Draghi hints at short term bond buying

The Australian Central Bank, the RBA, has kept interest rates on hold at 3.5%. The Governor admitted that commodity prices have fallen sharply, as Chinese growth has weakened. He added that domestic consumption was “quite firm” in H1 – however the most recent data suggests that spending has declined materially subsequently. Whilst unemployment has been low, capex spending on mining projects is declining, which will impact unemployment. He added that inflation was forecast to be within the target of 2.0% to 3.0%. The next move will be for lower interest rates and the market is pricing 50bps (two 25bps?) of cuts by the year end. The A$ rallied initially, but is weakening – currently US$1.0245;

The Japanese opposition is trying to force PM Noda to announce general election as soon as possible. They blocked legislation which would have allowed for deficit-covering bonds in the upper house of Parliament, which will delay a stimulus programme. With 2nd Q GDP likely to be cut from the initial +1.4% annualised on 10th September and both slowing domestic growth and weaker exports (contraction this Q?), the economic prospects for Japan look difficult to say the least;

The Chinese Central Bank, the PBoC, has pumped more money into the system yet again. In addition, Chinese authorities are considering measures which would provide a  rebate for exporters. The Chinese Securities Journal also reports that the government could offer subsidies for purchases of home appliances etc. Great, but the economy looks as if it needs much more. The Shanghai index closed -0.75% lower today;

Bond yields have risen in India, as expectations of interest rate cuts by the RBI (the Indian Central Bank) subside, due to higher inflation expectations. Indeed, some analysts do not expect any further interest rate cuts this year. Consumer prices rose by +9.86% in July, which is significantly higher than the other BRIC countries. Growth rebounded unexpectedly last Q, following 4 Q’s of declines, though with rising inflation, combined with a large budget and current account deficit, together with policy gridlock due to paralysis by the government, the situation in India is likely to weaken as the year progresses. Indeed, manufacturing expanded at the slowest pace for 9 months in August, increasing by just +0.2% Y/Y. However, an improving monsoon from earlier weaker rainfall, may well reduce food price expectations and therefore inflation. (Source Bloomberg);

Capital flight from Spain continues. CNBC reports that Spaniards withdrew some E75bn from their banks in July and deposits are down 10% in July Y/Y. However, savings remain high, at E2.3tr in deposits. The government is to pump E4.5bn into Bankia from its own resources to partially recapitalise the bank – not enough by a long way

Leaks from a closed meeting at the EU, with Mr Draghi, suggest that the ECB will announce that it will buy peripheral debt, up to a maturity of up to 3 years on Thursday. ECB purchases are to be limited to short term maturities 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. The EFSF/ESM are expected to buy longer dated paper. The leak has resulted in 2/10 year EZ peripheral bond spreads widening to a record high, with Spanish and Italian short term (2 year) yields declining by 30bps and 20bps respectively. 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.
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;

Moody’s cut the EU’s outlook to negative, reflecting risks to Germany, France, Holland and the UK. The 4 countries account for 45% of the EU’s budget. Moody’s stated that the risks of a downgrade to the EU’s sovereign debt rating comes from a “deterioration in the creditworthiness of EU member states”;

Interestingly, the EU Commission states that they are not ruling out granting the ESM a banking licence. As you know, I believe that the firepower of the ESM is grossly insufficient and the bail out fund will have to leverage itself to become effective. The German/Bundesbank position, well we all know that they will oppose the move, but privately Mrs Merkel knows that the ESM has to be leveraged up;

The UK’s construction industry PMI fell to 49 in August, from 50.9 in July, lower than the 50 expected. UK retail sales declined in August, for the 1st time in 2012. Sales in stores opened for 12 months declined by -0.4% Y/Y. Both construction and retail sales were negatively affected by the Olympic’s;

US August manufacturin
PMI came in at 51.5, as opposed to expectations of between 51.9 and 51.9 in July. Output was lower at 51.9, as opposed to 52.4 previously. New orders came in at 51.9, versus 52.6 with employment (slightly) weaker as well;

Outlook

Asian markets closed mainly lower, with European markets down as well. Gold is trading at US$1691, with Brent (Oct) higher at US$115.47, well off its highs of nearly US$1 higher.

Still basically in a wait and see mode.

Kiron Sarkar

4rd September 2012

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