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Tuesday, May 19, 2009

German Investor Confidence Shoots Up Again In Germany

Well, at the present time it seems that the sharper the German economy contracts, the more investor confidence rises. Well, that may be something of an exaggeration, but certainly the present confident mood seems somewhat strange given the very hard outlook facing the economy itself.

Thus German investor confidence rose to a three-year high in May after stock markets rallied and risk sentiment grew around the globe. The ZEW Center for European Economic Research said its index of investor and analyst expectations, which is a guage of investor sentiment for the six months to come, increased to 31.1 from 13 in April.

The expectations index, which measures the feeling of investors and analysts on the future trend of activity in Germany, was up to 31.1 in May, a rise of 18.1 points in one month. The index has now been rising since last November.

The slowing pace of the contraction in output and the positive trend in the equity markets
has lead to a renewal of investors’ and analysts’ confidence.

The ZEW survey seems to indicate that output will continue to decline, but that the pace of contraction will slow in comparison with that seen in the first quarter. As such this result is entirely in harmony with recent PMI surveys. Indeed, since the investors interviewed read those very same surveys, we may have some degree of cross-causality here.

But it is also important to remember that this is a measure of investor expectations, not an indicator of the real economy. Nowehere is this difference more evident than in a recent Deustche Bank report which recommended buying instruments in central and eastern Europe, due precisely to the yield differential their economies offer as a result of introducing damage protection policies in the context of the financial crisis.
Currency deals that profit from the difference in interest rates globally are returning to favor on speculation the worst of the creditcrisis may be over, spurring investors to buy eastern European assets,Deutsche Bank AG said.The Russian ruble, Hungarian forint and Turkish lira offer investorsthe best returns in the next two to three months thanks to the highestrates in the region, said Angus Halkett, a strategist at Deutsche Bankin London.The so-called carry trade, in which investors borrow in currencieswith low interest rates to buy higher-yielding assets, helped theforint and lira surge to record highs last year before the collapse of Lehman Brothers Holdings Inc. prompted investors to sell riskier assets.
Perhaps people should reflect a little more on the significance of those final few words: "before the collapse of Lehman Brothers Holdings Inc. prompted investors to sell riskier assets".

This is what is known as the "carry" trade, and it works like this. Stimulus plans and near-zero interest rates in developed economies boost investor confidence in emerging markets and commodity-rich nations with interest rates which are often in double figures.Using dollars, euros and yen these investors then buy instruments denominated in currencies from countries like Brazil, Hungary,Indonesia, South Africa, New Zealand and Australia which collectively rosee around 8% from March 20 to April 10, the biggest three-week gain since atleast 1999 for such carry trades, according to data compiled by Bloomberg . A straightforward carry-trade transaction would be to borrow U.S. dollars at the three-month London interbank offered rate of 1.13% and use the proceeds to buy Brazilian real and earn Brazil’s three-month deposit rate of 10.51%. That would net anannualized 9.38% - as long as both currencies remain stable, but the real, of course, is appreciating. Now all of this can present a big problem for a number of CEE economies, because:

Turkey’s key interest rate is 9.25 percent, Hungary’s is 9.5 percent and Russia’s 12 percent. The cost of borrowing in euros overnightbetween banks reached 0.56 percent yesterday from 3.05 percent sixmonths ago as the European Central Bank began cutting interest rates and pledges of international aid allayed concern the global slowdownwould worsen. The London interbank offered rate, or Libor, forovernight loans in dollars fell to 0.22 percent from 0.4 percent inNovember as the U.S. government and the Federal Reserve spent, lentorcommitted $12.8 trillion to stem the longest recession since the1930s.

So basically, "Big Ben's" US bailout is fuelling specualtion on Hungarian debt!

And don't miss this point from the Bloomberg article:
Deutsche Bank recommends investors sell the euro against the forint on bets the rate difference will help the Hungarian currency gain 10 percent to 260 per euro in two to three months from 286.55 today. Investors should also sell the dollar against the lira and buy the ruble against the dollar-euro basket, the bank said.
And it isn't only Deutsche Bank, Goldman Sachs recommended on April 3 that investors use euros, dollars and yen to buy Mexican pesos, real, rupiah, rand and Russia rubles.

We can see some of this impact in the German ZEW investor sentiment index. As can be seen, something interesting is happening somewhere, even if it is not immediately evident where. As Solow would have said, "I can see evidence for improved investor sentiment everywhere, except in the real economies".

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