Draghi urges EZ politicians to act


Japanese industrial output rose by +0.2% in April MoM, much lower than the +1.3% in March and below the forecast for an increase of +0.5%. Following the winding down of post tsunami spending, the Japanese economy is going to face a tough time later this year, (unless the Chinese stimulate their economy), especially given the strength of the Yen;


HSBC reports that the Yuan has declined by about 1.0% against the US$, in May, the largest drop since June 2010, when the US$/Yuan rate was “liberalised”. China is facing the strongest capital outflows since late 2011 – what a surprise – I think not. The report adds that the rise in reserves in the 1st Q was largely due to accounting. The fabled Chinese forex reserves look to have peaked – personally, I believe they will decline, putting yet more pressure on the Yuan (Source FT);


GDP in India rose by +5.3% in the 3 months to March this year YoY, much lower than the ludicrous forecast of +6.1% and the lowest rate of growth in 9 years. GDP rose by +6.5% (+6.7% expected) in the fiscal year to March 2012. Manufacturing declined and agriculture slowed materially. Forecasts for the current year (over 6.0%) remain optimistic and will have to be lowered. The Rupee continues to decline to record lows and I cant see how the decline will be stemmed. With political leaders effectively paralysed, I really cannot see where any improvement will come from;


Greek March retail sales slumped by -16.2% YoY, lower than the -12.9% reported in February;


The ECB reported that the 4 Greek banks had regained access to ECB liquidity, following their recapitalisation;


German unemployment was unchanged in May, due to stronger domestic consumption. The adjusted unemployment rate declined to 6.7%, the lowest in two decades. Analysts suggest that Germany needs a further 1mn workers. The strength of Germany (particularly the domestic economy) enables Merkel to remain tough re the crisis in the EZ. However, whilst the domestic economy remains robust, the German export machine is likely to come under some pressure with the slowing EZ and, indeed, global growth. A weaker Germany may well be more receptive to movement on the EZ crisis, especially as elections are due in late 2013;


Preliminary German April consumer spending rose by +0.6% MoM, higher than the forecast for a gain of +0.3%;


French April consumer spending rose by +0.6% MoM, higher than the +0.3% forecast;


Swiss economic growth rose by +0.7% in the first Q (+2.0% YoY), much better than the unchanged expected. The better than expected performance is the highest rate of growth in 1 1/2 years. The decision to peg the Swiss Franc to the Euro “for the foreseeable future” has helped. The Swiss economy is expected to grow by +0.9% this year and by +1.9% next, according to the OECD;


The Irish are expected to vote in favour of the fiscal compact in the referendum being held today. In reality they have no choice as to vote no will exclude them from financing, which they will (most likely) need;


Mario Draghi repeated that the ECB cannot be the sole organisation responsible for staunching the crisis in the EZ. Clearly right, but politicians (particularly Germany) are comfortable that the ECB be left to deal with the crisis. Can this last, clearly not. In addition, Draghi criticised the Spanish government for understating the problems at Bankia – he has called for an EZ banking regulator and for regulation to be taken away from national regulators. He added that the ESM should be used to recap EZ banks directly and for an EZ wide deposit insurance scheme. All sensible stuff and inevitable, in my humble view. Interestingly, Mrs Merkel stated that there should be “no taboos” in relation to the EZ bank recapitalisation – sure sounds to me that she is backing off her opposition to using the ESM to recapitalise the banks directly;


Mr Barosso calls for EU wide banking supervision, together with a deposit insurance scheme in the EZ. He has also proposed “stability bonds”, code name for Euro Bonds, to be introduced in stages, subject to EZ countries handing over budget responsibilities to a central organisation, to enforce discipline – a key German demand. The current situation is untenable and some movement from Germany is necessary, which I believe will come. Will it be enough, who knows, but Germany will have to move. The current situation is unsustainable;

Whilst a number of European banks are insolvent, the financial sector has been hammered to a level which has resulted in some very interesting opportunities;


EZ flash HICP fell to 2.4% YoY in May, from 2.6% in April and lower than the 2.5% forecast – I must admit I had expected an even lower number. Core inflation remained unchanged at 1.6% in April. However, the lower (and likely even lower in coming months) inflation will allow the ECB to ease monetary policy (interest rate cuts?), in the next few months or sometime this year at the latest;


133k jobs were created in May, according to the ADP employment report, lower than the 150k expected, though higher than the downwardly revised 113k (+119k previously) in April. Tomorrow’s NFP numbers are far more important;


US 1st Q GDP was revised lower to +1.9%, from +2.2% previously, though in line with expectations. The GDP deflator came in at +1.7%, higher than the +1.5% expected. Final sales were better at +1.7%, as opposed to +1.5% previously. Corporate profits grew at the slowest pace in 3 years, increasing by just +0.6%, Q/Q, the lowest rise since the decline in the 4th Q of 2008 and well below the +6.5% reported in the same period in 2011. Business investment was lower, at +1.9%, from +2.1% previously. State and local government spending declined by -2.5% on an annual basis, more than double the -1.2% previously reported. Inventory build was lower (just +0.2%, from +0.6% previously) suggesting a pick up (positive) in the 2nd Q. Wages and salaries rose by US$28.9bn in the 4th Q 2011, less than the US$89.1bn previously reported, which resulted in the savings rate declining to 4.2% – worrying. Overall, the view that the US is immune to the problems in the EZ is ludicrous;


US weekly jobless claims rose by 10k to 383k, higher than the forecast of 370k;


The Brazilian Central Bank cut its benchmark lending rate by 50bps to 8.5%, a historic low and well below the high of 12.5% last August. The Central Bank claimed that inflation threats were receding and that a global slowdown was posing risks to the country. It is clear that the authorities are far more concerned about growth, rather than inflation and, as a result, suggests that interest rates will be cut again in coming months. The Real should weaken even more. However, is inflation really contained?;




Asian markets closed lower, though European markets are modestly higher, even Spain !!! US futures suggest a flat to lower opening.


The Euro is hovering around US$1.24, with Brent around US$103.45.


The crisis in the EZ continues though, whilst I cant put my finger on it, I sense some movement. Will it be enough – history suggests that it will not be. However, with expectations at rock bottom, any positive news is likely to result in a sharp rally. Personally, I believe that it is now dangerous (on a risk/reward basis) to be short. A number of EZ financials are certainly insolvent, but there are (at least) some which are not. The number of bearish (verging on the hysterical)  views out there suggests we may well be close to a bottom.


German 10 year bunds at around 1.30% (and for that matter US and UK bonds) are really at ludicrous levels and certainly unsupportable in the medium term in my humble view. Looks like a sector to watch (with a view to short) very carefully indeed.


US data suggests a slowing economy, but the NFP data, to be released tomorrow, is far more important – suggests downside risk to the 160k forecast. US businesses are clearly being very cautious in respect of hiring.


Kiron Sarkar


31st May 2012



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