Japanese budget seems optimistic

The Japanese Parliament reconvened today. Details of their proposed budget for the fiscal year starting 1st April have been released. Total expenditures are expected to be Yen 92.6 Tn, with new government bond sales to amount to Yen 42.9 Tn and with tax revenues of Yen 43.1 Tn. The numbers do not add up, suggesting that further revenue receipts will come in. According to the budget, it will be the 1st time in 4 years that tax revenues exceed funds raised through the sale of bonds. The Japanese have assumed that the economy will grow by +2.5% next fiscal year, up from +1.7% previously, resulting in higher revenue generation. Nominal growth is expected to be +2.7%, up from +1.9% previously – no 2.0% inflation predicted there. Indeed, CPI is expected to rise to just +0.5% in the next fiscal year, though the 1st positive figure since 2008. GDP has been reduced to +1.0%, down from +2.2% previously, for the current fiscal year. The government intends to increase income tax and inheritance taxes on the wealthy. I believe, as do most analysts, that the governments growth targets are optimistic and, as a result, their assumption for tax revenues. Indeed, I believe that the eventual outcome is likely to be (materially?) worse. The government’s aspirations of a primary budget surplus in fiscal 2020 – well, lets just say thats optimistic, as well. Japan intends to sell its 1st inflation linked bond in almost 5 years;

Overseas funds keep pouring into the Indian market. Some US$3.01bn of foreign funds were invested into the Indian market YTD till 23rd January. Inflows rose to US$24.5bn in 2012. Investors have been lured by the policies and general reforms introduced by the Finance Minister, though a number of these reforms have not been implemented, so far. Personally, I think that the optimism is overdone – a credit downgrade is likely and, as we head into next year’s elections, the government will become more reluctant to agree to and/or implement reforms. Furthermore, the market is not cheap – trading around a multiple of 15.9 times. In addition, the government is likely to privatise assets to raise funds to keep the budget deficit within its target, suggesting quite a lot of supply will be coming. However, in the shorter term, the RBI is likely to cut interest rates tomorrow by 25 bps to 7.75%, which should help markets. (Source Bloomberg);

The Bank of Italy has approved a E3.9bn bailout of Monte di Paschi di Siena. However, this is unlikely to be the end of the matter and the “rescue” of this bank could well impact politically on the impending general elections, helping Berlusconi and his colleagues, whilst hurting Mr Monti and the current leader in the polls, Mr Bersani’s Democratic Party. Recent polls suggest the Mr Bersani’s DP will get 33.8% of the votes, with Mr Berlusconi’s coalition in 2nd at 26.6% and Mr Monti on 12.8%. Mr Bersani and Mr Monti have dropped by 1 point, whilst Mr Berlusconi has gained a point. A politically unstable Italy, will be bad news for the EZ;

US December new home sales declined by -7.3% to an annual rate of 369k homes, down from an upwardly revised 398k rate in November, and below the 385k annual rate expected. In 2012, builders sold a total of 367k homes, the most since 2005. Supply of new homes at the current sales rate is 4.9 months. Whilst December new home sales were lower than expected, home construction rose to an annual rate of 954k homes in December, with the median price up by +13.9% Y/Y. I continue to believe that the pace of building/sales will increase this year, which will provide continued stimulus for the US economy. The NAR advised that there were 1.82mn existing homes on the market in December, the lowest since January 2001;

Increasingly, it looks as if the US$1.2 tn of proposed cuts to the US budget will be triggered, as sequestration looks like taking effect on 1st March 2013. Negotiations between Congress and the White House suggests that a compromise will prove impossible to agree. Of the US$1.2 tn, defence will be cut by US$600bn over the next 10 years, with the balance representing cuts in discretionary spending. It is estimated that sequestration will reduce US GDP by -0.75% this year;

US durable goods orders rose for the 4th consecutive month by +4.6% M/M, higher than the 2.0% forecast and the +0.7% rise in November. A surge in aircraft orders impacted the numbers. Ex aircraft and defence, durable goods orders rose by +0.2%;

December pending home sales declined by -4.3%, as opposed to a revised increase of +1.6% in November and worse than the unchanged expected, the 1st decline since August;

Outlook

Asian markets closed higher, ex Japan which was down -0.94%.European markets closed flat though Germany and Spain were lower. US markets are flat though the Nasdaq is trading higher.

Government bond yields continue to rise – the US 10 year is currently yielding 1.98%, up over 25 bps since the start of the year.

The Euro is at US$1.3456 (the French seem to be getting uncomfortable, following its recent rise) with the Yen pretty volatile and currently at Yen 90.80 having once again traded above 91.

Gold is at US$1654, with Brent at US$113.25.

Markets look remarkably complacent, though I continue to believe that they are overbought and due a correction.

Kiron Sarkar
28th January 2013