IMF concern over Japan

The RBA minutes suggests that it will cut rates further (possibly as early as next month), given a slowing China and a weaker Europe – no great surprise, the RBA has been behind the curve. “There was an increased likelihood of growth over the coming year being somewhat weaker than earlier forecast”. In addition, they added “The board judged that it was appropriate for the stance of monetary policy to be a little more accomodative”.

The IMF is concerned at the rising government debt in Japan. Well, good for you IMF – Japanese debt to GDP is expected to rise to around 240% this year, the worst of any developed nation. OK, so most of the debt is held locally, but a (relatively modest?) increase in interest rates in Japan (and remember the BoJ states that they want to raise inflation to 1.0%) would have a significant adverse impact on the country. The political situation is getting more fraught (no party is likely to get a majority in elections, which should be called within the next 3 to 6 months) and the recent spat with China is not helping. In addition, Japanese manufacturers have lost their competitiveness. Japan’s trade surpluses have come to an end, as well – they are reporting deficits. I continue to watch the Yen more and more closely;

The WSJ reports that some US$225bn (or 3.0% of national output) has flowed out of China in the year to September – the real number is likely to be higher. Lombard Street research estimates that capital flight is around US$300bn. Capital flight is continuing – telling you something, do you think?. Legally, Chinese individuals are not allowed to take out more than US$50k per year, by the way. The increase in capital flight is another reason why Chinese forex reserves are unlikely to rise materially in coming months – indeed, they may decline;

The Greek finance minister has stated that the country needs a further 2 years to meet its targets. Thank you minister – we all know that’s what you want. However, the bigger issue is that the EZ is not going to give you a 3rd bail out package, though a further tranche of the 2nd bail out package is expected to be disbursed in November – basically throwing good money after bad;

The FT reports that Spain is likely to request for a credit line from the EFSF/ESM, in order that the ECB starts to buy its short term debt. An unnamed senior official from the finance ministry suggested that Spain does not need the money though !!!!. The official added that Spain would sign up to conditionality in the form of a “memorandum of understanding”, which they believe will not require any significant new reforms. However, any request would involve the IMF monitoring the fiscal position in the country. Germany has been reluctant for Spain to seek assistance, preferring to deal with all countries that require assistance in one go, due to political problems with its Parliament, which will have to approve the bail out. In addition, Spain faces regional elections on 21st October and the Spanish authorities are reluctant to request assistance ahead of that. The unnamed official admitted that Spain would not meet its budget deficit target of 6.3% – well that was more than obvious – however, the miss is likely to be significant and, in addition, will be the case for next year, unless the targets are raised materially, another reason why Germany is concerned – however, they have no choice;

Portugal announced its budget yesterday, which included a special 4.0% levy on earnings and which increases the average tax rate on earnings from 9.8% to 13.2%. The latest budget will result in E1bn of spending cuts and E4.3bn raised through taxes. To date, the Portuguese have, to date, reluctantly accepted the austerity measures imposed upon them. However, yesterdays moves were greeted by demonstrations and a national strike has been called for mid November. The increase in taxes has been made to try and keep to the upwardly revised budget deficit targets, which may well be a problem. In addition, it looks as if tax revenue in Portugal is declining, as tax rates increase – its that fiscal multiplier effect. Trying to reduce a decade + of over spending in just 3 years looks like trying to make a good attempt at committing suicide. The IMF has acknowledged that it had made a mistake in respect of the policy prescription re Portugal, but their comments clearly fell on deaf ears. Portugal will require a further bail out;

Italy’s August trade deficit with the rest of the world declined to E598mn, from E2.905bn a year ago. Even better, it recorded a trade surplus with the EU of E374mn, from a deficit of E402mn a year ago. It is true that reduced demand has helped materially;

The EZ August trade surplus to the rest of the world declined to E6.6bn (E10bn forecast), from E14.7bn in July, though much better than the E5.7bn trade deficit in August 2011. Exports rose by +3.7%, seasonally adjusted, from July.

EZ CPI rose by +0.7% M/M in September, lower than the +0.8% forecast, or +2.6% Y/Y. Higher oil prices were a problem;

German investor sentiment (the ZEW economic sentiment survey) came in at -11.5 in October, better than the -18.2 in September and the forecast of -14.9. Fifty percent of respondents believed that the German economy would be flat over the next 6 months – personally, I believe that the downside risk is higher. The current economic situation index fell to 10, from 12.6 in September.

The German Finance Minister Mr Schaeuble has called for a major move towards fiscal union, including centralised budgets – must be getting fed up of missed deficit targets and over optimistic growth forecasts. The trend towards fiscal union is clear and whilst a number of EZ countries will be opposed, I really don’t see what other choice they have. Timing, well that’s the question, but Mr Schaeuble wants the issue discussed at the EU Heads of State meeting on 18/19th October. Two senior CDU MP’s (Micharl Meister and Norbert Barthle) stated that Germany was open to granting a precautionary line of credit – certainly helping the Euro and markets;

UK inflation fell to +2.2% in September from +2.5% in August, the lowest since 2009, though still above the BoE’s target of 2.0%. However, rising utility prices may well result in inflation rising in coming months. As a result, the BoE is likely to have to revise its inflation forecast higher in its November inflation report, though will still be below the target of 2.0% over its 2 year time horizon;

David Cameron, the UK PM and Alex Salmond signed an agreement yesterday for a referendum to be called which could result in Scotland breaking away from the UK by the end of 2014. The Scots are unlikely to vote for independence – they will be worse off, given the subsidies they receive;

US September CPI rose by +0.6% M/M, slightly higher than +0.5% forecast and +0.6% in August. Y/Y, CPI came in at +2.0%, slightly higher than the +1.9% expected and +1.7% in August. Core CPI came in at +2.0% Y/Y, or +0.1%, lower than the +0.2% expected;

Outlook

Asian markets closed mainly higher, though India was lower and China flat. Europe is trading higher and, indeed, getting better. US futures suggest a higher open – reacting to “better” earnings. December Brent Oil is trading at US$114.67, with spot gold at US$1742. The Euro is trading at US$1.3048, higher as expectations of a Spanish bail out take hold.

Awaiting today’s 2nd Presidential debate. Certainly should be interesting, with the pressure on President Obama to perform.

Vikram Pandit, unexpectedly, has stepped down as CEO from Citi. Seem a bit strange, indeed more than a bit strange, to say the least, especially as they announced their earnings yesterday. Watch this space – there’s more to this announcement, I feel.

Still awaiting potential action from China and the EZ, in particular. I remain long European financials – still believe they have further to run

Kiron Sarkar

16th October 2012