ECB day today

The Australian economy rose by +1.3% in the 1st Q, on a Q/Q basis, twice the +0.6% rate forecast, or +4.3% YoY, the fastest rate since the 3rd Q 2007. Household spending. new engineering construction (the mining industry was up 19.7% Q/Q) and non dwelling construction were the major contributors, whilst exports declined modestly. The A$ rose on the news and forecasts of a rate cut of 50bps next month have been pared back. Having said that, I remain of the view that the RBA will cut rates by at least 25bps next month, following this months 25bps cut to 3.25%. The 1st Q’s rate of growth is unsustainable given the slowdown in China;

A report by Wood McKenzie, highlighted in the FT, suggests that China’s vast shale gas resources, may not be quite what they seem. Apparently a number of wells have been drilled, but none has resulted in commercial development. Lack of infrastructure (pipelines), geological challenges, land access and difficulties over the investment needed, remain serious problems. The bottom line is that China will remain an increasing importer of energy for a very long time;

Pollution in China is a serious problem. The Chinese solution – they are requesting that foreign embassies (the US, in particular) halt reporting on pollution levels, which is consistently worse than Chinese data. Some hope. When will these guys get real and start addressing their fundamental problems, rather than try and hide info from their public, which in an information age is going to be more and more difficult;

Russia and China announce further economic cooperation – Putin is in Beijing at present. The 2 countries agreed to setting up a US$4bn joint investment fund and hope to raise money from 3rd parties !!!!. Given that most Russians are wary of the Chinese and vice versa, this is going nowhere. Well, actually a number of rather sticky fingers (both Russian and Chinese) must be eying the US$4bn fund;

Spanish April industrial production unexpectedly declined by -8.3% YoY (-7.5% in March YoY) , the most since October 2009 and much higher than forecasts of a decline of -6.5%. Spanish GDP was down -8.9% in 2011, with the government forecasting that it will decline a further -4.0% this year – oh yeah, pretty optimistic, me thinks;

The Spanish economy minister called for EZ help to recap Spanish banks. The PM continues to prevaricate. Personally, I cant see help being delivered to Spanish banks, without Spain having to accept EZ overview/supervision. The precedent created otherwise will be dreadful and not in the interests of Germany, who (quite rightly) wants strict oversight/verification and fiscal discipline. The CDU (Mrs Merkels party) Parliamentary head, Mr Volker Kauder (a close ally of Mrs M), stated today that Spanish banks will not get direct aid and that the country needs to apply to the EFSF/ESM. At the end of the day, I expect that direct aid will be provided to Spanish banks, on the basis that Spain accepts supervision/oversight. In any event, a recap of Spanish banks will only be carried out following an audit of the relevant banks which is currently being carried out ie in quite some months time. Spanish views that they will require just E40bn looks optimistic, to say the least. Then there is the question as to who supervises the recapped Spanish banks, given their previous history;

The French Government has signed a decree which will reduce retirement age to 60, though only in certain circumstances. The cost is expected to amount to E3bn. Well, Hollande had to deliver, but clearly its madness;

Moody’s downgraded 6 German banks and three Austrian. The bottom line is that a number of German banks are seriously under capitalised and will need (significant) injections of capital;

German April industrial production declined by -2.2% MoM, much weaker than a decline of -1.0% forecast. March was revised lower to +2.2%, from +2.8% previously. Holidays may have impacted the data. However, I believe that German industrial data will continue to weaken, followed, in due course, by weaker domestic data. Strangely enough, weaker German economic data may be positive for the EZ, in that Germany may well become more flexible and begin to act to stimulate the EZ;

Irish May services PMI came in sharply lower at 48.9, from 52.2 in April, the 1st decline in 4 months. The grim headlines over May did not help. However, the export sector continues to perform. The Irish economy has bottomed, though its future is inextricably subject to developments in the UK/EZ;

The ECB saw demand for 7 day liquidity rocket to E120bn yesterday, twice last weeks figure. 4 Greek banks are now able to access ECB facilities. The ECB/EZ is going to face huge losses in respect of these facilities to Greek banks, but cannot do anything at present given the fragile state of the EZ and Spain, in particular. The ECB’s liquidity provision provides Greece with a stick to threaten the rest of the EZ, but at the end of the day, I remain of the view that Greece will have to leave the EZ, though only when contagion risks (to Spain, Portugal, Ireland and Italy) are sorted out;

EZ 1st Q GDP was confirmed as unchanged Q/Q, though on a YoY basis revised modestly lower to -0.1%, from unchanged previously. The EZ has just managed to avoid being in recession, unless the data is revised lower. However, this Q’s GDP should be negative. Exports increased by +1.0%, though corporate investment declined by -1.4%. Construction was down -1.1%;

UK May construction PMI came in at 54.4 (roughly in line with estimates) and down from 55.8 in April and the lowest reading in 3 months;

The FT reports that regulators are reviewing JPM’s public statements, given the recent problems at their CIO. The Office of the Comptroller of the Currency (“OCC”) may impose “remedial measures” in respect of pay claw backs. The CEO of JPM will face a grilling next week;

Yet more gloomy news re Brazil. The HSBC/Markit May services PMI fell from 54.4 in April to 49.7 in May. The manufacturing PMI came in at 49.3. With GDP at just +0.2% in the 1st Q on a Q/Q basis (+0.8% YoY), Brazil looks as if it is in deep trouble;


The key event today is the ECB’s meeting. I really cannot see what Draghi can say/do ahead of the French (and more importantly) the Greek elections on the 17th June and the EU Heads of State meeting on 28th/29th June, in particular. In addition, Mr Draghi does not want to relieve the pressure on EZ politicians to (finally?) act. Updated ECB forecasts should reveal greater flexibility to cut EZ interest rates (likely in July), as inflation is (very likely) to undershoot the 2.0% target, in particular. However, expectations by some of a major announcement(s), which is the case in some Q’s, are likely to be disappointed. German 10 year bunds are trading at a yield of 1.26%, higher than last weeks 1.15%/1.17%, though peripheral bond yields have declined.

The EU releases its paper on its initial plans for a banking union today, including a plan for bank resolution. Basically a lot of waffle and compromise, with very little action – it is the EU, after all. Unsurprisingly, German banks are lobbying hard against a joint deposit insurance scheme.

Markets have recovered somewhat on expectations of positive announcements in the EZ, with the financials outperforming materially, with the miners not far behind. Whilst I believe that the EZ will have to act in the very near future, I just hope that expectations for imminent policy action do not exceed the reality of the situation. May well need to be a bit cautious.

Asian markets were up materially today, ex China. European markets have also risen materially. Brent has risen to back up to near US$100 (indeed, just over US$100, at present) – the recent sell off looks overdone.

Kiron Sarkar

6th June 2012

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