Chinese Defaulting on Commodity Contracts

The BoJ meets tomorrow (2 day meeting) to decide on monetary policy.
Speculation continues that they will add to their stimulus measures,
which has weakened the Yen. Trade data is out on the 23rd May, which
may reveal that the Japanese trade deficit widened in April –  once
again Yen negative;

The FT reports that Chinese buyers of thermal coal and iron ore are
asking traders to defer cargoes – some have gone as far as to default
on their contracts. This should not have come as a surprise, given the
slowdown in China, but………Remain bearish on the miners;

Premier Wen reports that China will focus more on stimulating growth.
He called for “putting stabilising growth in a more important
position” and put less focus on inflationary concerns. The China
Securities Journal carried a front page story that China would
announce plans to stimulate growth shortly. The Securities journal
suggested that China could accept a higher fiscal deficit, lower
RRR’s, greater export rebates and a “stabilisation” of the Yuan.
Sounds good, but I believe that talk of a major stimulus programme is
way premature – most Chinese politicians/officials believev that the
2009 fiscal stimulus was a mistake. However, an interest rate cut,
once inflation declines further (below 3.0%?) seems likely. Analysts
are cutting GDP forecasts for the current year, but they remain around
8.0% – in my humble view, it’s still far too optimistic;

Chinese authorities are working to speed up approvals of qualified
foreign institutional investors who wish to invest in the domestic
market, particularly for the long term. Always happens when markets
come under pressure. Will foreign investors play – I think they will
remain cautious;

The Indian Rupee continues to decline – it’s down some 3.6% so far
this month. The Finance Minister claims that he will cut subsidies –
something that has proved extremely difficult in the past and
personally I will not hold my breadth. With bond yields rising, the
Government will, at some stage, be forced to take action if it wants
to avoid a balance of payments crisis as budget and trade deficits
widen, as does the current account deficit – quite possibly to
unsustainable levels;

Latest polls suggest that the Greek New Democracy Party continues to
gain support. It’s polling around 26.1%, as compared with the anti
bail out, default on everything crazies, within the Syriza Party which
is in 2nd place with 23.7%. As you know, I believe that the gap should
widen further, in favour of New Democracy, but am always aware that
Greece (and Greeks) are certainly different !!!!!. Interventions by EZ
leaders may backfire. German newspapers suggest that Schaeuble (who,
by the way, wants to become head of the EuroGroup – the EZ finance
Ministers group), rather than Merkel, suggested that Greece should
have a referendum on whether they wanted to remain within the Euro.
Interestingly, Mr Tsipras (the head of the Syriza party) is to visit
Berlin and Paris!!!! – very interesting me thinks – the anti bail
out/default on everything/exit Euro rhetoric by him to ease
off/reverse do you think – this guy may finally be getting it. In
addition, how will Mr Tsipras supporters view his visits to
Berlin/Paris – not well, me thinks;

Huge number of comments on yesterday’s note and, in particular, on EZ
banks. Look there are initial signs of bank runs in a number of EZ
banks. The EZ has to address this matter swiftly or you are going to
have one hell of a problem. A number of countries, both peripheral and
core, do not have the finances available to recap their banks and the
private sector will not provide the financing necessary. The ESM
and/or another EZ institution has to do it, as I have banged on
endlessly for months. The rules need to be changed to enable the ESM
to recap banks directly, rather than to lend to EZ states who can then
recap their banks with the funds provided. At present, Germany is
resisting this change, but will have to agree – there is no
The question of who takes the hits arises – from overvalued assets,
which banks have not provided for. I would hope that existing
shareholders/bondholders do. Will banks be recapitalised – I certainly
believe they must and will – it’s only a matter of time. Another
alternative is a blanket deposit insurance scheme, as proposed by Mr
Mario Monti. However, at the end of the day, European banks are
(grossly) under capitalised, have not accounted for losses, will not
be able to access private capital, will continue to deleverage, when
they should be lending and many will (indeed are) facing deposit
withdrawals. As a result, a solution is needed urgently. This issue is
likely to be at the top of the agenda at this weeks EU Heads of State

It is clear that Germany is backing off its tough austerity measures –
my gosh, do they now get it that these maniac austerity measures cause
more problems and, indeed, worsen the fiscal positions of the relevant
countries. France is pressing Germany on the Euro bond issue yet again
– a step too far for the German’s at the moment, but inevitable, in my
humble view. The German’s seem to be willing to grant the peripherals
more time to resolve their fiscal positions. In due course, new fiscal
targets (one’s that are not just plucked out of the air) will be

Germany was isolated at the G8 meeting last weekend. However, no
meaningful initiatives were announced. The next talking shop will be
the 23rd May EU Heads of State meeting. Most EZ leaders will press
Germany to allow the ESM to be able to recap EZ banks directly (likely
and sensible, as there is no alternative), though there are
discussions on an EZ/EU  wide deposit insurance scheme, which the
Italian PM, Mr Mario Monti is pressing. Spanish banks, in particular,
need to be recapitalised as many are insolvent, though most EZ banks
are materially under capitalised;

Interestingly Mr Asmussen, the German representative on the ECB board
suggests EIB project bonds ie Euro Bonds to finance pan European
infrastructure projects. The problem, as the US discovered a few years
ago, is that these projects take too long to implement – even worse if
the EU is involved. However, it is one further step towards Euro

Just one more piece of anecdotal info on the apparent “willingness” of
Germany to “accept” higher inflation. IG Metall workers (the most
powerful/ vociferous union in Germany) obtained a pay rise of +4.3%
over 13 months, the largest rise since 1992, though lower than the
6.5% initially demanded. Unions have won wage increases of around 6.0%
in the Telecommunications and public sectors recently. Mr Schaeuble
stated that pay rises could be higher than in the past. Inflation is
coming in the core EZ countries, boys and girls and, in particular, in
Germany and certainly more than the “corridor of between 2.0% to 3.0%”
suggested as “acceptable” by Schaeuble. OK, oil prices have declined,
which will reduce inflation in coming months, but do you really want
to buy German 10 year bunds yielding 1.41%, way below current
inflation in any event – certainly not mein herr – a bit too early to
short in my humble view though, but……;

It is interesting to note that the US and the UK are working on plans
to protect the general financial system in the event of a failure of a
systemically important bank. The  “resolution plan” would involve
existing shareholders and bondholders taking the first hits, by the
way. The EZ should learn – Sacre Bleu following the Anglo Saxons !!!;

The Brazilian Real has fallen some 20% since the end of February and
is trading at a 3 year low. The sharp decline is making the Central
Bank rethink. The bank issued appox US$650mn through a  currency swap,
leading to the Real gaining some +1.0%, though it still closed some
-0.7% lower given earlier losses. Whether the Central bank is now
satisfied with the lower Real and will continue to support it’s
currrency or that the action was to reduce volatility is unclear, but
the decline of the Real should lessen in coming months. (Source Brown
Brothers Harriman).
The Brazilian finance Minister states that the weaker Real has helped
competitiveness and that GDP will be higher than the +2.7% in 2011.
Indeed, he suggests that GDP growth will rise by +4.5% in the 2nd half
of the year. Hmmmmm, optimistic me thinks;

COT reports reveal that the number of Euro shorts (against the US$) is
at record highs last week, normally a bullish sign for the Euro.
However, I really cannot see the Euro strengthen in the medium term. I
remain short;


Asian markets closed mainly higher, with European markets up as well.
The Euro is flat at US$1.2768. US futures suggest that markets will
open some +0.4% higher. No material US economic news today, but
housing news tomorrow and Wednesday could be interessing.

Spot Brent is up at around US$108.60.

Barclay’s is to sell it’s near 20% stake in Blacrock, worth about
US$6.1bn. Need for more capital do you think? Expect other European
banks to continue to dump assets for quite some time.

Was at a pretty sophisticated dinner party on Saturday – an English
football team beat their German rivals – interestingly most,(who were
from EZ countries) cheered vociferously – in the past they would have
been solidly anti British – seems that Germany is more unpopular these
days. Having said that Mr Cameron, Osborne and King need to back off
their continued public criticism of the EZ etc – it’s getting way over
the top.

Kiron Sarkar

21st May 2012

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