A Short Note on Good Friday

Most of the world's markets are closed, but there are a few developments to note.  

First, a few Asian equity markets were in fact open and most posted small gains.  The Shanghai Composite is an exception, slipping marginally (-0.05%), but the Shenzhen Composite rose (0.3%).  Recall, China reportedly will reduce the required reserves for some "qualified" rural banks and this is expected to help small and medium sized businesses, which are more represented in the Shenzhen Composite.  

Second, China reported today that house prices in many cities are stabilizing.  In Beijing house prices were up 10% from a year ago, which is the slowest pace since last April.  House in Shenzhen are up 13%, the smallest increase since June 2013  This is consistent with the other recent data that showed some moderation in financial variables, like money supply growth and even aggregate financing (CNY5.6 trillion in Q1 14 vs CNY6.2 trillion in Q1 13).  

The Chinese economy has been gradually slowing since 2011 and we expect it to stabilize at somewhat better level over the next couple of quarters.  That does not mean that the yuan has bottomed.  In fact, the yuan finished this week at its lowest closing level in nearly a month (March 21).  

We think arguments about the yuan decline as an attempt to boost exports is misguided.  China's exports typically have only a modest about of yuan-denominated inputs.  Remember, imported parts and components are still mostly prices in dollars  Chinese workers assemble most and then export.  The value-added by Chinese workers is often estimated to between 12% and 20%.  This means that a small currency depreciation (~3%) is unlikely to change prices of Chinese exports. 

Third, few observers seem to be putting much stock into the agreement struck yesterday between the US, Russia, the EU and Ukraine aimed at deescalating the crisis  It called for the disarming of illegal groups and return of seized buildings.  Amnesty is to be granted protesters and a new constitutional process is to be established to ensure a broad dialogue.  The Organization of Security and Cooperation in Europe is tasking with facilitating this.  

Despite the skepticism, Russian shares jumped the most in three weeks, rising about 2.2%, and recouping almost all the week's decline today.  The rouble itself is up about 0.15% today, which due to the holiday that has shut most markets, is among the strongest currencies.  For the week, it is up about 0.25%.  

The agreement delays the next round of sanctions.  Many people seem to misunderstand the sanctions and seem to call a military response.  There has been a military response by Ukraine and NATO, which has moved troops to strengthen deterrence.  There is some questions about the US and Europe reducing defense spending and what some argue is a weak response to Russia's aggressiveness.  

Yet we remain struck by the fact that even during the heart of the Cold War, the US and Europe did not militarily confront the Soviet Union over its actions in Europe, such as its invasion of Hungary and Czechoslovakia.  Nor was there a military confrontation when Russia went into Georgia, which it still occupies part, in 2008.  If there is a doctrine here, it is that the US will not sanction a confrontation with Russia over areas in Europe, which it does not have a defense treaty with or strategic interests.  

Fourth, Italy's Prime Minister Renzi is pressing ahead with his fiscal efforts.  The cabinet is expected to approve the payroll tax cut today after parliament approved the multi-year budget plan.  There is much skepticism over Italy's projection that it will keep its deficit below 3%, while projecting slower growth than the Letta government.  

Many are skeptical about the 6 bln euros in spending cuts and it is not clear whether this is on top of what the Letta government proposed.  Additional one-off measures may be necessary. These may include a cut in the prescription rebates for high income people and a steep tax (26% possible) on the banks' stake in the Bank of Italy, which pending approval by the ECB will be re-valued significantly higher.  

While Renzi has indicated intentions to adhere to the EU budget agreement, he is pressing to delay by another year (until 2016) the structural balance objective.  The initial response does not look particularly favorable, but if France is given extra leeway, it is more difficult to reject Italy's request.  One take away from the recent developments is that peak austerity may be past.