Another difficult week for markets

Indian consumer prices rose by +10.36% in April YoY, as food prices increased, and higher than the +9.38% in March. Headline WPI rose to 7.2% in April, up from 6.9% in March. However, lower oil prices (particularly if sustained) will help materially in coming months;

The Bank of Spain reported that bad loans increased by 1/3rd over the last year to E148bn (over 3 months late). In March, bad loans rose to 8.37% of banks portfolio, the highest level since the property market collapsed and the highest since August 1994, up from a restated 8.30% in February. Some analysts suggest that bad loans may increase to 15% of the banks portfolio. Bank deposits rose slightly in March from February, but fell to E1.16tr or down -4.0% in the year to March 2012;

Spanish newspapers (El Mundo) report that Spain’s 2011 budget deficit will be even higher than previously reported (increased to 8.91% of GDP), from the previous 8.5% (which itself was far in excess of the 6.0% target), as several regions, including Madrid (though also Valencia, Andalusia and Castille-Leon), reported higher deficits – according to information from the Spanish Ministry of Finance. Here we go again. Spain claims that they will meet the target of 5.3% of GDP this year and 3.0% next. However, the EU forecast that Spain’s budget deficit will amount to 6.4% this year and 6.3% in 2013;

April’s ECB data reveals that lending to Spanish banks rose by 16% or E36bn to a record E264bn, accounting for 69% of total ECB lending to EZ banks. In contrast Spanish banks deposits at the ECB declined by 40% or approximately E35bn to approximately E53bn, well lower than the record of near E89bn, following the 2nd LTRO;

LCH Clearnet has raised the margin requirements on trading Spanish bonds. The news from Spain just gets worse and worse;

Just 1 more on Spain. Mr Hollande, the recently elected French President states that Spain will be able to use the EFSF/ESM to recap its banks. The rules need to be changed to allow this. However earlier in the day, Mr Ollie Rehn denied that Spain would require financial assistance from the EFSF/ESM in respect of it’s banks. Same old confusion. However, at the end of the day, Spain will require funding from the EFSF/ESM for it’s banks and itself;

Deutsche bank state that Irish banks may need more capital to cover as much as E4bn of additional bad loans than that assumed in last years stress tests. This will involve the Irish government requiring a further bail out. The Irish government has injected some E63bbn into it’s banking sector to date. The 10 largest Irish financial institutions have lost some E118bn in bad loans in the 4 years to last December. The Irish government claims that it’s banks have adequate capital, including appropriate buffers and will not need another bail out.
Most recent polls suggest that over 60% of the Irish population will vote in favour of the fiscal compact – I agree they will vote in favour. To do otherwise would mean that the Irish get no further access to funding;

The EU trade Commissioner stated that the EU is working on contingency plans in case of an exit by Greece from the Euro. Well great, but it would be better if Mr Karel De Gaucht just shut up. One of the big problems with the EU/EZ is too many people unnecessarily opening their mouths and just making the situation worse. Other EU sources denied the comments;

The BoE’s Adam Posen has become more dovish, stating that he was premature in stating that further stimulus was unnecessary. More QE is likely in the UK, but buying more gilts is futile, as the BoE already owns over 30% of the gilt market. Targeted purchases of mortgages would be far more useful, though the governor of the BoE, Mr Mervyn King, has expressed concern that such a course of action could involve the BoE taking unacceptable credit risks. I hope he changes his mind. Having said all that Paul Fisher, the BoE’s exec director for markets and on the Monetary Policy Committee stated that the BoE had concluded that the existing £325bn programme was sufficient, unless there were any “economic storms”;

Bloomberg and the WSJ reports that JPM’s losses on its huge derivatives and other instruments may rise to US$5bn. A definite whoops. The problem however is that these positions remain open (some say it will take till the end of the year to close) given their size and, as a result, the final bill will remain unknown for quite some time. In addition, hedge funds are likely to trade against these positions as they smell “blood in the water”. Regulators are scrutinising these trades far more carefully and I fear that more bad news is likely;

Employment rose in 32 US states in April lead by Indiana and Texas, whilst unemployment declined in 37 states, suggesting that the US labour market continues to improve. In addition, housing starts increased, with mortgage delinquencies lower, retail sales data was roughly as expected, industrial production and capacity utilisation higher, jobless claims slightly weaker and divergent (though suggests a slowing) Philly and Empire State data, though generally indicating some weakness. Overall, the data suggests continuing modest growth in the US;

In spite of stimulus measures, Brazil’s economic output declined by -0.35% in March MoM as opposed to a forecast of growth of +0.4% to +0.5%, making Brazil’s growth the 2nd slowest (after Argentina) in South America. Real GDP rose by just +1.1% in the 1st Q on an YoY basis, though slightly higher than the +1.0% in the 4th Q of 2011. Remember talk of the BRIC’s growth  “decoupling” from developed markets – just wonder where that’s gone !!!. It was and remains total rubbish;

Copper prices have turned negative for the year – not a good sign, as copper is a leading global economic indicator. In addition, various bullish trades by the Chinese may reverse – the Chinese have been using copper inventories as a source of financing given difficulties in accessing financing elsewhere, whilst ignoring the impact of a potential decline in prices. This could well be a definite whoops, as prices decline further;

Facebook’s IPO seems to have been a bit of a damp squib. The shares, priced at US$38 had to be supported by underwriters and closed at US$38.23, just +0.6% above the IPO price. Sure to attract the shorts. The weak performance adversely impacted markets/sentiment on Friday;

The CFTC reported last Friday that Hedge Funds and other money managers had reduced their long positions significantly in oil – to just 3.2 to 1 from 6.2 to 1 the previous week, the lowest since October 2011 and the equivalent of 54mn barrels – the largest decline since June 2006. However, the COT also reports that a category of investor defined as “other reportables” had increased their long positions and now have larger gross long and short positions and a larger net position in the market than hedge funds, CTA’s and other money managers. Who are the mysterious “other reportables”. I have my suspicions, but need to check out first. This issue could well prove to be important – watch it carefully (Source FT);

Outlook

Declines in energy, food and commodity prices will materially lower inflation in coming months – good news. A decline in inflation will provide Central Banks (FED, BOE, BoJ, ECB) the opportunity to consider further monetary easing measures, including addition QE by the FED and the BoE – the BoJ may also step up easing. The ECB is very likely to cut interest rates in the near future, though may wait until the outcome of the Greek elections is known ie a cut (25bps minimum, though possibly 50 bps) in July?, though it may be brought forward to June, if there is more bad news from Greece, later in the event of good news from Greece. However, I for one don’t believe that that will be sufficient and a resumption of bond purchases of, inter alia, Spanish and Italian debt by the ECB is very likely, particularly if Spanish yields rise to closer to 7.0%.

Portugal will need and will get another bailout – to be announced ahead of September (being 1 year ahead of the redemption of a large sovereign bond in September 2013) ie August at the latest, but most likely in June/July, to fulfill IMF requirements that a country must be able to finance itself 1 year hence – clearly impossible for Portugal. It would be great if at that time the EZ restructures Portuguese debt to sustainable levels. There is also a growing possibility of Ireland requiring a further bail out, even though the data (ex the banks) is improving.

All of the above, together with the total mess in the EZ, should weaken the Euro further in my humble view, in spite of my expectation that the FED will introduce another (version of a) QE programme.

Markets were weaker, yet again, last week. Whilst  I expect markets to open lower on Monday, I expect some stabilisation in the early part of the coming week. However, amongst other things, HSBC flash May Chinese PMI is due on Thursday – the odds are that it will disappoint (weaker A$ likely?), which may well put pressure on markets later in the week. Then you have the EZ……

Initial comments coming out of the G8 meeting are the same old hot air wishy washy claptrap that these meetings normally generate.

ECB policy will focus more on EZ countries ex Germany and, in particular, the peripherals, especially given Schaeuble’s comments that Germany would “accept” inflation within a “corridor” of 2.0% to 3.0%, something which I believe remains hugely significant, but (amazingly) seems to have been ignored by the markets to date.

Have a great weekend.

Kiron Sarkar

19th May 2012

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