Basel rules likely to be watered down

What do you do with a totally failed Finance Minister. Well, you “promote” him, off course. Mr Pranab Mukherjee, the Indian finance minister, is likely to become the next Indian President (a largely ceremonial position, admittedly), as a reward for his “excellent stewardship” of the Indian economy !!!! – the Indian economy is collapsing, by the way. Well that’s India for you and that’s why the country will under perform, in spite of its huge underlying strengths.
The RBI is to decide on interest rates on Monday – expectations are for an interest rate cut in spite of rising inflation !!!;

We all wait for the outcome of the Greek elections this Sunday. Whilst I believe that New Democracy will poll the most votes (with Syriza second), the real question is whether they can form a coalition. One of my readers suggested that a coalition was unlikely and, I must admit, it does indeed look tricky. A failure to form a coalition would be the worst outcome. A Syriza win will result, in my humble view, in almost certain coordinated Central bank action and a coalition formed around a win by New Democracy a bit of a relief rally – not sure how long it will last though I must admit. Will the Greeks have to have yet another election, if a coalition cannot be formed – possibly, but I would have thought not. Another technocrat Government – well possibly, but will achieve little to nothing. Clearly greater uncertainty in my view, but that uncertainty will force the EZ (read Germany) to come up with a solution far, far sooner than they would otherwise have had to. As a result, the inability to form a coalition suggests bad news initially, which could well force some Central Bank policy action though, more importantly, with the EZ coming out with much needed policy action sooner than otherwise – good news.
Having said that, are you not totally and absolutely fed up of Greece – well, I certainly am. Grexit is coming – its only a matter of time – probably when contagion fears are contained. However, as every day goes by, the cost to the rest of the EZ increases;

The Italian Government has announced measures (which it “says” amounts to E80bn), for home improvements, tax breaks to hire workers, funding of urban development projects and corporate R&D. In addition the government stated that it would raise some E10bn through the sale of State assets. With debt to GDP of around 120%, a weakening economy, which has contracted by -0.8% in the first Q (and with no prospects for growth) and some E1.96tr in government debt, Mr Monti is increasingly coming under pressure to act to stimulate the Italian economy. However, this announcement is no game changer. In addition Italian companies are materially under capitalised (much to do with the Byzantine cross holdings) and which remains a serious problem;

The IMF warns that Ireland may find it difficult to access the international capital markets next year (even though the country has met its budget targets) given the crisis in the EZ, suggesting that the country will require a further bail out. Portugal will definitely need a second bail out in the next few months. With the IMF now accepting that Spanish budget deficit targets are, in effect, pie in the sky, Spain will have to seek a bail out. In addition, the proposed E100bn to recap Spanish banks ain’t going to enough Seniors. Where’s the money coming from. The ESM. Hmmmm Think again and stop messing around – the ESM needs a banking licence;

Interestingly, the IMF has backed the Irish governments proposal to reschedule approximately E30bn of promissory notes – the Irish government has to repay 1/10th of the E30bn each year, which will require further spending cuts and/or tax increases – clearly insane. Too true, the EZ/ECB are being absurd. In addition, the IMF reports that some kind of fix is necessary for mortgages linked to the ECB interest rate, which is resulting in huge loses for Irish banks. Once again, too true. Finally, the IMF is pushing for the EZ to recap banks directly, rather than through the state – which increases the debt to GDP. Germany is resisting. Ultimately Germany/ECB will have to change its mind;

Bloomberg reports that the ECB could well reduce interest rates below 1.0% (a virtual certainty, in my humble view) and in addition to reduce the deposit rates to zero from 25bps, to discourage banks from depositing funds with them. Mr Draghi stated that there was “no inflation risk in any Euro-area country” and that inflation was well anchored yesterday, a clear signal that he intends to reduce the current 1.0% ECB benchmark interest rate, most likely by 25bps, initially, though it could well go even lower. As previously reported, the ECB is just waiting for the outcome of the Greek general elections before acting. However, once interest rates hits, in effect, zero, what do they do next – QE? – personally, I think there is a much better than 50/50 probability of QE in the EZ in due course;

US industrial production fell by -0.1% in May, much weaker than April’s (slightly revised lower) +1.0% gain and lower than the gain of +0.1% expected.
The University of Michigan consumer sentiment index came in at 74.1 in June, down from 79.3 in May and the lowest this year and lower than the 77.5 expected. Both current condition (82.1, from 87.2) and consumer expectations were weaker (68.9, from 74.3).
The Empire State index dropped to 2.3, from 17.1 in the previous month.
Certainly does not suggest that the US is immune from the EZ crisis as a number of analysts continue to allege – which truly mystifies me, I must admit;

The slowdown in Brazil is clear for everyone to see. Yesterday, Brazil’s President Mrs Dilma announced yet another stimulus package amounting to R$20bn, in the form of loans to the BNDES, the Brazilian State development bank. With interest rates down to a record low of 8.5% (will be reduced even further) in response to a likely contraction of GDP in April (the first since 2009) and declining industrial activity and investment, Brazil’s economy is the worst performer of the BRIC’s, though the others are in no great shape either. Remember those who promoted “decoupling”…………Analysts are reducing their estimates of GDP growth this year to around 2.5% – personally, I would be surprised if Brazil achieved 2.0%, unless there is a major global stimulus programme.
Pertobras, the Brazilian energy company, which should rank amongst the best in the world, is used as the piggy bank for Brazil, which is why it inevitably disappoints – most recently, it cut its production targets;

International regulators look as if they will water down the Basel rules designed to improve the safety of the financial sector, fearing that tougher requirements at present will exacerbate the EZ crisis. The WSJ reports that regulators may allow banks to count their holdings of gold and equities towards bank capital in respect of “liquidity coverage ratios”. Previously, essentially only Government bonds and cash were deemed acceptable. The watered down rules (if implemented) could, however, reduce banks demand for government bonds and may increase their willingness to buy equities and gold. In spring this year, the Basel Committee estimated that banks globally would require an additional E1.76tr of eligible assets if the liquidity ratio came into effect immediately. Banks are scaremongering it must be said. Mervyn King stated, “In current exceptional conditions, where central banks stand ready to provide extraordinary amounts of liquidity against a wide range of collateral, the need for banks to hold large liquid asset buffers is much diminished”. The UK, together with Switzerland, have been amongst the strongest supporters of the proposed Basel rules remaining in force – indeed, the Swiss have their own “finish” – however, it seems like the UK is shifting. A watering down of the rules will clearly make the banks more risky;


First we have the results of the Greek (and remember the French) general and parliamentary elections this Sunday. Then the G20, followed by the EU Heads of State meeting on 28/29th June. Great – lots of clap trap from politicians to look forward to !!!

On balance, I will continue to be long the equity markets, whilst uber cautious to negative EZ bonds (ECB interest rates cuts likely though) – shorting equities is dangerous in my humble view, as Central Banks will have to flood the system with liquidity in the event of a problem. In addition, the need for policy action for the EZ is coming pretty soon – the interminable delays are way past their sell by date. A great deal of you remain (lets be polite) highly sceptical – certainly can understand it, but……

Just as an aside, I write this blog on the basis that it reflects more a Global Macro Hedge Fund with monthly reporting requirements, rather than a long only, long term, buy and hold fund.

Have a great weekend.

Kiron Sarkar

16th June 2012

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