Will the BoJ increase its asset purchase programme next week

The impending US Presidential elections will remain the main focus over the coming 9 days. Intrade odds on President Obama winning have increased to 63.5%, well up from recent lows of around 55.0%. However, a number of analysts, with good historical track records of predicting the winner, continue to assert that Governor Romney will win. A number of polls report that Romney is ahead. The US NFP data next Friday will be an important data point – the forecast is for a modest 125k rise in non farm payrolls for October, with an increase in the unemployment rate to 7.9%, from a 3 year low of 7.8% last month;

In Europe, the focus will be on Greece and Spain.

The Germans are pressing to provide Greece with a 2 year extension (till 2016) to meet its budget deficit target of 3.0%. Mrs Merkel does not want a problem ahead of next September’s German general elections. She has become more confident that her coalition will support the changes to the existing terms, with the number of rebels decreasing. However, Greece continues to prevaricate and last Friday, finance minister Mr Schaeuble stated that he doubted that Greece had met all of its obligations proposed by the Troika. The head of the Greek Democratic Left party has rejected the labour reform measures proposed by the Troika and the Greek finance minister has stated that he wants the Greek parliament to sign off on the measures before he will accept them.

Its typically Greek and the talks will go down to the wire – presumably Greece and the Troika will need to reach agreement ahead of the finance ministers meeting on the 13th November, though there is a meeting on 8th November to discuss the EU budget, where Greece may come up. Mrs Merkel may have arm twisted members of her coalition to agree to the 2 year extension (to 2016), but on Friday, the Dutch finance ministry stated that they would only accept an extension if it did not cost any more money. Well clearly an extension will cost more – up to E30bn. Mrs Merkel may even be able to pressurise the Dutch (and the Finns) to agree to the extension (its going to be hard), but Greece will want more money ahead of Mrs Merkel’s general election next September – that is going to be an impossible sell.

The solution will probably be not only a 2 year extension to meet the budget deficit targets, but a loan repayment holiday and lower interest rates, if she can persuade her colleagues in the EZ. A haircut is not politically acceptable, though is inevitable in due course. In addition, Mr Asmussen of the ECB has suggested buying Greek bonds at a discount, thereby reducing its overall levels of debt – good idea, but it will not be enough. Yet more problems for the Finns (who have local elections today – the euro-sceptic Finn Party is expected to gain) and the Dutch, but Mrs Merkel unlike her colleague, Mr Schaeuble, is quite adamant and wants to delay the impending Greek default. Will this “cunning plan” work – given its the Greeks she is dealing with, almost certainly not in the medium to longer term, though a fudge in the short term is possible, with the likelihood that Greece will be given a reprieve.

Whilst I have no doubt that the EU will also fudge any report they prepare, what of the IMF. The IMF are pushing for a write down of official sector loans to Greece, currently E125bn of the E325bn that Greece owes – certainly not going to be politically acceptable, especially at present , but is a certainty in due course. How does the IMF reconcile its views with that of the EU in the report they are preparing jointly with the EU and the ECB . Lying is not an option for them, whereas with the EU, well………….


Prime Minister Rajoy continues to dither, as to whether to request a bail out or not. He would prefer to wait for the regional elections in Catalonia on 25th November, quite clearly. With his 2012 budget almost funded, he has a greater opportunity to, indeed, dither. However, bond yields are rising as the market begins to lose patience. Spanish 10 year yields rose by 28 bps last week. The head of Blackrock Mr Fink, stated that he expected Spain to request a bail out next week – the Euro surged on the news. I’m not sure how Mr Fink knows that as even the Spanish PM most likely does not – he remains firmly in dithering mode. Who knows when Mr Rajoy finally lets one of his colleagues ask for aid (I notice he has been away when Spain has a difficult issue to address/announce) – the only certainty is that it will happen fairly soon.


With all the nonsense with Greece and Spain, Ireland is being shafted – quite ironic, as Ireland is the only country in the EZ (that has been bailed out) to have met its targets and will continue to do so. The EZ is back tracking on previous proposals to take a large element of debt (in respect of bailing out the Irish banks) off the nations balance sheet, having urged (indeed forced) them to do so. Ireland remains the only success for the EZ – if Irish politicians don’t understand how to play the game, well I suggest they learn fast and/or get advice. They are being well and truly shafted, though Mrs Merkel has admitted that Ireland is a “special case”. In addition, further austerity measures are going to go down like a lead balloon. The budget will increase taxes and reduce spending by E3.5bn. Ireland passed its 8th quarterly review of its bailout programme last week.

If there is a resolution of any of the above, the Euro should rise. However, in the medium to longer term, I believe, quite firmly that the Euro will weaken materially. The recent EZ September M3 data shows a significant decline in credit – a clear warning sign. If this continues and I expect it to do so, the ECB will have no choice but to embark on outright QE , rather than on sterilised QE , as currently proposed. However, its one step at a time with Draghi and he has to convince his German paymasters. Clearly the time is not right to do so, especially as inflation is above the 2.0% target, established by the ECB. However, interestingly, Draghi advised German politicians last Thursday that deflation, rather than inflation was going to be a problem for a number of EZ countries, thereby taking the 1st step towards preparing them for unsterilised QE – most likely in the 1st/2nd Q next year – clearly bullish for the markets.

In addition, it is clear that the fiscal multiplier for Portugal is above 1.0, some suggest 1.5. Spain, arguably, could well be higher given its banking problems. That should tell the good and the great that further austerity measures in these countries will just aggravate the situation even further. Remember, the negative impact of the fiscal multiplier is worse when interest rates are near zero and when other countries are also implementing austerity measures. These policies are completely crazy given the present situation and are way beyond their sell by date – personally I believe that they will have to be changed within 3 to 6 months time;

Just a few other points.

The COT reports that a net short speculative position (-18.2k, as opposed to a long +10.1 in the previous week) has been established in the Yen last week, for the 1st time in 4 months – traders believe that the BoJ will increase its asset purchase programme (Yen10tr expected, though has been priced in, most likely) at its meeting on the 30th October. In addition, the BoJ is likely to tweak its wording in respect of its inflation target – may change the wording to an inflation goal, rather than an inflation target, especially as inflation is expected to remain below 1.0% for the next 2 years. Japan has suffered from deflation for some 20 years. The BoJ will report on its outlook for GDP growth and inflation for the fiscal year beginning in April 2014 at next weeks meeting. I remain short the Yen, against the US$. The BoJ has consistently disappointed, but the situation is now getting to more than a critical level and something will have to be done imminently;

Mr Ishihara, the governor of Tokyo, has resigned and is to run for a seat in Parliament. Mr Ishihara created the recent spat with China over the disputed islands by initiating the purchase of the islands from its private owner. The dispute with China is likely to lead to a more right wing and nationalist government in Japan, following the elections, which are being demanded by opposition parties and who have refused to vote for measures to increase borrowings by the government. The current administration has about 1 month to end the deadlock. The current PM, Mr Noda, is trying to delay elections, which must be called before the term of the lower house expires in August next year. Japan’s neutrality position may well be changed following an election, raising tensions in the region even further, especially with China. Mr Ishihara is likely to team up with Mr Hashimoto, the populist Osaka Mayor, who leads the new but increasingly popular Japan Restoration Party;

A number of Indian ministers have resigned, with new ministers appointed for foreign affairs, power, oil, rail, law and commerce today. The Indian PM is trying to clean up his act, following numerous corruption scandals. Notably, Rahul Gandhi was not appointed as a minister, as was widely speculated. The newly appointed finance minister has pressed ahead with reforms. The attitude has changed, with investors more positive on India. Its now necessary to implement to proposals that have been announced. The next general elections in India will have to held before May 2014;

Mr Berlusconi, recently found guilty of tax fraud and sentenced to 1 year in prison (he will not go to prison, though he faces additional charges of having sex with a minor) states that he will withdraw support for Mr Monti by calling for a vote of no confidence, which will result in elections in Italy ahead of time – elections were expected in March/April next year. The court has also banned Mr Berlusconi from holding public office for 5 years and from holding a corporate position for 3 years. Mr Belusconi has stated that he will not stand for PM. Mr Belusconi’s TV statement was designed to shore up support for his party, which has declined materially – a recent poll reports that it stands at just 14%. More political uncertainty in Italy is not what the country needs – economic data recently has been slightly more positive;

In case you think its all calm in the EZ, just listen to Mr Schaeuble. He stated last week that “I’m not so sure that the worst of the crisis (in the EZ) is behind us”. Hmmmm;

The market has ignored the downgrades of the largest French banks (including, BNP, Soc Gen and Credit Agricole) by S&P – dangerous. What’s more, the reason given was the deteriorating economic environment in France, including a likely decline in property prices. No guesses for what that means – the only question is whether the other agencies downgrade France by just 1 notch? – S&P downgraded France in January. Timing, early next year, I would guess – a 1st Q event? Maybe a good time for the ECB to announce unsterilised QE to compensate;

As usual, volatile markets, but hey, what do you want – a quiet life.

Have a great weekend.

Kiron Sarkar

28th October 2012

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