The Tremors Are Back: Japan Recession, China Trade Disappointment, European Periphery Slides

In a perfect trifecta of disappointment, overnight we had reality reassert itself with a thud as first Japan reported weaker than expected GDP which contracted for a second consecutive quarter and which technically sent the country into yet another recession, merely the latest one in its 30 year deflationary collapse. And it isn't about to get better: " Analysts expect another quarter of contraction in the final three months of this year due to sluggish exports to China, keeping the Bank of Japan under pressure to loosen monetary policy as early as this month." Of course, there is hope that the new, old PM, Abe will restore money trees and unicorns and get Japan to a 3% inflation target, without somehow destroying bank and insurance co balance sheets in the process, all of which are loaded to the gills with JGBs set to collapse should inflation truly return. Then after Japan, China reported miserable trade data, which flatly refuted all hopes of an economic pick up both in the mainland and across the world. As BusinessWeek reports "China’s exports rose 2.9 percent in November from a year earlier while imports were unchanged, leaving a trade surplus of $19.6 billion, the customs administration said today in Beijing. The growth in overseas shipments compares with the 9 percent median estimate of analysts in a Bloomberg News survey." This was below the lowest forecast of the range ($21.9-$32.2) with an average expectation of a $26.9 billion surplus.

Perhaps the reason China can not openly fudge its trade data, unlike its GDP, inflation, retail sales, industrial production and all those other indicators that none other than the incoming head of government Li Keqiang said are for "reference only" (a fact conveniently ignored when they are all going up, and duly noted when China is self-reportedly sliding) because other countries report the counterparty data and it is very easy to catch China lying in this particular case. And finally there was Europe...

Ah Europe: the gift that keeps on giving. Just when everyone thought all was fixed, last Thursday Monti's government lost support of Berlusconi's PdL and effectively lost control. It took the market 4 days to understand, and a statement from the Goldman horse's mouth himself, what this really means. Sure enough today Italian bonds are sliding on the Monti departure, and at last check were nearly 40 bps wider to 4.9%, the biggest rise in yields in 4 months, while latent fears over Spain following last week's weak auction and a DB note saying the hope rally may be over in Iberia, sent SPGB wider by 20 bps to 5.65% (more on DB later). We also learned that despite all attempts to disengage the banking and sovereign sectors in Europe, in Italy precisely this fusion is accelerating as sovereign debt held by Italian banks just rose to a record. To wit: Italian bank holdings of Italian sovereign debt rose to €340 billion, up €12.6 billion and the highest ever. In other words, the weakest link in the sovereign-banking symbiosis in Spain and Italy will once again be the fulcrum security when setting prices for sovereign bonds, and lead to another inevitable ECB, Troika bailout.

Far less relevant, but not helping, was Italian Industrial Production tumbling 1.1%, on expectations of a modest 0.3% drop following last month's 1.3% revised drop. How long until we start talking about the pre-Christmas deficit bomb miss announcement in both Spain and Italy, whose economies it will turn out have performed far, far worse than was publicly reported?

Finally, a look at Greece which is always full of fun lies, remember this out of Reuters on Friday:

Greece will not extend the deadline bondholders to participate in a crucial sovereign debt buyback scheme beyond Friday, a finance ministry official said.


Greek banks will hold board meetings on Friday to decide whether they will join in and must declare their interest by 1700 GMT.


"The auction will be completed today. There will be no extension," said the official, who declined to be named.

Turns out the finance ministry official source was merely pulling a Juncker-Geithner, i.e., lying. From Reuters as of moments ago:

Greece has extended its offer to buy back debt until Tuesday, seeking more bids from bondholders after falling just short of a target to retire bonds worth 30 billion euros at a cost of just 10 billion euros.


The buyback is designed to provide for about half of a 40-billion euro debt relief package for Athens agreed last month by the European Union and International Monetary Fund.


Its success is crucial to ensuring Greece's debt is put back on sustainable footing and -- more immediately -- to unlocking badly-needed aid for the country.


The offer had been due to end on Friday. The debt agency extended the offer to 1200 GMT on Tuesday.

This too will be "revised."

All one can do is laugh as the lies out of Europe, and everywhere else, in a desperate attempt to avoid facing the brutal reality, keep piling on. But the music is still playing, and those lucky enough to still manage other people's money have to keep dancing.

Finally, a less jaded take on recent events from DB's Jim Reid:

With central bankers increasingly 'all-in', political risk was one of our key themes in our 2013 Outlook. The fiscal cliff has clearly been the 'live' issue with our expectations that the Italian election would cause notable volatility towards the end of Q1. However a day is a long time in politics and after we went to press, the Italian political situation accelerated with the weekend seeing Berlusconi (remember him?) announce that he was planning to run for PM again and Monti looking like he intends to resign as soon as parliament passes the 2013 budget (ie before Xmas). Elections must be held between 45-70 days after parliament is dissolved so this raises the prospect of February elections but with a March 10th date that was a strong possibility before the weekend's events still possible.

So although the date of the election may not be too different, the campaigning looks set to be more confrontational with Berlusconi's PdL party looking likely to step up the anti-austerity and anti-German Euro leadership rhetoric thus leaving markets nervous that Italy might find it difficult to maintain their current reform program. The PdL are currently neck-and-neck with the populist Five Star Movement, led by comedian Beppe Grillo and has only around half the support of the centre-left Democratic Party (PD). So it'll be interesting to see how this changes with the weekend's news. The highest polling PM candidate, the PD’s Pier Bersani, came out over the weekend and committed himself to Monti’s reforms, stating, “we will respect the stringent commitments taken.”

If we do see a widening of Italian bond spreads as the election approaches it may serve to remind voters and Italian politicians of the still precarious economic situation that Italy is in. This could mean that Monti's reform agenda is eventually strengthened by any possible adverse market reaction. However one would now expect Italian risk to trade nervously until some clarity emerges as to the post election administration. This story and any lingering fiscal cliff issues will likely be the main events in Q1.

The weekend news followed S&P's negative comments on Italy late on Friday. It said that it was maintaining its negative outlook on the BBB+ rating partly reflecting what the agency views as “mostly downside risks” to the country's policy reform agenda. In particular they note the uncertainty around whether the next government coalition will remain committed to structural reforms and the significant risk that the economy might not recover in the 2H of 2013 which may “potentially undermine political and social support for reform”.

Turning now to China, markets are reacting positively to the weekend data dump for November. Overall the data remains consistent with a steady recovery with Industrial Production (10.1% v 9.8%) and Retail Sales (14.9% v 14.6%) printing ahead of market consensus. Fixed asset investment was unchanged from the previous month’s 20.7%. Inflation data also edged higher helped by a sharp rise in vegetable prices but still slightly below market estimates (2.0% v 2.1%).

PPI however fell -2.2% yoy v -2.0% expected and was 0.1% lower from the month before although DB’s Jun Ma is not overly concerned with this as it can be partly explained by seasonal factors. China also published its November trade numbers this morning which showed a drop in the trade balance to $19.6bn for November (vs $31bn previous month and $27bn expected) driven by exports which were materially lower than market consensus (2.9% yoy v 9.0%). Imports were also weaker than expected (0.0%yoy v 2.0%).

Overnight markets are trading stronger on the back of the weekend Chinese data, but gains have been pared following the weaker trade numbers this morning. The Hang Seng (+0.43%), ASX200 (+0.13%) and Shanghai Composite (+0.96%) are all trading higher, as are other China-related risk assets such as copper (+0.85%). In currencies, the AUDUSD (-0.1%) is trading slightly weaker this morning though, weighed by the weaker-thanexpected
Chinese import data.

Meanwhile, the Yen is steady against the greenback overnight despite headlines that Japan’s economy has sunk into recession again. The final Q3 GDP for Japan came in at - 3.5%qoq annualised (vs -3.3% expected and -0.1% in the previous quarter). Staying in the region the Philippines is said to be strongly supportive of a re-armed Japan as a counterbalancing factor to the growing military dominance of China in the region. Speaking to the FT during an interview, the Philippines foreign minister said “We are looking for balancing factors in the region and Japan could be a significant balancing
factor.” This comes days before the election in Japan and the potential re-election of former PM Shinzo Abe who is committed to revising Japan’s pacifist constitution and to beef up its military. As we highlighted in the outlook geopolitical risk is one of that is perhaps being overshadowed by the ongoing economic issues on both sides of the Atlantic. While Syria and Iran stand out on this front we are also keeping a close eye of developments elsewhere.
Looking at the week ahead, the conclusion of the FOMC’s two-day meeting and Bernanke’s press conference on Wednesday will be closely watched. Our economists expect the Fed to announce $45bn of longer-term treasury purchases per month after the year-end maturity of Operation Twist together with the continuation of $40bn in MBS purchases. In terms of guidance, our expectation is that the Fed will indicate that Treasury and MBS purchases will continue at a combined pace of $85bn per month until the labour market shows substantial improvement.

The other key macro highlight of the week is the December flash manufacturing PMIs for the Eurozone, US and China which are all scheduled for Friday. In terms of the European PMI, the market is expecting a 0.2pt, 0.5pt and 0.4pt month-on-month improvement in the French, German and Eurowide readings respectively, although all three are expected to remain well below the 50-mark. In Europe, other economic reports to watch for include today’s German trade data & French/Italian production; Tuesday’s German ZEW survey and Wednesday’s Eurozone IP and UK jobless numbers. In the US, the major economic reports of note include Tuesday's trade balance and inventories, Thursday's retail sales report and Friday’s industrial production and CPI.

We’re also expecting a busy political calendar ahead. Eurozone finance ministers will meet on Wednesday to discuss the banking union in the hopes of formalising an agreement before year-end. On Thursday, finance ministers are also expected to ratify Greece's next programme disbursement following the expected completion of the country's debt buyback. The results of Greece’s buyback are expected to be announced today. The EU leaders Summit begins on Thursday to discuss Van Rompuy's three-step plan to strengthen the economic/monetary union. Recent media reports suggest Spain will receive EUR40bn in funds for its banking recap this week. Turning to the US, fiscal cliff negotiations are expected to intensify this week in what is the second-last full week before the Xmas break. Markets will be closely watching for any concrete progress towards a compromise. Japan holds its elections on Sunday Dec 16th so we can expect further commentary from both major political parties on the role of the BoJ in the government’s fight against deflation.


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