Spain needs a maximum of E62bn to recap its banks – allegedly

Taiwan’s unemployment rate rose to 4.25% in May (forecast 4.20%), from 4.19% in April, yet more evidence of a slowing economy, particularly in Asia. Taiwan is important as it provides a good assessment of the Asian economy, in particular, as exports make up 2/3rds of Taiwan’s economy and have fallen in 5 out of the last 6 months;

The Indian Rupee declined to a Rs 57.256 against the US$ this morning, a 9 month low, given the economic problems which are worsening. Foreign investors continue to reduce their holdings in Indian securities. Cant see any respite in the short term;

Spain announced that its banks may need between E16bn, rising to E62bn (in an “extreme” case) to recap its banks through 2014. The EZ is set to provide up to E100bn, channeled through the FROB, (Spain’s bank recapitalisation fund), rather than directly to the banks, which will increase Spain’s debt to GDP to around 90% by the end of this year. The Spanish forecasts are viewed with extreme scepticism, given the Irish experience – quite rightly in my view. The IMF has criticized the EZ plans to channel the funds through the State, suggesting that a recap of Spanish banks directly would be much better – clearly right. However, Germany continues to resist such a change, though I suspect they may be persuaded, in return for EZ countries agreeing to strict budget targets and other measures to ensure fiscal discipline;

Italian consumer confidence fell to 85.3 in June, the lowest reading since 1996, from 86.5 in May and forecast of 86. A recession, combined with rising taxes and unemployment (rose to a 12 year high of 10.1% in April) is taking its toll. Mr Monti is losing support and there is a growing threat of elections being called in Autumn. However, the political parties will wish for Mr Monti takes the tough decisions so as to avoid any voter backlash, before they call elections;

The German President has agreed not to sign off on the ESM, as requested by the German Constitutional Court, following a complaint by a far left German party, which the Court states that they need to review. The Court may also be asked to consider the Fiscal Compact. Whilst, the Constitutional Court is not expected to rule against either the ESM and/or the fiscal compact, it is expected to take time to consider these issues, which could delay the ratification of these measures to mid to late July, creating yet more uncertainty. It is believed that German politicians have ignored the Constitutional Court, which based on this ruling, would appear “careless”;

The important German IFO business climate index came in at 105.3 in June, as opposed to the forecast of 105.6 and 106.9 in May, the lowest reading since March 2010. The current conditions component was stronger than the forecast 112.0, coming in at 113.9, above May’s 113.2, though the more important expectations component was weaker. It came in at 97.3 (forecast 99.8), down from the 100.8 in May. There were also signs that manufacturing is coming under pressure and recent employment gains are reversing. The weaker IFO data confirms the downbeat German ZEW and PMI surveys and suggests that German economic forecasts may have to be reduced in the 2nd half of the year, in particular. Counter intuitively, this is good news, as it will add pressure on Germany to deal with her EZ partners;

The meeting of the major EZ countries (Germany, France, Italy, and Spain) is not expected to result in any major announcements. Monti, supported by the French and Spanish, is pressing Mrs Merkel to relent on her tough stance – highly unlikely at this meeting, though some “concessions” by Germany are likely at the EU Heads of State meeting on 28/29th June;

The ECB is likely to loosen collateral rules for Spanish banks materially, by reducing the impact of ratings of credit ratings agencies on its refinancing operations. The major concession could allow greater use of (lower quality) asset backed securities by Spanish banks, thereby reversing a major liquidity squeeze, which has increased as depositors continue to withdraw funds from Spanish banks. Spanish banking stocks have, inter alia, responded positively to the expected announcement today. However, the move will increase the risk of the ECB;

Whilst generally, I cant see much opposition to Germany’s desire to enforce centrally controlled fiscal disciple in the EZ, the real problem country is France. They will fight such moves tooth and nail. However, I really don’t understand what alternative France has. Its not strong enough to tough it out by itself anbd its economy looks suspect. However, beware the inevitable political maneuvering;

Brazil and China announced a R$60bn (US$29bn) currency swap. China has entered into over 20 such agreements with various countries, though to date, only Hong Kong has has to activate its lines. To date, cheap Chinese goods have flooded into Brazil, impacting domestic producers, whilst Brazil has exported just unprocessed commodities;

US existing home sales declined by -1.5% in May, to an annualised rate of 4.62mn, though a 9.6% increase YoY. However, with cheaper mortgage rates,in particular, US housing is expected to continue to recover.

Moody’s reduced the credit ratings of 15 of the worlds largest global banks, with Credit Suisse suffering a 3 notch downgrade, though Morgan Stanley was downgraded by just 3 notches. The news was expected, though will increase the borrowing costs of the relevant banks and, in addition, increase collateral requirements demanded by counter parties. Investors have shrugged off the widely anticipated Moody’s statement;


Weaker US economic data added to the downbeat move in US markets yesterday, which has followed through into Asia and Europe, though Europe is recovering and US futures suggest a higher open. Oil (worryingly) sold off, with WTI and Brent trading below US$80 and US$90 respectively – some recovery this morning. I certainly would be worried if Oil trades below these levels for some period of time.

The German Constitutional Court issues are concerning, not that they are expected to stop ratification of the ESM and the fiscal compact, but because it will take more time (greater uncertainty), something which the EZ has run out of. Having said that, I continue to believe that the EZ will deliver something at the next heads of State meeting on the 28/29th June, most likely agreement that the EFSF/ESM will be able to buy bonds in the secondary markets. With expectations extremely low, some good news is likely to be received positively by markets. Furthermore, I believe, increasingly, that the ECB will cut rates on 5th July.

I continue to believe that it is dangerous to be short at present – indeed, I suspect it will be a buying opportunity next week, though investors may sell off into this weekend. The financials have not been beaten up, for example – indeed, European financials are performing well today, though the energy and mining sectors are weak. Gold does not look like the place to be, given declining inflation. In addition, historically, Gold has not acted as the insurance policy it is alleged to be.

The Yen has not strengthened in spite of the weaker US and European economic data. Shorting the Yen has been the quickest way to the graveyard in the past, but……..The Euro is looking weak, with the US$ and Sterling holding up.

Kiron Sarkar

22nd June 2012 .

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