China Cuts rates, Spain Downgraded, Bernanke hoses down expectations and Merkel remains recalcitrant.

June 8, 2012

Global Macro

By Greg McKenna

In a surprise move yesterday the Chinese Central Bank cut rates by 25 basis points and gave banks more flexibility to set rates for their customers. Clearly there have been concerns about China and its growth profile over the past month or so and the news about iron ore purchase, steel trading, reneging on contracts and the like have spooked markets into thinking that China is coming in for a hard landing. But even against this backdrop hardly anyone, myself included, thought China would cut rates so soon.

The official borrowing rate fell to 6.31% with the one year deposit rate falling to 3.25%. Additionally the Central Bank has given flexibility of banks to pay as much as 110% of the official deposit rate and charge as little as 80% of the borrowing rate.

Recent data has shown that Chinese growth is currently being driven by internal consumption and investment as the export sector suffers from the malaise of its biggest customer, Europe. So we probably should have expect that given it can’t fix Europe the Central Bank would aim at the domestic economy. But the theory was that they wouldn’t want to ignite another housing boom.

It’s an interesting move and markets initially rallied very strongly across Europe in the hopes that China can continue to do the heavy lifting for the global economy but the powerful rally was tempered by Ben Bernanke’s comments that seemed less ebullient towards further stimulus than his Vice Chair Janet Yellen just yesterday.

The Federal Reserve remains prepared to take action as needed to protect the U.S. economy in the event that financial stresses escalate…

Despite economic difficulties in Europe, the demand for U.S. exports has held up well

Equally like his ECB counterpart, MArio Draghi, the night before he also said the Fed can’t do it all. With reference to the fiscal tightening that occurs when the Bush tax cuts expire next year he said that this,

would, if allowed to occur, pose a significant threat to the recovery

This took the wind from the sails of the bounce in US time and the S&P 500 actually ended flat on the day.

Earlier in Europe Fitch ratings downgraded Spain to BBB from its previous A rating in the expectation it is going to need serious help with its current economic and banking trouble. BBB isn’t far of “junk” status but in a blow to hopes that Germany might be starting to get its act together for things such as Euro Banking bonds Merkel reiterated that Europe has the current weapons in its arsenal to get the job done. Reuters reported,

“It is important to stress again that we have created the instruments for support in the euro zone and that Germany is ready to use these instruments whenever it may prove necessary,” she said, referring to the euro zone’s temporary bailout fund, the EFSF, and to its permanent successor, the ESM.

If Spain does decide to seek help with recapitalizing its banks, laden with bad property debts and other underperforming loans, it is expected to ask for funds from the 440 billion euro EFSF or the 500 billion euro ESM, due to be operational in July.

Indeed echoing this continued German recalcitrance the Economist tweeted its front page from this week’s issue this morning – not sure whether it is a bell-ringer for an end to pessimism or just a reflection of reality but either way the pressure builds on the iron lady and she shows no outward signs of changing her tune.

So where does it all leave us? It forestalls hopes of a Fed, ECB or European rescue for the moment and leaves us waiting on the result of the June 17 election in Greece and the direction the Spanish situation goes. Last night Spanish rates rose again but markets were open to it as it issued more than 2 billion worth of its 10 year bonds.

So even amongst the carnage it’s not all bad news. Markets will probably spend some time consolidating between May’s pessimism and this June’s more optimistic tone until we get further news one way or the other.

Longer term my bias remains unchanged.

Have a great day

Greg McKenna

Please remember these are not recommendations for you to trade these are my views and I have my risk management tools and risk parameters that you do not have access to. Thus, this blog is for information only and does not constitute advice. Neither Greg McKenna nor Lighthouse Securities has taken your personal circumstances, objectives or financial situation into account. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs.

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