Sunday, November 22, 2009

Weekly Focus: Squaring Positions

Global update
  • Year-end position squaring is widening sovereign spreads in peripheral Euroland countries. In combination with the abundance of liquidity this is driving short bond yields to very low levels.
  • OECD has revised up its 2010 outlook.
  • US October data have been mixed, but with important signs of more progress among consumers. Unusually bad weather has probably had some temporary negative impact. In summary data continue to point to a solid Q4.
  • Japan published very strong Q3 GDP growth of 4.2% q/q AR showing the strongest performance among G7 countries so far.
Market movers ahead
  • The main event in US are the FOMC minutes. Home sales, durable orders and consumer confidence are forecast to show progress. House prices are on the agenda as well. Thursday is closed due to Thanksgiving and Friday is likely to be quiet.
  • In Euroland flash PMI and German Ifo will continue up, while the M3 growth will decline further. Euroland industrial new orders will be published as well.
  • In Japan CPI and unemployment will be released. Focus will remain on the appreciation pressure on the Asian currencies.
  • In Sweden Q3 GDP will confirm that the recession has ended and show strong growth of 0.8 q/q %. Retail sales, manufacturing confidence and PPI will attract attention as well.
  • In Norway mainland GDP is likely to show impressive growth of 1.4% q/q.

Global update: Squaring positions

Year-end risk reduction helps drive yields lower
At 0.69% the 2-year US bond yield is only 5bp from the low point during the crisis reached a year ago. 3-Month t-bill rates are again trading around 0%.
Mainly two factors are behind this development. First of all, investors and banks are most likely reducing risk towards year-end putting money in cash or highly liquid products. The risk reduction is also showing up in some risky assets such as peripheral bonds in the euro area. Especially Greece has been hit hard, but other countries also see their spread widening slightly. Greece is a story on its own as doubts are increasing over the sustainability of its public finances. The budget deficit is expected to be higher than 12% in 2010 for the second year in a row and the government debt is expected at 125% in 2010 and rising fast. Interest rate payments alone are 5% of GDP. If confidence in the Greek situation slides there is a risk of a negative spiral of rising yields adding to the interest payments of the government, which makes it even harder to improve the public finances.

A second factor behind the sharp decline in t-bill rates and short bond yields are the continued dovish signals from leading Fed members such as Chairman Ben Bernanke and vice chairman Donald Kohn. As economic data have been a bit mixed this week with both housing starts and industrial production disappointing, expectations of Fed hikes are being postponed further. Retail sales ex autos were also a bit softer than expected, although the details still point to improvement in underlying retail sales growth (see Flash Comment – US: More progress among consumers).

OECD revising global growth outlook higher - again
OECD published its Economic Outlook this week and upgraded its view of the global growth outlook. After having been fairly pessimistic on the global economy for some time (at least compared to our own assessment) OECD now takes the consequence of better data. It now expects growth in the US next year of 2.5% up from a previous estimate of 0.9%. It is still below our forecast of 3.2%, but the difference is much smaller. In Euroland we still have a more upbeat view than OECD reflecting expectations of stronger growth mainly in the next two quarters. The main difference between OECD and us is the estimate of how strong the impact will be from the inventory cycle. We believe this is a major factor behind the turnaround and a reason why OECD underestimates the pace of growth in the short term.

The inventory cycle is a global phenomenon and has been a strong driver behind the collapse in world trade. For some time companies were mainly producing out of inventories and did not order materials from suppliers abroad. Hence world trade collapsed. With inventories very lean at most levels of the supply chain, companies are starting to increase orders, which shows up in rising world trade. We expect the inventory cycle to run for at least another couple of quarters and therefore expect more of the same of what we saw in Q3. The latest country to report strong Q3 data was Japan. At 4.8% q/q annualised Japan has turned from underperformer to outperformer in the developed world. This is partly because Japan is highly exposed to world trade and partly because Japan benefits strongly from robust activity in Asia. However, domestic demand in Japan has also improved driven by higher capital expenditure which is a very positive signal for sustainability (see Flash Comment – Japan: From underperformer to outperformer).

Market movers ahead

  • In the US the main event is the FOMC minutes from the 4 November meeting, where focus will be on the revised economic projections and the committee's discussion about any future unwinding of alternative easing measures. We look for improving data in home sales, consumer confidence and spending for October. Revised Q3 GDP will be lowered to 3% from 3.5% q/q AR. House prices will attract some attention too.
  • In Euroland M3 data is due out on Thursday. If the monthly loan flows improve, this will give some comfort to the ECB ahead of the important December meeting. M3 growth will decline sharply from 1.8% to 0.4% y/y due to base effects. The release of flash PMIs for Euroland, Germany and France are projected to show further improvements. The Ifo index should show that the German economy is still improving. Expectations are set to increase further and the current conditions index should begin to improve more strongly. Euroland industrial new orders are likely to show a modest increase following three months of strong growth.
  • In Japan consumer prices and unemployment will be released next week. We expect the unemployment data to confirm that the unemployment rate has probably already peaked on the back of very solid growth in both Q2 and Q3. Otherwise the appreciation pressure on Asian currencies will remain in focus and it cannot be ruled out that some Asian countries will soon start to announce some controls on capital inflows to stem the recent appreciation pressure.
  • In Norway we forecast impressive growth in mainland GDP of 1.4% q/q driven by public and private spending. That said, GDP should still remain below the level a year ago.
  • In Sweden Q3 GDP is the main event. Manufacturing confidence for November and retail sales for October are also on the agenda.

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