Macro and Credit - Another Brick in the Wall

"Success is having to worry about every damn thing in the world, except money." -  Johnny Cash

Looking with interest at the elections of new French president maverick Macron, in effect putting another brick in the wall of worry, hence our title analogy, we reminded ourselves of Pink Floyd's 1979 rock opera with "Another Brick in the Wall being the title of three songs set to the variations of the same basic theme:  subtitled Part 1 (working title "Reminiscing"), Part 2 (working title "Education"), and Part 3 (working title "Drugs"). Part 2 was in fact a protest song which somewhat resonates clearly with the rise of populism in general leading to Brexit and Trump's election, whereas the results so far in 2017, seems to be the reverse of what has been playing out in Financial markets in 2016 where we had a dismal first part of the year and political surprises in the second part of 2016 in conjunction with a very significant rally in all things beta in the second part of 2016. 2017 so far has seen significant records being broken for equities indices, tighter credit spreads, and record low vix, which many pundits punting towards "complacency". In our previous conversations, we have indicated that while we did remain short-term "Keynesian" when it comes to our "risk-on" feeling, hence our reduction in both our gold miners exposure and duration exposure, we believe that the second part of 2017 could play as a reverse of the second part of 2016.

In this week's conversation we would like to look at a trade which has been put forward by many pundits including Jeffrey Gundlach of DoubleLine Capital, which is the case for EM equities versus the S&P 500 from an allocation and macro point of view.

Synopsis:

• Macro and Credit - Emerging Markets vs S&P 500, the old versus the new or the new versus the old?
• Final chart - Weak loan demand tends to be associated with high volatility

• Macro and Credit - Emerging Markets vs S&P 500, the old versus the new or the new versus the old?

While many pundits have been mesmerizing at the record low level touched recently by the "fear index" VIX, we reminded ourselves a previous conversation from 2013 entitled "Long dated volatilities: a regime change". As we posited back in 2013, it seems we are clearly back in the low regime of 2004-2007, and credit spreads as of late are also a reminder of the tightness in credit we experienced firsthand in our banking days at the time. Back in our old conversation we made some interesting comments relating to Emerging Markets and volatility which, we think, from a macro perspective are still extremely valid:

"Financial liberalization, for instance in Emerging Markets, has been a good way to attract foreign investments. It has often led to a rise in volatility given investors had been reaping in the process higher daily return rates. When equity market becomes more open, there are increases in stock return volatility (on the subject see the study realised by Vuong Thanh Long, Department of Economic Development and Policies at the Vietnam Development Forum - Tokyo Presentation - August 2007).

Regime switches also lead to potentially large consequences for investors' optimal portfolio choice hence the importance of the subject." - source Macronomics, January 2013.

We also mentioned at the time that different regimes corresponds to period of high and low volatility, and long and bull market periods in conjunction with the credit cycle. At the time of our previous post we also indicated that the importance of regime change was paramount to asset allocation given:

"The relation between the investor horizon of a buy-and-hold strategy and the optimal portfolio varies considerably from one regime to the other.

• For example, in a bear regime, stocks are less favored and short-term investors allocate a smaller part of their portfolio to stocks. 
• On the contrary, in the longer run, there is a high probability to switch to a better regime and long-term investors dedicate a larger part of their portfolio to stocks. 
• In a bear regime the share allocated to stocks increases with the investor’s horizon." 

- source The Princeton Club of New-York, 27th of April 2012, EDHEC-PRINCETON Institutional Money Management Conference.

Also we mentioned at the time that retail investors had been net sellers of stocks since 2007. Yet, in recent years, it seems many have returned using ETFs as an investment vehicle of choice, shunning active management to passive management in the process.

Returning to the very subject of our conversation, there is indeed a case being made which so far year-to-date has been validated performance wise to go long EM equities versus the S&P 500. As a reminder, since the inception of the MSCI EM index back in 1988, the MSCI EM / S&P 500 ratio has experienced two significant boom/bust cycles:

Arguably there has been a significant growing gap between both indices since 2014, while the S&P 500 has been no doubt racing ahead:

- source MacroCharts.pro

With the benefit of hindsight, we can summarize those two cycles in the following way:

Cycle 1 (1988-1999)

• Boom phase (EM outperforming between 1988 and 1996): With the disappearance of the Eastern Bloc, Second and Third World countries were bound to join the First World, and mankind would reach Fukuyama’s “End of history” (1992). Trade barriers fell, stable governments became the norm, and EMs became an investible asset class. The first EM boom culminated with the 1997 Asian crisis.
• Bust phase (S&P outperforming between 1996 and 1999): As EMs were still suffering from the aftermath of the crisis, US equities were led by the first tech bubble.

Cycle 2 (1999-Now)

• Boom phase (EM outperforming between 1999 and 2011): Following the tech crash 2000, investors turned away from the new economy. The term itself became used derisively, as the tangible economy came back with a vengeance, introducing new investment themes: the commodities super cycle, stagflation, the Hubbert peak, etc.
• Bust phase (S&P outperforming since 2011): In the early 2010s, the new economy finally started to become a reality, capitalizing on the huge infrastructure investments that were made during the first tech bubble. At the same time, new technologies (fracking, clean tech, electric cars…) made the developed world less dependent on energy and raw materials.

To sum up, EMs vs. S&P is not a merely a bet on global growth but put it simply a sectorial bet:

• MSCI EMs returns are dominated by old economy industries, commodity- and more generally stuff-producing companies. EM equities are a bet on scarcity and inflation.
• S&P 500 returns are dominated by the new economy: tech, platform companies, business services etc. The S&P is a bet on innovation, deflation and creative destruction.

One might argue that EMs are not pure old economy with the significant weight of Samsung and Tencent for example. But, one might also opine that Korea and Taiwan are not really truly Emerging Markets anymore. Though our simplified interpretation doesn't match the truly "old economy", you get our point when it comes to the sectorial bias.

After its nearly 60% correction since its 2011 heights, there are currently several factors at play indicating that we could be at the beginning of a third cycle in the MSCI EM / S&P ratio.

The CRB Industrial Metals Equity Index (CRBIX Index) has had a significant rally since January 2016:

Following the same trend until recently, there were some indications that there was somewhat a revival in the Chinese materials sector:

- source MacroCharts.pro

(Correlation 0.909, R2 = 0.826, 228 months in sample).

But given our premises that EM being a sectorial bet, still dominated by old economy industries, commodity and more generally stuff-producing companies, EM does indeed appear to be a bet on scarcity and inflation. With Chinese PPI slowing down, one might rightly ask, what's the overall picture if we take into account Chinese Iron Ore spot prices?

- source MacroCharts.pro

(Correlation 0.907, R2 = 0.823, 72 months in sample).

Clearly Iron Ore spot prices are very volatile particularly given the recent clamp down on the famous Wealth Management Products (WMP) by the Chinese government but also reflects a tightening in Chinese financial conditions as well.

After all, weaker commodity prices was reflected in the latest data out of China given the  producer price index (PPI) slowed more than expected in April, falling to a year-on-year pace of 6.4% from 7.6% in March.

Regarding commodities themselves, Dr. Copper, (the PhD in economics) is something we would like to look at to get some cues on this sectorial premise of ours:

- source MacroCharts.pro

(Correlation 0.896, R2 = 0.802, 228 months in sample).

Australia’s terms of trade is also an interesting indicator of MSCI EM/ S&P ratio, due to Australia’s heavy reliance on commodities:

- source MacroCharts.pro

(Correlation 0.932, R2 = 0.869, 228 months in sample).

After all, we are seeing tighter liquidity from China in its moves to rein in leverage which could potentially weigh on economic growth as it is attempting a "controlled demolition" of the shadow banking bubble which was let loose.

Regarding inflation, the recent increase in inflation expectations hasn’t yet been factored in by the MSCI EM vs. S&P ratio:

- source MacroCharts.pro

(Correlation 0.859, R2 = 0.737, 132 months in sample).

Additionally, Chinese devaluation fears, which roiled world markets during the summer of 2015, have substantially receded since the beginning of the year:

- source MacroCharts.pro

(Correlation -0.869, R2 = 0.741, 36 months in sample).

Yet the pullback in TIPS inflation "breakeven" rates with US 5 year breakeven rates trending lower have shown that the "Trumpflation" trade has been cooling as of late. Though the recent weakness in precious metals with silver getting spanked daily can be attributed to a gradual rise in real rates we think, another manifestation of Gibson's paradox as a reminder:

"Gold price and real interest rates are highly negatively correlated - when rates go down, gold goes up. When real interest rates are below 2%, then you get a bull market in gold, but when you get positive real interest rates, which has been the case with the rally we saw in the 10 year US government bond getting close to 3% before receding, then of course, gold prices went down as a consequence of the interest rate impact." - source Macronomics

On a side note, there has never been an episode in history when Gibson's paradox failed to operate. The real interest rate is the most important macro factor for gold prices. Also the relationship between the gold price and TIPS (or “real”) yields is strong and consistent. Gold and TIPS both offer insurance against “unexpected” (big and discontinuous) jumps in inflation. The price of gold normally falls along with the price of TIPS (which means that TIPS yields rise). So to conclude our side note, gold and gold miners are not the best hedge at the moment given the negative correlation with real rates. This is clearly illustrated in the below chart from Deutsche Bank European Equity Outlook note from the 11th of May:

- source Deutsche Bank

So far in 2017, the outperformance continues to play out in favor of EM as per the chart below displaying the S&P 500 performance relative to iShares MSCI EM:

- source Bloomberg

Flow wise commodities funds according to the latest Follow the Flow note from Bank of America Merrill Lynch have seen their eighth week of inflows, however showing signs of slowing down with gold and oil prices moving lower recently. We think most of the ongoing correction in the commodity complex is tied up to the "controlled demolition" of WMP led by China. Emerging market equities have historical strong correlation to commodities, yet, investors have continued pushing emerging market equites higher.

Given the pressure on Chinese A shares, should you want to play this trade via ETFs we would agree with Bloomberg's take from the video embedded in their article  "Gundlach Says Short the S&P 500 and Buy Emerging Market ETF" from the 9th of May, that you would be better off using IEMG ETF (South Korea and no China A shares) rather than EEM ETF given the ongoing tightening pressure in China. Yet, with KOSPI rallying as well 13.6% and breaking through the 2300 at an all-time high, the rally has been significant but mostly led by Samsung. We continue to believe that overall markets are trading on expectations of structural reforms in many instances (US, France, South Korea, etc.).

In relation to Emerging Markets, if in Macro, demography is destiny, we continue to like the asset class given as shown in the recent Bloomberg graph workforces are still expanding in India, Southeast Asia, Vietnam as well has a very young population and Southeast Asia overall is offering very compelling growth prospects:

- source Bloomberg (H/T Tiho Brkan

On top of that, China's Silk Road initiative with their willingness in expanding towards the West is clearly going to spur in its surroundings economic growth and renewed demand for commodities while China is transitioning its internal imbalances towards consumption rather than domestic fixed asset investments. The long term macroeconomic impact of such endeavor should not be underestimated.

While we still believe in some continuation of "risk-on", yet we could potentially get a pullback, we are closely watching oil, being at the moment the major brick within our wall of worry when it comes to potential credit spreads widening and spillover. We continue to follow closely the credit cycle and the global credit impulse which has shown recently by China and as well from the latest US Fed Senior Loan Officer survey, continues to point towards a slowdown thanks to weaker demand as per our final chart below.

• Final chart - Weak loan demand tends to be associated with high volatility

While markets have successfully climbed the wall of worry with the French elections angst, we continue to track the slowly but surely eroding credit cycle and credit impulse. The significant performance of risky asset classes and beta in particular since the second part of 2016 in the on-going low volatility regime thanks to central banks meddling, makes us feel a tad more nervous about the continuation of the rally in the second part of the year while we are acutely aware as we wrote recently that the final inning in a credit cycle always is often associated with a final large melt-up.

When it comes to the volatility quandary, we read with interest DataGrapple's take on the subject from their blog post from the 9th of May entitled "Is volatility a thing of the past?":

"Most of the political risk is behind us in Europe. Unless his party shows very poorly during the general election next month, Mr Macron should be in a position to at least form a coalition with the center right. In the UK, there seems to be little doubt that the Conservative will secure a strong majority in Parliament in a few weeks. In Germany, whoever comes on top in the September ballot will be a member of the current ruling coalition. So the main source of uncertainty is Italy where the 5-star movement and its anti-euro stance is leading the poll, but elections should not be held this year. We know that they will take place before May 2018, but their exact date has not been set. With talks around the restructuring of the Greek debt apparently making progress, the euro area should enjoy a period respite. That is the message sent to the market by investors who are selling options, betting on a very low realized volatility up to the September expiry. The implied volatility of options with a strike 10% out of the money are trading sub 40% on all indices for the next 5 expiries." - source DataGrapple.

Have reached peaked complacency? One might wonder. Our final chart comes from Bank of America Merrill Lynch Situation Room note from the 8th of May and displays C&I Loan demand versus the VIX index which clearly shows that often weak credit demand tends to be associated with high volatility which shouldn't be that surprising given we live in a credit based world:

"Senior loan officers vs. VIX

One of the key stories we have been tracking for most of the year is the lack of loan demand in the US across the board. That was apparent in the February Senior Loan Officer Survey as well as subsequently weekly bank asset data from the Fed. Hence not surprisingly today's fresh Sr. Loan Officer Survey showed continued very negative
growth in consumer loan demand as well as deterioration into negative territory for C&I lending. It thus appears that the key post-election story continues - i.e. while optimism is high everybody is in wait-and-see mode pending details on tax reform from the new administration. The longer this lasts the greater the risk of more weakness in hard data. It appears a great contradiction to these circumstances that the VIX closed today at 9.77 - the lowest since December 1993. Weak loan demand tends to be associated with high volatility, not low (Figure 1)."

- source Bank of America Merrill Lynch

If credit conditions are tightening in both China and the US, and we continue to see a weaker tone in the commodities space, it is hard not to start worrying about weaker aggregate demand overall and not only in oil prices. Yet another brick to keep an eye on in your personal wall of worry we think but we ramble again...

"Worry is interest paid on trouble before it comes due." - William Ralph Inge, English clergyman.

Stay tuned!

Credit - Osmotic pressure

"We want a story that starts out with an earthquake and works its way up to a climax." - Samuel Goldwyn 

Looking at the continued sell-off in Emerging Markets currencies with the Indian Rupee touching a record low level of 65.56 before bouncing back by 2.1%, on Friday the biggest move since June 2012 and the Brazilian Real which continued its slide before bouncing back as well 3.7% to 2.3488 following a 60 billion US dollar central bank pledge, made us venture towards our distant memories, in similar fashion like our previous posts made us revisit our musical souvenirs from the 80's.

Emerging Currencies "tapering" in true MMA fashion since Bernanke started mentioning "tapering" its QE programme, graph source Thomson Reuters Datastream / Fathom Consulting / Macronomics:

So why "Osmotic pressure" as our chosen title you might rightly ask?

This time around, our chosen title is directly linked to capital flows we are seeing, with the outflows from Emerging Markets towards Developed Markets. 

As the Osmosis definition goes:

"When an animal cell is placed in a hypotonic surrounding (or higher water concentration), the water molecules will move into the cell causing the cell to swell. If osmosis continues and becomes excessive the cell will eventually burst. In a plant cell, excessive osmosis is prevented due to the osmotic pressure exerted by the cell wall thereby stabilizing the cell. In fact, osmotic pressure is the main cause of support in plants. However, if a plant cell is placed in a hypertonic surrounding, the cell wall cannot prevent the cell from losing water. It results in cell shrinking (or cell becoming flaccid)." - source Biology Online.

Nota bene: Hypertonic

"Hypertonic refers to a greater concentration. In biology, a hypertonic solution is one with a higher concentration of solutes on the outside of the cell. When a cell is immersed into a hypertonic solution, the tendency is for water to flow out of the cell in order to balance the concentration of the solutes." - source Wikipedia

So the reasoning behind our chosen title is linked to our past "biology" classes of course, given since 2009, the effect of ZIRP has led to a "lower concentration of interest rates levels" in developed markets (negative interest rates). In an attempt to achieve higher yields, hot money rushed into Emerging Markets causing "swelling of returns" as the yield famine led investors seeking higher return, benefiting to that effect the nice high carry trade involved thanks to low bond volatility.

We did send a warning in June in our conversation "The Daisy Cutter":

"If you think rising yields are only putting global trade at risk, think as well how it will ripple through in various sectors and countries." - source Macronomics 

This is what we envisaged in our conversation "Singin' in the Rain" as well:

"If the dollar goes even more in short supply courtesy of Bernanke's "Tap dancing" with his "Singin' in the Rain", could it mean we will have wave number 3 namely a currency crisis on our hands? We wonder..."

The mechanical resonance of bond volatility in the bond market started the biological process of the buildup in the "Osmotic pressure" we think and bond volatility has yet to recede. 

The volatility in the fixed income space has remained elevated as displayed by the recent evolution of the Merrill Lynch's MOVE index rising from early May from 48 bps  towards the 100 bps level again, whereas the VIX, the measure of volatility for equities is finally reacting - graph source Bloomberg:

MOVE index = ML Yield curve weighted index of the normalized implied volatility on 1 month Treasury options.

CVIX index = DB currency implied volatility index: 3 month implied volatility of 9 major currency pairs.

Of course, what we have been tracking with interest is the ratio between the ML MOVE index and the VIX which remains elevated from an historical point of view if we look back since October 2000 - graph source Bloomberg:

With VIX picking up, no wonder the ratio between the MOVE index and VIX has fallen from last week 7.06 level towards 6.10 as the contagion in the equities space is finally picking up. Hence, last week our "Fears for Tears" concerns for our equities friend as the "tapering" noise increases as we move towards September.

As a reminder, we started pondering about the potential end of the goldilocks period of "low rates volatility / stable carry trade environment in June:

"As pointed out by Bank of America Merrill Lynch's note stable carry thrives in low rates volatility environment, the recent spike in US bonds volatility has had some devastating effect in high yielding assets:

"Carry trades love low risk-free interest rates, but they love low interest rate volatility even more. This is why over the past three years, billions of dollars have poured into high yielding assets like risky corporate bonds, emerging market currencies, and dividend paying stocks, driving their risk premiums to abnormally low levels."

So what we are witnessing right now is indeed "reverse osmosis" in Emerging Markets, and the osmotic pressure which has been building up is no doubt leading to an "hypertonic solution" when it comes to capital outflows in Emerging Markets.

Let us explain:

In a normal "macro" osmosis process, the investors naturally move from an area of low solvency concentration (High Default Perceived Potential), through capital flows, to an area of high solvency concentration (Low Default Perceived Potential). The movement of the investor is driven to reduce the pressure from negative interest rates on returns by pouring capital on high yielding assets courtesy of low rates volatility and putting on significant carry trades, generating osmotic pressure and "positive asset correlations" in the process. Applying an external pressure to reverse the natural flow of capital with US rates moving back into positive real interest rates territory, thus, is reverse "macro" osmosis we think. Positive US real rates therefore lead to a hypertonic surrounding in our "macro" reverse osmosis process, therefore preventing Emerging Markets in stemming capital outflows at the moment.

So in this week's conversation, as we moved towards the "interesting" month of September we will revisit some of our thoughts from our conversation "Singin' in the Rain" and look at the risk and opportunities lying ahead.

As a reminder from our June conversation:

"We got seriously wrong-footed by the market's reaction to the "tapering QE" scenario and we still think at some point the Fed will maybe redirect its buying towards MBS, given that rising rates could seriously dent any hope of a "housing recovery" should the move continue at a rapid pace like it has this week."

The "housing recovery is indeed at risk - graph source Thomson Reuters Datastream / Fathom Consulting:

As indicated by Prashant Gopal on the 22nd of August in Bloomberg in his article "U.S. Mortgage Rates Jump to Two-Year High With 30-Year at 4.58%": 

"The average rate for a 30-year fixed mortgage rose to 4.58 percent this week from 4.4 percent, Freddie Mac said in a statement today. The average 15-year rate climbed to 3.6 percent from 3.44 percent, the McLean, Virginia-based mortgage-finance company said. Both were the highest since July 2011.

Homebuyers are rushing to take advantage of historically low borrowing costs before they increase any more. Existing-home sales in July jumped 6.5 percent to the second-highest level in six years, the National Association of Realtors reported yesterday. Those transactions largely reflect closings of contracts signed a month or two earlier, when mortgage rates were just beginning to edge up." - source Bloomberg

From the same article:

"The Mortgage Bankers Association’s index of applications to lower monthly payments fell 7.7 percent in the week ended Aug. 16, the 10th straight decline. A measure of purchases rose 1.2 percent, the trade group said yesterday.

The 30-year fixed mortgage rate is well below its average of about 6.3 percent for the past 20 years, according to data compiled by Bloomberg. The 20-year average for a 15-year loan is about 5.83 percent." - source Bloomberg

Yes but, there is indeed a "convexity issue at play" given the US average Maturity of Fixed Rate Mortgages has been steadily increasing in the last decades - graph source Thomson Reuters Datastream / Fathom Consulting:

 And as our very wise credit friend former head of credit research said on the subject of convexity in June in our conversation "Singin' in the Rain":

"Convexity is a bigger issue in all the pensions + fixed income funds. That's one reason mortgages have been whacked. the Fed will basically have to do a ECB - stop buying USTs and start buying RMBS. But pensions (or Fannie / Freddie) do not hedge MBS with USTs - they do it with LIBOR"

At the time we argued:

"The Fed is likely to step in and actually increase QE to try and hold rates down, because mortgage rates have spiked substantially over the last month from a low of around 3.5% to around 4.3%, we have to agree with our friend that a "new dance" routine from the Fed might be coming." 

Central Banks Assets - graph source Thomson Reuters Datastream / Fathom Consulting:

Why the Fed might indeed increase QE? 

Point number 1:

Because the Fed is facing a raft of sellers and the economy is not as strong as it seems.

For instance, China’s holdings in May were $1.297 trillion, less than the $1.316 trillion reported by the Treasury last month. China’s stake dropped by $21.5 billion in June, or 1.7 percent according to Bloomberg as per Treasury Department data released on the 14th of August. On top of that US Commercial Banks as well have been selling as indicated by Bloomberg Chart of the Day from the 19th of August - graph source Bloomberg:

"U.S. commercial banks are dumping Treasuries at the fastest pace in a decade and boosting loans, helping make the debt securities the world’s worst performers as the economy gains momentum.

The CHART OF THE DAY shows banks’ holdings of U.S. Treasury and agency debt tumbled $34.7 billion to $1.81 trillion in July, the biggest monthly decline in 10 years, according to the Federal Reserve. The level dropped to $1.79 trillion in the first week of August, Fed data showed on Aug. 16. Also tracked are 30-year bond yields climbing to a two-year high. The lower panel records commercial and industrial loans as they surged to $1.57 trillion, the highest since 2008.

Bank sales of Treasuries accelerated after Federal Reserve Chairman Ben S. Bernanke said on June 19 policy makers may reduce the bond-buying program they use to support the economy. Concern the Fed will trim its $85 billion a month of Treasury and mortgage purchases helped send notes and bonds due in a decade or longer down 11 percent in the past 12 months. It was the biggest loss of 174 debt indexes tracked by Bloomberg and the European Federation of Financial Analysts Societies." - source Bloomberg.

Point number 2:

Our "omnipotent" magicians are desperately trying to "bend" the velocity curve and anchor higher inflation expectations. On that note we read with interest Professor Rogoff comments in Bloomberg article by Aki Ito and Michelle Jamrisko on the 12th of August - "Rogoff Saying This Time Different Calls for Reflation":

"Rogoff is espousing aggressive monetary stimulus, even at the cost of moderate price increases. At a time of weak global inflation, higher prices may even help the U.S. economy by lowering real interest rates and reducing debt burdens, he said.

“In more normal times, you’re looking for the central banker to be an anchor against high inflation expectations and to assure investors that inflation will stay low and stable to keep interest rates down,” Rogoff, co-author with Carmen Reinhart of the 2009 book “This Time Is Different: Eight Centuries of Financial Folly,” said in an interview. Now “we’re in this situation where many of the central banks of the world need to convince the public of their tolerance for inflation, not their intolerance.”

G-7 Inflation

Central banks across the developed world are struggling with inflation that’s too low. Consumer price increases in all but one of the Group of Seven economies are currently running under 2 percent, which has become the standard goal in recent years for monetary authorities. Two years ago, deflationary Japan was the only country struggling with below-target inflation."  - source Bloomberg.

The only issue is once the "Inflation Genie" is Out of the Bottle" as warned by Fed's Bullard in 2012, it is hard to get it back under control:

“There’s some risk that you lock in this policy for too long a period,” he stated.  ”Once inflation gets out of control, it takes a long, long time to fix it”

While the recent jump in interest rates, has created an "hypertonic surrounding" in the reverse osmosis plaguing Emerging Markets, it has had some positive effect somewhat for the insurance sector as well as the Auto Industry given that it has provided some relief in terms of "reserve adequacy" for insurers and a relief on "reinvestment rates" to plug the growing gap in pensions liabilities hindering the allocation of capital for the Car industry giants.

As a reminder from our conversation "Cloud Nine": 

"If we look at GM and FORD which went into chapter 11 due to the massive burden built due to UAW's size of "unfunded liabilities", they are still suffering from some of the largest pension obligations among US corporations. Both said this week they see a significant improvement in their pension plans liabilities because of rising interest rates used to calculate the future cost of payments. When interest rates rise, the cost of these "promissory notes" fall, which alleviates therefore these pension shortfalls. So, over the long term (we know Keynes said in the long run we are all dead...), it will enable these companies to "reallocate" more spending on their core business and less on retirees. Charles Plosser, the head of Philadelpha Federal Reserve Bank, argued that the Fed should have increased short-term interest rates to 2.5% in 2011 during QE2."

But, of course, what matters is indeed the "velocity" of the movement, and the intensity. So far we have avoided a major sell-off in credit. 

As indicated by Megan Hickey and Zachary Tracer in their Bloomberg article from the 1st of August commenting on US insurer's Metlife's results entitled "Metlife Says $10.9 billion of Bond Gain Erased, More Than Crisis", what matters is the pace of the rise in interest rates:

"MetLife Inc., the largest U.S. life insurer, saw $10.9 billion in bond gains wiped out in the three months ended June 30 as interest rates rose, exceeding the decline in any quarter of the financial crisis.

Net unrealized gains narrowed to $20.9 billion on the portfolio of available-for-sale fixed-maturity securities, from $31.8 billion three months earlier. The tumble helped cut MetLife’s bond holdings about 4.8 percent to $356.5 billion." - source Bloomberg

They also added the following comments from a Fitch Ratings analyst:

"Losses tied to deterioration in the creditworthiness of issuers are more worrisome than the more recent fluctuations related to interest rate movements, said Douglas Meyer, an analyst at Fitch Ratings. He said higher rates can help increase investment income at insurers and improve profitability on some products.

“The jump in interest rates, the way we look at it, it has a positive impact on the industry,” he said. “This will provide relief in terms of reserve adequacy, it will provide relief on reinvestment rates.”

An extreme spike in rates of more than 5 percentage points could hurt insurers, he said. Clients might redeem products that offered lower yields, forcing insurers to sell securities at a loss to meet withdrawal demands, he said." - source Bloomberg.

We quoted our fellow blogger and friend Martin Sibileau back in June in "Singin' in the Rain" on the risk ahead for credit:

"If Ben triggers a sell off in credit with the insinuation of tapering, the dealers on the other side, making the bid for the investors, will be forced to do the rate hedge their investors did not do, because they must be interest rate neutral! That means selling US Tsys for an average of 85% and 50% of positions in HY and IG respectively! In other words, the potential sell-off tomorrow may trigger a surprising self-feeding convexity. How are precious metals to react in such scenario?" - Martin Sibileau

And as we discussed above, "macro" osmosis has led to "positive correlations". When it comes for risks ahead, we share CITI's Matt King views from his European Credit Weekly, namely that after a pleasant summer for credit, it might be time indeed to continue to reduce exposure to neutral:

"Dominoes

One of my favourite games as a child was always dominoes. No, not the rather tedious business of laying tiles end to end and trying to match up their spots.

Rather, the much more thrilling challenge of creating long and winding lines before knocking them over, and being amazed at the far-reaching devastation which could be caused with a single flick of the finger.

European credit feels at present to us like the last asset in a similarly long chain – seemingly remote from the problem of higher UST yields, almost immune to date to the outflows starting to occur elsewhere, and yet nevertheless with an intricate linkage to other assets which belies its apparent distance.

Ironically, our best guess has been and remains that the domino run will not quite get started in the first place – or, at a minimum, that some benign and omnipotent central banker will reach in to remove a domino or two and stop any run before it reaches us. Our house forecasts show the UST backup abating, show credit spreads remaining tight, and the EM sell-off remaining contained to mid-2014.

Moreover, it is striking just how well spreads have generally performed in the face of the backup in UST yields to date. EM hard currency mutual funds, for example, have lost nearly one-third of the last three years’ cumulative inflows (Figure 2), against which the backup in EM spreads, while notable, is hardly cataclysmic. 

The outflows from credit funds have been tiny by comparison, and in Europe have been almost negligible. Unless outflows pick up very significantly, there is every reason to think € spreads remain resilient." 

Besides, in many respects the risks as we head into September seem rather obvious. Tapering has been extremely well flagged. The Fed minutes suggest it will happen this year, but did not seem overly attached to our view of a September start.

German elections have been talked about a great deal, but seem ever less likely to bring about a significant change in the political landscape. Conscious corporate releveraging seems largely confined to the US. Supply is likely to pick up significantly, but is likely to have been widely anticipated. Above all, we have little sense of any build-up in complacent longs during the summer in the way we earlier feared, as is vouched for by the lack of outperformance of most high-beta names.

And yet despite all this, we still recommend reducing any remaining longs in € credit to neutral." - source CITI

CITI's Matt King also added:

"When playing dominoes, it usually takes a few goes before the run really gets started (unless, of course, you didn’t mean for it to start, in which case there’s no stopping it). Our best guess is likewise that, despite the somewhat precarious lineup, not a great deal happens over the next few weeks, and that spreads trade more or less sideways.

But that’s a bit like leaving the room and hoping that when you come back later you’ll still find all the dominoes standing just as you left them. As those with younger brothers will know, you ought to be okay – but at this point we just don’t think you’re being paid for it." - source CITI

The issue for us is that from a "macro" perspective, if the reverse "osmosis" has truly started and with "positive correlations" still in place, there is indeed not only heightened risk from the continuation of the sell-off in Emerging Markets which could affect Developed Markets in the process, but, exogenous factors with political tensions and agendas could indeed roil further risky asset classes.

The $3.9 trillion of cash that flowed into emerging markets over the past four years has started to reverse, indicative of the "Osmotic Pressure" and "reverse osmosis" process taking place.

As we posited back in June for Emerging Markets:

"Why are we feeling rather nervous?

If the Fed starts draining liquidity, some "big whales" might turn up belly up. Could it be Chinese banks defaulting? Emerging Markets countries defaulting as well due to lack of access to US dollars?" - source Macronomics, June 2013, "Singin' in the Rain"

Moving back to our friend Martin Sibileau's June question on "precious metals":

"In other words, the potential sell-off tomorrow may trigger a surprising self-feeding convexity. How are precious metals to react in such scenario?"

At the time we argued that precious metal had further to fall and they did.

But, as we move towards September and what has already started is a bounce back. In similar fashion to what we confided in our January conversation "If at first you don't succeed...", we have once again put in practice the effect of our magicians ("omnipotent" central bankers practicing their "secret illusions") by starting being long gold miners via ETF GDX and some selected miners as well.

The S&P 500, the US 10 year breakeven, please note we have added Gold into our previous Chart,  graph source Bloomberg:

Once again we have broken our Magician's Oath:

"As a magician I promise never to reveal the secret of any illusion to a non-magician, unless that one swears to uphold the Magician's Oath in turn. I promise never to perform any illusion for any non-magician without first practicing the effect until I can perform it well enough to maintain the illusion of magic."

What is the rationale behind our call? We once again come back to our June conversation "Singin' in the Rain" where we quoted David Goldman's article about Gold and Treasuries and bonds in general which he wrote in August 2011 (the former global head of fixed income research for Bank of America):

"Why should gold and Treasury bonds go up together? Gold is an inflation signal and bonds are a deflation hedge. At first glance it seems very strange for both of them to rise together. Why should this be happening?

 The answer is simple: bonds are an option on the short-term interest rate, and gold is a perpetual put option on the dollar. Both rise with volatility.

 It’s like the old joke about the thermos bottle: “How does it know if it’s hot or cold?” If the policy compass is spinning and there’s no way to predict how governments will react, you don’t know whether to hedge for inflation or deflation, so you hedge for both. By put-call parity, if there is huge volatility in the policy responses of governments, the option-value of both gold and bonds goes up."

Our thermos bottle is lately behaving accordingly because the YTD movements in 5 year forward breakeven rates is falling again, which is indicative of the strength of the deflationary forces at play - source Bloomberg:

The 5 year forward breakeven was at 2.56% on the 21st of August but it has been breaking lower as per the most recent reading - graph source Thomson Reuters Datastream / Fathom Consulting:

QE and the US Dollar - graph source Thomson Reuters Datastream / Fathom Consulting:

Dollar index versus Gold - graph source Bloomberg:

So far we have bought the put leg of the put-call parity strategy and we are indeed thinking of adding the call leg shortly. That's all for magic tricks. We enjoy your company, dear readers, but we should not be breaking our Magician Oath too often as you haven't sworn to uphold the Magician's Oath in turn yet...

On a final note, in true Pareto efficient economic allocation, while some pundits wager about simultaneous developments having contributed to the weakness in Emerging Market equities, for us Emerging Markets have been simply the victims of currency wars ("Have Emerging Equities been the victims of currency wars?"), "Abenomics", and of course "reverse osmosis" courtesy of positive real interest rates in the US. It is therefore not a surprise to see that the biggest beneficiary of "reflationary"policies have indeed been the Japanese as displayed in Bloomberg's Chart of the Day from the 22nd of August displaying the Earnings Per Share for 6 regions:

"Prime Minister Shinzo Abe’s policies to lower the yen and end deflation are already paying off for corporate earnings, with Japanese companies’ profits outpacing the rest of the world.

The CHART OF THE DAY shows earnings per share in six regions tracked by Bloomberg rebased to 100 at the end of June 2011. Profits for the Topix climbed the most, rising 32 percent as companies in Japan’s equity benchmark recovered from the March 2011 earthquake that damaged large parts of the country’s north east. The lower panel of the chart shows the yen’s decline against nine other world currencies.

“Japan has been through a full earnings cycle over the past two years,” said Mert Genc, a London-based strategist at Citigroup Inc., which composed the graph. “First, largely as a result of the earthquake, earnings halved. But then they doubled again, with the latest boost coming from weakness in the yen and improving economic performance.”

Japanese exports jumped by the most since 2010 in July, showing the economy has benefited from the yen’s 22 percent slide against the dollar since the end of 2011. Earnings in the U.S. have climbed 16 percent since June 2011 as the Federal Reserve’s bond-purchasing program helped to stimulate growth. Profits in the U.K., the euro area, emerging markets and Australia have declined in the same period.

Analysts estimate earnings in the Topix will grow 11 percent in 2014, according to Bloomberg data, in line with the average for the other regions in the chart of the day." - source Bloomberg.

The MSCI Emerging Markets Index has declined 12 percent this year, compared with a 12 percent gain for the MSCI World Index of companies in advanced economies.

"Remember, the storm is a good opportunity for the pine and the cypress to show their strength and their stability." - Ho Chi Minh 

Stay tuned!

The inflation debate or why you can have inflation in a deflationary environment

From one article to the next, one site to another, the inflation debate is raging.

On the website Pragmatic Capitalist, the author of the blog TPC is arguing that the "inflationistas" are wrong in relation to the risk of inflation down the line due to the massive money printing exercise we have been witnessing.

It is indeed a very complex debate and in this post, I will try to add my contribution on the subject. The discussions surrounding the inflation debate will lead us to question the definition of inflation and inherently the definition of sound money.

To summarise the ongoing debate, is the massive liquidity injections we have witnessed in the world inflationary or not?

For TPC on its blog, it is not inflationary at least in the US do to the ability of the US to print money at will, same apply to the UK.

http://pragcap.com/talking-ourselves-off-the-edge-of-the-cliff

"First, the government doesn’t actually print money (at least not in terms of money creation). They simply press a button on a computer that changes accounts up and down. It’s not like they find a gold miner and print up a note and “monetize” anything. Most importantly though the government never actually has nor doesn’t have dollars. They simply change accounts up and down as they tax and spend. So what does the Fed do? They target the Fed Funds Rate via monetary operations with the belief that they are the grand wizard behind the whole operation. The Fed’s interest rate mandate or target of “price stability” actually means they can’t monetize the debt."

"Now, this is generally the point in the conversation where the inflationistas begin talking about the “effective default” of the USA via dollar devaluation. The problem is, each time the crisis flares up the price action in markets makes it abundantly clear that there is no inflation, but rather continuing deflationary fears. Einhorn’s comments regarding inflation are no different than the other inflationistas who continue to scream “fire” in a crowded theater despite no signs of fire. Of course, there has been no inflation because there is none. The inflationistas have made the same error that Mr. Bernanke made when he supposedly “saved the world” in 2008. Mr. Bernanke assumed that banks were reserve constrained while Mr. Einhorn assumes that adding to reserves is inherently inflationary. But as we see very low levels of borrowing (due to the private sector’s lack of debt demand – caused by the continuing balance sheet recession and de-leveraging) we see zero signs of inflation."

In this lenghty article TPC replies to the comments made by David Einhorn from Greenlight Capital.

TPC also add the following comment:

"In terms of government spending (or blanket Keynesianism as most doubters prefer to call it) it’s largely an accounting identity. Private sector deficit is public sector surplus. If government never spends private sector funds are slowly drained. Just imagine a one time 100% asset tax. What would happen to the economy? It would die of course. Contrary to popular opinion, government must spend before it can tax. Not vice versa. Therefore, a certain level of government spending is necessary. The recent CBO findings show that government spending was the primary reason why the economy didn’t sink into a black hole over the last year. We also know from borrowing data and bank conditions that monetary policy has failed entirely. Of course, I have argued that the government spending has been very poorly targeted and resulted in more malinvestment and ineffective output than should have been the case, but that shouldn’t surprise anyone when you allow the bank lobbyists to control legislation. Spending is not the answer, but we must understand that spending at the government level also isn’t the enemy. Regardless, these blanket statements that government spending is always bad is flat out wrong."

The issue and I agree with TPC in relation to Government spending is the quality of the spending. Government spending can be necessary provided it is acting as an investment such as infrastructure spending. In many countries, UK, France, Greece, the US, there is a lot of waste in goverment spending which have to be addressed.

We previously looked at what Canada did in the 90's in a previous post which lead to a decrease in the debt levels to GDP and boosted the economy. Of course there were short term massive pains but it generated long term gains.

The debate about inflation as highlighted by the response of TPC to David Einhorn's comments, is as well a debate between the Austrian School of Economy versus Keynesians believers.

I was recently given to read an article relating to the monetary situation of Europe following the First World War up to the Second World War and beyond. This article was written by Jacques Rueff, French Economist, Memories and Reflections on the age of inflation, 1956.

Jacques Rueff was very conscious about the risk the dollar faith economy would lead to.

In this article of the Daily Reckoning, published by Bill Bonner, Bill Bonner highlights the insight Jacques Rueff had in 1976, warning of the risk of a "faith dollar based economy".

http://www.dailyreckoning.com.au/jacques-rueff/2008/08/11/

"Since 1911, there existed in England a system of unemployment insurance that gave an indemnity to jobless workers, known as the "dole." The consequence of this regime was to establish a minimum salary level, at which workers would prefer to ask for the dole rather than work for less. It appears that in the beginning of 1923 salaries, which had been declining with other prices in England, suddenly hit this new minimum. There, they stopped falling, and since then, they practically ceased to move."

That's why France runs such high unemployment rates today; its dole is bountiful. When you add up the costs of "charges sociales," paperwork, and the minimum wage, more than one in ten potential workers is not worth the money. But no right thinking politician is about to suggest the obvious solution: get rid of the dole. So, Keynes came up with a subterfuge. The central bank should cause price inflation during a slump, he proposed. Rising prices for 'things' meant that salaries - in real terms - would go down. That was the greasy scam behind Keynes' General Theory of Employment, Interest and Money: inflation robbed the working class of their wages without them realizing it. The poor schmucks even thank the politicians for picking their pockets: "salary cuts without tears," Rueff called them.

"Full employment" was soon no longer a wish, but an obligation.

"No religion spread as fast as the belief in full employment," wrote Rueff. "...and in this roundabout way, allowed governments that had exhausted their tax and borrowing resources to ressort to the phony delights of monetary inflation. "

At the moment, TPC is right in relation to the deflation environmnent we are experiencing.

Jacques Rueff commented previously that the additional increase in money generates inflation when people receiving additional receipts, prefer to keep these receipts in their till or wallet, which means that these additional receipts of money, which are not desired, creates an excess demand, which then affect price levels.

"Au contraire, l'émission de suppléments de monnaie engendre un phénomène inflationniste si elle a lieu sans que les personnes qui reçoivent les encaisses supplémentaires désirent les garder dans leurs tiroirs-caisses ou dans leurs portefeuilles, c'est-à-dire lorsque ces suppléments de monnaie, n'étant pas désirés, suscitent une demande excédentaire, qui alors agit sur les prix."

This explains why excess credit in the US, which lead to an increase in house prices, was inflationary on many assets prices.
I strongly believe that the Austrian School Business cycle theory is the best explaination of the financial crisis which started in 2007.
Both Ludwig von Mises and Friedrich Hayek correctly warned of a major economic crisis before the Great Depression.
Hayek made his prediction of a coming business crisis in February 1929. He warned that a financial crisis was an unavoidable consequence of reckless monetary expansion.

http://en.wikipedia.org/wiki/Austrian_business_cycle_theory

"Austrian economists assert that inherently damaging and ineffective central bank policies are the predominant cause of most business cycles, as they tend to set "artificial" interest rates too low for too long, resulting in excessive credit creation, speculative "bubbles" and "artificially" low savings.

According to the Austrian School business cycle theory, the business cycle unfolds in the following way. Low interest rates tend to stimulate borrowing from the banking system. This expansion of credit causes an expansion of the supply of money, through the money creation process in a fractional reserve banking system. This in turn leads to an unsustainable "credit-fuelled boom" during which the "artificially stimulated" borrowing seeks out diminishing investment opportunities. This boom results in widespread malinvestments, causing capital resources to be misallocated into areas which would not attract investment if the money supply remained stable. Economist Steve H. Hanke identifies the financial crisis of 2007–2010 as the direct outcome of the Federal Reserve Bank's interest rate policies as is predicted by Austrian school economic theory."

In addition to the Autrian Business Cycle Theory, it is important to take into account Irving Fisher's contribution with his debt-deflation theory:

http://en.wikipedia.org/wiki/Debt-deflation

"In Fisher's formulation of debt deflation, when the debt bubble bursts the following sequence of events occurs:

Assuming, accordingly, that, at some point of time, a state of over-indebtedness exists, this will tend to lead to liquidation, through the alarm either of debtors or creditors or both. Then we may deduce the following chain of consequences in nine links:

1.Debt liquidation leads to distress selling and to
2.Contraction of deposit currency, as bank loans are paid off, and to a slowing down of velocity of circulation. This contraction of deposits and of their velocity, precipitated by distress selling, causes
3.A fall in the level of prices, in other words, a swelling of the dollar. Assuming, as above stated, that this fall of prices is not interfered with by reflation or otherwise, there must be
4.A still greater fall in the net worths of business, precipitating bankruptcies and
5.A like fall in profits, which in a "capitalistic," that is, a private-profit society, leads the concerns which are running at a loss to make
6.A reduction in output, in trade and in employment of labor. These losses, bankruptcies and unemployment, lead to
7.pessimism and loss of confidence, which in turn lead to
8.Hoarding and slowing down still more the velocity of circulation.
The above eight changes cause
9.Complicated disturbances in the rates of interest, in particular, a fall in the nominal, or money, rates and a rise in the real, or commodity, rates of interest."

Therefore a perceived inflation can happen in a deflationary environment, it can co-exist. We are witnessing it, in fact in the UK where recently inflation rose to 3.7% on an annualised basis while the UK is still entrenched in a very difficult deleveraging process.

The definition of inflation is as well a matter of intense discussion.

For the Austrian School and Ludwig Von Mises in particular, inflation is measured by the true growth of money supply.

http://en.wikipedia.org/wiki/Austrian_School#Inflation

This is what Ludwig Von Mises defined as inflation:

"Inflation, as this term was always used everywhere and especially in this country, means increasing the quantity of money and bank notes in circulation and the quantity of bank deposits subject to check. But people today use the term `inflation' to refer to the phenomenon that is an inevitable consequence of inflation, that is the tendency of all prices and wage rates to rise. The result of this deplorable confusion is that there is no term left to signify the cause of this rise in prices and wages. There is no longer any word available to signify the phenomenon that has been, up to now, called inflation. . . . As you cannot talk about something that has no name, you cannot fight it. Those who pretend to fight inflation are in fact only fighting what is the inevitable consequence of inflation, rising prices. Their ventures are doomed to failure because they do not attack the root of the evil. They try to keep prices low while firmly committed to a policy of increasing the quantity of money that must necessarily make them soar. As long as this terminological confusion is not entirely wiped out, there cannot be any question of stopping inflation."

A lot of people argue around the current level of gold prices as a sign of incoming inflation, the truth is that we are still deeply in a deflationary environment, but inflation will be increasing at some point, when and only when the deleveraging process will be over.
The issue at hand is can the liquidity be withdrawn from the system at the moment? Probably not. The fear of deflation is very real and clear, hence the requirement of quantitative easing to avoid a deflation trap.

Inflation might have receded but cannot disappear given the current fractional banking system we are living in.

Alan Greenspan, former chairman of the Federal Reserve said the following at the start of his career:

"In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves. This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard."


The discussion around inflation is central as it leads to the understanding of sound money.

Ludwig Von Mises said the following in relation to money:

"It is impossible to grasp the meaning of the idea of sound money if one does not realize that it was devised as an instrument for the protection of civil liberties against despotic inroads on the part of governments. Ideologically it belongs in the same class with political constitutions and bills of rights. The demand for constitutional guarantees and for bills of rights was a reaction against arbitrary rule and the nonobservance of old customs by kings."

In addition to the above and to open the discussion on the solution to the current environment, I would like to highlight Irving Fisher's proposed solution to the issue of deflation and his critics:

"Fisher viewed the solution to debt deflation as reflation – returning the price level to the level it was prior to deflation – followed by price stability, which would break the "vicious spiral" of debt deflation. In the absence of reflation, he predicted an end only after "needless and cruel bankruptcy, unemployment, and starvation", followed by "an new boom-depression sequence":

Unless some counteracting cause comes along to prevent the fall in the price level, such a depression as that of 1929-33 (namely when the more the debtors pay the more they owe) tends to continue, going deeper, in a vicious spiral, for many years. There is then no tendency of the boat to stop tipping until it has capsized. Ultimately, of course, but only after almost universal bankruptcy, the indebted-ness must cease to grow greater and begin to grow less. Then comes recovery and a tendency for a new boom-depression sequence. This is the so-called "natural" way out of a depression, via needless and cruel bankruptcy, unemployment, and starvation.
On the other hand, if the foregoing analysis is correct, it is always economically possible to stop or prevent such a depression simply by reflating the price level up to the average level at which outstanding debts were contracted by existing debtors and assumed by existing creditors, and then maintaining that level unchanged."

Reflation is currently what our governments are trying to achieve via massive liquidity injection and quantitative easing, and mind-blowing money supply increase as well as.

Remember Fisher's equation:
MV = PT where:
M is the amount of money in circulation
V is the velocity of circulation of that money
P is the average price level and
T is the number of transactions taking place

QE in the UK, as I said in March is not working:

http://macronomy.blogspot.com/2010_03_01_archive.html

MV=PT as per Irving Fisher's equation. The Bank of England bought 200 Billions worth of long dated Gilts with QE. The BOE by pumping M (M4) is expecting T to rise and it is not really happening...
As a reminder: MV = PT. M is the stock of money in the economy,V is the velocity of circulation or the speed at which money flows around the economy. P is the price level and T the value of transactions, or gross domestic product (GDP). Hence by
increasing ‘M’, QE aims to increase ‘T’.

The initial MV = PT equation means that a rise in ‘M’ leads in reality to a fall in ‘V’ leaving no net benefit.

The solution of reflation is not working unfortunately. Debt-deflation, which is currently what is being tested, will fail.

To conclude on this post, relating to the deflation-inflation debate is that we are currently in a deflationary environment which poses no short term threat of massive inflation, but creates a risk of high inflation, if there is no debt restructuring at some point, as well as some profound structural reforms in public finances in the very near future, which will push us towards a double dip recession. It is unavoidable.