Chinese Central Bank Governor concerned about impact of easy US monetary policy

The RBA left interest rates at 4.25% today, as expected. However, they did signal that rates would be cut, starting next month. The RBA stated that “The board judged that the pace of output growth to be somewhat lower than estimated, but also thought that it was prudent to see forthcoming key data on prices to reassess its outlook for inflation before considering a further step to ease monetary policy”. The next inflation report is due on the 24th April;

Australia’s retail sales rose by +0.2% in February (+0.3% in January) and in line with forecasts.

Mr Zhou, the Chinese Central Bank Governor warns that the financial crisis is still around and, in addition, that the US should take “more responsibility” for its monetary easing programme. Mr Zhou adds that “there are new elements that could bring the global economy back into recession”. Mr Zhou is right to be worried about easy US monetary policy as it raises inflation in China. However, the reason this happens is because the Chinese have, in effect, tied themselves to US monetary policy, by essentially pegging the Yuan to the US$ – yes the Chinese do change the peg, but YTD the Yuan has been flat against the US$. The Chinese cant have it both ways – if they want to be masters of their own destiny, they should internationalise the Yuan and remove capital controls. The problem is that they fear rapid movements in their currency, which could hurt their economy. Personally, I believe any rise in the Yuan will prove to be temporary and that capital will exit the country rapidly if capital controls are withdrawn;

Morgan Stanley are recommending that investors buy China. They state that fears of a hard landing are overdone and that stocks are cheap. The Chinese markets are up a modest 4.0% YTD, as compared with the S&P up 12%, the Nikkei and DAX up nearly 20% and 19% respectively and India and Brazil up around 13%. On a p/e basis, China is trading at a 20% discount to Asia (ex Japan) and a 12% discount to EM’s. I have been bearish on China for over 3 years and it has certainly paid off. However, I have to say that shorting China outright at these levels is now getting overly risky, though I still believe the mining sector will not bounce as much as analysts forecast. With a major change in leadership later this year, the Chinese are likely to take measures to stabilise their economy/markets. The Chinese services sector may well be the place to be, as China moves away from fixed asset/export model towards domestic consumption – will take years though. However, I will not be a buyer – don’t see any momentum (Source FT);

The EU/ECB/IMF (the “Troika”) have had to admit that Portuguese GDP will decline by more than expected this year, down by -3.25% is their most recent forecast. However, they add that “overall” the Portuguese programme is on track and that there has been noticeable progress in implementing structural reforms, though believe more needs to be done in respect of labour reforms. The Troika state that the current years budget deficit target of 4.5%, “remains valid”. Hmmmmm. The report acknowledged that rising unemployment poses a risk to the Portuguese austerity programme. In particular, the report urges reform of the Portuguese State owned enterprises;

Unemployment in Spain rose by 38.8k, lower than the 54k expected. Total unemployed is now 4.75mn. Whilst the number of unemployed in March was lower than expected, unemployment is around 23.6% in February (and will be raised higher following today’s announcement), suggesting to little old me that the current situation is unsustainable. More and more analysts question the budget deficit forecast of 5.3% this year. The forecast budget deficit is to be achieved through spending cuts and tax hikes amounting to E27bn, or roughly 2.5% of GDP. The official GDP forecast of a decline of -1.7% this year is ludicrously optimistic – personally, I believe that GDP will decline by at least -2.5% (most likely nearer -3.0%). In addition, the revenues estimates are also highly optimistic. Analysts expect that the likely budget deficit for this year will come in at around 6.0% – 6.5%. It has proved difficult to curb the spending of the autonomous regions in the past – yet another headache. In addition, estimates of no rise in social spending (unemployment) is a nonsense.

The Government has forecast that debt to GDP will rise to just under 80% this year. There are numerous reports circulating which suggest debt to GDP is already around 85% – some suggest that the actual number is much, much higher. Whatever, the Governments forecasts, once again, seem highly optimistic. Residential home prices have at least 20% further to decline (most likely 30%+) and a number of banks are insolvent – they are relying on the ECB’s LTRO’s. How will Spanish banks raise the E50bn they are required to by the Bank of Spain?. Frankly, the amount of equity needed by Spanish banks is way way higher than E50bn. The Spanish authorities have rejected an offer from the EU to accept bail out funds to recap their financials – personally, I am near certain that they will have to – their banks cant raise the funds necessary and Spain cant either. Spain is a major (4th largest, I believe) contributor to the EZ bail out funds. How long is that going to last. Not long as they will have to be bailed out, which means that the other EZ countries will have to increase their contributions. Whoops. Basically, its the same old nonsense from the EU/EZ;

Italian unemployment rose to the highest in more than a decade. Unemployment rose to 9.3% in February, from 9.1% in January and in line with forecasts. The Italian economy is expected to contract by -1.3% this year and the E20bn package of spending cuts and tax increases is forecast to reduce Italy’s budget deficit to zero next year. Italy’s total debt amounts to E1.9tr. Labour reforms, proposed by Mr Monti are facing stiff union opposition and indeed push back by some law makers. However, the Italian authorities believe that they can pass the proposed reforms through Parliament. May be tougher than they think;

The most recent poll shows that Hollande is some 12 points ahead of Sarkozy in the forthcoming French Presidential elections – in the 2nd round – more than the 8 points last week. Not good news;

EZ February PPI came in at +0.6% MoM, down from an upwardly (modestly) revised +0.8% in January. The annual rise in February was +3.6%, somewhat higher than forecasts;

UK March construction PMI rose to a 21 month high of 56.7, from 54.3 in Feb and much higher than forecasts of 53.4. Good news, though milder weather has flattered the numbers;

The UK’s British Chamber of Commerce (“BCC”) reports that GDP in the 1st Q 2012 should rise by +0.3% and has forecast a rise of +0.6% for the full year. Their Q’rly review states that domestic orders for manufacturers rose to 6 in the 3 months to 31st March, from -13 in the previous Q. Services domestic orders index rose to 7 from -9. Exports (both services and manufacturing) rose to the highest levels in a year. However, they warned that inflation would decline less quickly than expected;

US factory orders rose +1.3% in February, as opposed to the decline in January of -1.1%, though less than the rise of +1.5% expected. Orders, ex aircraft and defence, a measure of future business investment, rose by +1.7%, much better than the -3.4% decline in January. Unfilled orders rose by +1.3% in February, almost double the gain the January, suggesting a further pick up in production.

Outlook

Numerous comments on my reports re India. Essentially, I believe that India has the capacity to become a serious global economy, but current Government policy is total and utter madness. Just 1 issue. India relies on foreign capital. If that slows down and/or reverses – which looks as if its the case at present – watch out.

Asian markets closed higher, ex Japan. Oil is off a bit today – currently spot Brent is trading at US$125.07. The A$ continues to decline (US$1.0364) – anticipation of lower interest rates next month. The Euro, well its around US$1.3335. Gold is trading at US$1678.

European markets opened higher, but are backing off. Financials remain weak. Spain and Italy remain the laggards, especially Spain.

Really could not understand yesterdays sharp rise in European markets – what was all that about – however they are lower today.

FED minutes later today may contain some interesting prospectives.

Personally, I don’t really see markets taking off (ex some really positive news from the FED minutes, which is unlikely), especially as we head towards the Easter holidays. Overall, I remain bearish and expect a correction. Markets have rallied too far too fast, in my humble view. In addition, problems in Europe are likely to resurface.

Finally, Sino Forest went bust and just read about the accounting issues re Groupon. Prior to the IPO, there were huge question marks over Groupon’s accounting – why did people subscribe !!!!

Best

Kiron

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