US Attorney General Subpoena 7 Global Banks in LIBOR Probe

Chinese Premier Mr Wen stated that “downward pressure on our economy is still big and difficulties may last for a while”, though added that China would meets its growth targets this year. He added that declining inflation allowed the authorities more room for further monetary easing. Others senior party officials disagree and would prefer to wait, before authorising further stimulus, in particular. I continue to believe that, at the end of the day, the Chinese authorities will ease monetary policy and add to the present fiscal stimulus, in particular if the economic slowdown results in higher unemployment. In addition, it does look as if property prices are not just stabilising, but are beginning to rebound. Unlike a few years ago, markets remain deeply sceptical and words (even from Mr Wen) are not enough – actions are necessary;

FDI into China falls to a 2 year low in July. Investment declined -8.7% Y/Y to US$7.58bn, much worse than expectations of a decline of just -2.5% and the 8th decline in the last 9 months. In addition, China reported a US$71.4bn capital account deficit in Q2, the largest since 1998;

There is growing conflict between President Putin and his PM, Mr Medvedev. Tensions have been rising in recent months. The reason, this time, is the appointment of Mr Sechin as Chairman of Rosneftegaz, which has significant financial resources and which Mr Sechin wants to use to acquire assets. Mr Medvedev is opposed and wants to privatise Rosneftegaz. In addition, there is “history” between Mr Medvedev and Mr Sechin (Source FT);

Speculation is rising that Spain will submit its official request for funding in respect of its banks this week. There is also talk of a request for a full bail out. It is clear that Spain will require a full bail out, though the PM Mr Rajoy has been in denial, or dithering at best. His current position is that he wants to see the terms, which the ECB will impose in respect of their proposed purchases of short term debt, before deciding. However, Ollie Rehn, the EU Commissioner stated that Spain has an “open mind” on the issue. I would have thought that Germany would prefer that Spain request a full bail out, once their Constitutional Court has ruled – the ESM cannot be established until the Constitutional Court allows the German President to sign off on the establishment of the ESM. However, pressure is rising on Spain
Last month, the ECB imposed restrictions on the amount it will lend to Spanish banks (currently around 33% of ECB lending or E413bn), which will force Spain to request (at least part – E30bn) of the E100bn bail out for its banks far more quickly.
I continue to believe that Spain will need to restructure its debts – can’t see how even the current debt load (which is increasing) is sustainable, given the declining economy. To repay accumulated debt, Spain needs to generate a massive current account surplus, which looks impossible, especially as capital continues to exit Spain. In addition Spain continues to post a trade deficit, which in June was -E2.7bn, much higher than the -E1.925bn in May;

The German Foreign Minister Mr Westerwelle signalled willingness to give Greece more time to achieve their targets, given the “time lost due to the Greek elections”, though his views are very different to those expressed by his colleagues in the FDP, Mrs Merkel’s coalition partner. However, he added, “it is clear that there cannot be a substantial changes to reform agreements”. Greece had asked for an extension of the reform agreements till 2016, which the Greek PM is to discuss with Germany and France next week. In my view, if the ESM/Fiscal compact is established and the ECB starts buying short term peripheral debt, the flexibility provided to Greece will be limited, forcing a Grexit. If otherwise, the situation is uncertain. However, the bottom line is that it is politically impossible for Germany (Mrs Merkel) and a number of other EZ countries (Holland, Finland, for example), to provide further support for Greece. OSI is coming, as Greece has to restructure its debts;

EZ July CPI came in at +2.4%, in line with expectations and unchanged from June. Core CPI, at +1.7%, was also in line with expectations, though marginally higher than +1.6% in June;

UK July retail sales rose by +0.3%, better than the decline of -0.1% expected and June’s rise of +0.1%. Y/Y retail sales were +2.8% higher, much better than expectations of +1.4% and June’s +1.6%. Yet another data set which suggests that UK economic data is better than official statistics. Sterling rose on the news;

US July CPI came in unchanged, better than the +0.2% expected. Y/Y, CPI was +1.4% versus expectations of +1.6% and +1.7% in June. Core CPI M/M was +0.1%, as opposed to +0.2% expected, or +2.1% Y/Y. The lower CPI data supports the argument that the FED will introduce QE3 in September, though Goldman’s suggest that the FED will delay till January next year and Treasury yields are rising on expectations that QE3 in September is less likely;

US July industrial production rose by +0.6%, better than the increase of +0.5% expected and the downwardly revised +0.1% in June (from +0.4% previously). Autos and utilities (due to the warmer weather) improved. Capacity utilisation rose marginally to 79.3%, from 79.2% previously;

Empire State August manufacturing index came in at -5.85, worse than +7.0 expected and July’s +7.39 and the worst since September 2011. The new orders component declined to -5.5, from -2.7 previously, whilst prices paid rose to +16.5, from +7.4. The employment component was lower, at +16.5, as opposed to +18.5;

The US NAHB August housing market index came in higher at 37, versus expectations of 35, the highest reading since February 2007 and up for the 4th consecutive month. I continue to believe that US housing continues to recover, though I play it through the building materials sector. If the housing recovery continues, the positive impact on the US economy will be significant;

Foreign purchasers kept buying US Treasuries in June, though the pace slowed from May. TIC data reports that net purchases of US Treasuries by foreign investors increased by US$32.4bn, though lower than US$45.9bn in May. Monthly net TIC flows rose by US$16.7bn, compared with an inflow of US$121.3bn in May. Given the uncertainties in July, I would expect that inflows into the US would have increased materially;

Brazil has announced a US$66bn stimulus programme. Brazil is to sell concessions in 9 highways and 12 railways and may move to sell airports, ports and waterways. GDP last year slumped to just +2.7% and is forecast to rise by just 2.0% this year. Implementation risks are an issue. In addition, whilst helping in the medium to long term, the measures will not stimulate growth in the short term;

7 of the worlds largest banks have been subpoenaed by US attorneys general in respect of the ongoing LIBOR probe. The banks are Barclays, CITI, Deutsche, HSBC, J P Morgan, RBS and UBS. Other institutions (the FT mentions 20 in total) are likely to be investigated. In total, 18 banks were involved in setting LIBOR in London;

More speculation of military action by Israel against Iranian nuclear facilities. Speculation, together with hawkish comments by senior Israeli politicians, has increased speculation that Israel will launch an attack against Iran ahead of the US Presidential elections. Who knows. Israel is adept at maintaining its options and surprising opponents. In addition, talk that Israel does not have the military capabilities, ignores their proven military skills;

US housing starts, jobless claims and the Philly Fed survey will be the important US economic data later today.

Asian markets (though not China or Hong Kong) responded positively to Premier Wen’s comments !!!!. European markets are weakish. In addition, the Euro is weakening further – currently US$1.2270. Increased talk of an Israeli attack on Iran has strengthened Oil – back up to around US$114.60. Yields of the more “stable” countries rose yesterday, whilst the reverse was true for the peripheral EZ countries. That trade has stalled/is marginally reversing today.

Given the above, I continue reduce my equity positions and, in addition, become increasingly defensive.

Kiron Sarkar

16th August 2012

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