Australia 2nd Q GDP came in at +0.6% Q/Q, well below +1.4% in the 1st Q and below the +0.7% rise expected. Y/Y, the economy grew by +3.7%, though this pace of growth will decline sharply in H2 as capex in the mining sector (currently just in iron ore, but likely to extend to coal) declines, in particular. The A$ declined to a 6 week low – currently US$1.0190, though looking weak;
HSBC August Chinese services PMI came in at 52.0 M/M, down from 53.1, the lowest reading in an year. The Shanghai Composite index continues to decline – it closed down -0.5% today and at its lowest level since February 2009;
Differences of opinion between China and other S E Asian countries (supported by the US) relating to territorial claims of islands located in South China Seas continue – these discussions are going nowhere;
The Dutch PM, together with Mr Schaeuble, the German Finance Minister, state that they will not agree to a 3rd bail out for Greece. Indeed, the Dutch PM was even tougher – he added that he would only allow Greece more time, if it did not cost money. President Hollande states that Greece can only expect a 2 year extension if the Troika issued a positive report on Greece’s progress towards economic reforms. The German foreign Minister states that the EZ must impose sanctions on countries that breach the rules. A number of analysts tell me that Greece will remain in the EZ – I respectfully disagree;
Mr Fuchs, deputy CDU Parliamentary leader reports that Draghi does not have “too high support” from Mrs Merkel. Interesting, but personally, I think the Draghi/Merkel relationship is good and Merkel, privately, supports Draghi, but wont be overtly supportive in public for domestic political reasons. Mr Fuchs is opposed to excessive ECB bond purchasing of peripheral EZ bonds. He added that the German Constitutional Court (“GCC”) will authorise the German President to sign off on the ESM, subject to conditionality and, in addition, a referendum on that and other topics (Political Union) was unlikely. In addition, he stated that it would be very difficult for Greece to meet the terms and conditions of its MOU – competitiveness has to improve by 40% !!!. However, he reported that the situation in Spain and Italy was improving;
Mr Draghi reiterated yesterday that the proposed ECB bond buying programme (short term 2 to 3 years bonds) would help the ECB comply with its mandate. He was supported by Mr Asmussen, the German representative on the ECB executive board and who stated that ECB’s transmission mechanism was, in effect, broken ie supportive of the ECB’s proposed bond buying programme. Mr Weidmann, the head of the Bundesbank, remains isolated, being the only member of the 23 member board to oppose the plans;
I set out below my previous comments on Draghi’s possible comments tomorrow.
Leaks from the EU reveal that the ECB purchases of peripheral bonds are to be limited to short term maturities (2 to 3 years) to avoid the argument that the ECB is breaching rules which prohibit the financing of EZ states. The argument raised by the ECB is that their proposed bond buying programme in the secondary markets is to ensure that the ECB’s policy transmission mechanism remains effective, rather than providing financing for States – which is prohibited under EZ rules. The EFSF/ESM are expected to buy longer dated paper. It will be interesting to see whether Draghi talks about capping peripheral bond yields, which he hinted at at the last meeting. Given the follow up debate, I think he’ll fudge the issue and, in any event, will not provide any indication of the size of the ECB’s potential bond buying programme and/or a yield cap/yield spread etc.
Draghi is also likely to announce a relaxation of collateral rules, in particular as banks in countries such as Spain have run out of eligible collateral and are being provided with financing by their Central Bank through the Emergency Lending Assistance programme.
There is increasing speculation that Draghi may cut interest rates on Thursday, in spite of inflation exceeding the ECB’s 2.0% target – currently 2.6%. In addition, EZ July producer prices came in at +0.4% M/M or +1.8% Y/Y, higher than forecasts of +0.2% M/M and +1.6% Y/Y, as well. However, inflation is expected to decline to below the 2.0% threshold in early 2013;
The WSJ reports on the continuing problems facing Spanish banks, who are facing significant capital outflows and, in effect, problems in financing themselves. Basically, the banks have run out of eligible capital that they can use to refi at the ECB and are increasing borrowing from their Central Bank through the Emergency Liquidity Assistance programme (who do not provide any details), who are providing emergency loans to a number of Spanish banks. Deposits at Spanish banks declined by -4.7% in July to E1.51tr or down by E75bn, the largest decline since 1997, the year that the ECB started tracking this data. The problems are likely to result in the ECB relaxing collateral rules at tomorrows meeting – indeed, Draghi has hinted that he intended to do precisely that earlier this year. President Hollande has hinted that Spain will request a formal bail out at the October EU heads of State meeting in mid October;
UK August services PMI came in at 53.7 M/M, the highest in 5 months and higher than the 51.2 expected and the reading of 51.0 in July. Furthermore, companies expected that market conditions would improve – wow. Personally, I believe that there must be some Olympics related impact in there – the rise is far too great otherwise. Sterling reacted positively to the news, in particular, given the importance of the services sector in the UK – over 70% of the economy. The data will keep the BoE on hold this week;
Irish August services PMI came in at 51.7, higher than 49.1 in July and the 1st rise in 4 months. Even better, the new business component rose to 52.6 in August from 49.5 in July. The Irish August unemployment rate was 14.7%, in line with July, which was revised lower from 14.8 previously.
Other EZ countries August services PMI are set out below
France 49.2, lower than expectations of 50.2 and 50.0 in July;
Germany 48.3 in line with expectations of 48.3 and 50.3 in July and the lowest since July 2009;
Italy 44.0 higher than 43.0 expected and 43 in July, though the 15th monthly contraction;
Spain 44.0 higher than 43.4 expected and 43.7 in July, though the 14th monthly contraction;
Overall EZ August final services PMI came in at 47.2, below expectations of 47.5 and 47.5 in July.
Final August composite PMI came in at 46.3 from 46.5 in July, with Germany at 47.0, down from July’s 47.5, the lowest since June 2009.
Markit reports that the data suggests that EZ GDP will be between -0.5% to -0.6% lower in the 3rd Q;
EZ July retail sales fell -0.2% M/M in line with expectations, though down by -1.7% Y/Y, slightly worse than the decline of -1.5% expected. However, the DAX, having opened weaker, is up nearly +0.7% higher at present, in spite of the bearish news;
A poor German 10 year bund action today. The government sold just E3.61bn, less than E5bn planned. Bid to cover was just 1.1 times and less than the 1.8 times previously in August. The 10 year yield rose marginally to 1.41% – far too low, but will wait for the ECB/GCC announcements;
The US ISM index fell to 49.6 in August, the lowest since July 2009 and weaker than the reading of 49.8 in July. The production component declined to 47.2, from 51.3, the lowest since May 2009. New orders also declined to 47.1, from 48.0 in July, the lowest since April 2009. Exports,however, rose to 47.0, from 46.5. Employment fell to 51.6, from 52, the lowest since November 2009, but above the 50 level. Orders to be filled dropped to 42.5, from 43, with inventories up to 53, from 49. Certainly disappointing, but still a lot better than the EZ (PMI was 45.1 in August) and, I would argue, China (HSBC PMI index 47.6). The manufacturing sector is not as important in the US, which suggests that there will not be a material impact on GDP, though the sector has been the star performer and a further downturn is of concern. The weaker data is, however, supportive of QE3 being announced by the FED this month, though the NFP data, to be released on Friday, will be more important (Source Bloomberg);
US construction spending fell unexpectedly by -0.9% in July, as opposed to a rise of +0.4% expected, though up +9.3% Y/Y. Residential construction declined by -1.6%, mainly due to a surprise drop in home improvement by -5.5%, though single family residences improved by +1.5%, the highest level since December 2008. Private nonresidential construction fell by -0.9%, but is up +11.7% Y/Y. Public construction declined by -1.1% in July;
The US Dept of Justice is charging BP with “gross negligence and wilful misconduct” in respect of the 2010 Deep Water Horizon disaster. BP is trying to settle the dispute on the basis of paying fines of up to US$15bn. The DOJ charges, if proved, could involve BP having to pay up to US$21bn, together with further compensation and punitive damages. The trial has been set for 14th January. BP shares opened some 3.0% lower in London trading;
Outlook
Asian shares closed lower for the 5th consecutive day. European markets opened lower, though are picking up – currently flat to higher, with the DAX up +0.6%. The miners are being whacked, as is BP, which is now down -4.0%, following the DoJ announcement. Brent (October) is declining and currently trading below US$114, with gold at US$1691. The Euro is coming off and currently US$1.2550 – still believe its below US$1.20 by the year end.
US futures suggest a lower open, though has improved through the morning. The VIX closed just below 18 yesterday, up from the ludicrous level of below 15 recently.
I continue to believe that Draghi will find it difficult to reveal a great deal tomorrow, which runs the risk of disappointing the markets. However, a 25bps interest rate cut is certainly possible. The GCC decision next week remains the key – I continue to believe that there is a risk of a conditional approval, which could well be viewed negatively, but I’m no lawyer and/or an expert on the German Constitution/GCC, I hasten to add. The EZ PMI data reveals, quite clearly, that the region is in recession and that even Germany is not immune.
The possibility of FED announcing QE3 this month looks more likely, though the NFP data, to be released on Friday, will be critical.
I remain excessively cashed up and will wait for the ECB/GCC announcements, in particular.
Kiron Sarkar
5th September 2012
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