Yen trading around 91 against the US$

Japan remains in deflation. CPI (ex fresh food) declined by -0.2% Y/Y in December, in line with estimates. It was the 7 time in 8 months that CPI was negative. Ex food and energy, CPI came in at -0.6% Y/Y, worse than the -0.5% expected. The data leads me to ask how Japan will achieve their 2.0% inflation target, based on current policies. The more I look at the recent BoJ statement, the more of a non-event it truly was. The measures announced are not going to make the material difference necessary. In addition, the BoJ’s own forecast expects inflation to come in around +0.9% for the fiscal year ending in April 2014.

The BoJ monetary easing programme will result in the BoJ buying just Yen 800bn (US$9bn) per month, net of maturing bills, starting in January 2014 (as opposed to Yen 3 Tr a month this year), according to Nomura, so that’s not going to create inflation. The Finance Minister, Mr Aso, talks about limiting bond issuance, as opposed to the Japanese PM who talks about a Yen 20 Tr stimulus programme. In addition, Mr Aso is even talking about reducing the budget deficit (currently around 10% of GDP) by half or indeed to eliminate it – OK many years hence. However, that would not allow for the fiscal stimulus proposed by Mr Abe, the Japanese PM. Basically, it just does not add up. The Yen, well expect volatility, though I remain of the view that it will depreciate materially.

Comments by Japanese politicians and officials, including the PM, Mr Abe, acknowledge that the BoJ did not deliver as they had (prior to the BoJ meeting) lead us all to expect. As a result, expect on-going rhetoric about changing the BoJ law, placing more “compliant” people onto the BoJ board in March/April, including a new governor etc, etc. However, the focus on Japan has, in my humble opinion, highlighted the economic, financial and other serious problems facing the country – basically market sentiment is turning. Will Japan retain its “safe haven” status it has had to date – in my humble opinion, it will not. Indeed, it never deserved it, which I believe is what the market is finally beginning to understand. The Yen blew through Yen 90 against the US$, as I thought, but is now hovering around Yen 91, which is pretty impressive. Are Japanese financials selling – certainly looks like it – if I was a Japanese financial, I would certainly look at least to try and hedge somewhat. In addition, the most recent data, trade numbers, CPI (deflation still), problems with China etc, etc is all negative news which should weigh on the Yen, with little on the positive side. The Nikkei, well it continues to rise. However, I briefly listened to an interview with Kyle Bass – missed most of it. He stated that investors buying Japan is akin to “investors picking up dimes ahead of a bulldozer”. Hmmm, I can see where he is coming from. Really must follow him more closely;

Japanese officials stated that the Chairman of the Chinese Communist Party, Mr Xi, agreed to “consider” talks with the Japanese PM, Mr Abe. Mr Yamaguchi, the head of the coalition partner of Mr Abe’s LDP, met with Mr Xi in Beijing. I certainly hope they do talk and soon. China has, for domestic political considerations, way overplayed its hand over the disputed territories in the South China Seas. Putting the genie back into the bottle will prove difficult, given the previous rhetoric (and to need to save face and appease their public), though they will have to try really hard. Conflict with Japan, which will involve others in the region (and the US) is certainly not in China’s interest. OK, not in Japan’s either, but China will suffer materially as well, threatening the current regime;

The Indian government has raised the limit on foreign investment into Rupee denominated bonds by US$10bn to US$75bn. The cap on government bonds was increased to US$25bn, from US$20bn previously, yesterday. The move is yet another attempt to avoid a downgrade, (due to the current a/c deficit) though I don’t believe it will be enough. Generally, countries that face problems open up their markets more. The Rupee is little changed today;

The Italian government bailout of Monte dei Paschi di Siena may be delayed, following reports that the bank hid E700mn of losses, from regulators, on structured finance transactions. The loss will embarrass Mr Monti and Mr Bersani – Mr Bersani’s party runs the local government in Siena and which owns the largest shareholding in the bank. Mr Berlusconi has been quick to exploit this mess, though his administration was the first to start to bailout the bank. Will there be other problems at the bank – well, who knows, but it is an Italian bank !!!. The former Chairman of the bank and until a few days ago, head of the Italian Banking Association, Mr Mussari, resigned. This scandal could impact the upcoming general elections;

278 banks in the EZ have given notice that they will repay E 137.2 bn back to the ECB, in respect of the ECB’s 1st E489bn 3 year LTRO programme, well above the E84bn forecast. The actual repayment will occur 1 week later, on the 30th January. Repayments of borrowings from the ECB’s 2nd LTRO programme (E529bn) can occur on 27th February. Banks may have switched from the 3 year LTRO to a shorter maturity financing, so the true repayment will only be known some time ahead. The ECB allows banks to borrow as much as they need (against collateral) for 1 week and 1 and 3 months .The Northern European banks have repaid the most. The Southern European banks cannot afford to do so. The risk (a real risk) is that it will create a 2 tier EZ banking system, with the banks that repay considered stronger than those who cannot. The ECB has worked hard to avoid a banking crisis. However, will investors want a premium to fund those banks who do not repay – I would guess so. However, the ECB is likely to introduce further funding if necessary to avoid any potential liquidity issue, which will reduce, (though not eliminate), the borrowing spread between the banks that have repaid and those that have not. The equity markets should also ascribe a valuation premium to those that have repaid, as opposed to those that have not. Given the general calm, I do not expect a crisis at present, as investors do believe that the ECB will do “whatever is necessary” (as Mr Draghi put it) to deal with these and other issues. However…….The Euro rose on the news;

An amusing comment by Ms Christine Lagarde, the former French Finance Minister and now head of the IMF. Basically she stated that its would be “extraordinarily ambitious” for France to achieve its 2013 budget deficit target. Go for it Christine, you tell them. However, she should have said that those in France who reiterate that the country will achieve the 3.0% budget deficit forecast that they should definitely lay off the Absinthe – it really does make people delusional and, I suspect, leads them to cloud cuckoo land;

Mr Draghi, the President of the ECB, believes that the EZ economy will recover in H2 this year – so do I, ex Spain, in particular through , France, Italy and Portugal look vulnerable as well. I’m ignoring Greece – need a breather from that country. Indeed, we may even see some green shoots earlier;

The important German IFO index (business confidence) rose to 104.2 in January, higher than the 103.0 expected and up from 102.4 in December. The expectations component rose to 100.5, up from 98, with the current situations component also higher at 108.0, up from 107.1 in December. The government and the Bundesbank forecasts that GDP will rise by +0.4% this year, in my opinion, is well below the likely outcome – I continue to believe that German 2013 GDP will be +1.0%, indeed better. Furthermore, IFO raised Q1 2013 German GDP from flat to +0.2%. Yesterdays much better manufacturing and services data confirms the robustness of the domestic German economy, in particular and signalled that the manufacturing sector was recovering. I would expect that a number of economists will upgrade German Q1 GDP from flat to +0.2%/+0.3%. Yes Germany exports around 40% of its products to the Euro region, which remains deeply distressed, but exports to EM’s in particular are rising, as are exports to the US and the UK;

UK Q4 GDP declined by -0.3%, worse than the decline of -0.1% expected, though would have been -0.1% if it were not for maintenance issues with respect to oil production in the North Sea. GDP was unchanged Y/Y, weaker than the +0.9% growth in 2011.The UK economy was -3.3% in Q$, from pre-recession levels, the worst (apart from Italy) of the G8 nations. The current Q will be affected by the bad weather, though I believe that the UK economy will surprise to the upside this year. Sterling is being whacked – the Euro is currently over 0.85;

As I reported previously, Mrs Merkel has started to make more conciliatory comments in respect of the proposed UK referendum. With the exception of some issues on social policy and the financial sector in particular, the governments share roughly the same agenda. Expect more similar comments from Mrs Merkel – the French are going to go ballistic;

The US December index of leading indicators rose by +0.5% (unchanged in November), the most in 3 months and higher than the +0.4% expected. I’m not sure why, but the indicator which is supposed to look some 3 to 6 months ahead rarely has a major market impact.

The Markit US manufacturing Index for January rose to 56.1, the highest since March 2011, from 54 in December.

There is a view that yesterday’s strong unemployment data was due to a guesstimate of California’s jobless claims numbers as the State did not file a report. If that’s the case (and there is some debate on this speculation) an adjustment should be noticed in next week’s numbers.


China, Taiwan , Korea and Hong Kong closed lower, though most other Australasian markets closed up on the day – the Nikkei was up +2.9%. European markets are trading higher, with Germany above +1.2%, given the good IFO numbers.The FTSE is the laggard. US futures suggest a higher open.

The Euro is up again, currently trading around US$1.3444, with the Yen at Yen 90.96 against the US$, having been above 91 earlier

Spot gold is trading at US$1662, with March Brent at US$113.50.

Markets look perky. Have a great weekend.

Kiron Sarkar

25th January 2013

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