Kiron Sarkar
April 15, 2012
Chinese 1st Q GDP declined to +8.1% YoY (the slowest pace in 3 years),
below forecasts which ranged from +8.3% - 8.4% and below the +8.9%
reported for the 4th Q of 2011. However, most analysts believe that
Chinese growth will bottom out in the 2nd Q of this year and will pick
up in the 2nd half of 2012. Rumours continue to circulate that the
authorities will introduce stimulus measures, though much higher than
expected lending by banks in March (US$159bn), suggests that the
authorities have already embarked on such measures - bank lending is
very much controlled/directed by the authorities. In addition, urban and
rural wages rose by 9.8% and 12.7% respectively in real terms YoY in the
1st Q. Furthermore, the Government has been offering subsidies for the
purchases of cars and household appliances. Premier Wen stated recently
"We must strengthen our back-up plans and make room for contingency
policies, ensuring that we are well prepared for difficulties and
challenges". In particular, given the very serious political issues
recently, following the removal of Mr Bo and the fact that there is
going to be a major change in leadership later this year, the Chinese
authorities will not want any economic problems to increase current
tensions;
The PBoC has doubled the trading range of the Yuan/US$ to 1.0% of the
daily official rate. Analysts continue to report that these are the 1st
steps towards full currency convertibility. Personally, I continue to
believe that the real reason for this change is that the Chinese
authorities remain highly concerned about an appreciation of the Yuan
(particularly against the Euro, as Europe remains China's largest
trading partner) and are trying to slow down and/or even reverse the
appreciation. Going to be interesting in an US Presidential election
year;
Iran and the 6 world powers are set to meet again in 6 weeks time to try
and resolve the nuclear issue. No conclusion was reached during the 1st
meeting, though unlike earlier discussions, the Iranian side did not set
any pre conditions. It is clear that the 6 powers are keen for Israel
not to pursue military action, which will have a material impact on the
Oil price - President Obama, in particular, is not at all keen for
Israel to intervene militarily as a high oil price will harm his re
election campaign. However, if discussions do not result in a meaningful
outcome within a reasonable period of time, Israel will become more
emboldened to pursue military intervention, especially as they have
greater leverage in an US Presidential election year. However, in the
short term, the price of oil should decline as discussions continue;
The WSJ reports that Spanish banks gross daily borrowings from the ECB
averaged E316.3bn in March (E169.9bn in February). They accounted for
approximately 28% of the ECB's two 3 year LTRO programmes which, in
aggregate, totalled approximately E1.1tr. It is clear that the Spanish
banks have been buying Spanish Government bonds in an attempt to play
the carry trade - estimated by the WSJ at E40.6bn YTD. Complete madness,
as yields on the 10 year Spanish Government bonds rose to 5.99% last
Friday (up 21bps on the week and some 47 bps over Italian equivalents),
which suggests that these banks will have incurred material losses on
their purchases of Spanish bonds. However, it looks as if the Spanish
banks have run out of cash and will not be able to buy additional
Spanish bonds - Whoops - cant see anyone (in the private sector) being a
material buyer of Spanish debt, other than short term instruments.
Whilst Spain has been clever in prefunding a significant part (around
50%) of its 2012 financing requirements, it is going to have a real
problem financing the balance. In addition Spain and for that matter,
Italy, have been borrowing at the shorter end to avoid higher longer
term rates. In due course, these bonds will have to be refinanced.
Whoops again. However, Italy's average debt maturity profile is far
higher than Spain's. There is no doubt that Spain will need a bail out.
It will be interesting to follow the auction of 12 and 18 month Spanish
treasury bills on Tuesday and, in particular, the proposed 10 year
auction on Thursday. The amounts to be raised will be announced
tomorrow.
Will the ECB have to restart its SMP programme - looks very likely,
though the German's are going to hate it - however, they cant block it,
as they have just 2 representatives on the 23 member committee. In the
past, a rate of 7.0% for the 10 year bond has been seen as the moment EZ
countries have to seek bail out funds. Unless the ECB starts buying
Spanish bonds, a rise to 7.0% looks inevitable, increasing the losses
for the Spanish banks who bought their Government bonds recently. Whops
yet again.
The current situation is untenable. Yes the IMF is likely to provide
some funding to increase the size of the EZ bail out funds (announcement
this week), but the MD of the IMF, Lagarde, has been down playing the
size of the bail out funds that will be available to the EZ in recent
days, though a number of observers believe that the IMF will raise an
additional US$500bn - however, not all can be allocated to the EZ. As a
result, the total amount of EZ/IMF bail out funds available will simply
be insufficient, though an initial relief rally is certainly possible.
The ECB remains the only game in town. However, even with the ECB buying
more Spanish bonds, the problems within Spain remain. Spain's projected
budget deficit of 5.3% for the current year is impossible to achieve -
it will be closer to 7.0%. The Spanish Government has introduced
legislation which allows them to intervene if the regions overspend. The
measures will be strongly resisted, but the regions need help from the
Central Government to help pay the E35bn of unpaid bills they have
accumulated to date. Spanish CDS's rose to a record high - approaching
500bps on Friday, up from 380bps at the end of 2011.
Furthermore, austerity without growth is just going to make the
situation much much worse. Spanish debt to GDP is way higher than the
official number of approximately 70% - at least over 85% - indeed, a
number of analysts argue that it is (well?) over 100%.
The ECB is likely to reduce interest rates, though inflation remains
above the target of 2.0%. However, when EZ interest rates are reduced to
near zero, what do they do next. Money printing on a grand scale is the
only option, though Germany will be strongly opposed, as inflation will
rise much much more.
Spain is simply too big to rescue and too big to fail - there lies the
dilemma.
The Spanish authorities are also introducing measures to criminalise
those involved in street protests that "seriously disturb the public
peace", which suggests to me that there is going to be a lot of civil
strife in coming months. A ban of cash payments involving E2,500 and a
requirement to report foreign bank accounts (to avoid tax evasion) has
also been introduced.
There are no easy options. The bottom line is that Spain will need to be
bailed out, in spite of their daily denials. However, it's economy will
continue to collapse.
The Euro - well, forget the current level of US$1.3075, much more likely
US$1.20/1.10 or even lower - parity? by the year end;
Italian labour Unions protested against Mr Monti's pension overhaul on
Friday. The rise in the retirement age leaves a number of people who
elected for early retirement, without a pension. It looks as if the
authorities will cave in, with a resultant cost of E10bn, according to
the head of the Italian pension agency. There is speculation that the
Italian Government will introduce a wealth tax;
UK March producer prices rose by +0.6%, higher than the +0.5% expected
and by +3.6% YoY (+4.1% in February). Input prices increased by +5.8%
YoY, reflecting higher oil costs, in particular.
S&P reaffirmed the UK's AAA rating, with a stable outlook, unlike
Moody's and Fitch, who have both warned that the UK may well lose its
AAA rating. S&P stated that the stable outlook reflected their view
that the UK Government could continue to reduce debt, that net debt to
GDP will stabilise in 2014 and that "economic recovery will gain
traction over the medium term" However, they reported that the budget
deficit would amount to 4.0% this fiscal year, higher than the 2.9%
predicted by the Government;
The University of Michigan's confidence index dropped to 75.7 in April,
from 76.2 in March and worse than the unchanged expected. The weaker NFP
data, combined with lower earnings was cited as the reasons for the
decline. The current conditions component declined to a 4 month low of
80.6, from 86 in March. Consumer expectations (6 months
ahead) rose to 72.5, the highest since September 2009, from 69.8 in
March, however. Helpfully, inflation expectations over the next 12
months declined from +3.9% in March, to +3.4% in April. In addition,
lower prospective petrol prices and improving employment (assuming the
March NFP data does not reflect a weakening trend) should help
confidence data in future months. However, the continued problems in
Europe may well impact and I remain of the view that the FED will
introduce QE3 in coming months;
Difficult day for markets on Friday in Europe and the US and I expect
further weakness on Monday. The IMF/G20 meetings are unlikely to produce
any major news, though an increase of the EZ bail out fund, by the IMF
is likely. The IMF will release its global economic outlook on Tuesday.
The 1st round of the French Presidential elections is scheduled for next
Sunday (22nd April), with the 2nd round 2 weeks later. Mr Sarkozy is
expected to win the 1st round, though polls suggest he will lose the
2nd. However, my informed friends continue to believe that Sarkozy will
win the 2nd round.
I remain bearish.
Kiron
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