S&P downgrade for Spain
Kiron Sarkar
April 27, 2012

The BoJ has decided to increase the size of its asset purchase programme by Yen10tr (US$124bn), the 2nd increase in 3 months, though reduced the size of its credit lending programme by Y5tr. They left their key interest rate at zero to 0.1%. The move suggests suggests that the BoJ is more serious about it's inflation target (currently 1.0%). The Central Bank also decided to buy up to 3 year debt, rather than 2 years previously. Having said that the Governor's statements suggested that the BoJ will pause to assess the effects of the programme. The Nikkei rose by +1.0% on the news, but has backed off subsequently. Personally, I believe that creating inflation in Japan is pretty dangerous stuff, as interest rates will rise - not at all pleasant given the level of public sector debt. The Yen, should weaken on the news, though it was widely expected;

A Japanese output report shows that manufacturers forecast a MoM rise in production of +1.0% in April and a massive -4.1% fall in May. The decline in May is as a result of much weaker overseas demand. March retail sales were -1.2% lower MoM, well below the forecast for a decline of -0.5%. However, unemployment remained at 4.5% in March. CPI rose by +0.5% YoY;

The FT reports that the outgoing Premier Wen (later this year) is trying to introduce constitutional and political changes in China, following the dismissal of Bo Xilai who, together with a number of colleagues, was totally opposed to introducing further democracy into China. Mr Wen has failed in the past, but has been emboldened by the recent exit of Mr Bo. Reforms, including binding members of the Communist Party to be subject to the law (yep, they are exempt at present !!!) will take time and result in uncertainty - watch this carefully;

Corruption in India has no boundaries. The FT reports that by inflating the number of government subsidised latrines available, politicians and officials have pilfered at least US$1.7bn !!!!;

S&P has downgraded Spain's long term rating (the 4th largest EZ economy) by 2 notches from A to BBB+ (3 notches above junk) and placed the country on negative outlook - it's the 2nd downgrade YTD. The short term rating was reduced to A-2, from A-1. The ratings agency expects the Spanish economy to contract by -1.5% this year (the IMF is at -1.8%)and -0.5% next, much worse than their previous forecasts of an increase in GDP of +0.3% this year and +1.0% in 2013 . They added that the budget deficit is likely to increase further this year (they believe that the current target of -5.3% will not be met - they suggest -6.2% for the current year and -4.8% in 201) and that the country would need further fiscal support for its banking sector - no chance from Spain itself (it does not have the necessary funds and, in addition, has the disastrous Irish experience), it will have to come from EZ funds (EFSF/ESM). Furthermore, they added that a further downgrade was possible if Spain's debt to GDP exceeded 80% between now and 2014 - well they better do it immediately, because it is over 80% at present. Spanish 10 year bond yields rose above 6.0%, though are at 5.98% at present - personally, I believe they will rise much further. The news was not a major surprise, but a further downgrade (very likely) has not been priced in;

The Spanish Economy Minister stated "Nobody has asked Spain to bail out its banking sector". Yeah sure. Spain will have to bail out it's banks, though does not have the necessary funds. Morgan Stanley estimates that Spain will need between E50bn to E160bn to recapitalise their banks. In these kind of cases, the situation always turns out worse than initial estimates, so assume at least E160bn. However, Spain cannot afford even E50bn. EFSF/ESM or funds from the IMF (though the IMF can only lend to sovereigns), with assistance from the ECB, are the only options;

More bad news for Spain - 1st Q unemployment rose to 5.64mn (24.4% and an 18 year high), up from 22.9% in the 4th Q 2011 and much worse than the 23.8% forecast. Spain's official forecast of unemployment peaking at 25% looks a nonsense. Further reports revealed that Spanish inflation rose to +2.0% in April, from +1.8% in March YOY and that retail sales declined by -3.9% YoY;

French jobless claims rose by 16.6k in March to 2.88mn, the 11th consecutive month of increases and approximately 10% of the workforce - the highest in 12 years. Not good news for Sarkozy's Presidential aspirations;

Consumer spending, a key component of the French economy, declined by -2.9% in March MoM, much weaker than the -1.9% expected;

Presidential hopeful Mr Hollande stated that "It's not for Germany to decide for the rest of Europe". If Mr Hollande wins (which looks likely), it's going to get sticky in the EZ. However, with debt to GDP expected to rise to 89% by the year end (IMF estimate), one has to wonder what flexibility he really has. However, his dilemma is that he has made an awful lot of (expensive) promises, which are going be difficult to ignore;

German May consumer confidence declined to 5.6, from 5.9 in April. Recent numbers suggest a weakening of the German consumer - bad news if it continues, as German economic forecasts have been based on strengthening consumption;

The Dutch PM has managed to agree a deal with opposition parties which will result in Holland meeting its 3.0% budget deficit target next year, through a combination of revenue increases (VAT rise to 21%, from 19% at present) and a freeze on civil servant salaries;

The announcement that the UK is in a technical recession has been largely ignored by the markets - indeed, Sterling has recovered from it's initial decline and is now trading at higher levels. Revisions to the data (generally are positive) could well reverse the initial forecast. Importantly, the BoE is paying far less attention to GDP and more to unemployment and data contained in business surveys. As a result, the announcement of a technical recession is unlikely to impact the BoE deliberations on the need for further QE;

US jobless claims declined by just 1k to 388k in the week ended 21st April, worse than forecasts of 375k. The less volatile 4 week moving average rose to 382k, the highest since 7th January, from the previous week's 376k;

Whilst the jobless claims data was disappointing, US March pending home sales (existing homes) rose by +4.1% to 101.4, the highest level since April 2010 and well above the +1.0% expected. YoY, pending home sales rose by +10.8%. Sales of existing homes represents over 90% of the housing market last year and March's data is clearly good news. The National Association of Realtors ("NAR") reports that the US housing market "has clearly turned the corner". However, the banks have a large inventory of foreclosed homes just waiting to hit the market;

Minutes of the recent Brazilian Central bank meeting suggests that it could/would? continue to reduce interest rates (currently 9.0% and just above the historic low of 8.75%) as the economy improves more slowly than expected. The head of the Central Bank reported that the economy remains fragile, which is easing inflationary pressures. The Central Bank stated that they expected inflation to decline towards their target of +4.5%, from 5.24% in March. Another 25/50bps rate cut is expected next month. The Real has declined by some 10% against the US$, since late February;

Outlook

Asian markets closed generally weaker following the Spanish downgrade, having initially been positive following the increase in the BoJ's asset purchase programme. European markets opened sharply lower, but have rallied - amazingly, even Spain is higher.

The Euro has rebounded - currently E1.3222.

Spot Brent oil is trading at US$119.72.

Markets are amazingly resilient. Cant help feeling that's it's the lull before the storm.

All eyes on US 1st Q GDP later today.

Kiron Sarkar