Deflation – it must be, indeed is, Japan

The Australian finance minster states that the RBA has room to cut rates- read, please RBA, cut rates. Sounds like the A$ is going to weaken even further – indeed, its trading at a 5 week low against the US$;

South Korean industrial production fell by -1.6% in July M/M, the 2nd monthly decline and worse than the -0.9% expected. Y/Y, production rose by +0.3%.

Japanese consumer prices fell by -0.3% in July Y/Y, as compared with the central banks target of reaching an inflation target of +1.0% !!!! Sounds very much like the usual Japanese deflationary curse. Industrial output declined by -1.2% M/M in July (+1.0% Y/Y) and a private measure for manufacturing came in at the lowest since the March 2011 earthquake. Japan faces an almost certain economic decline in H2 in the year. Manufacturing PMI declined to 47.7 in August, as opposed to 47.9 in July, the 3rd consecutive monthly decline. (Source Bloomberg);

Chinese stocks declined for the 4th consecutive month in August, the longest series of losses since 2004.

Indian 2nd Q GDP rose by +5.5, higher than the +5.3% in the previous Q and the +5.2% expected. However, with persistently high inflation, a large budget  and current account deficit, the RBI has been reluctant to reduce interest rates. Personally, I believe that India faces tough times for quite a while yet. Government policy action has stalled, due to political and corruption related issues;

German July retail sales declined by -0.9% M/M (-1.0% Y/Y), much worse than the rise of +0.2% M/M expected and the previously (revised upwards) +0.5% in June;

Spanish newspapers report that Mrs Merkel has requested that Spain and Italy delay requests for a bail out. Constitutional Court concerns?

Spain will delay its decision to seek a bail out, until it knows the full terms of the bail out programme. Sensible, but Spain needs a bail out, irrespective of the terms. In any event, I really cant see that the conditionally attached to the bail out will be very much different to that around at present – however adherence to a specific fiscal target will be the key. The Spanish government continues to live in cloud cuckoo land;

Spanish adjusted real retail sales in July slumped by -7.3% Y/Y, as opposed to -5.2% in June;

The Spanish central authorities established an E18bn fund to assist regional governments. However, Catalonia, Murcia and Valencia have requested over 50% of that amount. Andalusia will undoubtedly be the next region requesting aid, expected to similar to Catalonia’s request in size. Basically, the fund is not big enough. A full scale bail out for Spain by the EZ is inevitable;

Spain suggests that they will recapitalise Bankia, using their own funds. Oh yeah. What with, monopoly money?

UK GfK August consumer confidence came in at -27 M/M, slightly better than the -29 expected and -29 in July. However, the index has been around this level since July 2011, the longest sump since the survey was launched in 1974. The British Chamber of Commerce cut its GDP forecast to -0.4% for the current year from +0.1% previously and the Confederation of British Industry has reduced its GDP forecast to -0.3%, from +0.6% in May;

UK home prices rose by the most in 2 1/2 years in August, reports Nationwide Building Society. Average prices rose by +1.3% M/M in August, the largest increase since January 2010 and is expected to remain “stable” for the next 2 years. The rise is surprising, given the general gloom and doom. However unemployment has not rise materially. Mortgage applications rose to 47.3k in July, up from 44.1 in June, though below the previous 6 month average of just above 50k (Source Bloomberg).

OK so Draghi is too busy to turn up to Jackson Hole. However, yesterday the ECB announced that he would not attend a meeting with the European Parliament – its getting serious boys and girls;

President Hollande states that a number of key decisions will be taken at the EZ meeting on the 19th October – well, its the EZ, boys and girls. Crisis, what crisis, they say?;

The EU proposes that the ECB supervise all EZ banks. That’s some 6,000 banks. The proposal is to be announced at the EU’s state of the union address on 12th September and must be approved by all 27 EU countries – unlikely. Germany (their finance minister, Mr Schaeube), for example, just wants the ECB to supervise the largest 20-25 European banks, with national supervisors responsible for the other smaller banks. He does not want Germany’s politically sensitive regional banks to be subject to ECB oversight. (Source FT);

The ECB is likely to reduce its forecast for EZ 2012 GDP growth next week. In addition, a number of analysts continue to expect that Draghi will reveal details of his bond buying etc programme next week. As the ECB has stated that they will defer their decision until after the decision by the German Constitutional Court, I really don’t understand why analysts expect details next week;

EZ August CPI came in at an estimated +2.6%, slightly higher than the +2.5% expected and July’s +2.4% – the slightly higher number reflecting higher energy prices;

EZ July unemployment rate came in at 11.3%, in line with expectations, but slightly higher than June’s 11.2%;


Asian markets closed lower – they have underperformed US and European markets for some months. Has anyone raised the “decoupling” argument recently !!!! – sorry, could not resist. European markets have reversed early declines and are trading higher. US futures suggest a higher open. The Euro is trading around US$1.2518, with Brent (October) up at US$113.30 and Gold also higher at US$1658. The VIX continues to climb, closing at 17.83 yesterday. Peripheral EZ bond yields continue to edge higher.

Bernanke day today, with his speech at Jackson Hole. I continue to  believe that he will set out the FED’s options, rather than announcing QE3, accompanied by a statement that the FED will act, if circumstances warrant.

The real market moving event remains the decision by the German Constitutional Court on the 12th September and details of Draghi’s bond buying etc policy thereafter. I notice that Morgan Stanley believes that there is a 60% chance that the Court ratifies the ESM. Personally, I believe that they will as well, but I really fear that they may impose some (restrictive) conditions – at least 50% probability, though quite likely higher – hence my cautiousness. In particular, I fear that the Court may limit the ability of the ESM to increase its firepower by leveraging itself. We all know that an E500bn (at best) ESM bail out fund is way too small.

I remain cautious and cashed up given the uncertainty, relating to the German Constitutional Court’s decision, in particular.

Have a great weekend.

Kiron Sarkar

31st August 2012

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