Grexit becoming more likely

RBA Governor Mr Glenn Stevens suggests that Australia’s mining boom will end within a year or so. He added that the RBA may act (to reduce interest rates) if growth declines. Mining capex is being cut, confirming Mr Stevens fears. Mr Stevens’s views were echoed by Australian Resources Minister Mr Feguson, who reports that the country’s mining boom has ended “you’ve got to understand, the resources boom is over”. The above comments, together with Mr Stevens view that the A$ is a “bit on the high side”, weakened the A$, which looks as if it has further to decline;

Job losses in China are rising, reports the WSJ, though relatively slowly at present. Rising unemployment, in my view, will spur Chinese authorities to increase their stimulus measures and provide further monetary easing, especially ahead of the change in leadership later this year;

The Indian Central Bank, the RBI states that the government is unlikely to meet it budget deficit target of 5.1% of GDP for the 2012/13 fiscal year – well what a surprise – I think not. The ratings agencies have threatened to withdraw India’s investment grade status – likely in my view;

Portugal is unlikely to meet ts budget deficit target of 4.5% of GDP this year even though the deficit for the period Jan – July contracted from E5.7bn last year to E2.79bn this year. Taxation revenues are declining;

Spain to request bail out. Reports circulate that Spain is in discussions with the EZ as to the terms that will be imposed in the event that the country requests a bail out. It had previously asked for help for its banks. A bail out is inevitable, but will have to wait till after the ruling by the German Constitutional Court;

Mrs Merkel and Mr Hollande kept up the pressure on Greece yesterday – the Greek PM, Mr Samaras, is visiting Berlin today and Paris tomorrow. Mr Samaras has asked for a 2 year extension to meet fiscal targets set in return for receiving a bail out. EZ leaders are reluctant to agree to a extension and it is politically impossible for countries, including Germany, to provide more aid. I continue to believe that Grexit is inevitable, quite possibly this year. Mr Kauder, head of Mrs Merkels Parliamentary party, stated today that neither the terms, nor the content of a Greek rescue can be renegotiated. The German Finance industry is studying a paper to assess the consequences of a Grexit. Unless the German Constitutional Court’s ruling is negative, the EZ (through the ECB) is slowly initiating measures to avoid/reduce, as far as possible, contagion risks, which lowers the risk attached to Grexit;

The Dutch Socialist party is likely to become the largest party in Parliament following next months generals elections. The party has been strongly opposed to the austerity measures (supporting stimulus measures) and remains euro sceptic. This could prove to be a major blow for the German inspired plans, in particular as Holland remains just 1 of the 4 AAA rated EZ countries. In the past, the SP has voted against rescue packages for Greece and Spain and, in addition, has been opposed to the (German inspired) fiscal compact, the ESM, Euro bonds and an European banking union. Good luck trying to find a speedy solution given those positions. However, it must be said that forming a government in Holland requires a coalition of a number of parties, which looks difficult at present (Source FT). The market has not focused on Holland and the impending election on 12th September – dangerous;

EZ PMI data released yesterday suggests that the bloc will face a 2nd recession in 3 years. The contraction in GDP is likely to amount to -0.5% this Q. The composite index was marginally higher at 46.6 in August, (46.5 in July), though has been below 50 for the 7th month. German composite PMI fell to a 3 year low and a 4th consecutive monthly contraction;

UK 2nd Q GDP has been revised higher to a decline of -0.5%, from -0.7% previously. Better construction data was the main reason for the improvement. Sterling has improved following the announcement. Whilst manufacturing (below 50 for over a year) was slightly better than expected (45.3, as opposed to 44.1 expected and 44.0 in July), services were marginally weaker at 47.5, from July’s 47.9 and expectations of 47.6;

US new home sales rose by 26% Y/Y in July to an annual rate of 372k homes (365k expected), whilst inventories declined to 142k, the lowest level since 1963. The Federal Housing Finance Administration reported that prices of existing homes rose by +1.8% in the 2nd Q, the largest increase in 6 years. I continue to believe that the US residential sector has stabilised and is improving. Personally, I believe the building materials sector looks better than the home builders, which appear expensive. A recovery in the US housing market remains the key for a pick up of the US economy;

US initial jobless claims rose to 372k, higher than the 365k expected and above last weeks 368k. Continuing claims came in at 3.317mn, higher than the 3.30mn expected;

US August manufacturing PMI came in at 51.9, better than the 51.2 expected and above July’s 51.4. New orders rose to 52.6, from 51.0 and employment declined, though only marginally from 52.7 in July to 52.5 in August;

Will the FED announce QE3 in September or not. A debate is raging. Personally, having read the minutes, the FED reported that they would act unless there was a significant improvement in the US economy. Has there been, I don’t think so, in spite of better retail sales numbers the other day. In addition, the bond and currency markets suggest QE3 is coming, as is Gold. Whilst tight, I believe that the ED will announce QE3 in mid September, with some hint at Jackson Hole. In addition, the FED may extend the guidance in respect of lower interest rates;

The Republican party is setting up a “gold commission” to consider restoring the link between the US$ and gold. Hmmmm;

Outlook

Weak US markets last night – closing near their lows. Asian markets closed around 1.0%+ lower, though European markets are only slightly lower. Gold is marginally lower(US$1664) though gold bulls suggest that the price will increase much further. Brent is trading at US$114.20, also lower on the day. Bond yields of the “better” countries continue to decline, the 10 year bunds are down to 1.36%, whilst the equivalent US bond is yielding just 1.68%. The UK 10 Gilt is yielding just 1.55%, below equivalent US yields. Amazing. However, the BoE will own over 40% of the UK’s debt market following the completion on the current round of purchases, more than double that owned by the FED.

I must say, I was surprised by the weaker markets yesterday, though continue to believe that being cashed up and waiting is the right policy. Risks/rewards are just not in my favour, I believe. However, I do believe that the FED will announce QE3 in September and that Draghi will deliver on the 6th September, though he may have to be a bit cautious ahead of the ruling by the German Constitutional Court – may well be positive for the financials.

Kiron Sarkar

24th August 2012

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