“Deal” on Greece announced – will it work?

The Japanese DPJ announced their economic policies ahead of the forthcoming general elections. Essentially, “trust us, we’ll fix our economic problems” routine. No concrete measures. They plan to weaken the Yen – how, Mr Noda;

The Shanghai Composite declined by -1.3%, closing at 1991.17 today, the lowest since January 2009. Market confidence in the governments ability to turn around the country’s economy is waning. The new regime, which takes over towards the end of the 1st Q of next year, will have a major task on its hand. Stimulus measures, likely targeted, are a distinct possibility starting in Q2, but history would suggest that such measures will prove questionable;

The Chinese National Bureau of Statistics reports that Chinese October industrial profits rose by +20.5% Y/Y, having risen by +7.8% Y/Y in September (which was the 1st rise in 6 months). The data does not seem to have been appreciated by the markets, however, given its lows today !!!!;

The Indian governments plan to allow majority ownership of multi-brand retail operations by foreign companies is being opposed vigorously by the opposition. The policy will remain the focus of Parliament, with questions as to whether other reform proposals can be passed until this proposal is sorted out. Tough going for the current coalition, but one has to presume that they will push it through – if not, well………;

The EZ/IMF reached a “deal” on Greece late last night. They have reduced interest rates on bail out funds, suspended interest payments, extended maturities on the loans and the ECB has given up its “profits” on Greek bonds owned by it. The EZ/IMF has also suggested a debt buy back which they emphasized. Stupidly a debt buy back has been leaked for some time, which has resulted in a near doubling in the price of Greek bonds. I must say, I had thought that Greek bonds were a risky investment at current levels. However, by emphasizing the need for a successful buy back, in particular by Mrs Lagarde of the IMF – indeed she has made it a condition for the IMF participating in a future bail out for Greece – the EZ/IMF has strengthened the position of debt holders – a completely stupid plan, as it will now cost more to buy back the bonds. The plan is to buy bonds at around 35 cents on the Euro – the EZ/IMF statement reported that the buy back would be concluded at a price no higher than that on 23rd November. The EZ is to disperse funds on 13th December, once the debt buy back (full details are not available) has been completed. Will the buy back be successful? I suppose that Greek banks will be lent on. However, do other bond holders really want to own an asset which clearly is worth much, much less?

Details of the deal are as follows. Greece will get E44bn, with the 1st installment of E34.4bn to be released on 13th December, though the rest of the funds will be disbursed in 3 subsequent stages in Q1 2013, as Greece meets certain conditions. The IMF’s element of the bail out funds will only be paid over once the debt buy back is successfully completed – once again strengthening the position of bond holders. Interest rates on official loans will be reduced to just 50bps over Euribor, from the current 150bps, once Greece achieves a primary surplus of +4.5% (expected in 2016, from 2014 previously), with maturities of existing loans extended to 30 years rather than 15. The Greeks will be given a 10 year interest rate deferral. Some E11bn of “profits” derived from purchases of bonds by the ECB will be handed back to Greece. The plan is to reduce Greek debt by E40bn and cutting it to 124% of GDP by 2020 and “significantly below” 110% in 2022. Privatisation proceeds (oh yeah) will be paid into a segregated account to cover debt financing, as will 30% of the excess primary surplus.

I can go on and on, but THIS PLAN IS NOT CREDIBLE. The forecasts are, I would argue, total fiction. Indeed, the Troika report (also prepared with rose tinted spectacles) suggests that Greek debt to GDP would amount to 126.6% in 2020 and 115% in 2022. The real intent of this “cunning plan” is to kick this particularly smelly can down the road an until Mrs Merkel’s general elections next September. Indeed, the EZ has advised that “other measures” may well have to be taken. Interestingly, Mr Schaeuble stated that Greek debt will have to be written down in 2016 – why not now, as everyone knows its not going to be repaid, Mr Schaeuble – Oops, sorry, nearly forgot about the German general elections in September next year. However, I’m far from convinced as to whether these measures will result in stability until after the German elections.

The deal has to be approved by the Parliaments of a number of EZ countries including Germany, Finland and Holland. German authorities report that they expect Parliamentary approval on 29th November and my clued up German friends report that the Greens and the SPD will support the plan, which will counter some opposition from members of the CDU/CSU.

The Euro, which rose to just over US$1.30 on the news has declined – currently US$1.2952 as the market digested the grand plan. Tells you that everything is not kosher. Unfortunately, Greece will come back, again and again and…..;

There are rumours that Spain will ask for a bail out. Its only a matter of time. With the elections in Catalonia out of the way, Spain would be crazy not to ask for aid as soon as possible – however, with Mr (ditherer) Rajoy in charge……..The bottom line is that the market believes that Rajoy will ask for a bail out – 10 year bond yields are 9 bps lower at 5.55%;

French November consumer confidence came in at 84, better than the 83 expected and the same as October;

The EU is to follow the US and delay implementing the Basel 111 rules, by about 6 months – I believe it will be longer. The US has postponed implementing the rules indefinitely – cant see EU implementation ahead of the US;

Mr Carney, the head of the Bank of Canada has been appointed as the next Governor of the BoE. A total surprise (the bookies had priced him at 66 to1 ), Mr Carney’s appointment has been welcomed by all parties. Mr Carney is believed to be less keen on QE and has proposed that banks increase their capital in the past – he is concerned that “too big to fail” remains an issue. He worked at GS and, as a result, understands banks and the markets – positive. Well lets see what happens, but initial reactions to his appointment are positive;

UK Q3 GDP was confirmed at +1.0% Q/Q, or -0.1% Y/Y. GDP for Q4 will be materially lower. PIMCO states that the UK will lose its AAA rating – likely;

US October durable gods orders came in flat, much better than the -0.7% expected. Ex defence and transportation, a much better data point, durable goods orders came in at +1.7% M/M, much better than the -0.5% expected and the revised -0.4% in September;

US 20 city September home prices (Case-Schiller) increased by +0.39% M/M, in line with expectations of +0.4% and a revised +0.42% in August. Y/Y, prices increased by +3.0%, in line with expectations. US home builders have had a great run – time to take profits, me thinks. However, I will retain my US/UK focused building material stocks;

The OECD cut its 2012/3 forecasts and sees a material risk of a recession in developed countries. They advise:

Global 2013 GDP has been reduced to +3.4%, from +4.2% in May, with the US at 2.0%, EZ at +1.4% (optimistic), China at +8.5% (optimistic) and Japan at +0.7% (optimistic, as well);

Japan needs a credible medium term strategy to cut its budget deficit;

They warn that excessive fiscal consolidation should be avoided and urge Europe to introduce monetary easing;

Interestingly they suggest that the ECB will cut rates by 25bps in December, with the FED and BoJ on hold. I do believe that the ECB will cut rates, though it may be in the New Year. Furthermore, they suggested that the ECB should provide future guidance on interest rates; and

EZ banks need E400bn of new capital. Yep, indeed. much. much more.

Outlook

Asian markets closed mixed, though the Shanghai composite was down -1.3%, the worst performer in the region. European markets are mainly lower (ex Germany and the UK). The market is uncertain as to the outcome of the Greek deal. US markets have just opened slightly lower, though I don’t see much action today.

Gold is trading at US$1745, with January Brent at US$110.43.

The Euro having reached US$1.30, is back down to US$1.2935, given the uncertainty. I’m itching to short the Euro, but will wait – Mr Rajoy may finally get real and request a bail out – and the Euro looks as if it still has some upside. The Yen has strengthened marginally as has the A$, which is near US$1.0470. The A$ is getting to levels which look interesting – to short that is.

Still see very little to attract me to buy or sell markets – will hold off for a while longer.

Kiron Sarkar

27 the November 2012