Australian economy susceptible to downturn

Australian banks are heavily reliant on wholesale financing and will, in due course, require RBA assistance. The FT quotes a report produced by Variant Perception that the RBA will be forced to cut interest rates aggressively or be forced to prop up their banks through domestic open market operations ie QE. For full disclosure purposes, I’m short Australian banks, as I am the A$;

The collapse in iron ore prices (down 25% since May) has forced Australia to reduce its 2013 forecast for its terms of trade by -6.0%, though analysts expect the actual decline will be closer to 10%+. An increase in the issue of debt by the government is expected, together with a greater fiscal drag (given the politically driven requirement to achieve a budget surplus) and lower interest rates – should reduce the attractions of the A$ (Source FT);

Japan’s Vice Finance minister threatens intervention to reduce the value of the Yen. Great, but without international assistance, which will not be forthcoming, the impact of any intervention will be short lived;

Italian consumer confidence declined marginally in August to 86, from 86.5, in line with forecasts. However, whilst the current climate component (in respect of the economy) rose to 69.4, from 68.7, the future expectations component declined to 76.7, from 79.8. The employment index remained stable at 112;

Catalonia has requested E5bn of funds from the Spanish central authorities. Total debts amounts to E42bn and the region is the 2nd in Spain to request aid. The request for aid from one of Spain’s “richest” regions just confirms that Spain itself will formally request aid, shortly after the decision by the German Constitutional Court decision. In addition, the region is expected to miss its budget deficit target of -1.5%, with the deficit coming in closer to -2.5% this year;

Deposits at Spanish banks fell to E1.509tr in July, from E1.583t at the end of June, as depositors withdrew funds and moved them off shore, mainly to Germany;

Reports circulate that the Troika will ease Portugal’s budget deficit target to 5.0% this year. In any event, Portugal will need another bail out;

Irish August consumer sentiment rose to 70, from 67.7 in July. Yet another indication that Ireland is recovering, though from a very low base;

Germany’s business lobby, the BGA, reports that the country will face a slowdown rather than a recession. They add that the services sector remains “positive”, with growth expected to be +2.0% this year and +2.25% next. Possibly, but it is beyond doubt that the important production/export sector is facing significant headwinds, which I would have thought would impact on the services sector;

German politicians want to cut their budget deficit to zero by 2014, rather than by 2016 as previously agreed. Well that’s Germany for you;

US August consumer confidence collapsed to 60.6, as opposed to 66.0 expected and 65.4 in July, a 9 month low. Whilst the current situation component came in a 45.8, roughly the same as July’s 45.9, the future expectations component (next 6 moths) collapsed to 70.5, from 78.4, the lowest since November 2011. Job expectations declined to 15.4, from 17.6. Those expecting better business conditions in the next 6 months dropped to 16.5, from 19 in July. Those expecting that their incomes would decline rose to 10 month high of 16.8, from 14.9 in July. Higher petrol prices, continuing problems in Europe and the US “fiscal cliff” were the reason cited for the decline in confidence;

US home prices rise in June Y/Y, the 1st time in nearly 2 years. The Case/Schiller index (20 major cities) rose +0.5% in June Y/Y (a massive +11.3% annualised over the last 3 months), though are still down by over 30% from the peak in 2006;

The second reading of US 2nd Q GDP was revised higher, from +1.5% to +1.7%, in line with estimates. Personal consumption was up +1.7% Y/Y, higher than expectations of +1.5% and +1.5% previously. Core PCE came in at +1.8%, as expected;

G7 countries urged oil producing nations to increase output to reduce prices and threatened to release strategic reserves, if necessary. The IEA has been less resistant on the prospect of the US releasing oil reserves from its strategic reserve in recent days;

Outlook

Asian markets closed mixed, though Chinese markets fell by a further 1.0% approximately. European markets are about -0.5% lower. Gold is trading around US$1662, with Brent lower at US$112. The VIX is up to around 16, though still reflects an amazing amount of complacency. US, UK and German 10 year yields are stable/marginally lower at 1.64%, 1.47% and 1.34%. The Euro is marginally lower at US$1.2544. Trading volumes remain depressed.

I remain cautious.

Kiron Sarkar

29th August 2012