Friday, June 24, 2016

Europe's Minsky Moment?

Herbert Lash and Marc Jones of Reuters report, World stocks tumble as Britain votes for EU exit:
Global capital markets reeled on Friday after Britain voted to leave the European Union, with $2 trillion in value wiped from equity bourses worldwide, while money poured into safe-haven gold and government bonds. Sterling suffered a record plunge.

The blow to investor confidence and the uncertainty the vote has sparked could keep the Federal Reserve from raising interest rates as planned this year, and even spark a new round of emergency policy easing from major central banks.

The traditional safe-harbor assets of top-rated government debt, the Japanese yen and gold all jumped. Spot gold rose more than 5 percent and the yield on the benchmark 10-year U.S. Treasury note fell to lows last seen in 2012 at 1.5445 percent.

Stocks tumbled in Europe. London's FTSE dropped 2.4 percent while Frankfurt and Paris each fell 6 percent to 8 percent. Italian and Spanish markets, and European bank stocks overall, were headed for their sharpest one-day drops ever.

Worries that other EU states could hold their own referendums were compounded by the fact that markets had rallied on Thursday, seemingly convinced the UK would vote to stay in.

Britain's big banks took a $100 billion battering, with Lloyds, Barclays and RBS plunging as much as 30 percent.

Stocks on Wall Street opened more than 2 percent lower but cut losses after about an hour of trading. The Dow Jones industrial average fell 340.24 points, or 1.89 percent, at 17,670.83, the S&P 500 lost 42.11 points, or 1.99 percent, at 2,071.21 and the Nasdaq Composite dropped 116.74 points, or 2.38 percent, at 4,793.31.

MSCI's all-country world stock index fell 3.5 percent.

Having campaigned to keep the country in the EU, British Prime Minister David Cameron announced he would step down.

Results showed a 51.9/48.1 percent split for leaving, setting the UK on an uncertain path and dealing the largest setback to European efforts to forge greater unity since World War Two.

More angst came as Scotland's first minister said the option of another vote for her country to split from the UK - rejected by Scottish voters two years ago - was now firmly on the table.

The British pound dived by 18 U.S. cents at one point, easily the biggest fall in living memory, to its lowest since 1985. The euro, in turn, slid 3 percent to $1.1050 as investors feared for its very future.

Sterling was last down 7.8 percent at $1.3719, having carved out a range of $1.3228 to $1.5022. The fall was even larger than during the global financial crisis and the currency was moving two or three cents in the blink of an eye.

"It's an extraordinary move for financial markets and also for democracy," said co-head of portfolio investments of London-based currency specialist Millennium Global Richard Benson.

"The market is pricing interest rate cuts from the big central banks and we assume there will be a global liquidity add from them," he added.

That message was being broadcast loud and clear. The Bank of England, European Central Bank and the People's Bank of China all said they were ready to provide liquidity if needed to ensure global market stability.


The shockwaves affected all asset classes and regions.

The safe-haven yen jumped 3.6 percent to 102.29 per dollar, having been as low as 106.81. The dollar's peak decline of 4 percent was the largest since 1998.

That prompted warnings from Japanese officials that excessive forex moves were undesirable. Traders said they were wary of being caught with exposed positions if the global central banks chose to step in to calm the volatility.

Emerging market currencies across Asia and eastern Europe and South Africa's rand all buckled on fears that investors could pull out. Poland saw its zloty slump 4 percent.

Europe's natural safety play, the 10-year German government bond, surged to send its yields tumbling back into negative territory and a new record low.

MSCI's broadest index of Asia-Pacific shares outside Japan slid almost 5 percent, Tokyo's Nikkei saw its worst fall since 2011, down 7.9 percent.

Financial markets have been gripped for months by worries about what a British exit from the EU would mean for Europe's stability.

"Obviously, there will be a large spill-over effects across all global economies ... Not only will the UK go into recession, Europe will follow suit," predicted Matt Sherwood, head of investment strategy at fund manager Perpetual in Sydney.


Investors stampeded into low-risk sovereign bonds, with U.S. 10-year notes gained two full points in price to yield 1.521 percent. Earlier, the yield dipped to 1.406 percent, only slightly higher than a record low 1.38 percent reached in July 2012.

“Right now it’s 'every man for himself' safety buying," said Tom Tucci, head of Treasuries trading at CIBC in New York.

The rally even extended to UK bonds, despite a warning from ratings agency Standard & Poor's that it was likely to downgrade Britain's triple-A credit rating if it left the EU. Yields on benchmark 10-year gilts fell 27 basis points to 1.0092 pct.

Across the Atlantic, investors were pricing in less chance of another hike in U.S. interest rates given the Federal Reserve had cited a British exit from the EU as one reason to be cautious on tightening.

"A July (hike) is definitely off the table," said Mike Baele, managing director with the private client reserve group at U.S. Bank in Portland, Oregon.
Fed funds futures were even toying with the chance that the next move could be a cut in U.S. rates.

Oil prices slumped by more than 4 percent amid fears of a broader economic slowdown that could reduce demand. U.S. crude shed $2.12 to $47.99 a barrel while Brent fell as much as 6 percent to $47.83 before clawing back to $48.60.

Industrial metal copper sank 3 percent but gold galloped more than 6 percent higher thanks to its perceived safe haven status.
A couple of days ago I wrote a comment to Brexit or not to Brexit where I stated my strong doubts that the Brits would opt out of the EU.

I was wrong, foolishly believing most people in the UK would vote rationally with their wallets. But in the end, populism won the day, which makes you wonder whether referendums should require 2/3 majority to set in motion any major decision impacting millions of people (Winston Churchill was right: "Democracy is the worst form of government, except for all the others").

However, in my comment on Brexit, I stated the following:
[...] let's say Brexit happens, then what? Well, investors will seek refuge in good old US bonds, they're going to sell the euro and pound and buy the yen. Markets will be in a tizzy and volatility will shoot up. Conversely, if Brexit doesn't happen, the euro and pound will rally, the yen and US bonds will sell off and global stocks and corporate bonds will take off.

Of course, if you ask Mr. Yen, the yen will strengthen past 100 per dollar this year, whichever way the UK votes in Thursday’s referendum. I hope he's wrong as the surging yen could trigger a crisis, especially another Asian financial crisis.

One thing is for sure,  David Cameron, the British prime minister, has no one to blame but himself for this vote. What else? The favorable opinion of the EU is plunging everywhere, especially in France.

In fact, regardless of the outcome in this week's referendum, Brussels has a huge problem, one that I see getting worse as the euro zone struggles to escape deflation.
The problem now isn't Brexit, it's the fallout from Brexit. The BBC reports that Brexit sparks calls for other EU votes:
The UK's vote to leave the EU has sparked demands from far-right parties for referendums in other member states.

France's National Front leader Marine Le Pen said the French must now also have the right to choose.

Dutch anti-immigration politician Geert Wilders said the Netherlands deserved a "Nexit" vote while Italy's Northern League said: "Now it's our turn".

The UK voted by 52% to 48% to leave the EU after 43 years. David Cameron has announced he will step down as PM.

Global stock markets fell heavily on the news and the value of the pound has also fallen dramatically.

The European parliament has called a special session for next Tuesday.

Analysts say EU politicians will fear a domino effect from Brexit that could threaten the whole organisation.

Ms Le Pen hailed the UK vote, placing a union jack flag on her Twitter page and tweeting: "Victory for freedom. As I've been saying for years, we must now have the same referendum in France and other EU countries."

She is the front-runner among candidates for the presidential election in 2017 but opinion polls suggest she would lose a run-off vote.

Alarm bells - BBC Europe editor, Katya Adler

The EU worries Brexit could reverse 70 years of European integration.

In all my years watching European politics, I have never seen such a widespread sense of Euroscepticism.

Plenty of Europeans looked on with envy as Britain cast its In/Out vote. Many of the complaints about the EU raised by the Leave campaign resonated with voters across the continent.

Across Europe leading Eurosceptic politicians queued up this morning to crow about the UK referendum result.

But the mood in Brussels is deeply gloomy. The Brexit vote sends screaming alarm bells, warning that the EU in its current form isn't working.


Last Friday, Ms Le Pen had told a gathering of far-right parties in Vienna: "France has possibly 1,000 more reasons to want to leave the EU than the English."

She said the EU was responsible for high unemployment and failing to keep out "smugglers, terrorists and economic migrants".

Mr Wilders, leader of the Party for Freedom in the Netherlands, said in a statement: "We want to be in charge of our own country, our own money, our own borders, and our own immigration policy.

"As quickly as possible the Dutch need to get the opportunity to have their say about Dutch membership of the European Union."

The Netherlands faces a general election in March and some opinion polls suggest Mr Wilders is leading. A recent Dutch survey suggested 54% of the people wanted a referendum.

Mateo Salvini, the leader of Italy's anti-immigration Northern League, tweeted: "Hurrah for the courage of free citizens! Heart, brain and pride defeated lies, threats and blackmail.

"THANK YOU UK, now it's our turn."

The anti-immigration Sweden Democrats wrote on Twitter that "now we wait for swexit!"

Kristian Thulesen Dahl, leader of the populist Danish People's Party, said a referendum would be "a good democratic custom".

European Parliament President Martin Schulz denied Brexit would trigger a domino effect, saying the EU was "well-prepared".

But Beatrix von Storch, of Germany's Eurosceptic AfD party, praising "Independence Day for Great Britain", demanded that Mr Schulz and European Commission head Jean-Claude Juncker resign.

"The European Union has failed as a political union," she said.If you ask me, heads should roll in Brussels, starting with Juncker. 
The EU is in a crisis and whether you like it or not, this uncertainty and wave of populism across Europe is going to threaten the global economy and financial markets for a very long time.

After Brexit, we will have to contend with Nexit, Frexit, Italexit, Swexit and one referendum after another, including another one in Scotland. And who knows, maybe Germany will just say enough is enough, we're out of here!

I sent an email to my close friends asking for their opinion. One of them, a cardiologist, replied: "This is really unbelievable.  The worst possible result…. not a clear majority overall with big regional differences between England and Scotland and Ireland. Horrible. It will tear the UK apart and probably destroy the EU.  I don’t know why they make these votes 50+1."

His brother who works in finance stated this: "The problem with the Euro is not Greece or any of the other PIIGS. It is actually Germany who is the 800 pound gorilla in the room. So, in my mind, there are two outcomes: the Euro falls apart or Germany leaves the Euro. Brexit is just the first symptom."

And my younger brother, a psychiatrist, stated this: "It's a binary outcome: either the Euro falls apart, or they tighten up and move towards a true fiscal , monetary, and political union. Status quo is now untenable. I'm betting it falls apart."

In these crazy markets, we need to listen more to psychiatrists and cardiologists and less to financial analysts. I remain short the euro and I'm keeping my eye on the surging yen. So far, despite the volatility, the reaction is one of relative calm (or complacency), but don't kid yourselves, this is the worst possible outcome for the UK, the EU, and the global economy.

One thing is for sure, the Fed is out of the picture for the remainder of the year and possibly all of next year depending on the global fallout of Brexit. Central banks are going to be pumping massive liquidity into the global financial system to limit the shockwaves but they are only doing damage control.

And that global deflation tsunami I warned of at the beginning of the year is now headed our way faster than I even imagined. If you don't believe me, listen to Bill Gross discuss the fallout of Brexit below where he rightly notes populist policies are deflationary.

Gross also discusses the ECB's policy following Brexit and the limits of negative interest rates but as I've stated bonds have entered the Twilight Zone and it could a very long time before rates normalize.

Also, a handful of other European countries say they want a referendum on the European Union. No doubt, Brexit will likely trigger a domino effect in the EU, one that could spell the end of the union.

Lastly, I embedded a Bloomberg clip (late April) where former Greek Finance Minister Yanis Varoufakis talked with David Gura about what he sees as potential Brexit fallout for the European Union and EU's ability to withstand another shock similar to the financial crisis of 2008.

Listen closely to his comments, he is absolutely right on "Brexit speeding up European disintegration, creating a gigantic deflationary vortex in Europe which will consume the UK" and possibly the world.

In this environment, you can forget about any melt up in stocks and you better understand why US bonds (not gold) are the ultimate diversifier. Also, ignore all the talk that the endgame for the dollar bull run is near.

Three years ago, Michael Sabia, the Caisse's CEO warned: "There’s a dark night going on in Europe, a dark and foggy night where bad things come out of trees and bite you. It’s a pretty scary place."

He was right. Welcome to Europe's Minsky Moment and be prepared for a long and volatile road ahead.

Thursday, June 23, 2016

Canada's Next Pension Challenge?

Don Pittis of CBC News reports, Now that Bill Morneau conquered the CPP it's time to move on to a harder pension problem:
Who would ever have guessed that hammering out a Canada Pension Plan solution would have been so easy?

With such widespread support for Finance Minister Bill Morneau's latest pension reforms, perhaps the government will finally have the confidence and wisdom to solve the other giant pension problem: the case of the missing money.

Only a year ago, calls for CPP reform seemed to be falling on deaf ears. Opponents labelled contributions to our own retirement a "payroll tax" and talked about the danger of big government.

Job losses

Small business hollered that their share of the contribution would slash profits and lead to job losses, something the government denies. Some of those objections have not gone away.

"Finance ministers are putting ... jobs in jeopardy and willfully moving to make an already shaky economy even worse," said Canadian Federation of Independent Business president Dan Kelly in a scathing release just after the federal-provincial accord.

According to the CFIB, the only good thing about the reform was that it superseded the Ontario government's pension plan, which Kelly called "the CPP's far uglier cousin."

Surprising support

The surprise was not the CFIB's intransigence. Unexpected was the amount of support from some business owners and from commentators often considered right-of-centre and pro-business, despite the fact that some details have yet to be worked out.

As the C.D. Howe pension panel adviser Tammy Schirle commented in the Report on Business, among many advantages of the plan, when employers and employees contribute to the CPP they effectively save the future taxpayer the cost of paying the way of people who failed to save.

That sounds like an argument I made in 2013 that at the time was a voice in the wilderness in the face of a tidal wave of opposition to CPP reform.

Politics have changed with the arrival of the Liberal government. But maybe the public mood has changed, too. If so, it is time for the government to solve the other great problem of Canada's pension system.

Several flaws with objections

There are several flaws with business objections to contributing to CPP. One is the idea that the true cost of contributing to the retirement costs of low wage and temporary employees should not come out of profits, but instead be borne by future taxpayers.

And this is exactly the next problem that Morneau, with his sophisticated understanding of the pension system from his career in that business, must now address.

There is no question that it is good to solve the problem of wage earners who fail to contribute enough to their own retirement, as the CPP reform goes part way to doing.

Far more unjust is the problem of people who dutifully contribute to a pension throughout their lives and don't see the benefit, once again leaving taxpayers on the hook. It is the problem of ghost pensions, and it is something that in the wake of the CPP success, should not be impossible for Morneau to address.

Fantasy fiction statements

The essential problem is that while employees watch their pension payments come off their periodic cheque and while benefit statements show their pension amounts growing toward a comfortable retirement, that money being set aside is imaginary.

Government employees are not exempt from the travesty, as we saw in the Quebec municipal pension cuts and the collapse of Detroit. In both cases, governments claimed to be tucking away the pension funds but suddenly employees discovered those pension statements were fantasy fiction.

In some ways, I suppose, when governments default on their responsibility, taxpayers are on the hook in any event, but the case of private companies that default on pensions is more egregious.

When companies go broke, money owed to pensioners is classified as part of the company's assets, so in the case of a large contribution shortfall, pensioners who gave up years of wages to cover their pensions, only get a fraction of the money they are owed. Secured creditors, those who lent money against a specific asset, get paid first, and theoretically are able to take all the money before pensioners get a dime.

Whether for public or private pensions, the solutions are surprisingly simple.

One easy fix is to make it a law that money set aside as indicated in pension statements is actually set aside. Instead of being kept in imaginary accounts, the funds are managed by bonded professionals whose only responsibility is to current and future pensioners.

Phased in changes

In that way, employers who strike a bargain with their workers immediately see how much it is costing them instead of running up deficits in their pension accounts that only get more and more impossible to repay when the employer gets into financial trouble.

In the case of companies that feel they cannot make a profit without the capital owed to pension funds, the simple solution would be to make it a law that any borrowing is treated as a secured creditor of the highest order.

Studies in the past have indicated that such rules, put in place when a company is healthy, are no impediment to companies raising money from other sources. Lenders do not expect healthy companies to fail or they would not lend them money in any case.

As with the CPP changes, there will be objections from business, but everyone else knows it should be done. The difficulty is making an abrupt change.

That is the brilliance of the CPP plan that Morneau could repeat here. By phasing the changes in over a number of years, employers would be able to adjust to the new reality, but future pensioners — and taxpayers — would be saved from unexpected losses.
I appreciate what Don Pittis is writing about in this article but I have an even  better idea: get companies out of running pensions altogether.

I wrote about this in my comment on real change to Canada's retirement system when the Liberals swept into power:
In my ideal world, we wouldn't have company pension plans. That's right, no more Bell, Bombardier, CN or other company defined-benefit plans which are disappearing fast as companies look to offload retirement risk. The CPP would cover all Canadians regardless of where they work, we would enhance it and bolster its governance. The pension contributions can be managed by the CPPIB or we can follow the Swedish model and create several large "CPPIBs". We would save huge on administrative costs and make sure everyone has a safe, secure pension they can count on for life.
Companies should focus on their core business, not pensions. I know, there are some excellent company defined-benefit plans but they're the few. The majority are struggling in a low rate, low return world.

Now that we got an agreement to expanding the CPP, maybe we can talk seriously about how best to deal with company DB and DC pensions. In my opinion, we can and should seriously think about having an entity like CPPIB manage all these pensions. If not CPPIB, then another public pension fund which specializes in managing pensions and is backed by the full faith and credit of the federal government.

Companies will sign on because they're already looking to cut their pension costs. Why do I like the idea of CPPIB or several "CPPIBs" managing all pensions? Because it makes sense and it will be in the best interests of all stakeholders: companies, governments, and most importantly, beneficiaries.

Again, imagine a world where all pensions are managed by the Canada Pension Plan. Workers in the private and public sector have automatic pension portability and those in the private sector can rest assured that no matter what happens to their company, their pensions won't be slashed and they can still retire in dignity knowing their pensions are safe and secure.

By the way, this is the future of pension policy. We're not going to have company pensions or even municipal pensions. We are going to have one big entity called CPPIB or several "CPPIBs" managing the pension contributions of all Canadians.

No more Ontario Teachers, HOOPP, OMERS, Caisse, bcIMC or even PSPIB. They will still be around but they're going to be covering the pensions of a lot more people.

You might think I'm dreaming but this is where we are heading or at least where we should be heading.

In related news, Andy Blatchford of the Canadian Press reports, CPP boost to cost feds $250M per year to offset fresh burden on low-wage earners:
The federal government estimates it will cost taxpayers $250 million per year to offset the additional financial burden that expansion of the Canada Pension Plan will eventually place on low-income earners.

Ottawa and the provinces reached an agreement-in-principle this week to gradually increase CPP premiums as a way to boost the program's benefits for future generations of retirees.

The announcement also included a federal commitment to enhance its refundable "Working Income Tax Benefit" to help compensate eligible low-wage earners for the higher CPP contributions.

The Finance Department projects that change will cost about $250 million annually once the CPP premium increase has been fully phased in.

The federal government also says it will allow the provinces to make specific changes to the tax benefit so it's more harmonized with their own programs.

Due to this, Ottawa says it will continue working with the provinces and territories before implementing the adjustments to the tax benefit.

The Canada Revenue Agency describes the tax benefit as a refundable tax credit that provides relief for low-income individuals and families who are already in the workforce. The agency also says the benefit encourages others to enter the workforce.

Earlier this week, every provinces except Quebec and Manitoba agreed to the deal to expand the CPP.

The agreement states that CPP premium increases on workers and employees will be phased in over seven years, starting on Jan. 1, 2019.

Under the deal, the federal government also said it would provide a tax deduction — instead of a tax credit — on the increased CPP contributions by employees.

The CPP changes will increase the maximum amount of income subject to CPP by 14 per cent, to $82,700.

The full enhancement of the CPP benefits will be available after about 40 years of contributions, the government said.

The income replacement rate will rise to one-third from one-quarter, meaning the maximum CPP benefit will be about $17,478 instead of about $13,000.
Also, Molly Ward of BNA reports, Canada to Extend Pension Plan Tax to Higher Incomes, Increase Rate:
Canada is to implement a new, separate tier for the Canadian Pension Plan (CPP) that would increase the existing upper earnings limit to C$82,700 ($64,580) from C$54,900 ($42,870) by 2025, according to an agreement reached by Canada's Ministers of Finance and published by the government June 20.

The current CPP contribution rate also is expected to increase by 1 percent for employers and employees to 5.95 percent from 4.95 percent over five years beginning Jan. 1, 2019, for those already in the existing annual pension earnings range, Canada's Finance Department spokesperson David Barnabe told Bloomberg BNA June 21. Actuarial assessments are to be used to determine final tax increase amounts.

Beginning implementation in 2024, earnings greater than the existing annual pension earnings range will be subject to a new tax for both employers and employees that is expected to be 4 percent, Barnabe said.

Under the two tier system effective 2025, the rates and ranges would be:
  • 5.95 percent for those at or less than the earnings cap (currently C$54,900 in 2016 but is to increase incrementally each year according to a legislated formula) and
  • 4 percent for those with earnings greater than the earnings cap to C$82,700 range that previously did not have coverage.
  •  Earnings more than C$82,700 will not be subject to pension plan contributions.
“We believe this is a positive move by the federal government. The plan is to make incremental changes and we are very supportive,” said Steven Van Astine, Vice President of Education at the Canadian Payroll Association.

The agreement was signed by eight provinces. Quebec and Manitoba withheld their signatures.

The federal government has asked the provinces to finalize the agreement by July 15.

Impact on Ontario Pension Plan

Ontario Finance Minister Charles Sousa has told Canadian media that the proposed adjustments to the CPP would allow the province to not continue pursuing the implementation of its own provincial pension plan, which was scheduled to go into effect on certain companies beginning January 2018.
Indeed, the Toronto Star reports, Ontario halts pension work with CPP deal looming:
Staff at the soon-to-be-disbanded Ontario Retirement Pension Plan have hit the “pause” button on implementing the retirement scheme while critics fume they are “twiddling their thumbs” at taxpayers’ expense.

Finance Minister Charles Sousa said the halt comes as Ontario and most other provinces face a July 15 deadline to approve a provisional deal reached Monday to improve Canada Pension Plan payouts for retirees.

“We’re working now to put a pause on all activity,” Sousa told reporters Wednesday, noting the ORPP will not proceed with its most costly step — hiring a company to administer the plan.

Officials will be meeting “in short order” to decide how to close out the ORPP and staff will have to stay on to handle those duties, Sousa said.

“That’s what we’re working on,” he added, correcting earlier statements from his associate minister Indira Naidoo-Harris that implementation was proceeding in case the CPP deal falls through. Progressive Conservative MPP Julia Munro said a contingency plan should already be in place because the government had long hoped its Ontario pension plan push would prompt other provinces to back an enhanced CPP.

“Fifty employees, including (chief executive officer) Saad Rafi and his $525,000-a-year salary, will spend an undetermined amount of time twiddling their thumbs in their offices,” warned Munro (York-Simcoe).

“Ontario has already sunk at least $14 million into the ORPP. This does not include severance payments that may be awarded to employees.”
I didn't even know they already hired a CEO and staff for the ORPP. What a total waste of money this is and I'm shocked that they didn't wait to see how the CPP talks were going prior to making such commitments.

One final note, I'm having troubles with my Gmail account, so if you didn't read my last comment on Brexit, you can do so by clicking here. By Friday morning, this will all be behind us.

Below, ministers have reached an agreement in principle on Canada Pension Plan reform. The federal finance minister says the changes, which would increase premiums to ensure a bigger payout at retirement, mark a "historic day."

And Premier Kathleen Wynne says Ontario's push to enhance the Canada Pension Plan led to the agreement reached by the country's finance ministers Monday. The federal NDP says the deal is a positive development, but more needs to be done.

More needs to be done but enhancing the CPP is a huge achievement, one that will lay the foundations for any future changes to pension policy.

Wednesday, June 22, 2016

To Brexit Or Not To Brexit?

John Geddie of Reuters reports, Beyond Brexit, easy central banks keep euro zone bonds in demand:
Investors hoovered up euro zone bonds on Wednesday, daring to look beyond Britain's EU vote to a world in which the U.S. Federal Reserve is in no rush to raise interest rates and the ECB stands ready to do more to nurture weak growth.

The recent rise in safe haven German bond yields -- which has come as investors discount the prospect of a vote for Brexit -- ground to a halt and low-rated debt was also in demand after interventions from the world's two most powerful central banks.

European Central Bank chief Mario Draghi renewed his pledge to use all instruments to tackle weak growth in the bloc, before U.S. Fed chair Janet Yellen put the kibosh on a July rate hike as she bemoaned slowing momentum in the US labour market.

"It took ECB President Draghi's statements, which were interpreted as being dovish, to usher in a bullish counter-movement on EMU (euro zone) government bonds," DZ Bank strategist Daniel Lenz said.

German 10-year bond yields were down slightly on the day at 0.05 percent, but still some 9 basis points above record lows hit last Thursday before the murder of pro-EU lawmaker started to shift momentum back towards a remain vote.

All other euro zone bond yields, including those in southern Europe which have been most vulnerable to worries around Brexit, were lower on the day.

Some analysts said the last day of campaigning before Thursday's Brexit vote could still change perceptions for what polls show will be a knife-edge vote.

But bookmakers' odds, which are more closely followed by those in financial markets, show just a 25 percent chance of a leave vote, down from around 40 percent last week.

Easing nerves around Brexit and the prospect of further monetary easing have also seen investors return to low-rated peripheral bonds, which were shunned last week in echoes of the euro zone debt crisis.

Societe Generale strategist Ciaran O'Hagan said that bond yields in Spain and Italy show there is "no worry at all ahead of a possible Brexit surprise".

Nowhere is the turnaround in sentiment towards Europe's riskier assets more evident than in Greece.

Yields on two-year Greek government bonds -- the lowest-rated in the bloc -- rose 200 bps last week and have fallen 125 bps so far this week.

And there is a strong chance they could fall further before Thursday's vote.

The ECB, at a governing council meeting on Wednesday, is expected to reinstate Greek banks' access to its cheap funding operations.

This would be a reward for painful economic reforms carried out by Alexis Tsipras' government and allow Greece's banks to come off expensive emergency borrowing. Greek banks lost their access to the ECB's cheap funding mechanism early last year when Athens came to the brink of being ejected from the euro zone.
The only good thing about the Brexit vote is it will be over this week and we can all go back to our lives and stop worrying about it.

I have publicly stated Canadian pensions shouldn't worry about Brexit and in my comment on global bonds in the Twilight Zone last week, I stated the following:
[...] I'm not convinced Brexit is a done deal. The Brits aren't stupid and when it comes down to it, they will vote with their wallets, just like Quebecers voted with their wallets in past referendums. At the end of the day, everyone thinks about their economic well-being. Period. I couldn't care less about polls when it comes down to voting day, I think Brits will stay the course.

However, Brexit is just one hurdle for the global economy. There are plenty of others and unless policymakers figure out a way to stimulate and sustain aggregate demand, deflation will rule the day and global bond yields will stay ultra low for a very long time.
But let's say Brexit happens, then what? Well, investors will seek refuge in good old US bonds, they're going to sell the euro and pound and buy the yen. Markets will be in a tizzy and volatility will shoot up. Conversely, if Brexit doesn't happen, the euro and pound will rally, the yen and US bonds will sell off and global stocks and corporate bonds will take off.

Of course, if you ask Mr. Yen, the yen will strengthen past 100 per dollar this year, whichever way the UK votes in Thursday’s referendum. I hope he's wrong as the surging yen could trigger a crisis, especially another Asian financial crisis.

One thing is for sure,  David Cameron, the British prime minister, has no one to blame but himself for this vote. What else? The favorable opinion of the EU is plunging everywhere, especially in France.

In fact, regardless of the outcome in this week's referendum, Brussels has a huge problem, one that I see getting worse as the euro zone struggles to escape deflation.

Below, on Tuesday, speaking in front of No. 10 Downing Street, Prime Minister David Cameron of Britain made an appeal to older Britons to vote to stay in the European Union.

Also, millions watched the BBC debate where Boris Johnson, Ruth Davidson and Sadiq Khan locked horns. You can watch the entire debate below but there are clips of the heated exchange available here.

I'll end with some humor. Last Week Tonight With John Oliver discusses what Brexit means. And Scottish comedian Billy Connolly 's colonoscopy skit. I did my first one yesterday and I'm glad it's over and that everything is fine. Don't worry about Brexit, it will be over really soon and we can all breathe a little easier until the next crisis erupts.

Update: Read my follow-up comment on Europe's Minsky Moment.

Tuesday, June 21, 2016

An Agreement on Expanding the CPP?

Geordon Omand of the Canadian Press reports, Finance ministers reach agreement on expanding CPP:
Most of Canada's finance ministers reached an agreement in principle Monday to revamp the Canada Pension Plan, although Quebec and Manitoba have not signed on to the deal.

Under the agreement, which would go into effect in 2019, an average Canadian worker earning about $55,000 will pay an additional $7 a month in 2019. That would increase to $34 a month by 2023.

Once the plan is fully implemented, the maximum annual benefits will increase by about one-third to $17,478.

Finance Minister Bill Morneau said the deal will improve the CPP in a way that will make a difference to working Canadians.

"We have come to a conclusion that we are going to improve the retirement security of Canadians, we're going to improve the Canada Pension Plan that will make a real difference in future Canadians' situations," he said.

Morneau said Quebec, which has its own pension plan, and Manitoba continue to be part of the process, despite not signing on to the agreement.

"Quebec is in a different situation," he added. "The Quebec pension plan is a different vehicle. The costs are different than the Canadian Pension Plan. The idea that more analysis is required is something that we completely understood around the table."

For Manitoba, Morneau said the deal comes too soon for the province's new Tory government.

"Manitoba is a brand-new government. They've been in power for four weeks, so they were a productive voice around the table, a voice of continued interest in working together, but of course this comes pretty fast and hard for them."

Ontario Finance Minister Charles Sousa said young Canadians will reap the benefits from Monday's decision.

"Today, this federal government has shown great leadership and great desire to do something of great benefit for our young people."

Sousa said the plan would replace the one his government had been working on.

British Columbia Finance Minister Mike de Jong, who had reservations about expanding the CPP, said he came on board because the plan is affordable for employees.

"I think we have reached a balanced approach to setting the objectives that were set out."

A change to the CPP needs the consent of Ottawa and a minimum of seven provinces representing at least two-thirds of the country's population.

Heading into Monday's federal-provincial meeting, it was still unclear whether Ottawa would piece together the minimum required provincial support for change. Saskatchewan, for example, did not support CPP enhancement.

Sources say Ottawa made a major 11th-hour push in hope of securing enough countrywide support to boost the CPP and suggest Prime Minister Justin Trudeau was involved in the extra effort.

There hasn't been such a level of consensus on CPP reform at a national scale since the 1990s.

Morneau has argued that enhancing the CPP is critical to ensuring future generations will be able to retire in dignity, no matter the state of their finances.

However, critics have warned that expanding the CPP would squeeze workers and employers for additional contributions — and hurt the still-fragile Canadian economy.

The federal government intensified its lobbying efforts over the final days and hours of meetings in Vancouver as it tried to attract support from enough provinces to ensure a CPP upgrade, said sources with knowledge of the talks.
This is great news for future generations of Canadians. Read my last comment on chasing a CPP consensus to get my thoughts on why it's critically important to enhance the CPP once and for all.

Bernard Dussault, Canada's former Chief Actuary, was kind enough to share his thoughts with me:
  • The increase in the 25% retirement pension rate (i.e. from 25% to 33.33%) is more modest than we ever heard before, still though a not negligible 8.33% increase.
  • To my unexpected great satisfaction, the few details provided about the strengthening mean that lower income (e,g, $25,000) workers will not be excluded form coverage.
  • Indeed, If the actual intent were to exclude them ($25,000), then Bill Morneau Statement's "a Canadian with $50,000 in constant earnings throughout their working life would receive a yearly pension benefit of around $16,000 instead of the $12,000" would be inaccurate because the strengthening with a $25,000 exclusion would provide a yearly pension of $14,000 instead of $16,000, as the first $25,000 of employment earnings would not benefit from the 8.33% increase.
Bernard also pointed out a few things which should be obvious:
  1. Even if Manitoba did not vote for the now agreed CPP expansion, it shall join and be part of it.
  2. Even if Quebec did not vote for the now agreed CPP expansion, it will have to expand the QPP in a manner similar to the CPP expansion. In this vein, QC may will do what it wants regarding the financing of their own expansion but shall not have a choice as to providing a design of benefits that shall be as beneficial as that of the CPP expansion. This relates to my point below, i.e. inclusion of low income earners.
  3. Ontario Finance Minister indicated in the midst of yesterdays ’announcement that it will not implement the ORPP if the agreed CPP expansion is ultimately approved.
I thank Bernard for sharing his insights. Below, CBC News reports on how most of Canada's finance ministers reached an agreement in principle Monday to revamp the Canada Pension Plan.

Monday, June 20, 2016

Chasing a CPP Consensus?

Geordan Omand of the Canadian Press reports, Revamp of Canada Pension Plan centre stage at finance ministers' meeting:
The federal finance minister says revamping the Canada Pension Plan is critical to ensuring that future generations of Canadians can retire in dignity, no matter the state of their finances.

Bill Morneau joined his provincial and territorial counterparts in Vancouver on Monday to discuss reforming the national pension program over concerns that some Canadians will struggle financially come retirement.

“We’ve heard from Canadians (about) the importance of retirement security,” Morneau said before the meeting.

“I’m looking forward to working together with my colleagues across the country to improve the long-term future for Canadians.”

The pressure is on to reach a deal as Ontario’s plans to develop its own pension program are well on their way, though the province’s finance minister said his preference would be for a national strategy.

“We want consensus. We want everybody to participate. We want everybody involved,” said Charles Sousa, adding that he wants to reach a deal in Vancouver.

Quebec Finance Minister Carlos Leitao was not as optimistic about coming to an agreement on Monday, saying that any change would have to be targeted, modest and gradual to earn his province’s support. So far Ottawa’s plan is only two thirds of the way there, he said.

Leitao put forward a proposal during the meeting that more selectively targets those Canadians who are the least likely to save in order to avoid putting an additional financial burden on low-income earners.

Under the Quebec plan, increased pension premiums would only kick in for those who make more than about $27,000 per year, which is about half the yearly maximum pensionable earnings for 2017.

The proposal argues that supplementing the income of Canada’s lowest earners is better achieved through other government policies, such as old age security and the guaranteed income supplement.

Reforming the pension system needs the support of at least seven provinces representing two thirds of the country’s population, which gives Ontario an unofficial veto over any decision.

The legislation, as currently written, also states that any reforms can only be implemented three years after a federal-provincial agreement is reached.

Coming into the meeting, Saskatchewan and B.C. have suggested economic conditions aren’t right for a change that’s likely to lead to an increase in the premiums that come off workers’ paycheques.

That premium hike is why some critics of the expansion call it a payroll tax, a common refrain from the Opposition Conservatives who oppose an across-the-board expansion of the program.

Federal research has suggested that workers who are the least likely to save for retirement tend to be under the age of 30, earn between $55,000 and $75,000 (although some estimates are higher), and either don’t save enough or lack access to a workplace pension plan.

The federal and provincial governments are looking at a possible increase in the $55,000 cap on annual maximum pensionable earnings, which would result in both higher premiums and increased pension benefits.
Of course, critics abound. Kelly McParland of the National Post reports, Can Bill Morneau save Canada’s pension plan from Ontario?:
Canada’s finance ministers will meet in Vancouver today for a new round of talks on pensions, resolute in their determination to solve a crisis that doesn’t exist.

Federal Finance Minister Bill Morneau has pledged to seek agreement on “enhancing” the Canada Pension Plan by the end of the year. An initial meeting with provincial counterparts in December was considered a success in so far as no one stomped out of the room in outrage. But no actual money was on the table at the time; the ministers merely agreed to “enter into discussions to review next steps,” and to meet again. The Vancouver meeting may mark the beginning of the hard part.

The task is complicated by several uncomfortable realities. One is that there is no crisis. According to any number of reports by respected institutions, both in Canada and abroad, Canadian seniors are doing quite well. Four out of five have the income they need in retirement. The poverty rate among seniors has plummeted over the past four decades: although advocacy groups pick and choose the figures they use to best bolster their argument, even the starkest numbers suggest seven out of eight seniors are above the line. Compared to other developed countries, Canada ranks near the very top; Statistics Canada figures show the share of seniors living in low-income families fell from 29 per cent in 1976 to 5.2 per cent in 2011, four points lower than the overall population.

Despite the lack of a sweeping need, Morneau and Ontario Premier Kathleen Wynne have nonetheless signalled their intention to save the day. They fear the country’s aging population will mean an increased number of elderly who find themselves outliving their means. Indeed, after years of decline, poverty figures have been creeping higher, especially among older, widowed women. “Progressives” argue that Canadians aren’t saving enough, and thus need government action to protect them from the consequences.

Ontario wants Morneau to “fix” the CPP by increasing contributions. Former finance minister Jim Flaherty resisted similar pressure because it would mean higher premiums, and smaller paycheques, for working Canadians who can ill-afford it. That argument makes little headway in Ontario, where Wynne’s government is determined to press ahead with an Ontario-only scheme that will start siphoning money from contributors on Jan. 1, 2018. Only a broader reform of the CPP will stop the province from barreling ahead with its ill-conceived plan.

Ontario’s resolve is wrong-headed on several fronts. It will represent an additional cost of doing business in a province that has seen its manufacturing base erode and its finances sink deeper into debt. It will put a strain on those at lower income levels who can’t afford the additional deductions, and who are already adequately covered by the package of benefits that include the CPP, the Old Age Security pension and the Guaranteed Income Supplement. While a second government pension might benefit some middle-class Canadians, it would reduce the income available during their working years for raising families and paying mortgages, as well as for personal investments. Advocates of pension reform seem oblivious to the fact that, thanks to health improvements, many older Canadians prefer to continue working beyond the traditional retirement age of 65. Canadian seniors are not the doddering grandmas and grampas of the government’s imagination, but a vibrant and energetic cohort of people who aren’t prepared to be put out to pasture.

The situation represents a problem for Morneau. To halt Ontario’s plunge into ORPP he needs agreement on a federal enhancement to CPP that won’t do more harm than good. To significantly change CPP he also needs agreement from seven of 10 provinces representing two-thirds of the population. But Quebec is reluctant — “I don’t think there’s any sort of crisis in our public pension system,” says Finance Minister Carlos Leitao — Saskatchewan is opposed and British Columbia has doubts. Manitoba’s new Conservative government may also by more prone to small, targeted improvements over a sweeping revamp.

Ontario’s ORPP would threaten the balkanization of a system intended to apply equally to all Canadians. It is in Canada’s interest to avoid this. Morneau must find a way to prevent Ontario from undermining the system as a whole while averting reforms that would be just as damaging. It’s a daunting task, demanded by an unnecessary crusade.
Every time provincial finance ministers get together to discuss enhancing the CPP, Canadians are bombarded by flimsy articles claiming "everything is fine, we don't need to enhance the Canada Pension Plan."

True, there is no imminent crisis and Canadian seniors are doing quite well on a relative basis but this is an extremely naive and shortsighted argument against not enhancing the CPP. It's like knowing the tsunami is coming but we should all just relax instead of preparing for it (click on image):

The premise behind enhancing the CPP is to offer Canadians who are not saving enough for retirement a pension that ensures they can retire in dignity and security in an era that will be marked by ultra low rates and returns.

I know, some experts claim there is no savings problem in Canada, but other experts disagree and think that far too many Canadians are ill-prepared for retirement. Others claim that the majority of Canadians are saving, just not wisely (although the advice they offer is equally terrible).

The truth is a lot of Canadians aren't saving enough in large part owing to the ongoing housing bubble in this country that keeps inflating residential real estate prices to epic levels. Many people are barely making their mortgage payments, leaving very little or no money to save for retirement.

But even those that do manage to save a lot of their discretionary income are better off with an enhanced CPP. Why? Because regardless of their family income and amount of savings, nothing beats a defined-benefit plan which offers predetermined benefits indexed to inflation that are not subject to the vagaries of public markets. Also, they can't outlive their pension contributions to the CPP whereas most Canadians with no workplace pension will outlive their savings soon after they retire.

What else? Despite the critics, Canadians are getting a great bang for their CPP buck. The folks over at CPPIB are pension experts who know what they're doing. They have the resources to pool investments, lower costs and invest directly in public and private markets across the world, leveraging off their scale, internal expertise and long investment horizon which allows them to capitalize on short-term market dislocations that can hurt or wipe out individual savers.

What about all those critics who claim that enhancing the CPP is a "tax" which will hurt the economy? They are completely and utterly clueless. Those CPP contributions will help fund the future retirement of millions of Canadians. And as the population ages, people with a fixed and secure income are in a better position to spend, allowing the federal and provincial governments to collect tax revenue in the form of sales taxes (conversely, the less money they have, they less they spend, the less sales taxes governments collect). Also, more people retiring in dignity and security means less money has to be spent on social welfare programs, reducing the overall debt.

In fact, the direct and indirect benefits of defined-benefit plans are grossly under-appreciated. It's simply mind-boggling that anyone claiming to be a policy expert fails to see them. I don't care about their political affiliation, good pension policy is good economic policy for the long-run. Period.

I mention this because one of my close friends is a die hard Conservative who totally agrees with me on enhancing the CPP. He too doesn't understand the case against enhancing the CPP (many Conservatives are way off on this issue letting politics cloud their judgment).

As far as Ontario, the ORPP isn't an impediment to an enhanced CPP and Premier Kathleen Wynne is signalling she's willing to abandon her proposal to create a provincial pension plan if Monday's meeting leads to a deal on improvements to the Canada Pension Plan.

Please keep all this in mind as the finance ministers debate yet again whether or not to enhance the CPP. I hope they get this right and finally introduce much needed change to bolster Canada's retirement system.

Below, Global News reports the provincial finance ministers will be meeting in Vancouver on Monday and on the top of the agenda will be the CPP. Ontario Premier Kathleen Wynne will be pushing for an expansion of the Canada Pension Plan as finance ministers hold two days of talks in Vancouver.