“Everyone knows that the Spanish are lying about the figures” – Sr EU/German sources

Chinese non manufacturing PMI declined to 48.4 in February, from 52.9 in January. However, the data may well have been impacted by the Chinese New year and, in addition, is not as relevant as manufacturing PMI.

Manufacturing PMI rose to 51 in February (a rebound following the Chinese New Year), from 50.5, in January. However, as the FT points out, the average recovery in PMI, post Chinese New Year, between 2005 and 2011, has been 2.8 points. There is no question that the higher oil price is hurting China (and other Asian economies) and, in addition, raising the threat that inflation (which has certainly not been dealt with) will rise once again;

There are conflicting reports on possible easing measures relating to property in China. However, Central authorities seem to have maintained their policy of maintaining curbs on housing. The National Peoples Congress, currently in session, may provide some clarification. However, regional authorities who, in the past have raised between 30% – 50% of their revenues from property sales, are in desperate shape and residential home prices continue to decline. Basically, something has to give;

China’s 1 child policy (implemented in 1979) will cut the number of 15 to 24 year olds by 27% to 164mn by 2025, reports the UN. However, those over 65 will surge by 78% to 195mn during that period. The policy has resulted in a significant increase in the male population, who are finding it tough to find a partner, to put it delicately. However, a reversal of this policy is unlikely in the short term, but will be inevitable, though clearly its impact will take a few decades to be felt. (Source Bloomberg);

The Chinese report that they are to increase defence spending by +11.2% this year (US$110bn), slightly lower than last years +12.7%, though in line with spending over the last 2 decades. With the exception of 2009, defence spending has risen by double digits, since 1989. However analysts advise (the well respected Stockholm Institute for Peace Research, for example) that Chinese official numbers account for just 60% of overall expenditure – new weapons expenditure is generally excluded. IHS Jane recently forecast that Chinese defence spending would rise by a massive +18.7% this year. The next (expected) President of the Communist Party, Mr Xi Jinping has much closer ties to the military than the the current President, Mr Hu. The US is cutting back on military spending generally, but refocusing on the region, which has been welcomed by a number of countries, though clearly not China. Other S E Asian countries, together with India are increasing their defence spending (Air Force and Navy in particular), in response to the increasing Chinese threat. Territorial claims, combined with, in India’s case, water rights are becoming an increasingly serious issue. Not a good development and must be watched very carefully indeed. (Source FT);

What a surprise – I think not. Mr Putin has (according to exit polls) been elected as President of Russia, with just under 60% of the vote – wow not the 99.9% he “normally” gets. There are allegations of electoral fraud/vote rigging, particularly following the last (widely believed) electoral “fix”. The result was expected – however, Mr Putin faces an exceedingly difficult task ahead – a number of Russian watchers do not expect him to survive the full 6 year term. Prior to the vote, Mr P promised a significant increase in Government spending – yep, but unless oil stays at current levels, an ever widening budget deficit is very likely. Russian markets have rallied recently – however, may well be a case of “buy the rumour and sell the news” in due course ;

The UK’s Telegraph reports that Greek authorities may have to enforce the CAC’s to ensure the restructuring deal on private sector bonds, as they may not reach (voluntarily) their desired target. The ISDA declared that there was no credit event last week – as there was no actual enforced haircut, as yet. However, if CAC’s come into play….The IIF state that they are confident that a Greek debt swap will succeed. Hmmmm. On balance, however, I really cant see how the EZ/Greece can avoid triggering CDS’s;

Mr Rojoy, the Spanish PM, unilaterally announced (amazingly, without having previously discussed the matter with his EZ colleagues), that Spain’s budget deficit for the current year would amount to 5.8% (down from 8.5%) in 2011, but above the 4.4% target. However, a few hours before, he signed up to the fiscal compact, which binds a number (25 out of 27) of EU countries (including Spain) to reducing budget deficits and debt to GDP by predetermined amounts, previously agreed.
Spain simply cannot meet its targets – unemployment is currently 23.2% and around 50% for under 25’s and forecast to get even worse. Its economy is imploding, in particular, given its previous reliance (estimated at 25% of GDP) on construction – which will not come back for many, many years. Mrs Merkel stated that “It makes no sense to declare right at the start that deficit-reduction goals aren’t valid any more”. Whilst I have a great deal of sympathy for Mr Rajoy, in particular given the serious economic and fiscal problems he has inherited from the previous administration (his administration has already agreed to E15bn of additional cuts in expenditure/tax increases and introduced labour reforms, since coming into power at the end of last year), his sense of timing is truly amazing, to say the least. Unnamed, EU/German officials are less generous. Senior EU/German sources state “Everyone knows that the Spanish are lying about the figures” – a response to the allegation that the current Spanish administration has inflated the 2011 budget deficit, so as to get a more sympathetic hearing on this years increased defict. When will these EZ politicians understand that transparency, credibility and honesty is a far, far better policy – the problem is that decades (centuries) of “alternative practices” takes quite some time to reverse !!!. However, continued austerity without growth is unsustainable – economically, financially and/or politically, irrespective of German views;

Mr Hollande, the French socialist candidate has repeated his promise to renegotiate the recent “fiscal compact”. Good luck Monsieur. With the 1st round of the Presidential elections less than 2 months ahead, domestic French politics is going to be an ever increasing market mover. At present, Sarkozy trails Hollande by a few % points, but the polls are all over the place, though my French friends tell me not to write off Sarkozy;

The Bundesbank are not happy bunnies, in particular, in respect of the most recent LTRO. The head of the Bundesbank (Mr Weidmann) has sent a terse letter to Mr Draghi. Yep, but at the end of the day, they will be outvoted, if a further LTRO is necessary. They are also deeply concerned as to the (approx E500bn) owing to them (mainly from the PIIGS), as a result of the Target 2 arrangements – essentially resulting from imbalances in the EZ central payments system. The Bundesbank are seeking collateral, as they are getting increasingly worried about counter party risk, if the Euro collapses – does that mean that the Bundesbank believe that there is a possibility that the Euro could collapse !!!!. In any event, some hope. Whist I do sympathise with the risk issue, this problem has been around for quite a few years (and ignored by even the Bundesbank). In addition, it is a monetary union after all, Mr Weidmann;


EM’s have benefited from a liquidity induced (ECB LTRO, for example) equity rally. Fund flows into EM equity funds tripled to US$1bn in the week to 29th February. However, local investors have not been as eager to buy as foreign investors. Do you really think that foreign investors know better !!!!! Morgan Stanley warns that the hike in oil prices is very bad news for Asian EM’s (Latam and Africa will perform better), resulting in reduced current account surpluses, increasing inflation and budget deficits for those countries (such as India) who subsidise oil products. The most affected will be South Korea, Thailand and India. Personally, I feel that the recent EM rally is way overdone and based on fund inflows, rather than a fundamental assessment of future prospects. I’m certainly looking to increase my shorts in due course (no hurry, given the capital inflows), especially if Oil remains at current levels. I can tell you that whilst recent inflation data in India indicates an improving picture, inflation is not under control – especially if subsidies are removed, which I accept is unlikely in the short term, but fiscally impossible to maintain for any length of time, I assure you.

Whilst I can see how Ireland and Portugal can (and will) be rescued (Greece remains a basket case – indeed, the German interior Minister suggested quite openly that its future would be better outside the EZ, last week) and, tough as it may be, even possibly Italy, I really cannot say the same for Spain. Watch out. By the way, my Italian friends (from the North of the country) are beginning to (semi jokingly) call for a split up (to get rid of the poorer South) of the country – far fetched, but……

Was Mr Bernanke’s omission to even obliquely mention the possibility of QE3, a sign that he/the FED are getting concerned about rising inflation – too early to tell but, I for one, think it may well be, though Mr Bernanke did say that inflation remains (allegedly) “subdued”. Hmmmmm. The head of the St Louis Fed, Mr Bullard, is critical/concerned that the ECB’s LTRO programme could increase global inflation. Was it not Mr Bullard (considered moderately hawkish), who advocated QE2 in the US in 2010? Hmmmm again. The reality is that (near 75%) of the ECB’s LTRO funds are effectively sterilised, as banks redeposit (I accept, voluntarily) the funds back with the ECB. If/when they start to do otherwise, what happens to inflation, though the additional liquidity (if withdrawn from the ECB) could well boost markets in the short term.

Watch this one carefully – I’m getting the awful feeling that inflation could well become a problem. If I’m right – OK the real value of accumulated debt declines (good news), but what about the current easy Global monetary policy?. Mervyn King recently (not really reported) raised the possibility of expanding the BoE’s mandate – to include employment, growth, credit conditions etc, rather than just an inflation target. Inflation in the UK has exceeded the BoE’s target for over 1 year, though the BoE continues with QE – recently implemented QE3. Interesting, me thinks. Personally (and please don’t send me the usual emails), I believe that Governments will have to accept elevated inflation levels – in my humble view, the current debt crisis cannot be resolved otherwise.

Finally, in spite of platitudes suggesting a meeting of minds, it is clear that the US is not at all keen on military intervention in Iran, whilst Israel is much more hawkish. Mr Netanyahu (no great fan of President Obama and vice versa) is in Washington today and meets with President Obama tomorrow. Very difficult to assess this, but Israel’s leverage is the greatest prior to the impending Presidential elections. Brent looks as if it has a US$15 – US$20 premium (at least), as a result of the Iranian situation, with the certainty of oil rising much, much further in the event of military action. All I do know is that the current oil price (if sustained at current, let alone higher levels) is a real and increasing problem for the global economy/inflation and generally, has made me bearish. Still prefer to focus on currencies – basically remain long the US$ and NOK, short the Euro, Yen and A$.

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