Monti suggests that Merkel will agree to Euro Bonds !!!!

Japanese consumer prices rose by +0.2% in April YoY (+0.1% expected), the 3rd monthly rise, though well below the BoJ’s 1.0% target;

Chinese officials report that lending by their biggest banks may come in at Yuan 7tr, lower than the  target of between Yuan 8tr – Yuan 8.5tr, the 1st time in 7 years. In April, new loans totalled Yuan 681.8bn, some 33% lower than March and well below the Yuan 780bn forecast. Initial data suggests that May’s numbers will come in much weaker. The lower lending numbers suggest that the economy is slowing down faster than thought. Personally, I believe that current forecasts for Chinese GDP to grow by 8.5%+ this year are wildly optimistic – indeed, I would be surprised if it hits 7.0%. The news adversely impacted markets yesterday;

Yet more talk about stimulus measures in China. To date they have just tinkered about. However, with a (sharply?) declining economy, it looks like Chinese officials may well have to ramp up stimulus measures. They will not want a very weak economy ahead of the change in leadership later this year;

Mr Subbarao, the governor of the Indian central bank reports that the RBI will do whatever it needs to to stem the decline of the Rupee. However, with forex reserves declining to US$258bn on the 11th May and down US$26bn from end October last year, is that credible. Given the huge (and rising) current account deficit, I personally do not believe it is. A decline in inflation (due to lower oil prices) will help, but will not be enough. I remain short the Rupee against the US$;

Talks between Iran and the P5+1 achieved little. What a surprise – I think not. Both sides agreed to meet again in Moscow on 18th June. I cant understand the recent IAEA statement that they would (soon) announce a deal;

The most recent poll suggests that the radical anti bail out Greek party, Syriza, is in the lead with 30%, whilst New Democracy is on 26% and Pasok on 15%. Another poll reports that New Democracy and Syriza are neck to neck at around 23%, with Pasok on 11%. Still early days, but I believe at the end of the day the Greeks will not vote for Syriza in the numbers suggested. 85% of Greeks want to stay in the Euro, but 62% are against the austerity measures !!!!. However, the alleged support for Syriza is likely to result in Greeks continuing to withdraw funds from their banks, causing a bank run – also likely in the other EZ peripheral countries. The EZ/ECB will have to take action to prevent facing even greater potential losses – personally I believe well before the 17th June national elections. Having said that I remain of the view that Greece will exit the EZ (75%+ chance), within a year at the latest, indeed quite likely sooner. Interestingly, a German finance Ministry spokesman suggests that the next tranche of bail out funds may be delayed till the end of June ie after the 17th June elections;

Greek banks got their E18bn recapitalisation funds. It will be interesting to see whether the ECB now allows them to use their facilities;

Spanish press reports state that Bankia is requesting more capital from the government – here we go. The Spanish government suggested that they would inject E9bn, but the press reports state that Bankia is seeking E15bn. The ESM is going to have to be used to finance banks pretty soon. Bankia is suspended – it publishes it’s restated 2011 report an accounts – yet more bad news;

Mr Draghi expects that EZ inflation will be below 2.0% by the end of the year or early 2013. The decline in oil is of material help. That should help with interest rate cuts/QE etc.
Interestingly, though unsurprisingly, his comments suggest that he is not totally enthused by a prospect of another LTRO;

Following the (absolutely useless, as usual) EU heads of State meeting, Mr Monti states that Germany (Mrs Merkel) can be persuaded that Euro Bonds are necessary, as she wants to ensure the Euro’s survival, which has and will continue to be in Germany’s interest. Interesting, but not quite what other EZ leaders have stated – indeed, they suggested (as did Mrs Merkel) that Germany, together with a few other EZ countries,  remain totally opposed. The head of the Bundesbank, Mr Weidmann states that it’s an “illusion” that Euro Bonds can fix the crisis and, in addition, more interestingly, Mr Weidmann refrained from speculating as to whether Greece would remain in the Euro – seems like more and more EZ officials are getting fed up of Greece. However, the inevitability of the creation of Euro bonds sooner than the “in years to come” line is a must,  as there is going to be no other alternative, if the Euro is to survive (which I believe it will) with the existing (ex Greece) members remaining;

Germany’s opposition parties have forced Mrs Merkel to consider a proposal on common liability, to be discussed with her opposition parties on 13th June. The plan involves a “redemption fund”, which, will allow the issue of Euro bonds in return for countries constitutionally agreeing to reduce debt to GDP to below 60%. The details are vague at present, but the move suggests that Merkel is moving (will it be enough?). De Spiegel reports that Germany is producing a growth plan involving investment. First there was just austerity, now its growth and austerity, and finally………;

French consumer confidence rose to 90 in May, from an upwardly revised 89 in April (previously 88);

German Gfk June consumer sentiment indicator remained unchanged at +5.7, from an upwardly revised +5.7 in May and slightly higher than the +5.6 forecast. The economic expectations component rose to +19.6 in May, from +8.5 in April and prospective spending indicator rose to +32, from +27.6, though income expectations declined by 1 point to +32;

US jobless claims declined by -2.0K to 370k in the week ended 19th May, in line with expectations. The less volatile 4 week moving average fell to 370k, from 375.5k. The number of people collecting benefits declined by -29k to 3.26k, whilst those on emergency and extended payments declined by 40.3k to 2.93mn;

US durable goods orders rose by +0.2% in April, in line with expectations.  Strong demand for autos helped. However, the orders for capital goods, ex transport and defence, a much better indicator, declined by -1.9% (much worse than the +0.7% expected), having fallen -2.2% in March and the first consecutive decline in a year. Unfilled orders decreased by -0.1% and inventories rose by +0.3%. The drag was from a decline of -2.8% in machinery orders (down -4.9% in March) and -3.4% YoY, suggesting potentially weaker manufacturing and/or business investment. Bloomberg reports that the 1st month of every Q has reported weaker durable goods orders – don’t understand, why that should be the case though;

Latest data from EPFR (week to 23rd May) reveals that US$478mn was withdrawn from EM bond funds, the 1st decline since early January. Outflows from equity funds were even greater at US$1.55bn, though less than the US$2.25bn the previous week. Latam was the weakest, with equity outflows of US$528mn, double the previous week, with Brazil suffering the most. (Source FT);


Asian markets closed mainly lower, though Japan and Hong Kong were marginally higher. Europe is mixed, with Germany higher whilst France is flat, with the FTSE somewhat lower. The Euro is recovering – presumably on Monti’s view re Euro bonds. US futures suggest a higher open, though with a holiday on Monday, markets are expected to be relatively muted.

The Euro is rebounding (Monti’s comments) – may well have further to go in the short term, but in the medium/longer term I remain bearish.

Spot Brent is over US$107, with Gold at US$1563.

A number of large European funds are dumping their Euro assets, given the Greece saga. Hmmm. I must say, it may well be the time to look at Europe more carefully with a view to buy. Whilst the current situation is hugely uncertain and on the face of it bearish, personally I have closed all my shorts and continue to add to my positions.

I am coming round to the view that the market will force the EU/ECB to act and, indeed, act pretty soon, with interest rate cuts, ECB bond buying, ESM to be used to recap banks etc, etc and then possibly even the elusive Euro Bonds?. This very sorry saga is way beyond it’s sell by date.

French bond yield spreads continue to narrow against the equivalent German bunds – the 10 year spread is narrowing to close to 100bps, well below last November’s high of over 200bps. Dutch spreads have also narrowed.

It just looks as if more pressure is being put on Mrs Merkel, obviously from her EZ (France and the peripheral countries) colleagues, but also, increasingly,  from opposition parties in Germany. Mrs Merkel is a master at understanding shifts of sentiment, pretty flexible and will move, in my humble view. However, in reality, Greece will have to exit for any material plan for the EZ to be effective, which I believe markets will take positively, so long as measures to avoid contagion are put in place, which I believe they will.

Kiron Sarkar

25th May 2012

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