Fitch downgrades Spain 3 notches, with a negive outlook

Japan’s current account surplus shrank to Yen333.8bn in April, well below the forecast of Yen441bn. Exports are being constrained by the strong Yen and the slowing global economy. The net international investment surplus is keeping the current account in surplus for present, though as this declines……..Japan did revise its 1st Q GDP growth rate upwards to +4.7% on an annualised basis, from +4.1%. Fitch warned today that Japan’s sovereign credit profile is under pressure, given the high and ever increasing government debt. When will it be time to short the Yen?;

Yesterdays announcement that Chinese banks will have more flexibility to set their own rates within a wider band of the benchmark rate has been taken up in full. Chinese banks have raised rates on demand deposits (about 40% of deposits, according to Bloomberg) to the full amount possible (10% above the benchmark), suggesting that banks are scrambling for deposits. The moves will reduce margins – oops;

The FT reported that views that the Yuan is undervalued may not be the case. I have and continue to totally agree with Mr Chanos (who is also of the view that the Yuan is not undervalued, indeed its overvalued) and the increasingly sceptical views of the FT. In my humble opinion, most analysts/observers have (grossly?) underestimated the deterioration of China’s economy and its terms of trade. The FT adds, that a reduction in forex reserves (likely in my opinion) will result in China selling US bonds – going to be interesting. The IMF has changed its views materially on the Yuan – it now says that the Yuan is “moderately undervalued” from previous statements of “materially undervalued”. Just follow the trend;

The surprising Chinese rate cut yesterday has been viewed with extreme scepticism. The market has taken the cut as a preemptive move by the Chinese authorities, in anticipation of much worse economic data coming out over the weekend. As you know, I believe that analyst expectations of GDP growth of 8.0%+ this year are wildly optimistic – reaching 7.0%, without a stimulus programme is going to be difficult. Having said that, I do believe that the Chinese authorities, having done too little too little, will act further, with lower RRR’s, interest rate cuts and a mini stimulus programme. The Chinese markets and Hong Kong markets closed lower today – they don’t seem to have viewed the rate cut optimistically either – the most telling indicator. However, I do expect that inflation will have reduced further – below 3.0%?;

Greek newspapers report that Greek banks experienced deposit withdrawals of between E5bn to E6bn in May, twice the average monthly deposit outflow over the past year;

Fitch downgraded Spain 3 notches to BBB from A previously, with a negative outlook, citing the cost of the bank recapitalisation and a lengthening recession. They also estimated that Spain would require E100bn to recap their banks (extreme case), some 9.0% of its GDP, though E60bn in the base case. Fitch now has the worst rating for Spain amongst the main agencies. Fitch followed up with downgrades for 11 local and regional governments and 5 PSES, today as usual – banks next.
Leaked reports suggest that the IMF estimates that Spain will require just E37bn in capital to bail out its banks. Whilst its impossible to assess the likely amount necessary, it is certain to be multiples of that amount. The silly game of understating losses/cap requirements is way past its sell by date. The IMF report is expected to be released next week, possibly on Monday. The Spanish government has also commissioned other reports which will be available in 2 – 3 weeks time. The Spanish authorities will then have the data to take the necessary decisions.
The leader of the Brussels based European People’s Party, which includes the Spanish PM and Mrs Merkel, states that Spanish banks will require E100bn and that the money will be channeled to the FROB – will that not increase Spain’s debt to GDP?
Reuters reports that Spain may make a request for aid to recap their banks this weekend – no comment from Spain, though their previous statements suggested that they wanted to wait until they received the reports on the financial situation of Spanish banks by their advisers – the Spanish authorities reported that the first stage of bank valuations will be ready on 21st June and that bank audits are to be released on July 31st – too late Seniors. Better to get this done sooner rather than later I would have thought. An EZ finance ministers conference call is scheduled for this Saturday.
Merkel has reverted to being tougher and reports suggest that she will not weaken on her demands that Spain be subject to additional oversight, if they need funds, which clearly they do. This issue seems to move every day – personally, I believe it would be much better if there was oversight.
Interestingly, the IBEX, having opened lower, is up at present, in spite of yesterdays credit downgrade by Fitch, announced after European markets had closed !!!! – does not suggest Armageddon to little old me;

Italian April industrial output declined by -1.9% MoM, much weaker than the -0.5% expected. Production has slumped -9.2% YoY on a workday adjusted basis;

Much more importantly, Germany’s April trade balance came in better at E14.4bn (March E17.4bn), as opposed to expectations of E13bn. The current account surplus declined to E11.2bn, from E19.9bn in March, though slightly higher than expectations of E11.0bn. Exports declined -1.7% MoM, much greater than the -0.7% expected, with imports down -4.8% (oil price impact?), versus expectations of just -0.1%. The data reinforces my view that Germany is not immune and that upcoming data will reveal a (sharp?) decline in exports, in particular, followed by a slowdown in domestic consumption, the key driver of the German economy recently. Funnily enough this will be good news, as it will put more pressure on Germany to act sooner;

The Bundesbank has raised German 2012 GDP forecast to 1.0%, from +0.6% previously, though downgraded its 2013 forecast to +1.6%, from +1.8%. However, they added that risks were rising materially, particularly given the situation in the EZ. Whilst the Buba has raise 2012 GDP forecasts, the overall views of the Buba were downbeat, indeed, particularly so – not surprisingly and suggests to me that the German economy is slowing far faster than most believe;

UK May producer output prices were -0.3% lower MoM, or +2.8% YoY, well below expectations of +3.2% YoY and the lowest since November 2009. Essentially, I expect UK inflation to decline materially this year;

Mr Bernanke’s comments to the Joint Economic Committee yesterday were taken negatively by markets, as he did not announce any FED policy action. However, given the upcoming Presidential elections and the fact that the FED has not used this event to announce decisions on monetary policy, I believe that market expectations/reaction were unrealistic. Mr Bernanke did say that the FED would act if necessary and, in recent days, a number of FED voting members ( including Janet Yellen for example) have made dovish comments. In addition, the composition of the FED board suggests that it is likely that the FED will act to ease further through another QE programme, rather than not, particularly if the situation in Europe deteriorates – he stated that the situation in Europe posed “significant risks”;


Asian markets closed lower, ignoring the Chinese rate cut on suspicion that the Chinese data, to be released this weekend, will be more negative than expected. Quite possible, though inflation data is likely to be lower than current estimates – maybe even 3.0% or lower?

European markets (ex Spain) are lower. The Euro is weaker, as is oil and gold. German 10 year bund yields have come in – currently 1.29%

Sentiment remains pessimistic. Whilst I can understand that, it seems as if there is progress in Europe – OK slower than markets want, but there is progress. In addition, markets will force the EZ politicians to act – I very much agree with Soros’s view that the EZ has just 3 months to act – indeed, I would be closer to just 1 month. I also believe that the ESM will have to be granted a banking licence – the resources available to the ESM are just insufficient for its purpose – clearly bullish.

One of my biggest fears in the EZ is France – the first round of the French Parliamentary elections is this Sunday, with the second round a week later. The most recent polls suggest that Hollande’s party will not gain a majority and will have to rely on the even more extreme left wing parties. How’s that going to work with Merkel’s/German views?. Not well. French bond yields have declined materially – I must say, I’m surprised (I’m much more negative) and will watch carefully, following this weekends elections.

The Chinese authorities will have to do more – the current policies are insufficient – once again bullish (OK in the short term as, in my humble view, the Chinese economy is near being described a “basket case”), assuming I’m right. Bernanke will enact another QE programme as will the BoE, if necessary, though I question as to whether these measures will have much of an impact. Yesterdays (part) sell off on no news from Bernanke was way overdone, though the concerns re China remain valid.

Whilst I’m not a super bull, the present gloom and doom, whilst understandable, seems overdone. Personally, I will look to nibble away on weakness, though only next week – will want to assess Chinese economic data to be released over the weekend – likely to be dodgy, ex better inflation numbers.

Have a great weekend.

Kiron Sarkar

8th June 2012

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