There is no investor panic over Brexit

The Remainiacs are trying to spin a slight devaluation in the value of the pound as investors losing confidence in a post-Brexit UK but as usual they're wrong.

Currency speculation is a high volume, short term investment. Traders are expecting a short term devaluation of the pound in the immediate aftermath of the referendum and they will welcome it. Trading currency is like trading anything else - buy your product as cheap as you can and sell it for as much as you can. They are dumping their sterling investments to help drive devaluation and once the referendum is over and the pound reaches the price they want they will buy it back at rock bottom prices and sell it on when it bounces back. It's not investor panic, it's how the markets work.

If you're looking for an indication of investor confidence then you need to look at the bond market. Bonds are basically loans given by investors to companies, governments and other organisations. The yield on a bond is the amount of profit the investor can expect to make when the bond matures and the issuer buys it back off you. The higher the yield demanded, the less confidence investors have in the ability of the issuer to pay. It's exactly the same principal as taking out a bank loan - the higher the risk of you not paying back your loan, the higher rate of interest the lender applies to the loan to cover their expected losses. If Greece was looking for a high street loan they'd be turning to the likes of Wonga, not Barclays.

A 10 year Greek government bond is attracting an 8.2% yield at the moment. Compare that to 1.6% for the US and 3% for China and you can see that investors have a lot less confidence in Greece's ability to buy back the bonds that they're issuing at the agreed price. 10 year UK government bonds are trading with a 1.146% yield today. That means investors have more confidence in the ability of the UK to buy back that bond in 10 years' time than they do in the United States to buy back theirs. UK government 5 year bonds are attracting a yield of 0.726% today compared to 1.38% for US government 5 year bonds. UK government 2 year bonds are attracting a yield of 0.38% compared to 0.88% for US government 2 year bonds. Investors aren't panicking about Brexit, they are expecting stability even in the short term.

The bond markets are rarely wrong - is Italy next?

Working on the principle that rich investors become rich by knowing where to invest their money, taking a look at the performance of bonds issued by eurozone countries gives a valuable insight into their economies.

Government bonds are like loans - investors effectively loan governments money by buying bonds which can be turned back into cash with a guaranteed amount of interest (the "yield") after a certain amount of time.  There is, of course, the ever-present risk that said government might find itself in dire financial straits and will default on the repayment of bonds when they mature.

Generally speaking, the risk of a government defaulting on bonds is tiny because if they need money they raise taxes or print more money (quantative easing).  But there is only so much money you can print before your currency becomes worthless and it costs a month's wages to buy a toilet roll like has happened in Zimbabwe and there is only so much people will pay in taxes before they start wondering what their leader's head would look like on a spike on the walls of that lovely big palace they live in.

Sometimes countries have no choice but to default on bond repayments because there simply isn't enough money to pay them - a situation Greece finds itself in now.  And it's because of these occasional defaults that investors expect a higher or lower yield on the bonds they are buying to reflect the higher or lower risk of not getting their money back.  This is no different to what happens in high street banks and just as there are credit reference agencies deciding on the credit worthiness of you and I, so there are credit reference agencies that decide the credit worthiness of countries and their bleak outlook on the economies of eurozone countries has lead to an EU proposal to censor them.

Using the information that the likes of Moody's and Standard & Poor produce and their own gut instincts, institutional investors offer to buy a certain amount of bonds at government bond auctions with a specific yield (interest rate).  The higher the yield, the higher the risk these people think there is of the country not being able to pay their bills and defaulting or of having to print so much money that they will devalue their currency so much that the bonds are worth less than they paid for them.  In the eurozone, countries can't just print their own money or devalue their currency because they're locked into the Franco-German controlled monetary union so a higher yield on a eurozone country's bonds is mostly based on their perceived ability to pay.

Ok, lesson over.  How are things looking on the European bond market?  Let's kick Greece while it's down: Angela Merkel is trying to play down hopes of a miraculous cure for Greece's financial problems and investors clearly agree - investors are asking for an average of 28% yields on 10 year bonds according to Trading Economics.  That means that for every million pounds the Greek government raises selling 10 year bonds, in 10 years' time they will have to pay back the original millon pounds plus £280,000.  Greece raised about €20bn by selling bonds at the start of last year - if it tried to raise that amount of money again at current prices, they'd be faced with a bill for €5.6bn in interest alone as well as the original €20bn sale price of the bond.

But it's not just Greece.  If you take a look at the big increases in yields over the last year, Ireland, Greece, Portugal, Italy and Spain top the list.  The UK and Norway have seen small decreases in the cost of borrowing and Switzerland has seen a very small increase - the UK is of course outside of the eurozone and Norway and Switzerland are outside of the EU altogether.  In fact, other than Austria, Sweden, Poland and the Czech Republic, the cost of borrowing has gone up across the eurozone while costs have decreased outside of it.  Belgium is high on the list of countries seeing the cost of borrowing increase by almost a third over the year and apparently presenting a higher risk to investors than, amongst others, serial bankrupt Japan and Thailand which is rumoured to be on the brink of another military coup.

If the bond markets are anything to go by, Italy is going to leapfrog Spain and be the next eurozone economy to fail.  That's certainly the fear the EU has at the moment - they held a meeting a few days ago to talk about a possible default in Italy.  Unfortunately for the people living in eurozone countries, there is no way out of the downward spiral into bankruptcy while they are tied into the EU's single currency.

EU planning to censor international credit rating agencies

The EU Commission is planning a crackdown on the international credit rating agencies after they downgraded Portugal's credit rating the other day.

By dropping a country's credit rating, it makes it more expensive for that country to raise money through selling bonds.  Government bonds are basically promises to pay a certain amount of money on a certain date - it's effectively a government asking for a loan without any monthly repayments.

The lower a country's credit rating, the higher the amount of interest investors will want because there's a higher risk they won't get paid.  It's just like when you take out a credit card - they have a headline interest rate that you will get if your credit rating is good but if it's bad you'll end up paying a higher rate.  And if your credit rating is awful then you have to go to the kind of high risk lender that advertises on low budget satellite TV channels.

A country's credit rating doesn't matter so much unless it's trying to raise money from selling bonds, like eurozone countries are right now.  The downgrading of Portugal's credit rating a few days before it was due to issue billions of pounds worth of new bonds will cost the Portuguese government a lot of money.  Instead of paying €1.04 for every €1 of bonds they sold two years ago, they're now going to have to pay at least €1.11.  It's only 7 cents but if Portugal issues €5bn in 10 year bonds, they will have to find €5.55bn when they mature in 2021.  They haven't got €5bn now, it's a big risk to assume that they're going to have €5.55bn in 10 years time.

Obviously the amount of money eurozone countries have to pay to borrow money, the less chance there is the euro can be saved so in desperation the EU Commission is preparing new laws to stop international credit rating agencies from giving bad news about EU countries.  As with many new laws that come from the EU, this one is based on a fundamental misunderstanding of what's happening in the real world.

It seems strange there is not a single rating agency coming from Europe. It shows there may be some bias in the markets when it comes to the evaluation of the specific issues of Europe.
- Emperor Barroso, President of the Imperial Commission

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(Source)

Far from helping eurozone countries, this will increase the risk of investing in government bonds from EU countries.  If they can't get accurate information about the risk of an investment then investors will steer clear of eurozone bonds or demand even higher interest rates to protect themselves from unknown risks.

Portuguese bond yields up 1% in a month

The Portuguese government is denying that it needs a bailout from the EU and IMF despite the yield rates on Portuguese bonds rising from an average of 6.7% a month ago to 7.6% today.

I don't care, I've stuffed my mattress with US dollars!

The higher the yield rate, the less confidence investors have in the Portuguese economy.  They demand higher yields (interest rates) on the bonds because they're taking on a bigger risk of not getting their money back than if they were buying bonds from other countries.

A month ago investors demanded only 6.7% interest on Portuguese bonds but today it reached 7.6% before the European Central Bank (ECB) intervened and bought bonds with lower yields to reduce the average rate and give the impression that the risk is lower.

Of course it's partly Portuguese money - money they pay into the ECB's Treasury - that's being used to buy Portuguese bonds but to the casual investor the low yield will be a convincing enough con to make them think it's a safe investment and for institutional investors the more money Portugal owes to the ECB, the less likely they are to let it fail.

I said a month ago that Portugal would capitulate within a couple of weeks.  It seems I underestimated their resolve but the outcome is still going to be the same: Portugal will be forced to take a bailout from the EU and the IMF and it will be soon.