South Korea’s economy rose by the slowest pace in 3 years. GDP rose by +2.4% in the 2nd Q on an annual basis (or +0.4% on a Q/Q basis), lower than the 2.5% expected. With approximately 50% of its economy dependent on exports, S Korea is facing significant headwinds, given the slowing global economy. The domestic economy is also slowing, with consumer sentiment the lowest for 5 months;

The WSJ reports on an issue which I have raised for some time now. The paper reports that the PBoC is guiding down the value of the Yuan, which has declined by -1.1% against the US$ this year. Last year, the Yuan appreciated by +4.7%. A response by the US is sure to come. In addition, the Chinese have been supporting/buying the Euro, which I suspect would have declined further and faster if it had not been for this intervention. Europe is China largest trading partner and 2nd largest export market 9after the US) and, as a result, the value of the Yuan counts. In addition, the IMF reiterated that the Yuan was “moderately undervalued”, which is thought to mean “less than 10%”. The Chinese representative on the IMF, Mr Zhang Tao disagrees with his colleagues, stating that the IMF’s characterisation of the Yuan “is not consistent with the reality”. He repeats Premier Wen’s statement that the Yuan is “roughly in equilibrium”. Whilst Mr Zhang Tao’s comments are not surprising, I am surprised that he publicly disagrees with his colleagues. Personally, I believe that the IMF’s statement is right, though am not positive on the Yuan in the medium/long term;

Bloomberg reports that China’s State Council, the guys that control China, approved plans to promote the development of 6 provinces in the Central China region, including Hunan. In addition, the central Chinese city of Changsha (population 7 mn) has announced an Yuan 829.2bn (US$130bn) investment plan, which just happens to be 150% of the city’s 2011 GDP. To put this into context, Changsha’s fixed asset investment was Yuan 351bn last year, including both public and private investment. The new programme, even over the 5 year period, amounts to Yuan 160bn each year, ie around 50% of last years numbers. These are big numbers, but the markets remain sceptical, as I feared. The downside is that fixed asset investment will, once again, rise as a % of GDP, which is exactly the opposite of what is needed and will result in a further and unsustainably distorted economy. However, personally, I believe that the weakness in copper (there is a shortage of supply) looks as if it is coming to an end in coming months. (Source Bloomberg);

Demonstrations continue in Russia, as the authorities introduce stricter measures to curb the growing protest movement. They are trying to use the Chinese trick of restricting internet access/content, though are also increasing fines (by 150 times), making Libel a criminal offence and regulating foreign-funded non-government organisations. Not going to work Mr P. Interestingly, Russia is the worlds most corrupt major economy according to Transparency International. (Source Bloomberg);

German newspapers suggest a further PSI in Greece. Barosso is in Greece at present. In addition, the German newspapers talk about the ECB repatriating alleged “profits” on its holdings of Greek debt. Profits on Greek debt, come now – this is getting to be mickey mouse accounting stuff;

Italian retail sales declined by -0.2% MoM in May, slightly better than the -0.3% expected and April’s -1.6% decline. Once again slightly better data from Italy. However, the IMF states that Italy needs a further E10bn of spending cuts this year to meet its budget deficit targets;

There are rumours that Spain will request a full bail out “in the next few days”, rather than just the E100bn (way too optimistic) for its banks. As you know, I believe that Spain will need a full bail out. However, such a request, especially ahead of the decision by the German Constitutional Court, will be unwelcome by the German’s. The Dutch are increasingly Euro sceptic (as are the Finn’s) and general elections are due in Holland in September. In addition, the EFSF/ESM does not have enough firepower. This is getting really tricky. Yes the ECB is there, but that’s not a long term solution;

German August consumer confidence came in at 5.9, higher than both expectations and July of both 5.8.
German import prices index for June declined by a much greater than expected -1.% in June (lower oil), as opposed to expectations of -0.9% and May’s -0.7%. On an YoY basis, the import price index rose by just +1.3%, lower than expectations of +1.9% and +2.2% in May and the lowest since 2009;

Siemens, Europe’s largest engineering company, stated that it would not meet this years forecasts and, in addition, missed in terms of its 3rd Q sales and earnings. The CEO blamed the slowing global economy, adding “We see growing reluctance among our customers regarding capital expenditures and stronger economic headwinds, especially in our industrial short-cycle business”. Even the weaker Euro has not helped. Expect further such announcements from German and other European companies;

The German finance ministry states that the EFSF still has E236.7bn left, out of its E400bn bail out fund. The EFSF has disbursed E100.7bn to date, out of the E188.3 earmarked for Greece Portugal and Ireland. Hmmmm. Portugal will need a 2nd bail out, by September at the latest. With E100bn allegedly allocated to bail out Spanish banks (OK not all at the moment), the remaining firepower looks limited. In addition, Spain will require a bail out. Whoops no more money left. OK, what about the ESM, you say – well yes, but the German Constitutional Court needs to OK its establishment – likely, but will there be additional conditions (quite possible) and, if so, what’s their impact. Getting really messy;

The OECD states that the risk that Portugal does not meet its targets are significant. They forecast that GDP in 2012 will be -3.2% and -0.9% in 2013, as opposed to the Bank of Portugal’s forecast of a deficit of -3.0% this year and flat next. They call for further reforms of the Labour market. Last year, Portugal met its targets through a 1 off transfer of pension funds;

The FT reports that the very poor 2nd Q GDP data released yesterday (-0.7% Q/Q) will threaten the UK’s AAA credit status. Personally, I believe that it will not be long before the UK loses that rating;

US new home sales unexpectedly fell by -8.4% in June MoM, to an annual rate of 350k, as opposed to an upwardly revised 382k (369k previously) in May (March/April were also revised higher to 352k/358k respectively) and below the forecast of 372k. Sales were the lowest since January, though up +15.1% YoY and higher than forecasts for the 1st half of the year, given the upward revisions to March, April and May. In addition, the US Commerce Department reported that home construction rose +6.9% last month to 760k homes, the highest level since October 2008 and home builders confidence rose by 6 points to 35 this month, the largest gain in nearly 10 years. Sales in the Midwest and the West rose by +14.6% and +2.1% respectively, though -60.0% lower in the Northeast and -8.6% in the South. The sharp decline of 60% in the Northeast suggests a lack of supply, rather than lower demand which indicates that construction activity, as suggested by the Commerce Department data, will ramp up in coming months. Furthermore, Caterpillar reported an increase in construction equipment in the US. Access to mortgage financing remains a problem however, even though Bloomberg reported that 30 year rates declined to just 3.53% last week (the recent Zillow report cited even lower rates of just 3.35%), the lowest rate in the history of the survey. I remain positive that the US housing recovery is continuing. In addition, the MBA reports that refinance activity is the highest since April 2009, which will increase disposable income. US markets reacted negatively to the headline new home sales numbers yesterday, especially home building stocks – investors really should check the detail. I still am long building materials stocks;

Mr Geithner’s testimony to the House Financial Services Committee is certain to create problems for the BoE and the British Bankers Association (“BBA”). He advised the committee that he had reported the problems relating to the setting of the Libor rate, to UK authorities (including the BoE) in June 2008, whilst he headed up the Federal Reserve Bank of New York. In addition, he set out detailed ways to fix the problem in a letter to the relevant UK authorities at that time. His comments were, effectively, ignored by UK authorities. Whoops. The BBA is going to be called to provide evidence to the UK Treasury Committee investigating the Libor scandal – they are going to have a rough ride;

The former head of Citi, Mr Sandy Weill called for a break up of large banks. His comments are extraordinary, especially as he pushed successfully for the abolition of Glass-Steagall which, as a result, allowed for the integration of commercial and investment banking. In addition, his intervention will add to the number of policy makers who want to separate investment banking from commercial banking. The head of the FDIC, Mr Tom Hoenig, has called for a “richer, deeper Glass-Steagall”. Mr Weill’s comments will prove to be a headache for his former protege (though he did fire him), Mr Jamie Dimon, now CEO of JPM;

Outlook

Investors/analysts are ignoring the major increase in fixed asset expenditure in China (see above), as I expected. Scepticism is rife. However, personally, at some stage, investors will start looking at the commodity stocks, in particular, copper related. In addition, supply problems could create a shortage of copper. Chinese GDP this year, which was declining, is likely to rise above 8.0% in the 3rd and 4th Q this year following the ramp up in fixed asset expenditure, suggesting better markets for the mining sector, for example, in due course. The Chinese stimulus programme should be bullish for markets.

However, I’m getting increasingly worried about the EZ. Politicians have not explained the situation/issues involved to their public, with a number of people/countries, especially in N Europe, becoming more Euro Sceptic eg, Germany, Holland and Finland. No great surprise, but can politicians in these countries take the necessary and fast approaching decisions in this environment? The 1st clue will come from Holland in September, following the general election, but Germany remains the key. The decision by the German Constitutional Court in September remains critical. European politicians are on holiday – you would have thought that there were a number of priorities to sort out, rather than to trip down to the beach !!!. Its going to be a difficult August and early September, to say the least. The inability/unwillingness for EZ politicians to take much needed decisions has created a dangerous policy vacuum.

The ECB is reluctant to buy Spanish and Italian bonds, as they see it as a political rather than a monetary issue, though if Spanish 10 year yields rise above 8.0%, will they have a choice – I doubt it. Indeed, Mario Draghi, the head of the ECB has just stated at a conference in the UK that the ECB “will do whatever is needed to preserve the Euro” and “believe me, it will be enough”, he added – markets reversed early material declines and are currently over +1.0% higher. In addition, Draghi (sort of) acknowledged that increasing yields of peripheral countries could represent an issue (ie not enabling monetary policy transmission to the periphery) which the ECB would need to address – wow, good news, as it confirms that the ECB will be prepared to buy EZ peripheral debt, if necessary. Will the ECB reduce interest rates further – very likely.

In theory, the EFSF could buy peripheral debt, but has limited resources and, in addition, it is unclear as to whether it will get the necessary approval from the 9 member German Parliamentary committee.

Following the report in the WSJ, it looks as if the FED will introduce additional monetary easing measures, as I detailed yesterday, quite possibly as early as the FED meeting next week. Some suggest that the FED will wait till September as it will have access to additional economic data, but personally I believe that if they intend to move (likely), there’s no point waiting. Indeed, if the FED does not announce further easing next week, the markets could well react negatively, given expectations. However, will these measures make a difference – unlikely, but better than bad news. The US$ could come under pressure though, especially in the short term.

Asian markets were mixed, with Europe under pressure, though have reversed completely following Draghi’s comments. The Euro which was trading lower has also reversed (currently US$1.2215) following Draghi’s comments and is now higher against the US$. Draghi also pushed Brent higher – currently US$104.69 and nearly US$1 above pre Draghi comments. Peripheral bond yields are sharply lower and Italian and Spanish markets are up over 2.50% and 1.50% respectively. US futures, having indicated a slightly weaker open, have also reversed following Draghi’s comments and now indicate a higher (over +0.8%) open – should go better. Should be a STRONG RISK ON day today.

As I have stated, I certainly wont be short these markets – the significant turnaround following Draghi’s comments was a clear indication of the rapidity of a bounce on better news. Essentially, it looks like Central Bankers are the name of the game.

Kiron Sarkar

26th July 2012

Category: Think Tank

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