Euro-Zone continues down the plug hole

Australian retail sales declined unexpectedly by -0.2% in April MoM, the 1st fall in 10 months. The weaker data suggests further cuts of interest rates by the RBA. The A$ declined on the news and, in addition, reports that China would not introduce a major stimulus programme;

The BoJ suggests that it has done enough (in terms of monetary stimulus) and it was now over to the government to act – clearly Yen positive;

The Chinese state-run news agency Xinhua reports that the country will not intervene (with a stimulus programme) on the same scale as they did in 2008 – as I read it, they did not totally reject a smaller stimulus programme. Without some kind of stimulus, the Chinese economy will deteriorate rapidly, with growth rates below levels deemed safe by the authorities, especially in a year where there are major changes in personnel at the State Council. As a result, I expect the authorities will have to introduce a mini stimulus programme (Yuan 1tr to Yuan 2tr) as proposed by Credit Suisse, together with further easier monetary policies, including cuts in interest rates and RRR’s – indeed, Xinhua quoted an NDRC official citing an RRR cut in June;

80% of Greeks want the current austerity measures watered down. However, far more interestingly, 52.4% of Greeks say that Greece should remain in the Euro, even if the austerity measures are not watered down. 81% of Greeks want to remain in the Euro. New Democracy (23.4%) continues to gain strength, with the anti bail out party Syriza (22.1%) losing support. It looks as if we will have to suffer Greece for a while longer, unfortunately;

The Spanish budget deficit increased to E25.5bn in the period January to April, much higher than the E19.7bn in the previous year. Spain has reiterated that it’s budget deficit would meet the 5.3% target this year – total cloud cuckoo land stuff. Based on the deficit for the 1st 4 months, it looks as if the deficit will come in around nearer 7.0%, particularly as the provincial finances look to be a real mess and their banks are insolvent. I just cannot understand why the Spanish PM does not seek a bail out from the EZ – it’s going to have to happen shortly in any event. Spanish 10 year yields have risen above 6.60% this morning and rising. A yield of 7.0% (for no particular reason) is considered to be the threshold where countries have to seek a bail out. Spanish newspapers suggest that the EU will extend (till 2014) the time for Spain to meet it’s budget deficit targets ie getting back down to 3.0% – finally accepting the inevitable;

The ECB did indeed block the Spanish plan to exchange sovereign debt for equity in the parent company of Bankia, which would then be used to obtain funds from the ECB. The ECB stated that the Spanish proposals for Bankia would breach the EU ban on monetary “financing” and, in any event, was not discussed with them. So no cunning plan possible – Spain now faces a serious dilemma. It will have to seek EZ bail out funds, sooner rather than later;

An EU report states that Spain has not done enough to meet it’s deficit targets and will need to implement further tax increases and spending cuts until the end of the decade. Furthermore, the report goes on to suggest that France has not done enough either, particularly to bring down it’s budget deficit to 3.0% next year – this year is apparently OK. “Budgetary consolidation remains one of the main policy challenges in France”, the report states. This is going to go down well with the newly elected President Hollande, who has promised to water down austerity measures – which was, off course, complete nonsense;

Italian debt sales missed their targets today. They raised just E5.732bn of 5/10 year BTP’s, as opposed to the target of between E4.5bn to E6.25bn. The 5 year was auctioned at 5.66% (up from 4.86%) with a bid to cover ratio of 1.35, as opposed to 1.34 previously. The 10 year yield was 6.03% (up from 5.84%) with a bid to cover ratio of 1.4 as opposed 1.48. The 10 year yield has risen above 6.0%;

A particularly interesting comment by the head of the Bundesbank, Mr Weidmann. He stated that EZ countries that wanted to mutualise debt would have to (effectively) give up their sovereignty. Clearly he’s right, though do his comments suggest that he is beginning to believe that debt mutualisation (Euro bonds) is on the table?;

EZ May business climate indicator came in at -0.77, much weaker than the -0.66 expected and well below the -0.51 reported in April;

The UK’s Daily Telegraph reports on a proposed German scheme known as the “European Redemption Pact”. The plan drafted by the German Council of Economic Experts was dismissed by Mrs Merkel in November last year. However, with the opposition SPD supporting the idea and the Greens pledging to vote against the fiscal compact in the German upper house the Bundesrat (and bear in mind that the CDU fared badly in regional elections), it looks as if Mrs Merkel may have to change her mind. The plan would ensure that 60% of EZ Sovereign debt would remain Sovereign. However, amounts above 60% would be transferred gradually into a redemption fund, which would be able to issue joint bonds ie Euro Bonds. The redemption fund would retire the debt over 20 years, financed by a kind of “Solidarity Surcharge”. Countries would have to pledge their gold and forex reserves to the Redemption Fund as collateral. The Redemption Fund gets around German Constitutional Court issues. The scheme would reduce interest rates for the periphery, in particular, though they would still have to stick to austerity measures. However, rates would rise for the core countries, compensated by prospective future higher growth.
Difficult to assess whether such a scheme will be acceptable, but something needs to be done, sooner rather than later. Will follow carefully though as such a scheme has major market implications;

The EU is willing to “envisage” setting up a “banking union”. Essentially, they “suggest” (their proposal is a recommendation, rather than a specific legislative proposal), that the ESM be used to bail out insolvent banks directly, rather than lending money to EZ countries who would then use the funds to recap their banks. Well thank you EU for this wonderful report – it was inevitable. The news resulted in the IBEX and other peripheral markets rebounding sharply, though have subsequently retreated. Personally, I cant see why banks will be recapitalised without the existing shareholders/bondholders having to take the 1st hits. Far prefer the financials in the UK. Germany (and Finland and Holland) has been opposed to such plans in the past, but I cant see any alternative. The EZ simply cannot recover until the banks are recapitalised – that’s the bottom line;

UK mortgage approvals increased marginally in April to 51,823, from 51,067 in March. Counter intuitively, the top end London market continues to strengthen as more and more exit the EZ and other difficult countries and seek refuge in London
M4 money supply was up +3.8% in the three months to April on an annualised basis, though lower than the 7.1% in the first Q;

Mr Romney has confirmed that he is the prospective Republican candidate, to challenge President Obama, with his win in Texas;

US pending home sales were down -5.5% in April, much weaker than the +0.1% expected. March was revised lower to +3.8%, from +4.1% initially reported. More talk of QE3 likely.


Asian markets closed lower following the reports by Xinhua denying a major stimulus programme. European markets opened weaker and continue to decline. US markets are some -1.2% lower at present.

The Euro remains under pressure (heading towards US$1.24) and (surprisingly) Sterling is weaker – currently US$1.5557.

Both Gold and Brent are lower, in particular Brent which is trading well below US$105.

Will watch possible developments re the European Redemption Pact and the suggestion that banks can access the ESM directly. Could well be positive for solvent European financials – still prefer some UK financials.

Still not enough pressure on the EZ, but getting close to the point where the EZ has to act, particularly as Spanish yields are nearing the critical 7.0% yield.

I must say that German bunds look dreadfully overpriced.

I realise it looks absolutely awful, but…….

Kiron Sarkar

30th May 2012

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