Sunday, December 20, 2009

Weekly Focus : A Bumpy Ride Towards Year-End

Market movers ahead
  • The data flow in the US should be relatively light. Key movers will likely be data on new and existing home sales in November. Forecasts are pointing toward improvement in the November data, but we still expect some weakness in sales data to materialise over the coming months.
  • In the first week of next year, the US dataflow intensifies, with the ISM surveys, non-farm payrolls and FOMC minutes
  • Nothing much of interest is expected out of the eurozone, although on December 23 we get industrial new orders. The data are awaited with some excitement following the downbeat October numbers.
  • In Denmark, GDP data for Q3 09 are due out. We expect GDP to contract by 0.2% from Q2 09 to Q3 09, or 6.2% y/y.
Global update
  • In the past week, European news headlines have been dominated by developments in Greece and the nationalisation of the Austrian bank Hypo Group Alpe Adria. S&P downgraded both Greece and Hypo Group in the past week.
  • Recently, the financial markets have focused increasingly on a potential further strengthening of the US dollar. Since December 1, the dollar index is up 4.5%.
  • US growth has shifted into a higher gear and should continue to strengthen heading into 2010.
  • The Tankan business survey for Q4 painted a mixed picture of the Japanese economy. On the one hand, it suggested very solid GDP growth in Q4 09, while on the other it indicated that GDP growth could slow substantially in Q1 10.
  • We highlight some of the main themes that will shape market developments in 2010, including the strength and sustainability of the recovery and central bank exit strategies.
  • We also throw the spotlight on public debt levels in the euro area and the future challenges posed by large and growing debt.

Market movers ahead

Global movers
The data flow in the US during the weeks surrounding Christmas is expected to be relatively light. Most interesting in the coming week is expected to be data for new and existing home sales in November. The forecast looks for improvement in the November data, but we still expect that some weakness in sales data will materialise over the coming months as the dynamics from first-time home-buyer credit reverses. Elsewhere initial claims data and durable goods data will provide some updated information about the state of the business sector. Durable goods orders have been on the weak side lately and we expect to see some payback in November, which would be welcome news for the investment outlook. In the week between Christmas and New Year, the final Michigan Consumer confidence and Chicago PMI are the most noteworthy events. Consumer confidence is expected to improve on a favourable cocktail of continued gains in equity markets, lower gasoline prices and slightly better job prospects.

In the first week of next year the dataflow intensifies with the ISM surveys, non-farm payrolls and FOMC minutes. It remains too early in the data cycle to gauge the exact outcome of these data, but we note that the recent soft reading on the Empire survey is causing some concern about our view for a continued improvement in the ISM in the near term. It seems that Euroland is on Christmas holiday for a two full weeks. At least if judged by the amount of interesting data to be published - i.e. not much. On December 23 we get industrial new orders. October was a disappointment with much downbeat data - not least because the month was short of one working day. Industrial orders in Germany dipped in October and we expect to see a small dip in Euroland orders, although they are still trending upward. On December 29 we receive preliminary German inflation figures. HICP is projected to increase from 0.4% to around 0.8%. Last, but not least, the ECB provide us with data on monetary developments for November. M3 growth would likely stay pretty flat at just above zero. M1 growth will rise from 12% to 13%, but this is just base effects. M1 growth is now firmly on a downward trend. We will also keep an eye on the monthly loan flows. We anticipate improvements following last month's disappointing retrenchment.

In Japan most economic data for November will be released between Christmas and New Year's Day. Recently several business surveys have suggested Japan GDP growth might slow substantially in Q1 10 driven primarily by a slowdown in private consumption, as the impact from fiscal easing has started to wane. Hence, we will pay particular attention to the labour market data. If the improvement seen in recent months in the labour market continues, Japan should be able to avoid a contraction in private consumption, as the improvement in labour incomes should start to compensate for some of the negative impact from fiscal policy. Because the decline in the unemployment rate has been unusually large in recent months, we expect the unemployment rate to be unchanged in November, but both employment and the job-to-applicant ratio should improve further in November. The other big theme in Japan currently is whether the BoJ should step up is non-conventional easing to fight deflation.

However, deflationary pressure has actually not been increasing in recent months. Deflationary pressure has been easing in recent months and it will now start to show up in the year-on-year inflation rate, which we expect to increase to minus 1.6% y/y in November from minus 2.3% y/y in the previous month. The increase in inflation is not only due to base impact from lower energy prices last year. As seen the chart underlying inflation has been increasing in recent months. Hence, the price development should really not be the main concern in Japan. However, the possibility of a substantial slowdown in growth in early-2009 is a concern

Global update: A Bumpy Ride Towards Year-End

A bumpy ride towards year-end
This week, European news headlines have been dominated by S&P's downgrade of Greece and the nationalisation of the Austrian bank Hypo Group Alpe Adria. Once again this should serve as a reminder that the crisis is contained, but not over. In the meantime, the potentially biggest game changer in the financial markets over the past few weeks could be the strengthening in the USD.

Since 1 December, the dollar index is up 4.5% - now trading at its highest level since September. Whether this shift is related to year-end unwinding of short-funded carry positions or whether it reflects a more permanent shift in investor sentiment towards the USD is probably too soon to tell. While we expect the USD strength to be temporary for now, the recent development bears watching as a continued and more permanent strengthening of the USD would have implications for the real economy, for investors and for policy choices down the road.

Elsewhere, the data picture continues to support our forecast for strong momentum in global growth heading into 2010. That said, there are now more evident signs that the pace of expansion is peaking in several places in Asia, as this week's decline in the Japanese Tankan highlights. In this respect, Asia still seems to be leading the global cycle and should face slower growth already in Q1. We expect a similar pattern to materialise in Europe and the US, but not before later in H1.

Still solid but more mixed US data
Over the past month, data has confirmed that US growth has shifted to a higher gear with growth rates around 4% heading into 2010. That said, last week's data has been more mixed regarding the H1 outlook. Indeed, it seems as if hard data is picking up, while soft and more forward-looking data has been more mixed.

Evidence from the US business sector confirms this picture. While the November data for industrial production revealed that the manufacturing sector outside autos is gathering speed, the local business surveys indicators have been mixed, so far. Also, in housing, hard and soft data have diverged. The NAHB survey weakened in December, while housing permits picked up in November. Despite the more flattish tendency in permits and starts over the past few months, the outlook is for an increase in residential construction by 15-20% in Q4 and similarly in Q1.

The huge slack in the economy is becoming increasingly evident in inflation data. Leaving out the spurious behaviour of auto prices, core PPI and core CPI are clearly trending lower at the moment. Indeed, the November data underpins our expectations that core CPI inflation will dip below 1% during 2010.

The Fed meeting this week did not add much new information regarding the policy outlook. The FOMC upgraded its assessment of the economy but did not change the outlook for growth and inflation. Once again, it was communicated that the exceptionally low level of interest rates will remain in place for an extended period. We continue to expect that the Federal Reserve will not hike before Q4 10, but that the central bank will probably begin absorbing excess reserves by the middle of next year.

Greece, Austria and the rest of Euroland...
This week all eyes have been on Greece…again. On Sunday, the Greek prime minister announced the measures the Greek government plans to implement in order to cut the deficit. These include a 10% cut in social security spending next year, introduction of a capital gains tax and a 90% tax on private bankers' bonuses. He also vowed to fight corruption and tax evasion, which he sees as Greece's biggest problems. The aim is to cut the deficit by 4% next year and then bring the deficit down to below 3% in 2013. The market did not take much comfort from the announcement and on Wednesday evening S&P followed in the footsteps of Fitch and downgraded Greek sovereign debt from A- to BBB+. The spread to Germany on Greek 10-year government bonds increased to more than 250bp.

Another focus of attention this week was Austria. On Monday, the Austrian government took over the bank, Hypo Group Alpe Adria - a major lender in the former Yugoslavia and in deep financial trouble. This reignited concerns about Austrian banks' substantial exposure to Eastern and Central Europe, which had been a theme at the beginning of the year. This is probably not the last bank to default or be nationalised. We would expect to see market jitters if and when larger financial players go belly-up.

With so much going on, key figures did not take centre stage. ZEW declined, but this was not much of a surprise. On a positive note Euroland and in particular German PMIs surprised on the upside. The PMIs are signalling strong growth for Q1, that we are very close to a peak in unemployment and that the ECB should still be on hold, but now with a bias towards hiking rather than cutting. We expect to see a first hike from the ECB in August next year.

Tankan suggests Japanese growth to slow in early 2010
The Tankan business survey compiled by the Bank of Japan (BoJ) was mixed. On the one hand it suggested very solid GDP growth in Q4 09, while on the other it suggested that GDP growth might slow substantially in Q1 10. While Tankan is consistent with our forecast of 4.0% q/q AR growth in Q4 09, it suggested that there might be considerable downside risk to our 2.0% q/q AR forecast for Q1 10. Business sentiment is mainly deteriorating for smaller enterprises within services, supporting the view that the slowdown in early 2010 will mainly be driven by a slowdown in private consumption as the impact from fiscal easing has started to wane. We expect growth in private consumption to slow to 1% q/q AR from close to 4% q/q AR in both Q2 and Q3 this year. However, based on recent business surveys, we cannot rule out the possibility that private consumption will contract in Q1 10.
The DPJ government has approved a new stimulus package; however, it is unlikely to have any major impact until Q2 10. Hence, we are likely to enter a period where the economic numbers will be very mixed and the markets will start to question the sustainability of the Japanese recovery. Hence, we cannot rule out the possibility that BoJ will step up its non-conventional easing further, most likely by increasing its purchase of government bonds. We think this will happen if growth slows below 1% q/q AR and the labour market starts to deteriorate again. This is not our main scenario, as the recovery in exports and industrial activity appears to be on track and the slowdown in private consumption should prove temporary.

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