IAEA claims to have reached deal with Iran

China Securities Journal suggests that the government will accelerate approvals and funding for infrastructure projects. I remain sceptical and certainly believe that the pop in the miners, due to these comments, is way overdone. Inventories af raw materials in China and, indeed, finished products eg steel remain high. In addition, the Chinese don’t need more infrastructure (bridges to nowhere) and are focusing on domestic consumption. A$ should weaken further as a result, in my humble view;

Fitch has cut Japan’s long term credit rating by 1 notch to A+, with a negative outlook. The foreign currency rating was cut by 2 notches to A+.The “downgrade and negative outlooks reflect growing risks to Japan’s sovereign credit profile, as a result of high and rising public debt ratios”. With debt to GDP in excess of 200%, the news should not come as a surprise (the OECD forecasts that debt to GDP will rise to 223% next year, from 214% at the end of this – though over 95% is held domestically), but the Yen continues to remain strong, even though it dropped on the Fitch news. One day however,……..;

The FT reports on a fascinating subject, namely that US$ denominated deposits in China are rising at the fastest pace in at least 5 years. Foreign currency deposits increased by US$89.4bn in the last four months to US$364.5bn, the largest increase since 2007, the PBoC reports. Chinese banks sold a net Yuan60.6bn (US$9.6bn) of foreign currency in April – capital flight do you think – yep. Dim Sum bonds have underperformed. I would expect that Chinese demand for the US$ will increase as the economy slows and as Chinese capital flight continues. A number of you remain sceptical of my view that the Yuan is not undervalued, as widely believed – personally, I believe there is mounting evidence to support my view;

Finally, analysts are beginning to cut India’s GDP forecasts. Morgan Stanley has reduced it’s forecast for GDP growth to +6.3% (previously +6.9%) for the fiscal year ending 31st March 2013. They cite the current account deficit of around 4.0%, the fiscal deficit of 5.8%, the whopping trade deficit of near 10% and inflation at 7.23%, as reasons. Furthermore, the high budget deficit of between 9.0% to 10.0% (ex one off telecoms revenues), with declining private sector investment does not bode well for the future. Income growth is slowing, whilst credit growth exceeds deposits (17.3% as opposed to deposit growth of just 13.9%), resulting in loans to deposits rising to near 80%. As banks hold nearly 30% of their deposits in Government securities, lending is being financed via inter bank liquidity from the RBI, resulting in high short term interest rates. Government has to reduce spending – that’s the bottom line – but politics and a bumbling administration…….The Indian Rupee fell to its 5th consecutive all-time low earlier today, though bounced back on Central Bank buying. The Rupee is the worst performing in EM Asia forex;

The Director general of the International Atomic Energy Agency stated today that he had reached a deal with Iran on it’s nuclear programme. He added that the agreement “will be signed quite soon”. The statement comes ahead of the next meeting between the P5 + 1 and Iran tomorrow. There’s nothing simple when Iran is concerned, but, on the face of it, it looks like better news;

Russian watchers suggest that Putin’s new cabinet is largely as anticipated. As expected, Sechin has been kicked out (numerous stories about that gentleman) and a new face Arkady Dvorkovich, Medvedev’s chief economic aide appointed – he will be responsible for Russia’s energy sector. The RTS rose +2.5% yesterday on the news (it’s down over 25% since mid March), suggesting the appointments are positive? or, at least, not negative. Russia needs an oil price in the high US$110’s to meet its spending programmes, without incurring a budget deficit;

EM bond issues (US$403.2bn) for the 1st 5 months of the year are at a record high (Source Dealogic) and fund inflows have soared. However EM bond defaults are rising and have risen to US$6bn in the 1st 4 months of the year, which is more than the US$4.3bn recorded for the whole of 2011, according to ING. In addition, some US$73bn are trading at distressed levels and US$53bn at stressed levels. The default rate peaked at 13% following the 2008 financial crisis – if liquidity dries up (remember European banks are exiting), default rates will rise. Latin America accounted for 48% of corporate distressed debt, with the oil and gas sector the main culprit (55%). The surge of investment in EM bonds looks misplaced and mispriced, in my humble view (Source FT);

The FT reports that the Greek banking system is being propped up by some E100bn in emergency (and allegedly temporary) liquidity, provided in accordance with the ELA arrangements. In theory, losses in respect of ELA lending are borne by the relevant National Central Bank, but if that Central Bank cant pay up, the losses are borne by the other 16 EZ Central banks on a predetermined ratio, with Germany the biggest loser. The ELA can be stopped for a country if 2/3rds of the 23 member ECB council oppose it, one way of forcing Greece out of the Euro, though the ECB is likely to seek political cover if it was ever to exercise such a move. However, the ECB is thought to have used this lever to force Ireland to seek a bail out. The ELA is not supposed to be used for insolvent banks – why then, you may well ask, are Greek banks being provided with funds?. The ECB is extremely reluctant to discuss ELA issues;

The IIF (which is an association of some 450 banks around the world) reports that losses by Spanish banks could rise to between E216bn to E260bn, with the banks needing some E60bn in new capital. However, they warn the the higher number (in terms of losses) was more likely, given the high unemployment rate and the macro economic conditions in Spain. The study was based on the Irish example
Spain raised E2.5bn through a bond auction today, though rates continue to rise – well above sustainable levels;

The EU is to accelerate a E939mn payment to Spain in respect of the “cohesion fund”. Sounds like a back handed way of providing financial assistance, especially as Spain is entitled to such payments, but only on a transitional basis ie to be phased out;

Whilst a number are calling for the ECB to launch another LTRO, personally, I believe that such a move is unlikely. A number of EZ banks used the funds to buy their sovereign debt, which are now trading at below their purchase price, eroding their capital even further. Whilst I had expected small and absolutely clapped out banks to play the carry trade, the number of much bigger players who participated in this ludicrous game has really shocked me – and they call themselves bankers. Much better, I would have thought for the ECB to buy Italian and Spanish bonds directly – will help some of these banks exit their losing positions as well;

The OECD is calling for the EZ to issue Euro bonds and for the ECB to buy peripheral bonds and, in addition, to cut rates to zero. They warned that the European crisis may well have a material impact on the global economy. In addition, they are forecasting a contraction of -0.1% in the EZ this year (+0.2% previously), rising to +0.9% in 2013 !!!, as compared with growth of +2.4% (2.0% previously) in the US and +2.0% in Japan, slowing to 1.5% next year. Interestingly, they forecast that China will grow by +8.2% this year and by 9.3% next – wildly optimistic in my humble view. Germany is expected to grow by +1.0% this year and by +1.9% next, France by +0.6% this year and +1.2% in 2013. Spain and Italy will contract by -1.6% and -1.7% this year and by -0.8% and -0.4% respectively next. Greece is expected to contract by -5.3% this year, but stabilise next. The situation in Ireland is improving – GDP is expected to rise by +0.6% this year and by +2.1% next, though down from previous forecasts of growth of +1.0% this year and +2.4% next.
Finally, the OECD suggests that the FED should not abandon QE;

UK April CPI rose by +0.6% MoM (as expected) or +3.0% YoY (+3.1% expected), though much lower than the +3.5% YoY in March and the lowest rate of inflation since February 2010. Mr King does not have to write a letter to the UK Chancellor to explain why inflation is above target. The sharp decline in oil will reduce inflation further in both the UK and across the globe this month. Core inflation declined to 2.1%, from 2.5% previously. RPI, slowed to 3.5%, from 3.6% previously. Sterling declined on the news – further QE is more likely, especially if the EZ continues to face problems;

The IMF has suggested that the BoE should cut interest rates and increase QE to boost demand, in particular, if the economy fails to pick up. It has also suggested that the government may need to slow down cuts in infrastructure spending and temporarily lower taxes, whilst cutting spending elsewhere – for example in public sector wages. The IMF stated that “fiscal easing and further use of the government’s balance sheet should be considered if downside risks materialise and recovery fails to take off”. Mrs Lagarde repeated that UK growth is too slow and unemployment too high. Sterling declined on the news
In common with the OECD, Mrs Lagarde suggested Euro bonds as a necessity;

The National Association of Business Economics forecasts that US payrolls will rise by an average of 180k per month this year, up from 170k forecast in February. They forecast 2012 GDP at +2.3%, in line with the FED’s estimate, with +2.7% in 2013. Housing starts are expected to rise to 720k this year, compared with 700k in February, and a jump to 850k in 2013;

Here comes more bad news. JPM’s Jamie Dimon stated that the bank would suspend it’s US$15bn share buy back programme, though would maintain it’s dividend payout. Core capital is expected to decline to 8.2%, from 8.4% previously – based on US$3bn of losses on the synthetic credit portfolio. Intriguingly, Mr Dimon stated that the losses at the CIO were probably “an isolated mistake”. Probably !!!! . Morgan Stanley is the latest bank who suggests that the losses may come in at US$5bn (some reports suggest US$7bn), rather than the US$3bn recently forecast by Mr Dimon. However, the size of potential losses remains a total guess as the position is open and unlikely to be closed for quite some time. Hmmmm. The shares closed nearly 2.9% lower yesterday. Analysts continue to suggest buying the stock – me, I prefer to sit back and wait;

Facebook closed at US$34.03, some 11% lower yesterday, or 10.4% lower than the IPO price of US$38. Underwriters are likely to be holding big positions, which will encourage the shorts. A definite whoops;

The Brazilian government announced a stimulus programme yesterday. They reduced (a) reserve requirements for auto loans (b) IPI industrial tax on various autos (c) general IOF transaction tax on borrowings for individuals to 1.5%, from 2.5% previously and (d) the Brazilian state development bank BNDES reduced interest rates for some buyers of machinery and equipment. The measures have raised increasing scepticism;


Asian markets responded to strong overnight US markets and closed, in the main, over 1.0% higher, though India is weaker (down near 1.0%). I would expect that May data will reflect a significant withdrawal of funds from India by overseas investors.

US futures suggest that markets will add to yesterdays strong gains.

European markets are trading higher at present – some +1.0%+ higher for the major markets. Spot Brent has reversed earlier falls and is flat to slightly higher. Gold is weaker.

The Euro is weaker against the US$, as is Sterling.

Expectations (by equity markets) for the EU Heads of State meeting seem pretty optimistic, suggesting to little old me, that there are (significant?) downside risks. Some kind of Euro project bonds are likely, as is waffle about growth measures, but I do not expect decisions on Euro Bonds etc (which for some reason the market does), though they are inevitable in due course. Given deposit flight from EZ peripheral countries, some comments on bank (rescues) could well be possible – if not, watch out.

The frighteners about the impact of a Greek Euro exit continue – amazingly from very senior individuals in the financial sector. Personally, as you know, I believe they are wrong. First I don’t believe, based on present info, that the head of the Syriza party, Mr Tsipras, will succeed in forming a government with him leading – a coalition comprising New Democrats and Pasok will be able to form a coalition, based on the most recent polls, though I totally accept that it’s early days. There is to be a TV debate nearer the election, which could well be crucial. I’m sure that Mr Tsipras’s opponents are, even now, warning Greeks that his win would result in a Greek exit from the Euro, something well over 75% of Greeks do not want.

However, much more importantly, even if I’m wrong, a Greek exit, would force the EZ/ECB to pull out all the stops (ECB bond buying of peripheral bonds, lower ECB interest rates, more ECB liquidity for banks, ESM to recap banks, possibly /likely even Euro Bonds (or at least a definitive assurance that they will be created), etc, etc – ie everything the market wants and something most of us have been calling for.

These measures will come as a huge relief to the other EZ countries, especially the peripherals. The EZ/ECB will have no alternative and essentially it also gets Mrs Merkel off the hook on having to take difficult decisions, even though I suspect she knows that that’s the eventual outcome. As a result, I believe that any initial sell off following a Greek exit will result in a markets rebound, following a more careful consideration of the matter. The added bonus is that Greece will disappear from the headlines. Please note that Greece is just 2.0% of EZ GDP and whilst financial losses within the EZ will be large, they will be containable. The real problem is contagion and I believe the above will deal with that.

All I can say is Mr Tsipras please win. I can assure you that most in Europe would be delighted to see a Grexit.

Kiron Sarkar

22nd May 2012

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