Chinese defaulting on commodity contracts
Kiron Sarkar
March 21, 2012

The BoJ meets tomorrow (2 day meeting) to decide on monetary policy. Speculation continues that they will add to their stimulus measures, which has weakened the Yen. Trade data is out on the 23rd May, which may reveal that the Japanese trade deficit widened in April - once again Yen negative;

The FT reports that Chinese buyers of thermal coal and iron ore are asking traders to defer cargoes - some have gone as far as to default on their contracts. This should not have come as a surprise, given the slowdown in China, but.........Remain bearish on the miners;

Premier Wen reports that China will focus more on stimulating growth. He called for "putting stabilising growth in a more important position" and put less focus on inflationary concerns. The China Securities Journal carried a front page story that China would announce plans to stimulate growth shortly. The Securities journal suggested that China could accept a higher fiscal deficit, lower RRR's, greater export rebates and a "stabilisation" of the Yuan. Sounds good, but I believe that talk of a major stimulus programme is way premature - most Chinese politicians/officials believev that the 2009 fiscal stimulus was a mistake. However, an interest rate cut, once inflation declines further (below 3.0%?) seems likely. Analysts are cutting GDP forecasts for the current year, but they remain around 8.0% - in my humble view, it's still far too optimistic;

Chinese authorities are working to speed up approvals of qualified foreign institutional investors who wish to invest in the domestic market, particularly for the long term. Always happens when markets come under pressure. Will foreign investors play - I think they will remain cautious;

The Indian Rupee continues to decline - it's down some 3.6% so far this month. The Finance Minister claims that he will cut subsidies - something that has proved extremely difficult in the past and personally I will not hold my breadth. With bond yields rising, the Government will, at some stage, be forced to take action if it wants to avoid a balance of payments crisis as budget and trade deficits widen, as does the current account deficit - quite possibly to unsustainable levels;

Latest polls suggest that the Greek New Democracy Party continues to gain support. It's polling around 26.1%, as compared with the anti bail out, default on everything crazies, within the Syriza Party which is in 2nd place with 23.7%. As you know, I believe that the gap should widen further, in favour of New Democracy, but am always aware that Greece (and Greeks) are certainly different !!!!!. Interventions by EZ leaders may backfire. German newspapers suggest that Schaeuble (who, by the way, wants to become head of the EuroGroup - the EZ finance Ministers group), rather than Merkel, suggested that Greece should have a referendum on whether they wanted to remain within the Euro. Interestingly, Mr Tsipras (the head of the Syriza party) is to visit Berlin and Paris!!!! - very interesting me thinks - the anti bail out/default on everything/exit Euro rhetoric by him to ease off/reverse do you think - this guy may finally be getting it. In addition, how will Mr Tsipras supporters view his visits to Berlin/Paris - not well, me thinks;

Huge number of comments on yesterday's note and, in particular, on EZ banks. Look there are initial signs of bank runs in a number of EZ banks. The EZ has to address this matter swiftly or you are going to have one hell of a problem. A number of countries, both peripheral and core, do not have the finances available to recap their banks and the private sector will not provide the financing necessary. The ESM and/or another EZ institution has to do it, as I have banged on endlessly for months. The rules need to be changed to enable the ESM to recap banks directly, rather than to lend to EZ states who can then recap their banks with the funds provided. At present, Germany is resisting this change, but will have to agree - there is no alternative. The question of who takes the hits arises - from overvalued assets, which banks have not provided for. I would hope that existing shareholders/bondholders do. Will banks be recapitalised - I certainly believe they must and will - it's only a matter of time. Another alternative is a blanket deposit insurance scheme, as proposed by Mr Mario Monti. However, at the end of the day, European banks are (grossly) under capitalised, have not accounted for losses, will not be able to access private capital, will continue to deleverage, when they should be lending and many will (indeed are) facing deposit withdrawals. As a result, a solution is needed urgently. This issue is likely to be at the top of the agenda at this weeks EU Heads of State meeting;

It is clear that Germany is backing off its tough austerity measures - my gosh, do they now get it that these maniac austerity measures cause more problems and, indeed, worsen the fiscal positions of the relevant countries. France is pressing Germany on the Euro bond issue yet again - a step too far for the German's at the moment, but inevitable, in my humble view. The German's seem to be willing to grant the peripherals more time to resolve their fiscal positions. In due course, new fiscal targets (one's that are not just plucked out of the air) will be established;

Germany was isolated at the G8 meeting last weekend. However, no meaningful initiatives were announced. The next talking shop will be the 23rd May EU Heads of State meeting. Most EZ leaders will press Germany to allow the ESM to be able to recap EZ banks directly (likely and sensible, as there is no alternative), though there are discussions on an EZ/EU wide deposit insurance scheme, which the Italian PM, Mr Mario Monti is pressing. Spanish banks, in particular, need to be recapitalised as many are insolvent, though most EZ banks are materially under capitalised;

Interestingly Mr Asmussen, the German representative on the ECB board suggests EIB project bonds ie Euro Bonds to finance pan European infrastructure projects. The problem, as the US discovered a few years ago, is that these projects take too long to implement - even worse if the EU is involved. However, it is one further step towards Euro bonds;

Just one more piece of anecdotal info on the apparent "willingness" of Germany to "accept" higher inflation. IG Metall workers (the most powerful/ vociferous union in Germany) obtained a pay rise of +4.3% over 13 months, the largest rise since 1992, though lower than the 6.5% initially demanded. Unions have won wage increases of around 6.0% in the Telecommunications and public sectors recently. Mr Schaeuble stated that pay rises could be higher than in the past. Inflation is coming in the core EZ countries, boys and girls and, in particular, in Germany and certainly more than the "corridor of between 2.0% to 3.0%" suggested as "acceptable" by Schaeuble. OK, oil prices have declined, which will reduce inflation in coming months, but do you really want to buy German 10 year bunds yielding 1.41%, way below current inflation in any event - certainly not mein herr - a bit too early to short in my humble view though, but......;

It is interesting to note that the US and the UK are working on plans to protect the general financial system in the event of a failure of a systemically important bank. The "resolution plan" would involve existing shareholders and bondholders taking the first hits, by the way. The EZ should learn - Sacre Bleu following the Anglo Saxons !!!;

The Brazilian Real has fallen some 20% since the end of February and is trading at a 3 year low. The sharp decline is making the Central Bank rethink. The bank issued appox US$650mn through a currency swap, leading to the Real gaining some +1.0%, though it still closed some -0.7% lower given earlier losses. Whether the Central bank is now satisfied with the lower Real and will continue to support it's currrency or that the action was to reduce volatility is unclear, but the decline of the Real should lessen in coming months. (Source Brown Brothers Harriman). The Brazilian finance Minister states that the weaker Real has helped competitiveness and that GDP will be higher than the +2.7% in 2011. Indeed, he suggests that GDP growth will rise by +4.5% in the 2nd half of the year. Hmmmmm, optimistic me thinks;

COT reports reveal that the number of Euro shorts (against the US$) is at record highs last week, normally a bullish sign for the Euro. However, I really cannot see the Euro strengthen in the medium term. I remain short;

Outlook

Asian markets closed mainly higher, with European markets up as well. The Euro is flat at US$1.2768. US futures suggest that markets will open some +0.4% higher. No material US economic news today, but housing news tomorrow and Wednesday could be interessing.

Spot Brent is up at around US$108.60.

Barclay's is to sell it's near 20% stake in Blacrock, worth about US$6.1bn. Need for more capital do you think? Expect other European banks to continue to dump assets for quite some time.

Was at a pretty sophisticated dinner party on Saturday - an English football team beat their German rivals - interestingly most,(who were from EZ countries) cheered vociferously - in the past they would have been solidly anti British - seems that Germany is more unpopular these days. Having said that Mr Cameron, Osborne and King need to back off their continued public criticism of the EZ etc - it's getting way over the top.

Best
Kiron