ESM to be leveraged?

China sentenced Mr Wang Lijung (Mr Bo’s police chief) to 15 years in prison today. China watchers suggest that Mr Bo will also face a criminal trial.  The next Communist Party Congress is expected between 15th to 18th October and not the 10th October as I reported yesterday by the way, subject to the Bo affair being sorted out – suggests that the authorities will move quickly to “deal” with Mr Bo. My clued up friends also tell me that no stimulus measures should be expected ahead of the Congress – the new leaders will want to take the credit for any measures – makes sense. Suggests that another stimulus programme may yet come – personally, I would give it a 75%+ probability;

Chinese Beige Book suggests that manufacturers and retailers are less optimistic than was the case 3 months ago. Sales expectations have been lowered and, in addition, businesses are shedding labour. The Chinese Beige Book is modelled on the US version;

South African workers are demanding higher wages in the mining sector.  Following the deal achieved by Lonmin, mineworkers are demanding additional pay from other mining companies. South African mineworkers are paid more than other sectors and the spill over effect could well become serious. I have been and remain bearish on South Africa and the Rand;

Germany and France failed to agree on measures to establish banking union at the start of next year. France wants a speedy resolution, though Germany believes that more time is necessary. Basically, forget about banking union by 1st January 2013. In addition, banking supervision by the ECB is likely to involve just the systemically important banks in the 1st instance;

There are discussions taking place to leverage the ESM. Following the approval by the German Constitutional Court (“Court”), I wrote about a possible means to leverage the ESM. It looks as if the EZ is pursuing those measures. Essentially, the ESM will issue bonds, which will be bought by the private sector – mostly by the financials, I suspect. The financials will be able to use the bonds as collateral to access cheap financing from the ECB. It is likely that the “collateral haircut” on these bonds, by the ECB, will be marginal to spur demand from financials, in particular. The profitable round tripping will help generate profits for the financials.

The Court stated that the German exposure to the ESM must be capped at E190bn, without the prior approval of the Bundestag. The pricing of the bonds, to be issued by the ESM, will reflect the cap on the exposure to the ESM by each contributing country. However, it is unlikely that countries such as Spain will contribute capital to the ESM (thereby reducing the headline capital of the ESM to below E500bn), as they will need to be bailed out, though the Spanish authorities are still dithering. By allowing leverage, the size of the ESM should, however, be expanded above E500bn – very much needed, though talk of E2tr seems far fetched at present. The ESM will not, in my view, be granted a banking licence. With the ECB prepared to buy peripheral short term debt in (theoretically) unlimited size and an ESM with adequate firepower (assuming leverage), bond yields of the periphery should decline, whilst those of the core countries (contributors to the ESM) should rise. This is positive news;

Mr Meister (CDU Party chief whip and parliamentary finance spokesman) states that Germany is open to a full bail out programme for Spain – indeed, he appeared exasperated at Spain’s dithering to date – quite right too – Mr Rajoy is living in cloud cuckoo land. However, the bail out will have conditions – “conditionality will and must apply” – is that clear enough for you Mr Rajoy.  Lets hope that the Spanish authorities stop dithering – well the will have no choice anyway – its only a matter of time. The recap of Spanish banks is the priority, he added. Mr Meister added that banking union in the EZ will be sorted out “very fast”. Well, that’s interesting, as Merkel/Schaeuble seem to suggest that a 1st January 2013 start date is unrealistic and, indeed, only want the EZ systemically important banks to be included in the process;

Germany’s September IFO business climate index came in at 101.4, much weaker than 102.5 expected and 102.3 in August and the 5th consecutive monthly decline. The current conditions component came in at 110.3, as opposed to 111.0 forecast and 111.2 in August, though the expectations component came in at 93.2, much weaker than the 95.0 expected and 94.2 in August. However, around half of the polling data was taken before the decision by the German Constitutional Court to allow the ESM to be established. The IFO institute does admit that economic momentum has declined in the 3rd Q, however. They add that inflation is not a problem for German businesses. Whilst consumption remains relatively robust, despite labour weakness, exports are declining, says IFO. Exports of luxury cars seem to be stalling/declining. The Euro declined on the news. Personally, the much more important IFO index (than the ZEW) suggests that German GDP could decline in H2 2012. The IFO survey highlighted a slowing China – its taken them so long to figure that out !!!!!;


Asian markets were mainly weaker (though the Shanghai Composite bounced at the end) as are European markets. US futures suggest a weaker open. The Euro continues to decline – just over US$1.29 at present. Spot gold is at US$1756, with November Brent oil at US$109.82.

Cant see any respite for the Euro and remain bearish on the A$.

Mining sector is weak, yet again, though I would have thought that the possibility of leverage re the ESM should be positive for financials, though they are not really reacting. No significant economic news from the US today.

However, generally bearish/no good news out there.

Kiron Sarkar

24th September 2012

Print Friendly, PDF & Email

Posted Under