Markets React Positively to Spanish Bank Bailout

Japan’s seasonally adjusted May consumer confidence index came in at 40.7, slightly higher than the 40.0 in April;

Chinese trade data came in much better than expected – a real surprise. Exports rose by +15.3% in May YoY to a record, up from April’s +4.9% increase and way above analysts forecasts of an increase of just +7.1%. Imports were up +12.7%, well above April’s +0.3% increase and forecasts of an increase of just +5.5%. YTD, exports rose by +8.7% YoY, with imports +6.7% higher. China’s trade surplus came in at US$18.7bn, above April’s US$18.5bn surplus and a total of US$37.9bn YTD, up 65% YoY. Not surprisingly, exports to Europe increased marginally to +1.3% in YTD (though the first increase in 3 months), though up +23% to the US YoY.

Interestingly copper imports rose by +11.9% in May YoY – good for the miners/Australia/A$. Interesting numbers and certainly not what was expected. The numbers could reduce calls for more stimulus (bad news), but need to assess more data, especially as these numbers contradict, for example, Saturday’s numbers. Some of the better performance could be attributable to more work days in May, rather than April and, in addition, these are Chinese official statistics, but I still feel they were surprisingly better. Chinese car sales rose by 22.6% last month YoY (possibly channel stuffing?). In addition,financial incentives to upgrade cars were reintroduced it must be said. In addition, oil imports rose to 5.98mn bpd, 10% higher than April. with an average purchase cost of US$120 – given oil’s continued decline June CPI will come in even lower (Sources FT, Bloomberg)

However, the much better trade data did not stop the Commerce Minister from warning that China faced a difficult trade outlook this year and “if lucky” will be able to achieve its annual target of 10% growth in exports

Chinese M2 money supply was up +13.2% YoY, higher than expectations of +12.9%, and up from +12.8% previously;

Just a few points on the E100bn (maximum amount at 3% – 4.0%) Spanish bank bail out announced over the weekend. The Spanish claim the deal is a victory, but in reality, they desperately needed the money and will require further (significant) funding, almost certainly for their banks, but also for the country.

The E100bn (roughly 10% of GDP) is the max (ultimately unlikely to be enough, though Goldman’s beieve it will be !!!), with the actual amount to be determined following the release of reports by consultants hired by Spain to review the Spanish banking sector;

The IMF has upped its assessment of the needs of Spanish banks to between E60bn to E80bn and will review the progress of Spanish banks in the future even though they were not involved in the lending programme !!!! Very interesting.- German insistence?;

The funds will be provided by the EFSF/ESM (details yet to be released) to the Spanish bail out Fund, the FROB, which will result in Spanish debt to GDP rising by approximately 10 points to around 90% at the end of this year – unsupportable;

EFSF funds will rank parri passu to existing Spanish sovereign debt, though funds from the ESM will have preferential status ie ahead of existing private sector holders Spanish sovereign debt holders, though below the IMF. In addition, if it remains consistent, Finland will want collateral for its element of a loan provided – whats that?;
Germany won the argument that the loan to Spain was directed to the FROB and not directly to Spanish banks – which, if invested directly into banks would have resulted in a lower debt to GDP for Spain. Personally, I believe that Germany was right. In addition, the loan is subject to Spain meeting its budget targets, which, quite frankly I would have thought was impossible.

Interestingly, some 78% of Spaniards believe that their PM is doing a bad job. Leaving the weekends bail out announcement to his economy minister was pretty silly – he finally had to give a Press Conference, though clearly the Spain/Italy soccer game was more important to him.

The above suggests to me that Spanish bond yields will (indeed have) decline initially, in a knee jerk reaction to the news, but will rise again, given the higher debt to GDP which will follow.

As a result, I am increasingly of the view that Spain will require a full bail out. The funds available to the EFSF/ESM are insufficient for the (expanding) needs of EZ countries and will need to be increased. Either (EZ non bailed out countries) increase their funding, which in my humble opinion is unlikely, or the ESM is granted a banking license, which at present, seems the more likely alternative – market positive.
The market’s focus may well move to Italy. Mr Monti is losing support in the country.

The EZ, for the first time, has under promised and over delivered – good news, especially if it continues.

President Hollande’s Socialist Party could, together with other allies (the Greens for example) be able to achieve a majority in the lower house, following the first round of Parliamentary elections – they and their electoral allies came in with 35% of the vote, similar to Mr Sarkozy’s party, the UMP, with 35%. However, with the Greens, this could push Mr Hollande’s support to 40%, which could well allow him to gain an absolute majority in the National Assembly. Whilst better than having to rely on the extreme leftist parties, his agenda seems pretty difficult to understand in today’s times. The second round is next Sunday;

French April industrial production was up +1.5%, we above the unchanged expected and much stronger than the revised -1.0% in March. However, April manufacturing industrial output fell -0.7% MoM, from +1.4% in March;

Moody’s states that developments in Greece and Spain could result in downgrades for EZ countries. A virtual certainty;

Outlook

Asian markets are up sharply (the MSCI Asia Pacific index is up +2.5%) on the news of the Spanish bank bail out. In addition, measures by the Chinese which have (quietly) already put in place are increasing commodity imports – good for the miners and the A$, for example.

European markets are up strongly, with Spain up +4.5%+. European financials are also performing particularly well.

German 10 year bund yields rose by 10bps to 1.40%, over 25bps from its lows. On the other hand, Spanish 10 years are 14bps lower at 6.08%. Whilst Spanish bond yields are lower today, will it last?.

The Euro has recovered sharply (against the US$) on the news – yes, but for how much longer. However, its weaker against Sterling, which has been beaten up significantly (too much) recently.

Oil has risen sharply to US$100.50 (Brent).

Market volatility in June is likely to be severe. The Spanish bail out is positive, but there’s a long way to go and the deal is far from a solution. However, for the moment, I’m a happy bunny.

Kiron Sarkar

10th june 2012