Overnight Sentiment: Spanish Budget Hangover And Month End Window Dressing
Those confused by yesterday's rapid move higher in stocks, which fizzled by day's end, which was catalyzed by the non-event of the Spanish budget declaration which will prove to be a major disappointment as all such announcement are fated to be, can take solace in the following summary by DB's Jim Reid: "Yesterday's risk rally on the back of the 2013 budget announcement coincided with a trend seen over the last couple of years of rallies into month and quarter ends. We'll probably get a clearer picture of underlying sentiment by early next week with the new quarter starting, especially as it commences with a bang with the Global PMI numbers on Monday." In this vein, tonight's overnight sentiment showing weakness confirms yesterday's move was one which merely used Spain as a buying catalyst without reading anything into it. Because an even cursory read through shows major cracks. Sure enough the sellside readthroughs appeared this morning: "In our view the Spanish 2013 budget is based on a too optimistic GDP growth assumption" from Citi. Once again, the market shot first, and asks questions later, as the weakness in the futures confirms, EURUSD retracing all overnight gains, and Spain now 1.6% lower on this, as well as uncertainty of today's latest non-event - the local bank stress test vers 304.2b - whose results will be announce at noon NY time, and which just may find Bankia (and its Spiderman towel collection) is quite solvent once again.
Citi continues: "Spanish budget highlights resistance to pass serious and convincing reforms due to domestic politics. Most recommendations from Europe were postponed until after regional elections.... Budget is ambitious and challenging effort in line with Bank of America estimates; only surprise is new tax measures that could add 0.3% of GDP in revenue; growth assumptions still too optimistic" and so on from Bank of America's Ruben Segura-Cayuela and Laurence Boone, and UBS summarizes: "Pare back long positions in Spain." And while Spain has yet to do anything but give out empty promises, we just learned that September inflation soared by 3.5% on expectations of a 2.8% rise due to the arrival of a VAT hike this month. Just call it stagflation and a record high misery index: it's not like the people don't know.
Elsewhere things are back to normal as strikes by public sector workers move from Greece and Spain to Italy: university professors, public administration employees and health workers in the CGIL and UIL unions are expected to stop work today with rubbish collectors also expected to join the work stoppage.
Once again recapping the Spanish announcement with DB:
So Spain’s 2013 budget targets a reduction in the deficit from 6.3% of GDP in 2012 to 4.5% in 2013. As ever, growth is the key to whether these targets can be met and so far the evidence of those making such cuts has been that growth has disappointed. On that note, the Spanish government’s projections are based on an assumption of a 1.5% contraction in the Spanish economy this year, followed by a 0.5% contraction in 2013. The latter looks particularly optimistic with DB’s economists forecasting a 1.1% contraction in 2013. The government was keen to point out that cuts in spending, rather than tax hikes will account for the majority of the deficit reduction. Tax revenues are budgeted to increase by just under 4%, although this is largely mitigated by an increase in interest costs which will increase by 30%. Ministry spending was cut by 8.9% and public servant wages were frozen.
In terms of reforms, the Spanish government announced that it will introduce 43 new laws in the next 6 months to liberalise the energy, services and telecom sectors. New measures will be introduced to reform public administration and deepen labour market reform including wage bargaining. The government, however, shied away from the politically sensitive move of freezing pension indexation. Perhaps most importantly, the EU's economic chief Ollie Rehn said that the Spanish plan goes beyond what the European Commission had recommended in July and represents a “major step” - which may provide Rajoy some comfort that additional conditionality attached to EU/ECB aid will be limited.
The Spanish Government remains undecided on a bailout, with Finance Minister De Guindos saying "The government is in contact with the countries involved…to see what the different possibilities are and how they would work…then we will make a decision" (WSJ). For now the fact that reforms have been announced and that Europe has provisionally endorsed them will arguably encourage Spain to hold out for a few more days and weeks. Watch out for headlines from the important European players over the next few days reacting to Spain's news. This will show how far they think Spain have come.
Meanwhile markets continue to ponder when Moody’s will conclude its review on Spain’s Baa3 rating. Moody’s said in August that the review is “likely to continue through the end of September” however it did say it would wait for more information on Spain’s banking recap needs (which are due today) before deciding. Overnight, US-based rating agency Egan-Jones downgraded Spain’s rating to CC from CC+. Although, after having downgraded Spain seven times this year alone (Reuters), markets could hardly be surprised by this move.
Some more from Citi:
Spanish budget and reform plans. Yesterday the government presented the budget proposal for 2013. The government expects that the 2012 deficit target of 6.3% of GDP will be met as, according to Economy Minister Christobal Montoro, tax revenues will exceed targets. For 2013 the budget cuts will be focused on reductions in expenditures particularly on social spending rather than tax increases. The budget is based on the forecast of a contraction in GDP by 1.5% in 2012 and 0.5% in 2013. According to the economy minister, there would be an adjustment in expenditures of 0.77% of GDP in 2013 and an adjustment in revenues by 0.56% of GDP. Including the measures implemented in 2012, the budget includes an increase in revenues by 3.8% YY in 2013 and a cut in central government spending by 7.3% YY. Over a two-year period the minister expects that the new tax measures would boost revenues by €4.7bn. In order to improve the liquidity situation, the government plans to tap €3bn from the €69bn national pension reserve to help fund pensions. The government also announced the creation of an independent fiscal body to oversee the implementation of the budget measures. In addition, the government approved a reform package under which 43 new laws are planned to be introduced in the next 6 months. According to the proposal the package includes measures to limit early retirement, but not an increase in the retirement age; and further labour market reform initiatives – including a decree on wage bargaining. In addition, there should be a liberalisation of the energy, services and telecoms sectors.
Comment: In our view the 2013 budget is based on a too optimistic GDP growth assumption – we expect a contraction by 1.8% in 2012 and by 3.2% in 2013. In that respect, the total fiscal tightening measures of 1.3% of GDP are probably not enough to meet the 2013 deficit target of 4.5% of GDP. On the reform agenda, leaving the retirement age unchanged and only taking measures to restrict early retirement looks disappointing. However, the wage bargaining decree seems to be a good step. It remains to be seen how quickly the measures will be implemented.
For those who think Olli Rehn's immediate canned remarks praising the Spanish promises are sufficient to get Spain to request a bailout and the conditionality is in place, think again. Rehn is just one voice - many more will have to speak up, especially those who actually fund the bailout mechanisms.
EU's Rehn suggests Spain's economic reforms would meet the Commission's conditionality requirements for financial assistance – EU Economic and Monetary Affairs Commissioner Olli Rehn acknowledged Spain's detailed timetable for economic reforms, which he described as an ambitious step forward and being "clearly targeted at some of the most pressing policy challenges", while going in some cases beyond what the European Commission has asked of Spain. Mr Rehn stressed that he "particularly welcomed the ambitious plans to establish an independent fiscal Council, to further liberalise professional services, and to effectively reduce the fragmentation of the internal market in Spain."
Comment: Alongside an austere 2013 budget relying more on spending cuts than tax increases, this reforms package is, in our view, designed to pre-empt the likely conditions of any international bailout. Reading between the lines, we believe that Commissioner Rehn is sending a clear signal that the Commission would be unlikely to require extra conditionality to give a green light to a Spanish request for financial assistance. However, it remains unclear if the euro area creditor countries – which have to approve a MoU for a Spanish programme in the ESM board – are fully convinced by the Spanish budget and reform package.
Elsewhere in overnight markets:
Markets continue to ponder when Moody’s will conclude its review on Spain’s Baa3 rating. Moody’s said in August that the review is “likely to continue through the end of September” however it did say it would wait for more information on Spain’s banking recap needs (which are due today) before deciding. Overnight, US-based rating agency Egan-Jones downgraded Spain’s rating to CC from CC+. Although, after having downgraded Spain seven times this year alone (Reuters), markets could hardly be surprised by this move.
Recapping yesterday’s action, European markets closed broadly higher, with the Stoxx 600 (+0.3%), CAC (+0.7%), DAX (+0.2%) and FTSE100 (+0.2%) all rebounding from the week’s earlier lows. Spanish 10-yr yields rallied 12bps while the EURUSD gained 0.3%. Markets were helped by a positive lead-in from China where stocks rallied 2.6%, fuelled by yet more rumours of policy action ahead of Chinese holidays next week. Spanish news aside, European data remained soft. The EC’s economic sentiment index hit a fresh 3-year low of 85 (vs 86.1 expected). The ECB’s credit aggregates report indicated that lending to the private sector fell 0.6% (vs 0% expected). In Germany, there were more signs that the economy is slowing, with unemployment rising for the 6th straight month. Meanwhile, Spanish data was predictably weak with housing permits and retail sales down 37% yoy and 2.1% yoy respectively.
Events in the US took a back seat but the S&P500 (+1%) posted a solid gain, closing near the day’s highs, with the bulk of the intraday move coming after the Spanish finance minister said that reform plans go beyond EU recommendations. There were further hawkish comments from the Fed's Charles Plosser, who said that the economy is in a 'funk' and that he was dubious that QE3 would stimulate an economy which is being held back by uncertainty and deleveraging. Markets shrugged off the weaker data prints. Pending homes sales (-2.6% mom vs +0.3% expected), durable goods orders (-13.2%, impacted at the headline by declines in aircraft orders and defence capital goods) and final Q2 GDP (revised back down to 1.3% saar) all surprised to the downside. On a more upbeat note, initial jobless claims fell 26k to 359k, and is encouragingly back at the lower end of the year-to-date range (352k to 392k).
Moving to overnight markets, Asian markets are trading with a positive tone with the Hang Seng (+0.3%) and Shanghai Composite (+1%) leading the way, supported by this week’s record liquidity injections from the PBOC. Domestic Chinese media are reporting comments from Premier Wen that the Chinese economy is due to improve in the coming months, and the government may ease policy if Q3 data disappoints. The Nikkei (-0.7%) is underperforming following the usual monthly data dump in Japan, with the key highlights showing IP down 1.3% mom and CPI unchanged from last month at -0.4% yoy.
In other European news, there was more debate about the ESM’s role in banking recaps. The Bundesbank's Weidmann said that legacy liabilities in banks are national responsibilities and governments should only share risks after Euro-wide bank supervision is in place. Meanwhile, the German president signed the ESM ratification into German law. Back in Spain, the parliament of Catalonia approved holding a referendum on independence from Spain.
However, Spanish Deputy Prime Minister Sáenz de Santamaría said the central government has constitutional means to prevent such a referendum "is willing to use them".
Turning to the day ahead, the key event will be the release of Spain’s banking stress tests (time yet to be confirmed). Elsewhere in Europe, the key datapoints are French and German consumer spending data and EU CPI. In the US, we get August personal spending and Chicago PMI reports. China’s final HSBC PMI will be released over the weekend for those not watching the golf.
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