JPM reports trading losses of US$5.8bn in respect of its CIO

China released its GDP and other data today:
GDP (Q2) Y/Y 7.6% vs exp 7.7% (Prev 8.1%)
GDP (Q2) Q/Q 1.8% vs exp 1.6% (Prev rev 1.6%);
GDP (Q2) YTD Y/Y 7.8% vs exp 7.9% (Prev 8.1%)
Industrial production (Jun) 9.5% vs exp 9.8% (Prev 9.6%)
Retail sales (June) 13.7% vs exp 13.4% (Prev 13.8%)
Investment (June) YTD 20.4% vs 20.1% (June)

Basically slightly below expectations and the slowest growth for 3 years. However economists expect that growth will pick up in the 2nd half of the year, particularly in 4th Q. Further interest rate and RRR cuts are likely. In addition, the Chinese will increase stimulus, if needed. Residential property prices seems to have stabilised and may just be rising – property sales volumes rose by 6.9% in June, a turnaround from 7 months of decline (Price data is to be released on 18th July). Investment spending has increased materially into June and continues. However, electricity generation was weaker which casts some doubt on the above numbers.
Muted reaction on the stock market to the above news – closed 0.5% higher. Hong Kong was just 0.3% higher;

The Bank of Korea reduced its 2012 GDP forecast to 3.0% (lower than Ministry of Finance’s estimate of 3.3%), from 3.5% in April and 3.7% in December. CPI has been reduced to 2.7%, from a forecast of 3.2% previously;

Singapore’s GDP unexpectedly declined by -1.1%, in the 2nd Q, well below the gain of +0.6% expected. GDP rose by +1.6% YoY, well below historic growth rates;

Indian exports declined by 5.45% in June YoY. Imports fell by 13.5%, resulting in a trade deficit of US$10.3bn. Cant see an imminent fix to the Indian economy, given the political/policy paralysis;

Moody’s cut Italy’s credit rating by 2 notches to Baa2 and warned that further downgrades were possible. The downgrade leaves Italy just 2 notches above junk. However, Italy auctioned over E3.5bn of 3 year bonds today at a yield of 4.65%, below the 5.30% previously (June 14th) and the lowest since May. They also sold a further E1.75bn of longer dated debt. Bid to cover was also better, indeed higher for the longer dated (11 year) paper. Personally, I believe Moody’s has over reacted. Italy is in better shape than the latest rating suggests.
A senior official in Italy’s PDL party confirmed that Mr Berlusconi will run in next years general elections. However, the PDl has suffered recently and maybe Mrs Merkel will be spared the return of Mr B – I still cant get over what he called her. Unprintable unfortunately, but will send to those interested;

The central authorities in Spain have threatened to take control of budgets in regions that don’t meet their austerity targets, whilst offering financial assistance to held avoid defaults. They refused to relax the 1.5% budget deficit targets for the Spanish regions, reducing to just 0.7% next. The semi autonomous regions accounted for 69% of the overspending last year;

UBS, in a report in the FT, believe that investors are taking the upcoming ruling by the German Constitutional Court too lightly. The commonly held view is that the Court will rule that Germany’s participation in the ESM and the fiscal compact is legal constitutionally, a view that my clued up German friends also believe, though even they will admit to a degree of concern. In particular, UBS raise the following points:
a) the EFSF, which has sufficient funding for current proposes, relieves the Court from having to decide on the case quickly – analysts believe it will take 2 to 3 months;
b) according to the second senate president, Mr Andreas Vosskuhle, Germany has largely used up the transfer of budgetary sovereignty permitted under the Constitution. If this is the case, the ESM and participation in the fiscal compact impinges on the Bundestag’s sovereignty to an extent that is no longer acceptable;
c) the Court may want to protect its interest, as otherwise the European Court of Justice would have precedence in the future;
d) one of the members of the Court, Mr Peter Huber, has often taken an Euro sceptic position. He used to be a member of Mehr Demokratie (more democracy) , which just so happens to be one of the major claimants in the law suit on the ESM and the fiscal compact.
UBS add that Mr Vosskuhle and Mr Huber, the 2 most important judges, have previously complained about a perceived lack of democratic legitimacy at the supra-national level, as well as overstretched limits to the transfer of German national sovereignty.
It is certainly true that the judges have over ruled Mrs Merkel 3 times in the last few years and that Merkel has allegedly ignored the German constitution in her bail out policies. Relations between the 2 parties are not great.
Mr Schaeuble has hinted that a referendum may be called. Well, before that all hell will have broken loose. In addition, German politicians have not sold the whole EZ political union, including fiscal and undoubtedly transfer union to the German public – I repeat B dangerous. The EFSF has sufficient capacity to meet the requirements of Greece, Ireland, Portugal and Spain, together potentially Cyprus, but will have only E100bn left and with no guarantee as to when the ESM will be up and running, well………..
Whilst not an immediate problem, more air time will be devoted to this in coming months. Its the uncertainty created, as I keep banging on, which is of concern. In addition, this is a tricky issue and not easily understood. Its also going to be near impossible to be sufficiently confident (in my opinion) to be comfortable – there are serious arguments for both sides;

The US has announced additional sanctions on Iran. The IEA stated that Iran’s oil production fell to 3.2mn bpd last month, the lowest for 22 years, due to the sanctions. Brent crude has risen to US$101, as a result;

JPM announced that it has restated 1st Q results which reduce net income by 8.7% or US$459mn to US$4.92bn. JPM also reported a US$4.4bn trading loss (US$4.0bn expected) in the 2nd Q and more than double the initial estimate on its CIO synthetic credit portfolio.Total losses incurred by the CIO were US$5.8bn – though some positions remain open !!!. They added that “recently discovered information raises questions about the integrity of the trade marks and suggests that some individuals may have been seeking to avoid showing the full amount of losses being incurred in the portfolio during the first quarter”. Yes, but what about your internal controls, which are supposed to detect such issues, Mr Dimon. He admitted to “material weakness” in internal controls. Apparently JPM has “significantly reduced the total synthetic credit risk” ie not all the positions are closed. On first blush, this does not look good, though JPM’s 2nd Q results were much better than expectations – eps of US$1.21 as opposed to expectations of just US$0.90c and its underlying business remains highly profitable. Indeed, in pre market trading, JPM is up +1.7%;

US June PPI M/M 0.1% vs exp of -0.4% (Prev -1.0%). On a Y/Y basis it came in at 0.7% vs exp 0.2% (Prev 0.7%)
Ex food and energy June M/M 0.2% vs exp 0.2% (Prev 0.2%). On a Y/Y basis, June came in at 2.6%, vs exp of 2.6% (Prev 2.7%)
The rise was unexpected;

12 global banks could face US$22bn in penalties and damages to investors and counter parties in respect of the Libor rigging scandal reports Morgan Stanley. The potential final cost could be even greater once ongoing US and EU cartel investigations are concluded. The cost could amount to between 4% to 13% of banks 2012 eps or -0.5% of book value. The average fine paid by a bank could amount to US$400mn, though Deutsche and RBS could each face fines of US$1bn+;

The IEA forecasts that oil demand of 45.7mn bpd from EM’s will overtake consumption in DM’s, by 600k bpd. Current global demand of 89.9mn bpd is expected to increase by 1mn bpd next year;


Modestly higher Asian markets, though European markets are up, though off their highs. US futures suggest a modestly higher open.

It looks as if China is stabilising and I for one, expect that 2nd half GDP will be higher.

However, my major concern remains the German Constitutional Court. Whilst my extremely clued up friends tell me that the Court is unlikely to rule against the fiscal compact and the ESM, it is, I suspect, not with the 90% certainly they generally feel. This issue will be ignored for a while, as the decision is expected to take some 2 to 3 months to decide upon, though uncertainty in due course will weigh on markets. The real problem is that EZ, including German, politicians remain reluctant to consult their public – a very dangerous habit in my view.

There is increasing chatter that the ECB could introduce a negative deposit rate (as early as September), to force banks to stop parking money with them and to buy assets/lend. Draghi is certainly proactive and I suspect this idea may well be being considered seriously. The Euro is drifting lower – currently US$1.2174.

Have a great weekend.

Kiron Sarkar

13th July 2012

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