Weaker US 1st Q GDP

To avoid social discontent and, in addition to stimulate the economy, China has embarked on a (serious?) policy of building cheap housing for the urban poor. A total of 5mn homes are expected to be built this year, with goal of reaching 36mn by 2015. However, the financing for this proposed rapid build out is questionable. The Government has increased central funding for low income housing by +23% to 212 Yuan this year, though the expected bill for the 36mn homes comes in at Yuan 5tr !!!. Local Governments, however, are not keen on spending on social housing. In addition, corruption has, in the past, meant that affordable homes have been sold to relatives/friends etc, etc – estimated at near 80% !!!! (Source GK Dragonomics) and authorities classify certain building programmes as social housing, when they are clearly not. As a result, I remain totally sceptical of this programme;

Indian authorities are to extend the time that major shareholders have to reduce their shareholdings in listed companies. The edict was due to come into effect by June 2013 this year for private companies and by August 2014 for State owned companies and will result in some US$7.6bn of postponed share sales.

Another government falls in Europe, as anti austerity takes hold. Romania’s right wing government lost a vote of no confidence on Friday. The leader of the opposition Social-Liberal Union, Mr Ponta, was nominated as the next PM. The Czech Centre right Government was nearly toppled on Friday. Holland is likely to turn more leftist. However, the crucial election is France next Sunday – Hollande, the Socialist candidate is expected to win;

The Irish Government has revised its economic forecasts. It now expects 2012 GDP to come in at +0.7%, from +1.3% previously. The 2013 forecast has been cut to +2.2%, from +2.4% previously, with debt to GDP peaking at 120.3% in 2013, from 119% previously. The current years budget deficit target has been lowered to -8.3%, from -8.6% previously. Ireland is critically dependent on the EZ and news from that front remains bleak;

The Spanish Government does not see job growth returning until 2014. Unemployment in the 1st Q of 2012 was 24.4% (non seasonally adjusted) and, according to the Government (22.9% in the 4th Q 2011), expected to peak at 25%. More than 50% of under 25’s are out of work. The EZ average unemployment is 10.7% by comparison. Clearly unemployment peaking at 25% does not look realistic, with some estimates suggesting that the rate could hit 28%+. Neither does this years budget deficit target of -5.3% look achievable – the budget deficit this year is likely to exceed 6.0%. Spain has forecast that the economy will grow slightly in 2013 (+0.2%) and by +1.4% in 2014 – both unlikely – after contracting -1.7% this year. Debt to GDP (according to the Government) will peak at 82.3% this year, falling to 81.5% next. As debt to GDP is well over 85% at present, if you take into account just unpaid bills, this forecast is delusional. The Government expects to raise a further E8bn next year in indirect taxes.

Many Spanish banks are insolvent – the Government is wary of recapitalising them for fear of getting into the same problems that Ireland did. A bad bank, which would take over non performing assets, is proposed, though the Government states that the finances will have to come from the banks – who simply don’t have the resources. A bail out of Spain, a la Ireland, Portugal and Greece is impossible given the lack of funding available to the EFSF/ESM, even with IMF support. However, the EFSF/ESM could be used to recapitalise the Spanish banks, though such a move is being opposed by the Germans. However, is there any alternative – I think not. However, the EZ will bumble along until the next crisis and, reluctantly be forced to act. However, as usual, it will be too little too late and this crisis is set to go on and on and…;

Yields on the Italian debt rose on Friday – the May 2017 bond was auctioned at a yield of 4.86%, up from 4.18% at the end of March this year, whilst the yield on the 10 year bond rose to 5.84%, from 5.24% previously. YTD, Italy has raise just 35% of it’s current year’s needs;

The Dutch finance minister expects Parliament to approve measures to cut their budget deficit to -3.0% in 2013, though has not set out a timeline. Holland has to submit a report to the EU by 30th April as to how it intends to cut it’s 2013 budget deficit to 3.0% – they are proposing to increase VAT (to 21% from 19%), introduce a bank tax and freeze civil servants salaries. Without additional measures (which add up to E12bn), the 2013 budget deficit was expected to rise to -4.6%. The deal has been supported by the Green left party, Christian Union and D66 democrats, which hold 77 out of the 150 seats in the lower house. The Labour party, together with the Socialist Party and the Freedom party are opposed. This deal is very important to the EZ as Holland has been vociferous in demanding that EZ countries stick to their budget deficit commitments. Elections have been called for 12th September this year, following the collapse of the coalition when the ultra right wing Freedom party exited over the proposed budget cuts. As far as I’m aware, the only bit of good news yesterday in respect of the EZ;

The most recent polls suggest that Hollande leads Sarkozy by 55% to 45%, a modest improvement for Mr Sarkozy, but unlikely to be enough;

Comments by the Swiss Central Bank Governor yesterday could be interpreted as the Swiss wanting to devalue the Franc further – it is currently pegged to the Euro at Franc 1.20 to the Euro. Mr Jordan stated that the Franc the peg helped to reduce the “very substantial overvaluation”, though “the currency remains overvalued”. However, I believe that the Swiss authorities will be on hold for a while;

The BoE has not been opposed to Sterling weakening. However, Sterling has strengthened, in spite of the technical (and questionable) double dip recession announced last week. In particular, Sterling continues to strengthen against the Euro – currently at a 22 month high and the US$ – indeed, it is up approx +1.6% over the last month against the 10 leading developed nations currencies – only the Yen has performed better. The strength of Sterling is really a story of weakness of other currencies and a desire by a number of countries to weaken their currencies. However, with yet more uncertainty in the EZ, currency flows into the UK should continue, suggesting further Sterling strength (US$1.6260 and E0.8149). A stronger Sterling will help ease persistently stubborn inflation;

US 1st Q GDP came in at +2.2% on an annualised basis, weaker than the +2.5% to +2.7% expected and lower than the +3.0% in the 4th Q of 2011. Consumption was strong, growing by +2.9% on an annualised basis (the strongest rate in 5 Q’s) and added 2.0% to growth – auto sales were strong. Services spending continued to be weak, rising by just +1.2%. Final sales, rose by +1.6%, up from the +21.1% in the 4th Q 2011. However, real disposable income rose by just +0.4% and savings rates declined to 3.9%, from 4.5% questioning whether this level of consumption is sustainable. Government spending (particularly defence) declined, resulting in a reduction of -0.6% to growth. Business fixed investment declined for the 1st time since the beginning of the recession (probably reflecting the ending of tax breaks at the end of last year), though inventory build up added +0.6%, which could suggest that production will slow in the 2nd Q. Residential investment however rose by approximately 19%, the most since 2nd Q 2010 and probably reflecting the better weather conditions, though was offset by a 12.0% decline in non residential construction. Basically weaker than expected data, though it is the 1st estimate with revisions in coming weeks possibly making a material impact. It looks as if the current Q’s GDP estimates will be around 2.0% to 2.25%;

The University of Michigan consumer confidence index for April increased to 76.4 (75.7 forecast), from a preliminary 75.7 and 76.2 in March. Current conditions increased to 82.9, from 80.6 in March, though expectations dipped slightly to 72.3, from 72.5. However, the index is the highest since February 2011.One year inflation expectations have declined marginally, to +3.2%, from +3.4%;

Outlook

Crazy markets in Europe on Friday. Having opened significantly weaker, European markets rallied sharply and closed near their highs, in spite of the 2 notch Spanish downgrade by S&P (OK expected) with a negative outlook (not totally expected, I would have thought), weaker retail sales, higher unemployment, higher Government borrowing costs etc, etc in the EZ. Go figure – certainly surprised me. Spanish 10 year bond yields having touched 6.0%, declined to around 5.88% around the close of play !!!!, though 5 year CDS’s were some 5 points higher. I have to say, I just don’t get it.

Energy prices (spot Brent) having declined to near US$117, is back above US$120 – not good news.

The Euro, having initially declined on the Spanish and other EZ bad economic data, reversed and closed much higher at US$1.3255. Madness, but there you have it. The Euro seems to be in a trading range of between US$1.30 to US$1.33.

The BoJ did as little as it could last Friday and it’s subsequent comments suggest that it is on hold for quite a while.

The weaker US 1st Q GDP has raised the question of QE, yet again. Personally, I believe that the US will be negatively impacted by the nonsense in the EZ and that growth will turn out weaker, resulting in further QE by the FED. However, if US housing continues to rebound (which certainly has been picking up recently – I play it through the building materials sector), I will become a believer in the sustainability of the US recovery without the need for further QE. Next Friday’s US NFP data should be interesting – recently, weekly unemployment claims have been rising.

The key will be the French Presidential elections next weekend and if Hollande is elected, as expected, the situation in the EZ is going to get much more fraught. Mr Hollande’s proposals are unaffordable (and potentially ruinous) for France and impossible for the EZ, given German opposition. However, it will bring matters to a head, rather than left to drift as at present. Exciting times.

I remain bearish and, in addition, we are heading into May.

Have a great weekend.

Kiron Sarkar

28th April 2012