Europe again

Just a short note on Europe today – full service will resume on Monday.

The EZ has agreed to the 2nd Greek bail out, subject to Greece implementing (with verification) the reforms that it has agreed to – some hope. Raising the size of the EFSF/ESM (at todays EZ Summit) was off the agenda, as a result of German pressure. However, in spite of the official German opposition to increasing the size of the bail out funds, I believe the EZ will – the current E500bn is grossly inadequate and other countries/IMF are highly unlikely to provide resources to the bail out fund unless the EZ does more;

Spain unilaterally set its 2012 budget deficit at 5.8% of GDP, much higher than the 4.4% previously agreed with the EU. The budget deficit came in at 8.5% last year, once again higher than the target of 6.0%. A “discussion” between Spain and the EU is inevitable, especially as (to date) the EU has insisted that Spain sticks its prior commitment. Quite an interesting development, particularly as it has come on the same day that 25 out of 27 EU countries (excluding the UK and the Czech Republic) signed up to the “fiscal compact” which, once approved by each country’s national Parliament (Ireland will need a referendum), will introduce the German inspired “debt brake” into their constitutions – basically commits the 25 EU countries to reduce borrowings and, indeed, balance their budget deficits.

Spanish unemployment rose by a massive +2.4% MoM in February, with youth (under 25) unemployment over 50%, yep that’s 50%.

The EU has a tough task. If it offers concessions to Spain, expect Portugal, Ireland, etc, etc to submit their own “requests” However, I just cant see how Spain can meet its prior commitment. Officially, GDP is forecast to be -1.0% to -1.7% this year, though in reality the actual outcome will be closer to (indeed may exceed) the more pessimistic forecasts;

Whilst Spain is facing increasing pressures, Italy announced today that its 2011 budget deficit fell to -3.9% (-4.6% in 2010), better than the -4.0% forecast. 2011 GDP came is a marginally higher at +0.4%, (+0.3% expected). Whilst Italy entered into recession in the last Q of 2011 and its economy is expected to contract this year, Italy has pledged to balance its budget deficit by 2013.

As I keep banging on, Italy is in far better shape than Spain, in spite of its higher headline debt to GDP. Spanish and Italian bond spreads continue to converge – I remain of the view that Italian bond yields will decline below equivalent Spanish bonds;

European budget problems are not just a PIIGS issue. The Dutch will have to make further cuts in their budget , following a forecast that the country’s budget deficit could be as high as 4.5% in 2013, as opposed to the 3.0% limit. The cuts could well result in the current (right wing) coalition collapsing and allow the opposition Socialists (who are not at all wedded to austerity measures) to form a Government – the Socialists are gaining support. Holland (the country is in recession) has retained (just) its AAA rating, for the moment;

German January retail sales fell by -1.6% MoM, far far worse than the expected RISE of +0.5%. To date, German retail sales have held up, as opposed to the past, where Germans have cut back on spending at the first sign of a weaker economy. GDP for the current year has been based on domestic consumption holding up/improving. Oops;

EZ leaders have (finally) started to talk about growth, rather than just austerity. However, its just talk for the moment, following pressure from Sarkozy – after all, he does have an impending election. OK, so we have tough austerity measures and growth !!!!;

Even more unhelpfully, Euro Zone January producer prices rose by +0.7% MoM or +3.7% YoY, higher than the +0.5% and +3.5% respectively, expected;

Banks deposited a record E776.9bn overnight at the ECB on Thursday (earning just 25bps), over 60% more than the previous day. It will take quite some time for this ECB LTRO (1.0%) money to find its way into the real economy. Some of the 800 banks that subscribed for the E529.5bn will undoubtedly play the carry trade, but the large banks are unlikely to want to admit that they are increasing their holding of EZ Sovereign debt;

The impending Russian Presidential elections will no doubt result in Mr P winning 99.8% (sorry 99.9%, how silly of me) of the votes cast. However, the current status quo does not seem sustainable – expect further capital flight;

With Brent remaining around US$125, I really cannot be bullish, though I remain of the view that the current price is utter madness and will have to decline materially – yes I appreciate the Iranian issue. Furthermore, inflation (actual and/or forecast) seem to have risen in China, Europe and the US – certainly a problem for the current easy global monetary policy. OK more liquidity is sloshing around, courtesy of Central banks and investors are still cashed up, but, for the moment, I’m just not interested in equity markets – indeed, I’m (modestly) short the miners and certain EM’s (South Korea and South Africa) + Spain. Basically, just too much uncertainty around to be long as the risk/reward is not in my favour, in my humble view. Besides, the returns in the 1st 2 months of this year were extraordinary by any standards – better to be safe.

The Chinese National People Congress will be interesting to follow – expect measures to increase domestic consumption and “social” spending. The Chinese have certainly relaxed the purse strings and lending will increase, given the severe credit conditions prevailing at present. However, I am increasingly of the view that inflation will remain a problem, particularly in the 2nd half of the year, which, if I’m right, limits easier policy measures. OK, so the Government had adopted “extend and pretend” measures in respect of the mountain of bad debts in the banking system, but these loans (in particular to the financing vehicles of the provinces) are never going to be repaid.

I believe that currencies are a better play at present and will continue to be short the Euro,Yen and A$, whilst long the US$ and NOK. The Euro only recently near US$1.35 (for reasons that totally amaze me) is way down – around US$1.32 at present. The Yen continues to weaken materially – off 0.5% against the US$ today.

Analysts suggest to me that US QE3 is off the table. Whilst US economic data continues to improve, I’m not totally convinced. In addition, a bigger EZ “bazooka” in terms of the bail out funds (very likely) will be positive. However, I believe its better to sit back and wait for the moment.

Have a great weekend.