Sunday, December 13, 2009

Weekly Focus: From Dubai to Greece

Market movers ahead
  • Focus turns to the Fed meeting in the coming week. They are not likely to change the language much and will hold on to the “extended period” phrase.
  • The final ECB 12-month tender is expected to show moderate demand from banks.
  • German Ifo and Euroland PMI are expected to show a further moderate increase.
  • The Tankan survey for Q4 in Japan will likely show another rise for large manufacturers.
  • Scandi focus will be on monetary policy meetings in both Sweden and Norway.
Global update
  • Attention moved from Dubai to Greece as markets fretted over the soaring deficit and public debt. However, the risk of default is very small in our view.
  • October production data has disappointed globally. It may be due to workday distortions but warrants the close tracking of data in coming months.
  • Growth in Asia is losing momentum but overall still expected to be robust.
  • Danish unemployment data is a cause for concern.
  • The need for tighter monetary policy in China and the weak US dollar suggest that China will resume gradual appreciation against the dollar in 2010.The risk of a sharp rise in the US savings ratio has been reduced.

Market movers ahead

Global movers
In US the FOMC meeting will take centre stage next week. No doubt that there are differing views within the FOMC but the remarks by Bernanke and Dudley this week, both belonging to the inner-circle of the committee, suggest that changes to the statement on Wednesday are likely to be minor. Given that markets have already reversed the more aggressive pricing of Fed hikes following last week's employment report, a dovish message next week will probably not have a strong market impact. Furthermore, we will receive a new round of inflation and housing data. We expect the increase in core consumer prices to be subdued and look for a decline in the annual growth rate over the coming months. Headline inflation on the other hand will move higher driven by base effects from the collapse in energy prices last year. Housing data have been mixed lately, but we expect housing starts to take a rebound in November and look for flat readings on NAHB and building permits.

In Euroland we are in for an interesting week, with a flurry of December confidence indicators due out. In addition the ECB's final 12-month auction takes place on Wednesday. We expect moderate demand from banks given that the conditions have become less attractive and more complicated after the ECB decided that the rate applied on the loan will be fixed at the average minimum bid rate. Tuesday will see the release of the German ZEW indicator. Our ZEW model suggests that last month's decline will continue this month, and we believe the ZEW could drop below 50. We will keep a closer eye on the PMI, due out Wednesday, and we look for a modest increase. The inventory/order ratio and the OECD's leading indicator signal a continued large improvement, although slightly weaker European data recently have dampened our expectations. Our model for the German Ifo - set for release Friday - points to a roughly unchanged level. Our final call will depend on the other indicators due in the coming week, but at the time of writing we expect a modest increase in Ifo expectations. The week will also see the release of some hard data - not least, eurozone industrial production for October, which is likely to decline slightly. We have already received quite a few disappointing numbers for October, which was one workday short of the average.

In Asia focus next week will be back on Japan with the release of Bank of Japan's (BoJ) Tankan survey for Q4. Current conditions should continue to improve for large manufacturers on the back on continued recovery in exports and industrial activity, while current conditions for non-manufacturers should be broadly unchanged reflecting that domestic demand - particularly private consumption - will start to slow in Q4 as the impact from fiscal easing starts to wane. The outlook for manufacturers is only expected to improve slightly, suggesting growth in industrial activity will slow in Q1 10. Outlook for non-manufacturers appears to have deteriorated suggesting private domestic demand might be slowing more than we expect. As seen in the chart this development is still consistent with growth around 4% q/q AR, but it suggests there could be downside risk to our 2% q/q AR GDP forecast for Q1 10.

BoJ has already reacted at its recent emergency meeting to the deterioration in several business confidence indicators and so far the Japanese government and BoJ appear to have been successful in stemming the appreciation of JPY. Hence, there is unlikely to be any major news in connection with Friday's policy board meeting.

Global update: From Dubai to Greece

Calm didn't last long
The calm after the Dubai crisis didn't last long. This week everyone's eyes moved from the Middle East to Greece that experienced the worse confidence crisis since joining the euro. The Greek 10-year bond spread to Germany widened 65bp and the turmoil led to renewed flight-to-safety flows into German bonds.

There are several factors behind the “panic”. Greece shocked investors - and not least EU leaders - when it a couple of months ago revealed that the budget deficit in 2009 would not be -5.1% but a stunning -12.7% instead. With an already high debt level of 99% of GDP this is a serious issue. The EU Commission projects the deficit to continue to be close to 13% in both 2010 and 2011, which will lead to a further strong rise in the debt level. The new socialist Greek government has made a plan to cut the budget deficit in 2010 to 9.1%, but this has not been enough to soothe investors and rating agencies - or the EU for that matter. This week rating agency S&P put Greece on negative outlook on its A-rating and shortly after Fitch made an actual downgrade from A- to BBB+. The market “panic” has been reinforced by the fact that it is year-end - a time of year when investors are generally reducing risk and liquidity in the markets is very limited.
There can be no doubt that Greece is in an extremely difficult situation. The government will have to come forward with more budget cuts very soon to calm the markets and it has signalled that this will already happen on Monday. Reducing the budget deficit in a time of crisis is not easy and will require very harsh measures. But as is the case with all panics the top priority is to turn confidence in order to get bond yields (and hence interest rate costs) down again. The usual alternative is to devalue, but this is not an option within the euro and the costs of leaving the euro are likely to be even greater.

Although the situation in Greece is very serious, we find the risk of default limited. For several reasons Greece will likely get help from the EU if needed: Firstly, it would be a major political failure of the euro system if Greece defaulted. Secondly, the losses would be significant for the banking system and lead to another strong negative spiral in financial markets where the crisis would spread to other countries very fast. Towards the end of the week EU policy makers also made clear that Greece would not be allowed to go bankrupt and spreads started to narrow a bit. Since we don't believe in a default we believe there is value in Greek bonds, but timing is of course of the essence. When investors return to the market past year-end we could see some narrowing of spreads.

October production weak across countries
This week Germany, the UK and Sweden joined the club of countries showing weak industrial production data for October. This comes on top of disappointments in both the US and Japan. Is the recovery already losing momentum? We doubt it. Inventories are being reduced very fast, which means that the gap between production and sales is very large. Production still needs to rise a fair bit to close that gap. We also know from Japan, which is the only country to release specific production plans, that companies planned to raise production by 3% in November. October had a work-day less than average, which may have been a factor hitting all countries. That said, it is important that production shows improvement in coming months if we are to be right about our growth scenario.

Fed dovish while Obama pushes down the pedal even further
It has been interesting to follow the Fed speeches this week leading up to the FOMC meeting next week. Chairman Bernanke stated on Monday that the three conditions for keeping rates low for an extended period - low rates of resource utilization, subdued inflation, and stable inflation expectations - are still in place. On Tuesday, further dovish remarks were provided by New York Fed president Dudley. If his forecast for US growth comes through, unemployment will stay high and inflation low, implying that an exceptionally low Fed funds rate will be appropriate for an extended period.

More fiscal stimulus is likely to be directed to the economy in 2010 according to a speech by President Obama Tuesday. The extra spending or extensions to the existing provisions will be aimed at boosting infrastructure spending, supporting hiring and investment by small businesses (including a hiring tax cut), and income support for certain groups. The funding would be unspent money from the TARP programme. The proposal still needs to make it through Congress and we will have to wait for some more weeks to get more details and see the final proposal. Finally, although initial jobless claims rose this week, the 4-week moving average and the insured unemployment rate declined further. These data thus continue to suggest that the stabilization in the labour market in November is for real and will hold.

Asian recovery losing momentum, but should stay robust
Data in Asia have become more mixed recently. This is particularly the case in Japan where Q3 GDP growth was revised sharply lower to just 1.3% q/q AR from previously 4.8% q/q AR. The downward revision was mainly due to lower business investment and inventories' contribution to GDP growth. In addition, consumer confidence and several business surveys suggest that private consumption is slowing substantially after two strong quarters. As the impact from fiscal easing starts to wane we expect private consumption to slow below 1% q/q AR in Q4. However, GDP growth in Q4 will remain well supported by the recovery in exports and industrial activity and we still expect GDP growth to be close to 4% q/q in Q4. That said the recent weak data suggest some downside risk to our growth forecast for the coming quarters.

Chinese data for November on the surface looked strong, with not least the year-on-year growth in industrial production accelerating to 19.2% y/y in November. However, this acceleration is to a large degree due to the base impact from lower industrial production last year. Industrial production now points to GDP growth around 9% q/q AR in Q4. This is only slightly higher than in Q3 and less than our previous forecast of 12% q/q AR GDP growth . Hence we are likely to revise our GDP forecast for 2009 slightly lower from our current 8.5% forecast. November data did confirm though, that China's growth drivers have shifted somewhat from domestic demand to export.

Year-on-year inflation in China as expected turned positive in November, again mainly because of the base impact from lower prices last year. As of yet there are no signs that underlying inflation is rising and hence the government does not seem to be behind the curve in removing its stimulus measures.

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