Chinese /Japanese spat over islands escalates

RBA minutes suggest that the strength of the A$ and slowing growth in China poses threats to the Australian economy. Well thanks for that RBA – pretty obvious to most of us, I would suggest. The RBA as been slow at cutting interest rates – that is likely to change, with a cut in October likely. The RBA reported a material decline in spot prices for iron ore and coking coal, two of Australia’s major commodity exports. The Central Bank released data which showed that commodity prices have declined by -4.3% in August M/M and -18.5% Y/Y in A$ terms, and the index is at its lowest since April 2010. The A$ declined following the release of the minutes;

Another clear sign of weakness in the base metals markets. Australia has cut its forecast for iron ore by 20%, as prices declined following a reduction of imports from China. The Australian Bureau of Resources and Energy Economics has forecast that revenues from iron ore will decline to A$53.2bn this fiscal year, from A$67bn, forecast in June and A$63bn last year;

The dispute between China and Japan over certain disputed islands in the South China seas escalates. China is threatening to ban exports of rare earths to Japan and take other actions if the Japanese do not reverse their purchase of certain islands in the South China seas. Wont happen. Trade between the 2 countries is a massive US$345bn, with China’s shipments to Japan amounting to around US$150bn, lower than China’s imports from Japan of US$195bn, according to Chinese customs data. A Chinese General threatens to take “other actions” !!!!!. More Japanese businesses have closed down their operations in China. The net effect will be that foreign investors will continue to relocate production facilities to closer to home – bad news for China and, for that matter Japan and other manufacturers in S E Asia. This problem is going to last a long time and I for one, don’t see the solution. There is an imminent change in leadership in China and general elections will be called in Japan in the new year. The Chinese side will certainly not back down, but the Japanese cant. Bad news for the entire region. Will this impact the Yen – I would have thought so, but the Yen moves in mysterious ways;

Newly constructed home prices rose in just 35 of the 70 Chinese cities covered in August, as compared with 49 in July. Prices declined in 19 cities, whilst remaining flat in 16 cities;

Indian consumer prices rose by 10.03% in August Y/Y, higher than the 9.86 in July. Food price increases were the main reason. The reduction in the diesel subsidy will increase inflation further in coming months;

Whilst the Spanish PM Mr Rajoy dithers, his countries bond yields are rising. The Spanish 10 year yield was back up to 5.97% yesterday (up 19 bps) from a low of 5.63% last Thursday, with the 2 year yield rising to 3.35%, from a low of 2.74%. Whoops. Mr Rajoy needs to remember that markets don’t provide even PM’s the opportunity for dither and delay. However, it must be said that Germany is trying to delay Spain’s request for a bail out due to potential problems with its Parliament, the Bundestag, though last weeks Constitutional Court decision will have helped Mrs M. In addition, Mr Rajoy faces regional elections in Galicia and the Basque country on the 21st October and he would ideally want to delay a request for a bail out until after those elections. An ECB board member warned Spain yesterday that bond yields would rise very quickly unless they submit a request for aid. Mr Juncker stated that the EZ would impose tough conditions on Spain in terms of meeting certain cuts in spending and structural reforms;

It looks as if Spain will reduce its estimates of funds necessary to recap its banks to E60bn, from a max of E100bn, earmarked by the EZ. Well, I hate to be sceptical, but………..The Stress Test results in respect of Spanish banks will be released on the 28th September. Spanish bank’s bad loans rose to E169bn in July, or 9.86% of total loans, up from 9.42% in June – and Spain believes that they will need less capital to recap their banks !!!!!!;

The German ZEW economic sentiment survey for September came in at -18.2, better than the -20 expected and -22.5 in August and the 1st improvement in 5 months. The current conditions component fell to 12.6, as opposed to 18 expected and 18.2 in August, the lowest since June 2010. However, the economic sentiment component (looking 6 months ahead) was much improved, albeit negative, at -3.8 in September, as opposed to -21.2 in August;

More talk about a negative deposit rate policy by ECB members. I’m surprised that the ECB is thinking of that policy, I must admit, as it does have consequential effects – money market funds, for example. In addition, ECB members are floating the idea of a reduction in interest rates – likely;

Interestingly, the IMF is reported to have said that the Troika (of which it is a member, together with the EU and the ECB) has delayed decisions in respect of the EZ and, furthermore, limited possible options. Whilst the ECB, under Draghi, has been a breadth of fresh air as opposed to that ……Trichet, the EU/EZ …..well let me just say, I both understand and sympathise with the sentiments expressed by the IMF;

UK August CPI came in at +2.5% Y/Y, in line with expectations and lower than the +2.6% in July. M/M CPI came in at +0.5%, once again in line with expectations and higher than the +0.1% in July. August RPI came in lower at +2.9% Y/Y, as opposed to +3.1% expected and +3.2% in July or +0.4% M/M, slightly lower than the +0.5% expected and +0.1% in July;

 

The Empire State economic index declined materially to -10.41 in September, the lowest since April 2009, from -5.85 in August and well below the forecast of -2.0. The new orders component declined to -14, the lowest since November 2010, from -5.5 in August. Employment collapsed to 4.3, the weakest this year from 16.5 in August. However, the prices paid component rose to 19.2, from 16.5, whilst prices received increased to 5.3 from 2.4. Fiscal cliff issues seem to be having an impact. However, executives were more optimistic – the outlook (6 months hence) rose materially to 27.2, from 15.2;

Fears of higher inflation in the US as a result of the recent FED action. Market expectations for US inflation rose above 2.7% yesterday, based on the break even rate, though declined to below 2.6% subsequently. However, if inflation was a real threat, Gold would be soaring – it fell yesterday, though up marginally today;

Purchases of long term equities and bonds rose to US$67bn in July, much higher than the US$9.3bn in June, and higher than the US$27.5 expected. Including short term securities, foreign investors bought a net US$73.7bn in July, well above the US$15.1bn in June. The crisis in the EZ resulted in investors fleeing to the US. Chinese investment in Treasuries rose by US$2.6bn to US$1.15tr, with Hong Kong holding a further US$136.7bn. Chinese holdings are likely to be even larger, as some of the UK holdings are most likely Chinese;

The US current account deficit declined by a more than expected 12% to US$117.4bn in the 2nd Q, from US$133.6bn in the 1st Q and better than the US$125bn deficit expected. However, the most recent data suggests that the current account deficit will widen in the 3rd Q;

The US National Association of Home builders index rose to 40, from 37, the 5th consecutive increase. The US residential property market is improving and the recent FED policies will help the sector gain more traction;

Fedex, the express parcels service, reduced its earnings guidance for the full year. It warned that the global economy was weakening. Fedex is a pretty good proxy for global demand, or not as is currently the state. The CEO stated that over the last 25 years, global trade had generally grown faster than the world economy, but that has not been the case in recent months;

Outlook

A down day for markets in Asia and Europe. US markets are lower at present, though higher than their opening levels. The Euro, well it lived above US$1.3150 briefly and is currently trading at US$1.3045. Still believe it will decline further – the ECB is likely to cut rates further after all. Oil plunged yesterday for some unknown reason and has not really picked up – rumours of a release from strategic reserves came after the initial plunge. November Brent is currently trading around US$112.76, with Gold up a bit at US$1767. The A$ is weakening – no surprise given the RBA minutes released today.

European and US markets are lower this week, but I still believe that it is better to be long the markets. Added to some of my financials and property/building materials stocks (focused on the US/UK) today.

The inflation debate continues. Yes higher food prices (due to weather conditions) will increase inflation in EM’s in particular, but for DM’s, I believe inflation is likely to trend lower. The significant overcapacity/overproduction in China, together with declining GDP, suggests to me that China is in no condition to export inflation and neither are Asian countries. In addition, other than food, I believe that commodities will weaken, which is why I’m bearish the miners. Just read a piece by Marc Chandler of Brown Brothers Harriman – he has the same view. There are other reasons why I believe that deflationary forces are strong – will discuss shortly.

Kiron Sarkar

18th September 2012

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