German Constitutional Court to decide on legality of ESM in 2 to 3 months

Australian consumer confidence rose to a 5 month high, as the RBA interest rate cuts of 125bps are taking effect. The sentiment index rose by +3.7% to 99.1, the highest level since February. The A$ continues to rise and is at a record against the Euro. The news (see below) that China is to spend more (basically a stimulus programme) on fixed assets will also help, particularly the mining sector;

China sent in 2 patrol boats into territory claimed by Japan. The Japanese government has threatened to buy these islands from the private owner. The Chinese do not want to discuss these issues at the upcoming Asean Summit – some hope;

Premier Wen stated that the country needs to maintain “a certain amount” of economic growth. He added that promoting growth is the key to stabilizing China’s economic expansion and “Growth-stabilizing policies, include boosting consumption and diversifying exports, but currently, what is important is to promote a reasonable growth in investment”. The statement was posted on the uber important State Council web site. Investment is to be be focused on railways, public utilities, energy and telecoms, health care and education (Source Bloomberg).
With a change in leadership later this year, China has no choice. In addition, fixed asset expenditure is the fastest way of increasing GDP, as China does not have the same problems as we do, such as planning approvals etc. Whilst spending will be less than in 2008/9, I guess the Chinese will increase spending to as much as is necessary, if they do not see pretty rapid results, especially as the change in leadership is set to occur in October this year – indeed, its getting very late. Indeed, recent statements suggest that there is more than a hint of panic in China.
The Chinese markets were up – but only by approx 0.5% today. The news should, in theory, be good for the miners (and A$) in the short term, in particular, though markets are increasingly sceptical re China. Indeed, the miners are not really responding today. In addition, it looks as if the Chinese authorities are dithering – well politicians in developed economies are doing the same, so why should they be different. However, whilst markets may pop in the short term (indeed, I believe they will) as the Chinese authorities move far faster to implement a larger stimulus programme, I remain BEARISH on China in the medium to longer term;

The IMF has revised Italy’s budget deficit to 2.6% for the current year, from 2.4% in April. The Italian government is working on a deficit of just 2.0% !!!!;

Spain is to cut its budget deficit by as much as E65bn over the next 2 1/2 years, starting with a VAT increase in August this year. These measures are the 4th austerity package in 7 months !!!!. VAT is to rise to 21%, from 18% presently, unemployment payments are to be reduced, following an initial period, ministerial budgets are to be cut, some subsidies ended and/or reduced and the regions are to be offered sovereign financing in return for spending cuts. The cuts are expected to amount to 2.3% in 2013 and 1.9% in 2014. OK, so the EU increased Spain’s budget deficit forecasts to 6.3% this year, from 5.3% previously. However, Spain’s central governments budget deficit rose to 3.41% for the 5 months to end May, approaching the target of 3.5% for the year. Personally, I believe that Spain’s budget deficit will come in at closer to 7.0%. As you know, I expect Spain to request a full bail out within the next 3 months. With the German Constitutional Court issue overhanging (see below), well….I suppose the EFSF can deal with funding requirements initially.
In a further statement, the EU states that senior bondholders and depositors would not be involved in burden sharing. OK, but a number of the banks subordinated debt holders (who will be affected) also happen to be the banks retail customers – estimates suggest that some E7bn in respect of 100k Spaniards is involved. This is getting messy. However, I continue to believe that shareholders/debt holders will have to share in the burden sharing.
Spanish miners are on the march to protest austerity measures. The previous government awarded the mining industry with subsidies that equate to E290k per miner last year !!!;

The German Constitution Court is to take 2 to 3 months to decide on the the legality of the ESM and the fiscal compact. This is mighty dangerous. Whilst my very clued up German friends tell me that the Court will not declare the agreements illegal, this is going to create much uncertainty. Very dangerous. The UK’s Daily Telegraph allege that Merkel/Schaeuble broke German law in respect of allowing the ESM to recap banks directly – hence their back peddling recently !!!!. Really getting dangerous;

The Irish press state that Ireland is likely to get around E15bn for the banks that it pumped E28bn of taxpayers funds later this year.A further E31bn however is expected to remain with the state, though the annual repayments of E3.1bn per year are to be spread over a longer time. Well better, but not enough, basically;

Bob Diamond, the ex CEO of Barclays, wants to return to provide evidence to the UK Parliamentary Treasury Committee. Well, he was going to be recalled anyway. However, I think he’s not going to like it. There are a number of issues, which he will find to be a problem. In addition, members of the committee want blood;

US mortgage applications for the week ended 6th July came in at -2.1% lower W/W, better than the -6.1% the previous week;

US May trade deficit came in at -US$48.7bn, lower than the revised April number of -US$50.6bn and in line with expectations of -US$48.6bn. Lower energy prices was the main reason for the decline;
The deficit with China amounted to -US$26.0bn,(-US$24.6bn in April).
With Europe, the deficit was -US$10.5bn, higher than April’s -US$8.7bn; and
The deficit with Japan came in at -US$6.4bn, virtually unchanged from the -US$6.3bn in April.

The drought in the US mid west (the worst since 1988) has resulted in the US government cutting corn production by 12% for this year, much greater than expected. Food prices are rising generally.


Asian markets closed mainly higher, though only modestly. Very disappointing given Premier Wen’s statements. This is a major issue as markets are ignoring China – the 2nd time in the last few weeks. Bearish.

European markets having opened mainly (modestly) higher have retreated lower.
US markets have opened and are modestly higher, though are now drifting lower.
The Euro is weak again – currently US$1.2250 and weakening. Brent’s up around US$98.50, with gold at US$1575, modestly up.

The news that the German Constitutional Court could take some 2 to 3 months to decide on the fiscal compact and the ESM is particularly worrying, though markets have taken it in its stride – why?. The lack of reaction to Premier Wen’s statements is also a major concern and is really worrying me.

Personally, I think that risk/reward suggests caution, indeed becoming bearish.

Having said that, I have no doubt that the Chinese authorities will ramp up their stimulus programme so as to get an impact – they have no choice. The EZ, well, I cant get the German Constitutional Court out of my mind. However, the FED will go for another bout of QE if there’s a problem.

Think its better to be safe at present, though markets (particularly emerging markets and European) are cheap.

FED minutes to be released today will be important.

Kiron Sarkar

11th July 2012

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