Mr El Arian of PIMCO reports that Chinese GDP will decline to between 6.5% to 7.0% in coming Q’s. Most analysts are forecasting GDP growth of around 7.5%, as suggested by Premier Wen. Recent reports by Chinese economists suggest GDP will be around 7.2% to 7.4%. Personally, I believe that Me Al Erian is right. Indeed I believe that Chinese 2013 GDP will be around 6.5% at best (indeed, likely lower), unless the new administration at that time introduces real and significant stimulus measures – a great deal of the recent announcements were essentially rehashing previously announced capex projects. Furthermore, announcements of massive projects by the regions are great, but wheres the money coming from boys and girls?. The rice bowl is empty. There are also increasing reports of material capital flight out of China which, if true (and it sure looks like it), does not inspire confidence. The greatest threat is that most analysts expect the Chinese authorities to engineer a “soft landing”. I’m not sure how they arrive at this conclusion. Indeed, I remain unconvinced.
The next meeting of the Communist Party has indeed been set for 10th October and, in addition, the authorities have confirmed that the number of members on the Standing Committee of the Politburo will be reduced to 7, from 9 currently. There are reports that the responsibilities of most of the members, elected to the Standing Committee, will not be disclosed at this time – yet more uncertainty if true;
The Indian market is at its highest level for more than a 1 year, with the Rupee rallying, following the reform package announced by the PM and the finance minister Mr Chidambaram. Some US$1.2bn of funds have flowed into Indian equity markets, following the announcement of the reform package. Whilst Ms Banerjee’s party Trinamool Congress is withdrawing from the coalition, the Samajwadi Party is to support the coalition, according to the PM. The sooner that the ruling coalition dumps Ms Banerjee the better – she is a loose cannon – quite frankly a lot, lot worse. Finally, whilst the reforms will help, the Indian authorities have to increase power production materially, in particular and, in addition, modernise the country’s infrastructure, which is certainly creaking at the seams;
The head of the Cypriot ruling Communist Party reports that the country should exit the EZ, if the EZ imposes tough bail out terms – well please do, these guys are living in cloud cuckoo land. The Cypriot government tried to get an additional rescue package from the Russians, but the Russians baulked. However, the important issue is that if Cyprus exits, the pressure will mount on Greece. Last week, representatives of the Troika announced that they would leave Greece to return in a week. Other reports (purportedly by IMF representatives) suggested that no announcement on Greece will be made ahead of the US Presidential election, though were officially denied by EU officials – officially denied – whoops that means that its likely to be true. Greece has yet to agree on all the additional budget cuts that the Troika is requesting. In addition, the IMF will face problems from their board if they are to provide more financing – unlikely. The EZ will not provide more financing and Greece’s request for more time is going to be a tough sell with, for example, the Finns, though it remains a possibility. The German finance minister states that the EZ wants Greece to remain in the Euro, but it must fulfil the conditions of its 2nd aid package ie all the proposed austerity measures – pretty close to impossible. Greece remains in the EZ because Mrs Merkel fears the contagion effects of a Grexit – that’s it. Her finance minister, Mr Schaeuble believes otherwise, though to date, Mrs Merkel has won the argument. Basically, a complete mess, as usual. It looks as if I will be reporting on Greece, yet again – I’m truly sorry;
The Spanish banking, fiscal, economic and political situation is deteriorating so rapidly as to suggest that a major crisis is likely pretty soon. The EZ had previously agreed that a sum of E100bn be allocated to recap Spanish banks. The Spanish authorities have reported (even as late as last week) that they would need only E60bn to recap their banks, which I have been deeply sceptical of, as you know. Well what a surprise – recent reports suggest that Spanish banks will need more than E100bn. Results of a stress test are due out this coming Friday (28th September). Bad loans have risen to E169bn in July, or 9.86% of total loans, up from 9.42% in June and will be even higher at present, as the economy has continued to deteriorate, unfortunately at an increasing pace. The Spanish, it must be said, have been “economical with the truth” for many years and, even now, just don’t seem to understand that they have to come clean.
The Spanish budget deficit for H1 2012 was north of +8.5% – remember the (upwardly revised) target for the current year is +6.3% – clearly impossible to meet. The head of the (economically very important – some 20% of Spanish GDP) Catalonia region is talking about breaking away from Spain – the meeting between PM Rajoy and the head of Catalonia, Mr Mas went very badly last week. Furthermore, Spanish authorities remain in denial and are trying to negotiate a condition light bail out, when they are being told in terms which are crystal clear (from the ECB and the EZ/Germany etc) that tight restrictions will be imposed. Spain faces 2 regional elections – in Galicia and the Basque country on the 21st October and the government does not want to agree to a bail out (with tough terms) ahead of that – the current PM promised that he would not accept, in effect, EZ oversight of Spain. Finally, the Germans are not keen to have Spain request a bail out at this stage, due to possible problems with their Parliament, the Bundestag – some members of the coalition are likely to oppose further aid packages and the government has had to rely on the opposition in the past to pass the necessary measures, for example on the establishment of the ESM. However, the opposition, whilst more pro Euro, has suggested that they will demand more political concessions if the government need their support, which clearly Mrs Mekel will not be keen on.
Basically, yet another complete and total mess in the EZ.
I have reported previously that Spain cannot sustain its current debt levels – I am now convinced about it. Adding more debt onto a country whose debt is increasing as rapidly as it is in Spain is a recipe for an impending disaster. Spain needs to introduce additional structural measures, including labour reforms (which, reluctantly, they are beginning to understand, though are still far from acting upon), though with the population becoming increasingly hostile (unemployment remains above 25%) the government is dragging it feet. As a result, the economy will continue to decline, as the EZ heads into a recession, just making the situation even worse.
The current plan of kicking the can down the road is way, way past its “sell by date”. Spain will need to restructure its debts – better to take that action now, accompanied with the necessary structural reforms and a sensible bail out package, in particular, to recap their insolvent banks. Yes, that will force countries such as Portugal, at the very least, to have to restructure its debt and address their banks, as well – quite likely other countries. However, the current plan is unworkable and will buy far less time than the allegedly “good and the great” in Brussels and the rest of the EZ believe. Essentially, it is time to take the painful, but necessary, action.
EPFR Global reports that investors withdrew US$17bn from money market funds and have invested roughly the same amount into equity funds in the week ended 19th September (a 4 year high) and a further US$6.3bn in bond funds. Some US$4.3bn went into EM equity funds, the most in 32 weeks, whilst EM bond funds witnessed inflows of US$11.4bn, the 15th consecutive week of inflows. Inflows into European funds rose to their highest levels in 19 weeks, though investors sought to invest in global funds, with inflows rising to a 1 year high. The actions taken by the FED, ECB and the BoJ were the main reasons cited. (Source FT);
It looks as if previous (pessimistic) estimates on US corn and soya production were unwarranted and that production forecasts will be revised higher. Farmers are beginning to report that yields are looking as if they will come in higher than expected. If confirmed it will be good news for EM’s in particular, as their inflation basket is weighted far more heavily towards food (and energy) and a resulting decline in inflation will allow central banks in the region to reduce interest rates. Oil prices have also declined, in spite of QE3 and the actions by the ECB and BoJ. Generally, I remain unconvinced as to the arguments that inflation will rise materially as a result of recent central bank action – certainly over the next 3 to 6 month horizon. Indeed, I believe that inflation will decline globally over that period;
The latest CFTC data suggests that the number of Euro shorts has declined materially. Whilst a number of analysts expect the Euro to climb, I do not. The EZ has a remarkable ability to screw things up and deliver bad, rather than good, news.
Outlook
The FED, ECB and, to an extent, the policy action by the BoJ have been helpful for equity markets. However, dark clouds are beginning to gather, far sooner than expected. The situation in China is deteriorating quite fast and (much needed) remedial policy action has not been announced, as yet. Tensions between China and Japan are increasing. The EZ is, as usual, a total mess. The US is heading towards a Presidential election, with Obama, at present the clear favourite, though a “fiscal cliff” issue to address. However, the good news in the US is that the residential property market is doing much better than expected in my view which, if sustained, will have a material positive impact on the US economy.
The hysteria over inflation, I believe, is way overdone, particularly over the next 3 to 6 months. There are strong deflationary forces out there, which suggests to little old me that inflation is likely to decline, rather than accelerate, in coming months. If I’m right, the good news is that more central banks globally will reduce interest rates – likely in my view.
I am net long at present, though will be watching markets even more carefully – though, overall, I remain of the view that central bank policy action supports markets, for the moment.
I continue to believe that the Euro and the A$ remain overvalued, against the US$ and other currencies – NOK possibly even the CAD, though there are (increasing) concerns relating to the Canadian residential property sector.
Have a great weekend.
Kiron Sarkar
23th September 2012
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