs are more acute, and they are facing some significant amortizations in April and June (two times €4.5-5.0bn) which will require measurable borrowings before then (Portugal does not publish their cash holdings, so we don’t know their exact needs.)  Like for Ireland, a decision to ask for help is a political one, but given their ongoing borrowing needs, the present spreads hurt the budget process directly.  Also, if they were to ask for help, negotiations on the underlying policy conditionality would likely be more complicated than for Ireland because of the need for much more wide-reaching structural reforms in Portugal (but do-able, of course.)  While I haven’t seen any reports on it, I rather suspect that the Commission is reaching out to Lisbon this weekend to encourage a more detailed discussion of a Plan B on Tuesday. In spite of their differences, if (when) Ireland or Portugal officially seeks help, it can only be in everyone’s interest to start the process for the other country at the same time.

-6     Following months of speculation and hints, yesterday French PM Fillon submitted his resignation to president Sarkozy.  A cabinet reshuffle is likely to be announced later today or tomorrow.  The key objective will be for Sarkozy to re-energise his government for the last 15 months of his presidency and create a stronger platform for himself from which to run for re-election in 2012.  We do not think it’ll have material impact on domestic policies relevant for investors.  A number of commentators have suggested that Fillon may be re-appointed as the safe pair of hands he is on the domestic front, leaving Sarkozy the necessary time to roam on the global stage as chairman of G20.  Lagarde has been mentioned as a possible new foreign minister, unless she stays in her present position.

-7     In terms of data, this past week was dominated by the key Euro-zone GDP numbers for Q3, coming in at the expected +0.4%qoq (non-annualised), driven largely by Germany (+0.7%), while Spain delivered a respectful flat number.  The German locomotive helped several others perform well; the Czech Republic and Hungary reported Q3 GDP growth of 1.1% qoq, non-annualised, and 0.8%, respectively.  We also got industrial production numbers for September, and for this volatile series, the third quarter ended relatively poorly for the Euro-zone, erasing much of the strong gains in previous months, bringing us back to our estimated trend-line.  Quarter-on-quarter, IP was up 0.4% (non-annualised.)  As I discussed last week, the early indicators for Q4 are looking good, suggesting some (moderate) upside risk to our +0.3% Q4 GDP forecast; +0.3% Q4 growth would give us our full-year 1.7% growth number (which I was laughed out of the room on on more than one occasion when we launched it earlier this year – Dirk Schumacher discussed these numbers in greater detail in Thursday’s European Weekly Analyst, and we’ll publish revised 2011 and new 2012 forecasts in early December.)


Turning to this coming week:

-8     In the Euro-zone, the highlight will be the Eurogroup meeting on Tuesday, followed by the Ecofin on Wednesday.  It’ll obviously be an excellent opportunity to express support and solidarity with the crisis-hit periphery, if they don’t do so even before Tuesday, but I rather doubt it’ll be more than that.  As discussed above, I think we are still some way away from a formal announcement of official financing being launched – but this is, of course, pure guessing on my part because, the Irish government does not need the money for several months so its all a political decision.  Also on the political side, it’ll be important to keep an eye on Italy.  Last Thursday Future and Liberty Party head Fini refused to a proposed cabinet reshuffle without Berlusconi first resigning and an aid to Fini then said that the Future and Liberty Party will pull out of the coalition this coming week; the press reports that the resignation letters are already on his desk.  The crisis may lead to either a reshuffle of the cabinet or it could lead to early elections.  Either way, we do not think it’ll impact the 2011 budget process or outcome.

-9     In terms of data releases, it’ll be an extremely light week in the Euro-zone.  We’ll start Monday with September trade data.  They have an EMEA-relevance score of zero, so our interest is more in terms of the growth rates for exports and imports.  The shift in Q2 from Euro-zone growth being primarily export driven to primarily domestic demand driven was accompanied by stronger import growth (than export growth), opening up a (still small) trade deficit, so it’ll be interesting to see if that remained the case as Q3 closed.  Then on Tuesday we’ll get the full inflation report for October; the flash estimate showed an increase in headline inflation to 1.9%yoy (from 1.8%), so the news will relate to the underlying components, specifically core inflation which we think has remained stable at 1.0% before moving gradually higher towards the end of the year.  On a normal reaction function, the ECB should already be well into its exit, but – like other central banks – normal reaction functions seem a curiosity of the past these days, so it’ll come slowly during 2011’H1, we think.  Finally, Eurostat is set to publish 2009 Greek deficit and debt figures on Monday, and the Troika will discuss the Greek loan program – I’m sure this will attract considerable attention, comments and questions, but we are nowhere near a place where the program is in trouble.

-10     In the UK, we are heading into a week of CPI inflation (Tuesday), unemployment and wages (Wednesday) and retail sales (Thursday).  We expect inflation to have eased to 3.0%yoy in October (from 3.1%) mostly due to base effects, although food and energy prices moved higher in October (and a major provider has just announced a big jump in retail gas prices in November), so one shouldn’t get carried away here; these elevated inflation levels seem likely to be around for a long time.  We are in line on unemployment and earnings growth (7.7% and 2.3% respectively) and slightly above on retail sales (0.5%mom versus 0.2%).  Wednesday also sees the release of the minutes of the MPC’s November meeting.  The consensus expectation is for an 8-1 vote in favour of unchanged policy; we’d be surprised if Adam Posen reversed his vote for more QE after only one meeting.  In any event, as Ben Broadbent has pointed out, it’ll be more important to watch for any shift in the general tone of the minutes, in particular, to see whether the sentence depicting the dovish bias of the Committee – “some members felt the likelihood that further monetary stimulus would become necessary had risen in recent months” – is retained.  Released alongside the minutes are the monthly Agents’ survey and, as is usual a week after the Inflation Report, the detailed numbers behind the MPC’s latest set of forecasts.  It’s also usual to see a spate of MPC speeches after the purdah of the quarterly forecasting round and we get three – Weale on Monday, Posen on Thursday, Tucker on Friday.  Tucker and Dale also give evidence to the House of Lords Economic Affairs Committee on Tuesday afternoon.

-11     In Switzerland, we’ll get producer and import price inflation for October on Monday and trade data (also for October) on Thursday.  We expect the headline Supply Price Index to jump to 0.8%yoy (from 0.3%) on the back of a massive base effect.  The key component to watch will be import prices, for any evidence of further disinflation as a result of CHF appreciation.  The trade data will be important to watch in case the trend line (in a volatile series) for exports were to continue its softening into the end of the year.

… and that’s the way it all looks to me on this lovely mid-November day in Chiswick.  I somehow feel that I’ll be writing more emails to you this coming week, but for now I’ll be heading to the High Street for my (belated) morning coffee.

Best

Erik F. Nielsen
Chief European Economist


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