CICC - The Big Dark Cloud

Document Sample
CICC - The Big Dark Cloud Powered By Docstoc
					                                                                                                              Macro Brief
  July 9, 2012                                             Overseas Economies                                                     RESEARCH
Michael CHUI                       Jieyun WU
SFC CE Ref: AYC483                 SFC CE Ref: AXQ260                     The Big Dark Cloud is Still Hanging
michael.chui@ciccuk.com            wujy@cicc.com.cn
                                                                                         Over the Euro Area
The sentiment in the financial markets has continued to improve amid a large black cloud of uncertainty hanging over
the global economy. In Bank of England Governor Mervyn King’s words: “The black cloud has dampened animal spirits, so
that businesses and households are battening down the hatches to prepare for the storms ahead. The result is that lower spending
leads to lower incomes and a self-reinforcing weaker picture for growth.” Indeed, incoming data suggests that global growth
momentum is loosing steam. This has prompted the European Central Bank and the Bank of England to loosen their policies last
week to boost growth. While central banks have been at their innovative best to diffuse the dark cloud, decisive actions from the
governments are still required to completely restore market confidence. In this sense, the meeting of the euro area finance
ministers on Monday will be a key event to watch as markets are expecting some further details about the financial assistance to
Spanish banks as well as the roadmap on the banking union. If the meeting conclusions fall short of market expectations, that
could trigger another bout of volatilities.

Market sentiment has generally improved but nervousness remains in some sectors. The outcome of Greece’s general
election and the euro area summit agreement have contributed to a significant improvement in investor sentiment. Equity and
credit market uncertainties, as measured by the option-implied volatilities of equity indices and investment-grade corporate CDS
spreads, have declined markedly since early June (Figures 1 & 2). Ireland even managed to return to the bond market for the
first time in almost two years and sold €500mn of 3-month government bills at a yield of 1.8%. However, as the week wore on,
investors appeared to be getting increasingly frustrated about the lack of details in the euro area summit agreement. The news
that the Finnish and Dutch governments might oppose the European Stability Mechanism (ESM) to buy sovereign bonds in the
secondary markets has exacerbated the investor nervousness. Consequently, 10-year benchmark Spanish and Italian government
bond yields rose back to ~7% and ~6% on Friday respectively (Figure 3).
   Figure 1: Option-implied volatilities of equity indices                     Figure 2: Investment-grade corporate CDS spreads

                          Stoxx 50             S&P 500                                         CDX North America         iTraxx Europe
                                                                         70
                                                                                                                                                300

                                                                         60
                                                                                                                                                250

                                                                         50
                                                                                                                                                200
                                                                         40

                                                                                                                                                150
                                                                         30


                                                                         20                                                                     100


                                                                          10                                                                     50
    2008/01    2008/10   2009/07     2010/04    2011/01   2011/10   2012/07     2008/01   2008/10   2009/07   2010/04   2011/01   2011/10   2012/07


   Source: Bloomberg                                                           Source: Bloomberg

Meanwhile, incoming data suggests that the weakness in the European economic outlook continues. The euro area
manufacturing purchasing managers’ index (PMI) remained unchanged at 45.1 in June (Figure 4). A reading below 50 signals a
contraction. Importantly, the heightened tensions in the euro area appeared to have impacted on Germany’s economic prospects.
Germany’s PMI fell to a 3-year low of 45 in June and the country’s new orders for Germany’s plant and machinery industry fell
6% YoY in May. Meanwhile, the euro area labour market conditions continue to deteriorate with the overall unemployment rate
rising to 11.1% in May – a euro-era record. Whereas Germany’s unemployment rate stayed at 5.6%, while Spain’s rose to 24.6%



                              Please read carefully the important disclosures at the end of this report
                                                                                                                       CICC Research: July 9, 2012

  Figure 3: Italian and Spanish 10-year government bond                                Figure 4: The euro area and Germany manufacturing
  yields                                                                               PMI
                                                                            %
                                   Italy       Spain                                                                 Euro area        Germany                     70
                                                                                 7.5
                                                                                                                                                                  65

                                                                                 7.0                                                                              60

                                                                                                                                                                  55

                                                                                 6.5                                                                              50

                                                                                                                                                                  45

                                                                                 6.0                                                                              40

                                                                                                                                                                  35

                                                                              5.5                                                                                 30
    2012-06-01   2012-06-08   2012-06-15   2012-06-22     2012-06-29   2012-07-06       2008            2009           2010               2011         2012


  Source: Bloomberg                                                                    Source: Bloomberg

Against the backdrop of the fragile financial market and weak economic outlook, the ECB and the Bank of England
loosened monetary policy further to boost growth. As widely expected by market participants, the Bank of England kept its
interest rate unchanged but announced further quantitative easing. The ECB governing council decided unanimously to cut its
benchmark interest rates by 25 basis points, taking its main refinancing operation rate and interest rate on deposit facility to
0.75% and 0% respectively.

The effectiveness of monetary easing is dampened by the dark cloud of uncertainty. Currently, monetary transmission is
severely impaired, resulting in low credit growth in many parts of Europe. Two important factors have contributed to the weak
credit demand. First, the large black cloud of uncertainty has raises households and corporations’ risk aversion, leading to a
general weakness in credit demand. Second, the pressure on banks to rebuild their balance sheets also weighs on banks’ ability
to lend. As we believe that the interest rate cut will at best have marginal effect in easing these two factors, it is unlikely to kick
start the real economy in the area.

But the ECB’s action can provide some breathing space for the troubled banks in Spain and Italy. The reduction in ECB’s
main refinancing operation rate will mean that the banks that borrowed some €1,100bn longer-term refinancing operation
(LTRO) loans will pay less interest. Banks in Italy and Spain, which account for 54% of the total LTRO outstanding, will
therefore benefit most from the cut in the rate (Figure 5). Furthermore, home owners in Spain will also benefit from the rate cut
as most mortgages are floating-rate loans that tie to the ECB interest rate. Meanwhile, Italian and Spanish banks will not be
affected much by the 0% deposit rate as they are not heavy user of the ECB facility. By contrast, deposits by German banks at
the ECB, which represent more than 1/3 of the total, will not earn any interest anymore (Figure 6).

  Figure 5: LTRO by country (€ bn)                                                     Figure 6: Deposits at the ECB by country (€ bn)
         Euro area total         Germany                                     1200              Euro area total        Germany                                 1200

         Spain                   Italy                                                         Spain                  Italy
                                                                             1000                                                                             1000


                                                                             800                                                                              800


                                                                             600                                                                              600


                                                                             400                                                                              400


                                                                             200                                                                              200


                                                                             0                                                                                0
    Jan-09   Jul-09    Jan-10    Jul-10    Jan-11       Jul-11   Jan-12                  Jan-09    Jul-09   Jan-10    Jul-10     Jan-11     Jul-11   Jan-12


  Source: ECB and national central banks                                               Source: ECB and national central banks




                                Please read carefully the important disclosures at the end of this report
                                                                   2
                                                                                             CICC Research: July 9, 2012

Facing a weak economic outlook, the Bank of England launched further quantitative easing to boost the economy. The
UK economy is currently in recession. The Bank of England decided to keep interest rates unchanged at 0.5% but increase the
size of its Asset Purchase Programme (ASP) by £50bn to £375bn to boost the economy. This was the second time this year the
Bank of England expanded its ASP. In February this year, the Bank increased the programme by a similar size to a total of
£325bn. For similar reasons to the euro area, the UK economy is suffering severe impairment in the monetary transmission
channels. Thus we believe that the growth impact of the expansion of the quantitative easing will also be marginal.

With existing policy tools losing their effectiveness, central banks may have to be more innovative in developing new
tools to either calm the financial markets or to boost growth. While leaving the door open for further stimulus, ECB
President Draghi hinted that the central bank is unlikely to launch another 3-year LTRO, as some countries’ banking systems are
awash with liquidity. Specifically, he discounted the press speculation that the ECB will scrap the ratings-based collateral
eligibility standards to effectively allow banks to borrow more from the central bank. Furthermore, the interest rate on its deposit
facility is now at zero percent. While practically, the ECB can lower that rate further, i.e., to start charging banks to park money
in its deposit facility, that could have other implications. For example, when the ECB purchase sovereign bonds under its
Securities Markets Programme (SMP), it needs to sterilise the liquidity injection through its deposit facility. But the zero deposit
interest rate is likely to pose problems for the sterilisation operation in the event the ECB decided to resume its SMP. Against the
background of institutional and practical constraints, we expect central banks will become more innovative in their policy
decisions. In particular, we would not be surprised to see more central banks in the developed world to engage in directed
lending to boost growth.

Ultimately, the onus of removing the dark cloud lies within the governments. As long as the large black cloud is still
hanging over the global economy, corporations and consumers will be hesitant to spend while banks are unwilling to lend. And
the uncertainty is created by the twin weaknesses in the balance sheets of governments and banks. To help lower this
uncertainty, governments need to show the public some clear direction. In this regards, the euro area finance minister meetings
on July 9 could bear important consequences on the financial market developments. The ministers should lay out the
conditionality of the proposed bailout of up to €100bn for Spain to recapitalise its banks as well as a clear timetable towards a
banking union. Failing to do so could roil the markets!




                         Please read carefully the important disclosures at the end of this report
                                                            3
                                                                                                                            CICC Research: July 9, 2012


                                                           Important legal disclosures
                                                                           General Disclosures
This report has been produced by China International Capital Corporation Hong Kong Securities Limited (CICCHKS). This report is based on information available
to the public that we consider reliable, but CICCHKS and its associated company(ies)(collectively, hereinafter “CICC”) do not represent that it is accurate or
complete. The information and opinions contained herein are for investors’ reference only and do not take into account the particular investment objectives, financial
situation, or needs of any client, and are not an offer to buy or sell or a solicitation of an offer to buy or sell the securities mentioned. Under no circumstances shall
the information contained herein or the opinions expressed herein constitute a personal recommendation to anyone. Investors are advised to make their own
independent evaluation of the information contained in this research report, consider their own individual investment objectives, financial situation and particular
needs and consult their own professional and financial advisers as to the legal, business, financial, tax and other aspects before participating in any transaction in
respect of the securities of company(ies) covered in this report. Neither CICC nor its related persons shall be liable in any manner whatsoever for any consequences
of any reliance thereon or usage thereof.
The performance information (including any expression of opinion or forecast) herein reflect the most up-to-date opinions, speculations and forecasts at the time of
the report’s production and publication. Such opinions, speculations and forecasts are subject to change and may be amended without any notification. Past
performance is not a reliable indicator of future performance. At different periods, CICC may release reports which are inconsistent with the opinions, speculations
and forecasts contained herein.
CICC’s salespeople, traders, and other professionals may provide oral or written market commentary or trading ideas that may be inconsistent with, and reach
different conclusions from, the recommendations and opinions presented in this report. Such ideas or recommendations reflect the different assumptions, views and
analytical methods of the persons who prepared them, and CICC is under no obligation to ensure that such other trading ideas or recommendations are brought to
the attention of any recipient of this report. CICC’s asset management area, proprietary trading desks and other investing businesses may make investment
decisions that are inconsistent with the recommendations or opinions expressed in this report.
This report is distributed in Hong Kong by CICCHKS, which is regulated by the Securities and Futures Commission.
This report is distributed in Singapore only to accredited investors and/or institutional investors, as defined in the Securities and Futures Act and Financial Adviser
Act of Singapore, by China International Capital Corporation (Singapore) Pte. Limited (“CICCSG”), which is regulated by the Monetary Authority of Singapore. By
virtue of distribution by CICCSG to these categories of investors in Singapore, disclosure under Section 36 of the Financial Adviser Act (which relates to disclosure
of a financial adviser’s interest and/or its representative’s interest in securities) is not required. Recipients of this report in Singapore should contact CICCSG in
respect of any matter arising from or in connection with this report.

This report is distributed in the United Kingdom by China International Capital Corporation (UK) Limited (“CICCUK”), which is authorised and regulated by the
Financial Services Authority. The investments and services to which this report relates are only available to persons categorised by CICCUK as either a professional
client or eligible counterparty. This report is not intended for retail clients.
This report will be made available in other jurisdictions pursuant to the applicable laws and regulations in those particular jurisdictions.
                                                                          Special Disclosures
CICC may have positions in, and may effect transactions in securities of companies mentioned herein and may also perform or seek to perform investment banking
services for those companies. Investors should be aware that CICC and/or its associated persons may have a conflict of interest that could affect the objectivity of
this report. Investors are not advised to solely rely on the opinions contained in this research report before making any investment decision or other decision.

Distribution of ratings is available at http://www.cicc.com.cn/CICC/english/operation/page4-4.htm.
Explanation of stock ratings: “BUY” indicates analyst perceives absolute return of 20% or more within 12 months; “ACCUMULATE” 10%~20%; “HOLD” -10%~10%;
“REDUCE” -20%~-10%; “SELL” -20% and below.
Copyright of this report belongs to CICC. Any form of unauthorized distribution, reproduction, publication, release or quotation is prohibited without
CICC’s written permission.




                                                                                     4
Beijing                                             Shanghai                                       Hong Kong
China International Capital                         China International Capital                    China International Capital
Corporation Limited                                 Corporation Limited – Shanghai Branch          Corporation (Hong Kong) Limited
28th Floor, China World Office 2                    32nd Floor Azia Center                         29th Floor, One International Finance Centre
1 Jianguomenwai Avenue                              1233 Lujiazui Ring Road                        1 Harbour View Street
Beijing 100004, P.R. China                          Shanghai 200120, P.R. China                    Central, Hong Kong
Tel: (86-10) 6505-1166                              Tel: (86-21) 5879-6226                         Tel: (852) 2872-2000
Fax: (86-10) 6505-1156                              Fax: (86-21) 5888-8976                         Fax: (852) 2872-2100

Singapore                                           United Kingdom
China International Capital                         China International Capital
Corporation (Singapore) Pte. Limited                Corporation (UK) Limited
#39-04, 6 Battery Road                              Level 25, 125 Old Broad Street
Singapore 049909                                    London EC2N 1AR, United Kingdom
Tel: (65) 6572-1999                                 Tel: (44-20) 7367-5718
Fax: (65) 6327-1278                                 Fax: (44-20) 7367-5719



Beijing Jianguomenwai Avenue Branch                 Shanghai Middle Huaihai Road Branch            Shenzhen Fuhuayilu Branch
1st Floor, Capital Tower                            398 Huaihai Road (M)                           Rooms 107 & 201, Annex Building
6A Jianguomenwai Avenue                             Shanghai 200020, P.R. China                    Shenzhen Duty Free Commercial Tower
Beijing 100022, P.R. China                          Tel: (86-21) 6386-1195                         6 Fuhua 1st Road, Futian District
Tel: (86-10) 8567-9238                              Fax: (86-21) 6386-1180                         Shenzhen 518048, P.R. China
Fax: (86-10) 8567-9235                                                                             Tel: (86-755) 8832-2388
                                                                                                   Fax: (86-755) 8254-8243

Hangzhou Jiaogong Road Branch                       Nanjing Zhongshan Road (North) Branch          Guangzhou Tianhe Road Branch
1st Floor, Euro American Center                     2nd Floor, Greenland Plaza                     40th Floor, Teemtower
18 Jiaogong Road                                    1 Zhongshan Road (North)                       208 Tianhe Road
Hangzhou 310012, P.R. China                         Nanjing 210008, P.R. China                     Guangzhou 510620, P.R. China
Tel: (86-571) 8849-8000                             Tel: (86-25) 8316-8988                         Tel: (86-20) 8396-3968
Fax: (86-571) 8735-7743                             Fax: (86-25) 8316-8397                         Fax: (86-20) 8516-8198

Chengdu Binjiang Road (East) Branch                 Xiamen Lianyue Road Branch                     Qingdao Middle Hongkong Road Branch
1st & 16th Floors, Shangri-La Center                4th Floor, Office Building, Paragon Center     11th Floor, Shangri-La Center
Block 9B, Binjiang Road (East)                      1 Lianyue Road, Siming District                Block 9, Hongkong Road (M), South District
Chengdu 610021, P.R. China                          Xiamen 361012, P.R. China                      Qingdao 266071, P.R. China
Tel: (86-28) 8612-8188                              Tel: (86-592) 515-7000                         Tel: (86-532) 6670-6789
Fax: (86-28) 8444-7010                              Fax: (86-592) 511-5527                         Fax: (86-532) 6887-7018

Wuhan Jiefang Road Branch                           Chongqing Honghu Road (West) Branch            Changsha Chezhan Road (North) Branch
4th Floor, New World Centre Tower                   1st & 10th Floors, Ourui Lanjue Center         3rd Floor, Annex Building, Securities Tower
634 Jiefang Road, Qiaokou District                  Block 9, Honghu Road (W), New North District   459 Chezhan Road (North), Furong District
Wuhan 430032, P.R. China                            Chongqing 401120, P.R. China                   Changsha 410001, P.R. China
Tel: (86-27) 8334-3099                              Tel: (86-23) 6307-7088                         Tel: (86-731) 8878-7088
Fax: (86-27) 8359-0535                              Fax: (86-23) 6739-6636                         Fax: (86-731) 8446-2455

Foshan Jihua 5th Road Branch                        Tianjin Nanjing Road Branch                    Dalian Jinma Road Branch
12th Floor, Trend International Business Building   10th Floor, Tianjin Global Trading Center      128B Jinma Road
2 Jihua 5th Road, Chancheng District                219 Nanjing Road, Heping District              Economic-Technological Development Area
Foshan 528000, P.R. China                           Tianjin 300051, P.R. China                     Dalian 116000, P.R. China
Tel: (86-757) 8290-3588                             Tel: (86-22) 2317-6188                         Tel: (86-411) 8755-5088
Fax: (86-757) 8303-6299                             Fax: (86-22) 2321-5079                         Fax: (86-411) 8801-7568

Ningbo Yangfan Road Branch
11th Floor, Building Five, 999 Yangfan Road
Hi-tech Industrial Development Zone
Ningbo 315103, P.R. China
Tel: (86-574) 8907-7288
Fax: (86-574) 8907-7328

				
DOCUMENT INFO
Shared By:
Categories:
Tags: CICC
Stats:
views:35
posted:7/20/2012
language:English
pages:5
Description: The Big Dark Cloud is Still Hanging Over the Euro Area