Moody’s downgrades Germany, Holland and Luxembourg

HSBC’s Chinese July flash PMI came in at 49.5, up from 48.2 in June and a 5 month high. Whilst improving, the flash PMI number remains below the expansion threshold of 50. In addition, whilst the output sub-index came in at a 9 month high of 51.2 in July, the employment component declined (which will put more pressure on the government to act with further stimulus measures), though most of the other components registered an improvement. The Yuan traded at its lowest level against the US$ this year. With (increasing) capital flight, much lower FDI and a declining trade surplus, it looks as if the PBoC will be in no hurry to strengthen the Yuan;

Rosneft has stated that it is interested in buying BP’s 50% stake in TNK-BP. BP’s Russian “partners” are also interested in buying at least half of BP’s stake (which BP is not interested in) and are in negotiations with BP at present;

Representatives of the Troika (EU,IMF,ECB) are in Athens. It is clear that Greece has not met its commitments, which casts serious doubt as to whether Greece will receive the next (delayed) tranche of its bail out funds. The German Vice Chancellor stated that Greece will not get any further aid unless it complies with its commitments. With the German public increasingly opposed to further bail outs (and in respect of Greece, in particular) and especially of country’s that do not comply with their commitments (Greece, again), I cannot see how the Troika can suggest that further aid (especially ahead of the decision by the German Constitutional Court’s decision on the 12th September) be provided to Greece – it looks politically impossible. As a result, a Greek exit from the EZ is a near certainty in my humble view. I had thought that it would have been deferred to next year, but the chances of a Grexit in 2012 is increasing. Mr Barroso is due to visit Athens on the 26th July, which clearly indicates the extent of the crisis. The Greek economy is expected to decline by between -7.0% and -7.5% this year;

Spanish newspapers report that Spain will seek a full bail out, unless the ECB starts to buy its bonds. With 10 year yields over 7.50% (currently 7.58%) and no hope of lower rates in the immediate future, Spain simply cannot keep borrowing at these rates. In addition, it is expected that between 6 and 8 (out of 17) of Spain’s autonomous regions will seek emergency aid from the E18bn of funds that have been made available by the Central Government. However, the requests for aid will far exceed the resources available, especially if unpaid bills (payable by the regions) are taken into account. Catalonia itself has E41.8bn of outstanding debt, of which E13.5bn matures this year, E5.7bn in the 2nd half, reports the FT. In aggregate the Spanish regions have a combined debt load of E145bn.
However, it would be politically difficult for Germany/Mrs Merkel (and Holland, given its impending general election) to have a Spanish bail out at present, which makes it difficult, though if necessary the EFSF will have to act. That leaves the ECB, who will be reluctant to intervene, as they rightly see this as a political issue. However, with politicians unwilling/unable to act at present (including the Germans, who will be reluctant to act, ahead of the Constitutional Court issue), the pressure for the ECB to start buying peripheral bonds will increase. Spanish authorities allege that they have funded 68% of their requirements for the year, but with demands from the provinces, that level of funding looks optimistic to say the least.
Spain sold E1.63bn of 3 month bills at an average yield of 2.434%, as compared with 2.362% previously. The 6 month bills yielded 3.691%, higher than the 3.237% previously;

Moody’s downgraded its outlook for Germany, Holland and Luxembourg to AAA negative, from AAA stable, citing the increased likelihood of support for Italy and Spain and the higher probability (a certainty in my humble view) of a Grexit. Finland is now the only EZ country with a AAA stable rating, according to Moody’s (the same as S&P), given its “unique credit profile”. The ratings of both France and Austria (currently AAA negative) will be reassessed, with a decision to be taken by 2nd September. Whilst not unexpected, this news will put yet more political pressure on Germany/Mrs Merkel (very dangerous to underestimate) and, in addition on Holland, which is facing an election in September. Holland is becoming more and more Euro sceptic, an issue which has not really been focused on by analysts – also extremely dangerous. Finally, Moody’s expressed its concerns about German banks, especially given their exposure to Italy and Spain – a big issue, as German banks are materially under capitalised, if they were to provide fully for losses. German banks, in addition, have material exposure to Spain and Italy;

German July services PMI came in at 49.7, lower than the 50.0 forecast and 49.9 in June. German July manufacturing PMI came in at 43.3, also lower (markedly) than forecasts of 45.3 and 45.0 previously. The July composite PMI came in at 47.3, lower than June’s 48.1;

EZ July services PMI came in at 47.6, slightly higher than expectations of 47.2 and 47.1 in June. EZ July manufacturing PMI came in 44.1 (the lowest in over 3 years), lower than expectations of 45.3 and June’s 45.1. The EZ July composite PMI came in at 46.4, in line with forecasts and unchanged from June, though the 6th consecutive monthly decline;

The French business confidence indicator declined to 90 in July, from 92 in June. The French July composite index came in at 48.0, higher than the 47.3 in June and a 4 month high;

US residential home prices rose by 0.2% in the 2nd Q YoY, the 1st time since 2007, according to a well followed index published by Zillow. Indeed, Zillow reported that prices rose by +2.1% in the 2nd Q of 2012 Q/Q, the largest gain since the end of 2005. This and other similar data is yet another sign that US residential home prices have stabilised and, dare I say it, improving;

UPS cut its full year forecasts following a decline in international sales. In addition, 2nd Q earnings missed forecasts. The results highlight the problems and, indeed, the slowdown of the global economy;

US July PMI came in at 51.8 (the lowest since December 2010), lower than the forecast of 52.0 and June’s 52.5. Whilst the employment component came in marginally better at 52.9, as opposed to June’s 52.8, the new orders component declined sharply to 51.9, from 53.7, suggesting a weaker outlook;


There’s far too much uncertainty around to be positive about markets – indeed, the risks are to the downside. Germany/Mrs Merkel has turned cautious, which is certainly a major negative as far as I’m concerned. The only player that has the flexibility to act, the ECB, sees the problem (rightly) as a political/policy issue, but if the situation deteriorates further (quite likely) will be forced to act, I suspect.

Interestingly, the DAX has held up well, but the peripherals (Spain and Italy) are materially lower. German bund yields have risen following the Moody’s downgrade.

The Euro is on the weaker side. Brent and Oil are marginally higher.

Get the feeling that the current difficult environment will continue for some time, unfortunately

Kiron Sarkar

24th July 2012

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