Australian unemployment rose unexpectedly in June by -27k (mainly full time jobs, which were down -33.5k, bad news), almost wiping out the upwardly revised +28k revised gain in May. The unemployment rate rose for the 2nd month to 5.2% from 5.1%. The data represented a reversal of better economic news and resulted in a weaker A$, which has declined by over -1.0% against the US$. Tomorrow’s Chinese GDP and other data will be important for the A$;

The BoJ refrained from adding additional monetary stimulus today. Whilst expanding its asset purchase programme by Yen5tr to Yen45tr (US$565bn), it cut its loan facility by a similar amount to Yen25tr. The BoJ will increase its purchases of short term debt. In addition, the BoJ kept its interest rates between zero and 0.1% and its monthly bond purchases programme at Yen1.8tr. The BoJ reiterated that inflation would increase to to its target level of +1.0% – well they better lay off the Saki if they believe that. The Nikkei declined following the BoJ’s decision;

South Korea unexpectedly cut interest rates by 25bps to 3.0%, the 1st cut since February 2009. A further rate cut is very likely, the forecast is for October.The Korean economy is facing a downturn with weaker exports and imports. The services economy is being impacted by weaker manufacturing and slowing exports. It is expected that the BoK, tomorrow, will lower its 2012 GDP forecast from 3.5% at present. Inflation declined to 2.2% in June, well below the 3.0% midpoint BoK’s target range. Korea is a good indicator for trade, not only in Asia but globally, as it is heavily reliant on exports
Indonesia, by comparison, kept rates on hold, as expected;

The PBoC announced that new loans rose to Yuan920bn in June, as compared with Yuan880 forecast and Yuan 793bn in May. M2 rose by +13.6%, in line with estimates, though slightly lower than the PBoC’s target of 14.0%. Forex reserves were US$3.24tr at the end of June, from US$3.31tr at the end of March, a record Q/Q decline – basically stop buying Euro’s !!!;

Mrs Clinton weighed into the South China seas dispute, though far more diplomatically this time. He stated that she wanted ALL parties to be involved in talks to settle the dispute, which is sure to antagonise China, who wants bilateral negotiations – basically, the divide and rule principal;

Indian industrial output rebounded by +2.4% in May YoY (+1.8% expected), better than the (downwardly) revised decline of -0.9% in April, from the initial estimate of -0.1%. Industrial output is revised constantly and is not considered a very reliable economic indicator, other than the trend. The Rupee declined on the news and the Sensex closed -1.4% lower. The more important inflation numbers are released next week, with forecasts that wholesale price inflation will rise by to over 7.6%, from 7.55% in May;

Deposits held at the ECB overnight deposit facility dropped to E325bn yesterday, from over E809bn before the ECB’s cut of its deposit rate by 25bps to zero, which came into effect yesterday. However, the amount of funds parked in the ECB’s current account balance (which also pays zero, above the legal reserve requirement of E107bn) rose from E74bn to E540bn – will the ECB go for negative interest rates? – certainly a possibility in my view in coming months. Some of these funds have also gone into the better quality, short term EZ sovereign debt, including German, French and Dutch bonds. However, with short term yields at zero for such EZ sovereign debt, banks are going to have to think as to what to do with their excess funds much more carefully. However, for the moment safety is the prime factor.
A turf war has erupted between the ECB and the EU’s French Commissioner on the regulation of the banking sector. If the ECB loses, it will be bad news. The EU Commissioner Mr Barnier is considered dangerous by many market participants, a view I share.
Finally, the ECB expects the EZ economy to face further headwinds and states that “downside risks have materialised” according to their monthly bulletin – no great surprise. Inflation is expected to decline further (goody – more interest rate cuts);

EZ industrial production rose by +0.6% in May MoM (-2.8% YoY, as opposed to the -3.3% expected), better than the unchanged expected and the (downwardly revised) -1.1% in April;

You cant keep a “good” man down. Mr Berlusconi is allegedly going to stand for PM in the general elections scheduled in early 2013. That should exact a response from the EZ and Mrs Merkel, in particular.
The Italian government report that their forecast for a decline of GDP by -2.0% this year is conservative. However, Italian 2012 GDP will decline by at least -2.4% according to an Italian business association – much more likely.
Better news. Italy sold 1 year bills at a yield of 2.697%, as compared with 3.972% in the 13th June auction. There are medium to longer term debt auctions tomorrow.
The Italian Senate approved the fiscal compact today. It now goes to the lower house;

A poll reported in the German newspaper Stern states that 54% of those surveyed said that Mrs Merkel’s policy in the EZ crisis had been right. A much better 72% report that Merkel is well representing German interests abroad. The poll was taken between the 5/6th July;

Irish 1st Q GDP (seasonally adjusted) declined by -1.1% QoQ, well below the -0.4% expected. Oops. However, 2011 GDP was revised higher to +0.7% from -0.2% previously. June CPI came in at -0.2% MoM, from flat in May and +1.7% YoY, lower than May’s +1.8%
The Irish finance minister reported that Ireland had met its commitments, following the Q’rly review by the Troika. Interestingly, he stated that tax revenues were rising, in contrast with other PIIGS countries. In addition, the government is to privatise state owned assets starting next year. However, the Troika added that growth expectations will remain “modest” in 2013 and 2014.
Personally, I believe that the Irish economy is stabilising, though the danger remains a weaker EZ;

Analysts continue to downgrade US 2nd Q GDP forecasts. Goldman’s have reduced their forecast to +1.3%, down from +1.4% previously. Barclay’s is down to +1.5%, from an amazing +2.5% previously. Mr Buffet also suggests that the US economy is weakening, but remains positive, as do I, about the US housing market;

The US yesterday sold 10 year bonds at a record low yield of just 1.459%, with a bid to cover ratio of 3.61 times, higher than June’s 3.06 times. Analysts had expected the notes to be sold at a yield of over 1.51%. A difference between the actual yield of the auction and forecast yields is virtually unheard of. Yields were at 1.622% at the last 10 year auction in June this year. 30 year bonds are due to be auctioned today. The demand, particularly at these yields, is not a good sign for the equity markets;

FED minutes suggested that a few FOMC participants consider more stimulus will be necessary. Indeed, 12 out of 19 participants stated that they had based their economic assumptions on the basis of further balance sheet measures. 11 out of the 12 agreed with extending Operation Twist, whilst 2 members said that further bond purchases were appropriate. Certain Fed members suggested employing new tools. There was an intriguing reference to a possible slowdown in Asia and China, in particular. The market was disappointed that the FED minutes did not commit to taking action, rather than suggesting that they were seriously considering it. However, I must say that this is a somewhat churlish response;

US weekly unemployment claims came in at 350k, a decline from the (revised) 376k previously, better than the 372k expected. The better (for trend purposes) 4 week moving average came in at 376.5, a 10k decline from the revised 386k previously.
May import prices declined materially to -2.7% YoY (energy related) from -1.8% previously. Yet more reason why, I believe, the FED will go for QE3;

Brazil, as expected, cut its benchmark interest rate by 50 bps to a record low of 8.0% yesterday. Expect more cuts, especially as the Brazilian economy is under pressure – expectations of GDP growth of just +2.0% this year, though inflation was below 5.0% in May. Unemployment came in at a record low of 5.8% in May, but is likely to level off initially and then rise in coming months;

Outlook

Huge number of emails on the German Constitutional Court issue and press reports that suggest that proposed direct aid to Spanish banks by the ESM has not been approved by the German Parliament. All I can say is that most clued up Germans state that the Court will not deem the ESM and the fiscal compact illegal. In addition, the German Parliament is likely to approve the transfer of funds directly to Spanish banks in due course, as well. The negative issue is uncertainty, especially as there will be more problems in the EZ. That’s why I’m cautious, indeed more bearish at present.

Asian markets were weaker as are European. US futures suggest a weaker (-0.7%) open. The Euro, well no surprise its lower – currently below US$1.22 and at a 10 year low against the Yen. Indeed, Marc Chandler of Brown Brothers Harriman reminds me that its trading below the OECD’s measure of PPP, though IO believe it has further to decline. There is little doubt that the Chinese are trying to stop a precipitous decline of the Euro, given the impact on its export sector, but…..

Brent is off sharply at US$98.30, with gold lower at US$1563.

I remain cautious, indeed bearish, certainly in the short term. However, I continue to believe that China will have to ramp up measures to stimulate its economy. In addition, I believe that the FED will announce a QE3 programme. The EZ, well I continue to worry about the German Constitutional Court issues, though the EZ is moving to (ultimately) political union, which means a strictly enforced fiscal union, combined with a banking and a transfer union. Volatility will remain high. Will be watching US earnings reports, in particular revenues, cash flows and forward looking statements.

Kiron Sarkar

12th July 2012

Category: Fixed Income/Interest Rates, Think Tank

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