German constitutional ruling as expected
Kiron Sarkar
September 07, 2011

Hi,

Australian 2nd Q GDP rose by +1.2% QoQ (-0.9% in the 1st Q, revised up from -1.2% previously), and above expectations of +1.0%. Growth came entirely from the domestic side - net imports was a negative -0.5%. Inventories (+0.8%) and personal consumption (+0.7%) were the main contributors. However, the next move by the RBA will be to lower rates, though given today's data, may well be further down the road. The A$ clearly picked up on the news. The only worrying issue is inflation. Real gross domestic income rose by +6.5%, the most since 1987. More importantly, average compensation per employee rose by +1.2 in the Q. However, my biggest concern is Australia's dependency on China in particular;

Are the Chinese about to U Turn on monetary tightening. the Chinese Securities Journal reports that the Central Bank may ease policy. The journal suggested that the Central Bank may either reduce reserve ratio requirements and/or buy bills from banks ie QE. The key is inflation - the August report is due this Friday and expectations are for a drop to +6.2% YoY. Chinese equity markets reacted positively to the Journals comments. However, my view is that Chinese economy will contract by much more than current forecasts, particularly given a global slowdown and very little evidence of an increase in domestic consumption. I remain bearish, and indeed increasingly so, on the Chinese economy;

Yesterdays move by the SNB is even more amazing when the ultimate impact is that the SNB has chosen inflation to devalue its currency, in effect. However, inflation in Switzerland is not a problem at present. If the Swiss go for inflationary policies, when will the Euro Zone - OK, for different reasons. The removal of a safe haven suggests that there will be more focus on the Yen and Gold, I suppose, but the Japanese will likely intervene, a la SNB;

The Swedish Riksbank kept interest rates on hold, as expected - the benchmark repo rate was held at 2.0%. They are concerned about the situation in the Euro Zone - Sweden is not a member of the Euro Zone - sensible people;

The Italian Senate is to hold a confidence vote (which is part of the legislation to force through measures which will increase revenues) today, having been approved by the Italian cabinet yesterday. Italian bond yields continue to decline - currently 5.36%;

As expected, the German Constitutional Court has rejected the plaintiffs challenge to the Euro Zone bail outs, funded to a large extent (approx 30%) by Germany. However, they stated that the German Parliament must be involved in decisions that involve the budget and that the Government must get approval of the parliamentary budget committee before granting aid. The decision was as expected - however, it looks as if further aid to Greece will be a problem, if Parliamentary approval is required. The head of the Constitutional court stated that it was a "close decision" and that it should not be interpreted which would allow for a "blank cheque". Good news, as Greece has totally ignored its commitments and its time for the country to get real. However, in reality Greece will now certainly default - over 70% haircut.

The EFSF may not be as neutered, given that decisions need to be cleared by the German Parliamentary Committee (rather than Parliament) which is helpful. However, the focus of any market intervention remains with the ECB and they want to get out of this role - however, one interpretation of the Court ruing is that the ECB (effectively the Euro Zone national banks) purchases of Italian and Spanish bonds could be impacted by this Court ruling - need to check ie does it need prior approval of the German Parliamentary budget committee. In addition, in a key concession, Mrs Merkel has allowed the German Parliament to define its own powers in respect of decisions relating to Euro Zone bail outs - once again bad for Greece;

Talks between German, Dutch and the Finnish finance minister re the Finns demand for collateral in exchange for providing further aid failed to resolve the issue. However, the fact that Greece is not complying with its commitments may make the collateral issue irrelevant. I really cant see how the Euro Zone can continue to provide funding for Greece, when they clearly are not committed to meeting their targets - certainly a view expressed recently by the Germans and now the Dutch. The hardening of views of Euro Zone members (now facing domestic voter dissatisfaction) can be seen quite clearly in the losses suffered by Mrs Merkel in all 6 regional elections this year. In addition, the Finnish PM made it quite clear today - bail outs ONLY in exceptional circumstances - bye, bye Greece, though quite frankly, no great loss. However, can the Euro Zone deal with the under capitalised banks and, in addition, stop contagion spreading - difficult, given recent anemic measures and policy differences, etc, etc;

UK house prices fell for the 1st time in 4 months in August - down -1.2% from July (source Halifax Building Society). However, luxury home prices in London show no sign of declining;

UK July manufacturing output was up +0.1% MoM or +1.9% YoY. UK data been all over the place recently, so its very difficult to assess the true state of the economy. In my view, the official data paints a more bearish picture of the UK economy than is the case, a view the BoE is also coming to. The UK Government statistic office needs to be improved;

Testimony by former News International executives, totally contradicts testimony given by James Murdoch at the Parliamentary Select Committee. I cant see him surviving. He is likely to be recalled by the Select Committee. Their bid for BSkyB looks impossible;

Brazilian inflation rose for the 12th month in a row - now at its fastest pace since 2005. The recent 50bps cut by the Central Bank was clearly premature. Consumer prices rose by +0.37% in August MoM or 7.23% YoY, up from +6.87% in July.

Summary

US markets were down, but we off their lows yesterday. Asian markets took up the baton as are European markets. However, whats changed. I remain bearish.

The Euro is slightly firmer (for how much longer) and Gold is off. Brent is back above US$113. Government bonds still well bid.

US futures indicate a positive start. Personally, I would sell into any strength.

Best
Kiron