May 28, 2013 7:12 pm

EU eases hard line on austerity

By Peter Spiegel in Brussels and Scheherazade Daneshkhu in Paris

Spain protest©AFP
Spanish anti-austerity protest

Brussels will on Wednesday give its clearest signal yet that it is moving away from a crisis response based on austerity, allowing three of the EU’s five largest economies to overshoot budget deficit limits and pushing instead for broader reform.

In its annual verdict on national budgets of all 27 EU members France, Spain and the Netherlands will be given a waiver on the annual 3 per cent deficit limit. Brussels will also free Italy from intensive fiscal monitoring despite its new prime minister’s decision to reverse a series of tax increases imposed by his predecessor.

The European Commission will make these moves on the condition that national governments embark on stalled labour market reforms. Brussels believes the delay in implementing them has contributed to the region’s unemployment crisis. “There are limits to what can be achieved with austerity,” said Maarten Verway, a senior European Commission economist.

Commission officials insist they are not abandoningfiscal discipline altogether, noting that even France and Spain, which will receive two-year extensions to their deficit deadlines, will still have to take stringent measures to get ballooning budgets back under control.

In addition, Brussels is expected to criticise several governments for their slow pace of reform and will demand immediate action by several it believes are at risk of prolonged economic stagnation. These include France, where senior officials in Brussels and Berlin believe time is running out for sufficient labour and economic reforms.

François Hollande, the French president, sought to show he was making unemployment in France and the rest of the EU a priority telling a meeting of European finance and labour ministers in Paris that they had to acturgently” to help the region’s 6m jobless youths.

Mariano Rajoy, the Spanish prime minister, called on the EU to change its deficit procedure so countries would no longer be penalised for spending money on fighting youth unemployment.
“We have to rescue an entire generation of young people who are scared. We have the best-educated generation and we are putting them on hold. This is not acceptable,” said Enrico Giovannini, Italian labour minister.

German officials, however, are keeping a close eye on the recommendations by Olli Rehn, the EU’s economic chief, for Paris. Some officials believe Mr Rehn’s reform agenda for Paris may be more far-reaching than Mr Hollande will be willing to accept.

Mr Hollande is facing similar pressure at home. Christian Noyer, governor of the Bank of France, said on Tuesday the government would have to go further in pension and labour reforms, warning that Paris cannot rely only on increased taxes and must cut spending to close its fiscal gap.

Over a certain threshold, which our country has probably crossed, any increase in public spending and debt has extremely negative effects on confidence,” Mr Noyer said in presenting his annual report on the French economy to Mr Hollande. “The old model doesn’t work any more” he said of traditional efforts to boost demand by encouraging spending.

He added that France had to move away from public policiesoverly concerned with preserving the jobs of the past” and allow for liberalisation that could help future job creation.

Additional reporting by Michael Paterakis in Brussels and Hugh Carnegy in Paris
Copyright The Financial Times Limited 2013.


Updated May 28, 2013, 12:22 p.m. ET

Bond Yields Jump to a Different Beat


Government-bond investors have spent months being lulled by the harmony of central banks on the subject of monetary policy. But some discordant notes are creeping into the melody.

After a long period where seemingly never-ending loose monetary policy has driven U.S. Treasurys, German bunds, U.K. gilts and Japanese government bonds, greater divergence is coming as markets focus more on local economic fundamentals.

Two big developments stand out. First, the Bank of Japan's radical effort to raise inflation expectations has boosted volatility in Japanese bond markets: 10-year yields have swung wildly and briefly spiked above 1% last week. This may yet be a temporary bout of indigestion, however.

Clearer communication from the BOJ about its planned bond purchases and further reforms by the government could calm the market and rein in yields.

Second, the U.S. Federal Reserve is now clearly debating whether and when to curtail its bond purchases. That has investors paying closer attention to economic data. In the second half of 2012, U.S. Treasury yields became disconnected from economic surprises as the Fed offered an extended promise of easy money, Goldman Sachs GS +1.95% notes. They are now reverting to better reflect the U.S. outlook, with 10-year yields jumping 0.1 percentage point to 2.12% Tuesday and perhaps heading toward 2.5% in the second half of the year.

The European outlook remains uncertain. U.K. investors are awaiting the arrival of new Bank of England Gov. Mark Carney to see whether a new era of "monetary activism" is about to dawn. But with inflation stubbornly above target and growth perhaps picking up, his room to maneuver may be limited, potentially pushing 10-year gilt yields higher from their current level of 1.96%.

Meanwhile, the European Central Bank appears more likely to cut rates further than anything else. With the euro-zone economy stuck in recession and inflation falling, German bunds could yet benefit, even though 10-year yields remain low at only 1.45%.

Differences, or spreads, between the yields on German bunds and their U.S. and U.K. peers are widening already. That trend could well continue. Failure by the BOJ to calm the Japanese market could throw further discord into the mix. Having listened to the orchestra for so long, investors will need to home in on each player's individual notes to avoid miscues.

Copyright 2012 Dow Jones & Company, Inc. All Rights Reserved

May 28, 2013

Central Banks Act With a New Boldness



Christopher Gregory/The New York Times, Yoshikazu Tsuno/Agence France-Presse — Getty Images, Daniel Roland/Agence France-Presse — Getty Images, Toru Yamanaka/Agence France-Presse — Getty Images
Clockwise from top left: Ben Bernanke, chairman of the Federal Reserve Board; Mervyn King, governor of the Bank of England; Mario Draghi, president of the European Central Bank; Haruhiko Kuroda, governor of the Bank of Japan.

 When James Bullard, president of the Federal Reserve Bank of St. Louis, arrived in Frankfurt last week, he issued an unusual public warning to the European Central Bank: Be bolder.
Central bankers, anywhere in the world, are a cautious lot. They prefer slow and steady over the dramatic gesture. And they rarely go public with criticisms of other central banks.
But the economic stagnation of the major developed nations has driven central banks in the United States, Japan, Britain and the European Union to take increasingly aggressive action. Because governments are not taking steps to revive economies, like increasing spending or cutting taxes, the traditional concern of central bankers that economic growth will cause too much inflation has been supplanted by the fear that growth is not fast enough to prevent deflation, or falling prices.
The Fed has announced plans to keep borrowing costs at historic lows until unemployment declines. The staid Bank of England has bought more than a half-trillion dollars’ worth of bonds to ignite British business activity.
Last month, Haruhiko Kuroda, the new chairman of the Bank of Japan, steered the central bank toward an audacious new policy of reinflating the Japanese economy by doubling the money supply. It is considered the boldest step so far by a central bank.
So far, the results of these activist central banks have fallen short of expectations. “I’m not sure why we’re not getting more response,” said Donald L. Kohn, a former Federal Reserve vice chairman who is now at the Brookings Institution. “Maybe we’ve made some progress in identifying some of the causes, but it’s not fully satisfying why we have negative real interest rates everywhere in the industrial world and so little growth.”
Certainly investors around the world watch for any sign that the central bankers are backing away from their bold stepsStock markets wobbled in Japan and elsewhere last week on fears that the Federal Reserve might start pulling back on its stimulus sooner than expected and that Japan’s effort might fall short of its goal of reviving the economy. A few central bankers’ reassurances seemed to calm the markets.
The lackluster results have provided cover for the European Central Bank, which has remained the most cautious of the major central banks. It is sticking to the more traditional formula of cutting interest rates — a string Japan ineffectually pushed for more than a decade — in the hopes that it will encourage banks to lend more money to businesses.
The Federal Reserve in the United States has been significantly more aggressive since December 2008, when the Fed reduced its benchmark short-term interest rate nearly to zero. Ever since, it has pursued a pair of experiments aimed at dragging other interest rates closer to zero, too.
The Fed has tried to bolster confidence that rates will stay low by talking more about the future. In December, it said it intended to keep short-term rates near zero at least as long as the unemployment rate remained above 6.5 percent, the first time it had tied policy to a specific target. That, and buying almost $3 trillion in Treasury and mortgage-backed securities, has helped to cut borrowing costs for businesses and consumers.
While the share of Americans with jobs has barely budged and other economic indicators remain weak at best, the Standard & Poor’s 500-stock index has doubled since the Fed announced its first round of bond purchases in November 2008. Interest rates on mortgages and car loans are near the lowest levels on record. Average yields on junk bonds fell below 5 percent for the first time.
Corporations with strong credit ratings, like Apple, also are borrowing vast sums at little cost.
Still, for all the daring, some critics argue that the Fed is not trying hard enough. It’s as if we went to the biggest fire we’ve ever seen and we poured more water on it than we’ve ever poured, and the fire isn’t completely out,” said Joseph E. Gagnon, a former Fed economist now at the Peterson Institute for International Economics. “Well, we should try more water.”
Officials in Britain, too, are debating its central bank’s ability to do more. Last month, the departing governor of the Bank of England, Mervyn King, gave a speech at the International Monetary Fund in which he said — a bit acidly — that there was a limit to what monetary policy could do to spur recovery in a country like Britain, where a small number of stingy banks dominate the economy and the government is tightening its spending.
Like other central banks around the world, the Bank of England, by far the oldest of them all, has done its part to ward off a depression. It has bought, to date, the equivalent of $569 billion worth of government bonds — a bold use of the printing press for an institution known for its hidebound ways.
This shock treatment, the professorial Mr. King pointed out, equaled 20 percent of the British economy, outpacing the central bank interventions of the European Central Bank, the Bank of Japan and the Federal Reserve.
And what does Mr. King have to show for his monetary exertionsbeyond record stock market highs and bottom-scraping yields for British corporate bonds? An anemic recovery. Growth this year is expected to be 0.5 percent, according to the I.M.F., while Japan’s gross domestic product grew at an annualized rate of 3.5 percent in the first quarter and the United States’ is expected to grow a little more than 2 percent.
“There is a limit to what the central bank can achieve,” said Robert Wood, chief economist for Britain at Berenberg Bank in London, who worked previously at the Bank of England. Britain’s problem is that it is still paying for its past sinssimply wishing we could be where we were before the crisis is just not going to happen.”
Japan’s willingness to use huge government spending — despite racking up incredible debt to do so — is unique among the developed economies.
Under Prime Minister Shinzo Abe, the country is coupling its central bank action with fiscal stimulus, which means that the new money created by the bank is put to use. Calls for austerity have largely fallen on deaf ears. In the land famous for building bridges to nowhere, Mr. Abe pushed through an emergency stimulus package of 10 trillion yen, or $98.7 billion, and Parliament passed a further 92.6 trillion yen budget for 2013, with heavy spending on public works.
But in a happy confluence of policies, because the central bank promises to buy up the bonds that the government issues, interest rates are for now unlikely to soar out of control, while the weakening yen has created a surge in exporter profits, putting Japan in a policy sweet spot.
All eyes are now on Mario Draghi, president of the European Central Bank. A creative and determined central banker, he must find some unconventional way to prevent Europe from becoming stuck in the economic rut that held back Japan for most of two decades.
An interest rate cut in early May is unlikely to do much to promote the flow of credit to countries like Italy, Greece, Portugal and Spain. Even with the benchmark rate at 0.5 percent, down from 0.75 percent, cheap money is not persuading banks to lend and businesses to borrow.
There is fear that Germany and other countries like Austria and Finland are about to be swallowed by the recession that has afflicted Southern Europe for more than a year and has just reached France. Unemployment in the euro zone is 12.1 percent, and in Greece and Spain more than a quarter of the work force is jobless.
The European Central Bank faces legal and political restraints that make it harder for the bank to imitate the other major central banks. It cannot finance governments, which limits its ability to buy any country’s bonds. Mr. Draghi has argued that doing so in any case would not accomplish much in the euro zone because most companies get their credit from banks rather than by issuing corporate bonds.
“It is different from the United States,” Mr. Draghi told reporters after the bank’s governing council met this month in Bratislava, Slovakia.
“In the United States, 80 percent of credit intermediation goes via the capital markets,” he said. “In the European situation it is the other way round. Eighty percent of financial intermediation goes through the banking system. So, you are left with buying what?”
The European Central Bank is sworn to guard price stability above all else, so it is extremely cautious about any effort to inflate the currency, even as inflation in the euro zone is 1.2 percent and falling. But other central banks, operating under similar mandates, have concluded that deflation is now a greater concern.
Falling prices can freeze economic activity as buyers wait for still-lower prices, a cycle that is hard to reverse. Japan, the only major economy to fall into such a pattern in modern times, has struggled to escape for almost two decades.
Marie Diron, a former European Central Bank economist who now advises the consulting firm Ernst & Young, said, “The Japan scenario is a risk.”
On his trip to Frankfurt, Mr. Bullard told an audience at Goethe University that Europe needed to act. “The lesson of Japan is that once you get stuck, it’s very hard to get out.”
One way to get stuck,” he said, “would be not to take aggressive action.”

May 27, 2013 9:02 pm

The pension gap

By John Authers

English local authority pension plans pay vastly different fees to investment managers for similar rates of return

With its national parks and miles of stunning coastline, the English county of Devon has obvious attractions to pensioners. But there are less obvious attractions, too.

Devon’s pension fund pays relatively little in fees to investment managers compared with other English countiesyet the performance of the fund is in line with its peers. Staffordshire’s pension fund pays more than three times as much, for a fund that is almost identical.

The difference, revealed by a ground­breaking study based on annual reports of the 100 local authority pension plans in the UK, provided to the FT by Investor Data Services, a London consultancy, was not unusual. The most expensive quarter of funds paid an average of more tan four times as much for investment management as the cheapest quarter.

To enlarge graph click on :

With returns falling, fund managers across the world face complaints about fees and a lack of transparency. Active managers are under pressure to justify their fees in the face of growing competition from cheaper passive funds that merely track benchmark indices. These findings will fuel debate over how UK council pensions should be run and whether funds are sufficiently transparent.

The council’s funds are managed by some of the biggest names in global asset management. But it is impossible from public data to ascertain the fees and commissions each charge.

UK council plans, which managed £187.3bn between them at the end of the last financial year, are typical of many across the world – but the UK’s public-sector disclosure rules allow a look at fees that might stay hidden.

Neither Staffordshire nor Devon is exceptional; they are an interesting example because they appear similar. They are the same size: Devon had £2.68bn in March 2012, against £2.62bn for Staffordshire. They have a similar spread of assets in fixed income, equities and property, with a little money given to hedge fund managers. Both hold the same top three stocks (Royal Dutch Shell, Vodafone and HSBC) while three fund managers work for both counties. They follow the same public-sector procurement rules.

Yet Staffordshire paid £7.152m for fund management in 2011-12, while Devon paid £2.669m. And Staffordshire’s bill for administration came to £2.033m, while Devon paid £1.225m.

Over the preceding eight years, Devon paid £3.9m less in investment fees per year and £850,000 less in administration fees. That means Staffordshire paid £38.2m more than Devon for essentially the same job. In overall return over the past decade, Devon has gained 6 per cent a year and Staffordshire 5.7 per centin line with the average council, according to State Street Investment Analytics.

Staffordshire county council said: “Hymans Robertson, the actuarial and investment consultancy, has conducted extensive analysis of fee statistics for local government pension schemes and has confirmed that our level of fees are consistent with those paid by other authorities.

Fund structures can be very complex, so even if they appear to be superficially the same, without detailed analysis it is very difficult to make a ‘like for like comparison.”

Council annual reports do not offer benchmarks for costs. It is only by collating cost data, often buried in footnotes, that discrepancies emerge.

One reason anomalies develop is the length of the value chain for pensions. The final return to investors is stated but it is unclear how much this has been reduced by avoidable fees.

Hymans Robertson, which could not comment on individual cases, said that funds the size of Devon or Staffordshire should be paying fees of 25 to 35 basis points. Anything lower would imply that they werenot fully disclosing fees”. This could be because they invest in pooled fundswhere the manager fees are charged within the fund and reflected in the unit price rather than paid explicitly” by the council. (Devon had a 6 per cent allocation to pooled funds in its latest report). High charges could stem from “funds of funds”.
Officials at Devon said they doubted that a cost benchmark would be useful because strategies vary widely.

Another explanation for the discrepancies is that not all the necessary data are available to the public. The costs that funds’ investment managers incur in buying and selling stocks are shown in report footnotes (Staffordshire’s managers spent £3.28m on commissions, Devon’s £959,000). Commission charges vary hugely across the sector, according to IDS’s data.

When Christopher Sier, an independent consultant, built a database on commissions using freedom of information requests, he estimated average portfolio turnover at about 120 per cent a year – which seemed high as many funds were passive. But firm conclusions were impossible because information was redacted, often including the names of both the fund managers and their brokers.

Local authorities are already attacking costs. Some are forming consortiums to award contracts or planning to merge their administration. Concentration of managers is falling, with the top five managers accounting for 38 per cent of externally managed assets, from 56 per cent a decade ago.

They are also moving from active managers to passive index-trackers, which now account for 24 per cent of assets, according to the WM UK Local Authority Fund Annual Review up from 14 per cent 10 years earlier.

Some are negotiating more aggressively with their fund managers. Linda Selman, of Hymans Robertson, said: “They simply ask managers what fee concessions they can make and explain the environment they are living with. 

That’s had a pretty good level of success. When managers have been put under pressure they’ve offered maybe 10 per cent of the fee.”

Some also negotiate on outcomes. One small council cut its investment management fees to only 0.05 per cent in one year because it had entrusted all its assets with one fund manager, in return for a rebate if performance dropped below an agreed benchmark. The manager failed to meet its three-year benchmark and forfeited fees.

The IDS research suggests pension funds will need to offer far more transparency about their charges – and that fund managers can look forward to even more aggressive negotiations in future.

Copyright The Financial Times Limited 2013.