Labour market report (Nov): another decline in payrolls despite end of recession
Factory orders (Oct): up again solely due to non-durable goods orders
The ISM manufacturing index jumped from 52.6 to 55.7 in October,
mainly due to the employment component having crossed the expansion
threshold - despite the labour market report later revealing a sharp
decline in manufacturing jobs. The indicators do not bode well for
November's ISM manufacturing index: the New York Empire fell by 11
points, and the Richmond Fed index declined to its lowest level since
April. The Philadelphia Fed index and small business optimism improved
but remained on a relatively low level. We thus expect the ISM
manufacturing index to have gone down to about 52.0 in November. The
Chicago PMI, to be released one day earlier, is likely to have
retreated from 54.2 to 52.0 too. However, the ISM non-manufacturing
index, which had gone down slightly in October, could have recovered
somewhat from 50.6 to 51.5 in November.
The ECB press conference will attract more attention than usual
this week, with financial markets waiting to see whether President
Trichet confirms that the central bank is to cease its 12m Long-term
Refinancing Operations after December. If so, the move will be
interpreted as being the first step by the ECB in unwinding its
unconventional policy measures. Meanwhile, in the UK, there has been a
divergence of views on the MPC on the appropriateness of the most
recent QE extension. MPC member Posen (who voted with the majority to
extend the BoE's Asset Purchase Facility by £25bn) speaks on Tuesday,
while Chief Economist Dale (who voted against a further extension to
the APF) speaks the following day. On the data front, there are a
flurry of purchasing managers' surveys released this week across the
globe. Moves in the employment balances within the US reports and
Wednesday's ADP reading are precursors to Friday's US labour market
data. Here, we expect non-farm payrolls to decline by 160k in November
and the unemployment rate to stay unchanged at its 26-year high of
10.2%. Until the unemployment rate shows a sustained downward trend,
the Fed is not likely to raise interest rates. On Wednesday, the Fed's
Beige book is likely to characterise the gradual recovery in the US.
In the UK, we expect both the manufacturing and services PMIs to
post small declines to 53.3 and to 56.5, though clearly the readings
are well above the fifty level, signifying expansion. As a consequence,
we expect the level of the composite PMI recorded to date during Q4 to
corroborate our expectation that the economy will exit recession in the
current quarter - chart a. There are a number of housing releases to
watch out for too. Lending to individuals data for October are released
on Monday, as is the November Nationwide house price index. The Halifax
also releases its house price index during the week. As for policy
maker rhetoric, the MPC's Posen (who voted for the MPC's £25bn
extension to the APF) speaks on Tuesday, while Chief Economist Dale
(who voted against the extension) speaks the following day.
German adjusted unemployment (November): short-time work still dampening upward trend
EMU inflation flash estimate (November): back in positive territory
ECB council: rates unchanged, gradual exit from non-standard measures
German retail sales are likely to have decreased in October. German
consumer confidence improved, but retailers’ business assessment
plummeted. The Purchasing Managers’ Indices for the German and EMU
manufacturing sector in November are unlikely to be revised
significantly. The same applies to Q3 EMU GDP.
U.S. housing statistics reinforce notion that market is on
the mend, by early next year, the Case-Shiller price index will be back
in the black. However, any the gains are unlikely to materially dent
the 30% drop from the peak
Initial jobless claims and
other employment indicators look increasingly promising that job gains
could be in store in a matter of a few months
U.S. third quarter GDP revised down to 2.8% (annualized) from 3.5%
In the Fed minutes, the FOMC revised up the economic growth forecasts
for 2009 and 2010 to the range of -0.4% to -0.1% (from -1.5% to -1.0%)
and the range of 2.5% to 3.5% (from 2.1% to 3.3%), respectively
Canadian retail sales rose 1.0% in September, indicating that the
Canadian consumer has helped propel the economy into recovery in the
third quarter.
The Teranet Home Price Index was down 1.8%
from year ago levels in September, however, the decline in this measure
has improved significantly over the past few months.
The Canadian current account deficit widened to a record $13.1 billion, as imports exceeded exports.
UNITED STATES - DARE TO DREAM
As economists, we often craft elaborate and lengthy presentations
detailing every wiggle and hiccup within the economy. But at the end of
the day, all anyone really wants to know is whether their investments,
job and home are safe. At least in terms of the latter two, the data
this week should help investors sleep a little easier.
When you hear the words ‘bidding wars’ and ‘home price gains’, do
you think “oh, that was sooo 2006”? Well, not anymore. The September
Case-Shiller home price index posted its fourth consecutive monthly
gain. The annual rate of decline in home prices has now eased to 9.4%
from 19% at the start of the year. If prices continue to improve at a
very moderate monthly pace (0.1-0.3%) over the coming months, this
price measure will finally break into the black by January, ending a
three year journey that left a trail of red ink.
The Swiss franc and the Japanese yen were among the top performing
currencies this week after equity and credit markets worldwide
plummeted on fears over a possible debt default in Dubai and a sharp
decline in Chinese equities. USD/CHF fell to parity and USD/JPY fell
below 85.0. GBP ended the week lower against the USD and the EUR as
participants turned away from pro-risk currencies. The AUD and NZD were
also hit alongside the CAD and NOK as commodity prices slumped.
A sharp fall in the Shanghai composite on Tuesday set the wheels in
motion for a round of profit taking in global equities and high yield
and commodity currencies following an almost uninterrupted rally since
early November. The flight-to-quality lifted the USD index off its 2009
low of 74.17, though sellers of the USD slowly re-emerged on Friday and
suggest that the reprieve for the USD of further weakness could be
short-lived. Price swings were exacerbated by thin liquidity as US
markets were closed for Thanksgiving.
The JPY was the best performer among G10 currencies, logging gains
ranging between 1.3% vs the Swiss franc to 3.8% vs the NZD. The
Japanese Ministry of Finance expressed its increased frustration at the
strength of the JPY overnight on Friday and this whisked USD/JPY off
the lows back towards 87.0. The Nikkei has underperformed the FTSE-100
by more than 11% in November on profitability concerns for Japanese
exporters, causing foreign investors to move out aggressively of JPY
stocks in the latest week. GBP/JPY dropped 4.7% over the space of two
days but a late spurt of buying on Friday and a bounce in the FTSE-100
prompted GBP/JPY to close the week over 143.0.
In the first half of the week, risk appetite roared back ahead of
the Thanksgiving holiday in the US, erasing last week's losses in the
equity market. Good data, mildly positive FOMC minutes, strong
corporate earnings and light volume kept investors from fretting over
the reduction in the second Q3 US GDP reading (to +2.8% from +3.5). The
FOMC minutes showed the Fed believes the continuing decline in the
dollar is orderly and unemployment will remain elevated for an extended
period of time; the Fed also hiked its US GDP growth forecasts
slightly. Weekly initial claims dipped below 500K for the first time
since January, putting the four-week moving average below 500K. With
the sharpened appetite for risk, the dollar got close to 12-month lows
against the euro and ten-month lows against the yen. Natural gas
futures rose to their best level in three weeks on Wednesday, surging
8.3% in part due to lower than expected inventory data from the EIA.
But the positive tone in the markets was sand blasted away by a
storm blowing out of the Middle East. Dubai World's surprise
restructuring announced on Wednesday shook global markets in the latter
half of the week on fears of a new contagion spreading through the
world financial system. The Dubai story was used as cover for punishing
what was perceived by some as a growing recklessness in credit and
asset markets: Equity markets fell an average of 3% worldwide, the
dollar strengthened rapidly, and commodities tumbled. After approaching
$1,200 early in the week gold fell back to as low as $1,140 on Friday,
and crude hit its lowest mark in six weeks. For the week, the DJIA lost
0.1%, the Nasdaq fell 0.4%, and the S&P 500 ended flat.
Fed minutes reveal relaxed attitude towards dollar weakness
Dollar plunges to new lows against euro, yen and Swiss franc
Dubai requests debt standstill for state holding company, dollar strengthens
ECB embarks on exit, December 12-month tender could be the last
After lacking direction for several weeks, the dollar fell to new
lows against various currencies this week. During the course of the
week, EURUSD firmed to 1.5144 temporarily, a 15-month high, only to
plummet again towards the end of the week. The Swiss franc breached
parity (i.e. the 1:1 level) with the dollar, and the dollar tumbled to
84.82 against the yen, its lowest level since 1995.
The reasons for the dollar's plunge to new lows are diverse and
complicated, however. The dollar's current weakness is basically
connected with a more optimistic assessment of the economic outlook,
which is increasing risk appetite. This tendency is spreading as market
participants are observing that, compared to the ECB in particular, the
US Fed seems to be showing little inclination to end its ultra-loose
monetary policy. The ample supply of cheap liquidity is also boosting
carry trades, whereby cheap US dollars are used to fund riskier assets
world-wide.
Overview
Optimists are blaming holiday-thin conditions for large moves in
many markets. Being of a gloomier bent we see this as another 'emperor'
found to be wearing no clothes as year-end pressures mount. This time
round it was Dubai World and Nakheel's request for a moratorium on debt
repayments while they are restructured by Delloitte LLP. It could have
happened to any one of hundreds of other heavily indebted
organisations. Bank and construction shares hit first, questions later,
iTraxx Crossover index widening from 510 to 555. Stock Indices lost up
to 5% on the day (Hang Seng), Russia down almost 8% on the week, the
Nikkei with a weekly close below 9,300 thereby completing a
'head-and-shoulders' top (as has Istanbul's index). A rush into 'safer'
products took Treasury yields lower, US TIPS out to 2013 now yielding
up to a negative 86 basis points. Lowest ten-year maturities are
Switzerland (1.85%) and Japan (1.25%), lowest two-year US (0.616%) and
Sweden (0.513%), and slight jitters in front money market futures as
one wonders who has the biggest exposure to Dubai. The yen and Swiss
franc gained against all currencies, the former to 84.82 and its
strongest since 1995's record 79.75, the latter to CHF0.9910 weakest
greenback since April 2008. The Euro slipped from a new high for this
year at $1.5145, similarly Singapore from SGD1.3769. Commodities mixed,
spot Gold retreating sharply from a new record high at $1,194.90 per
ounce, Base Metals off recent highs, Energy prices stuck for a sixth
consecutive week.
Political and Economic Developments
Though events in the Middle East have overshadowed all else, some of
this week's economic numbers are worth considering. Japanese October
Supermarket Sales were –5.2% Y/Y, close to February's –5.4% and not far
off the record low –7.1% of 2005; Large Retailers Sales –7.2% (negative
territory that has dominated for most of the last fifteen years), while
nationally CPI is running at a new record –2.5%. Q3 GDP figures
tweaked: US's down a little, UK's a little less negative, and Germany's
unchanged from the original estimate – German precision. Eurozone
October M3 Money Supply growth has collapsed to just +0.3% Y/Y (record
low) from a peak at +12.5% this time in 2007, while Bank Lending to the
private sector is shrinking at an even faster pace than the previous
month, -0.8% versus –0.3% (another record).
EMU economic sentiment and industrial confidence (November): up
PMI manufacturing index EMU (November): up
German CPI inflation (November): yearly rate back in positive territory
M3 growth (October): decelerating further
The ifo business climate for Germany will probably have improved in
November. The German ZEW economic sentiment has deteriorated, but the
US ISM manufacturing index has risen. German yield spreads have
widened, because long-term interest rates have gone up, whereas
short-term rates have decreased slightly. The DAX has recovered, after
a temporary fall. Both the euro and crude oil prices have been
fluctuating. The German GfK consumer confidence for December could have
remained more or less unchanged.
Currency markets to remain beholden to the risk trade
Bullion's bull-run still intact
Sterling takes a hammering, focus on 3Q GDP and public finances
Key data and events to watch next week
Currency markets to remain beholden to the risk trade
The moves this week should convince anyone that had any doubt, that
the correlation between equity markets and currencies remains alive and
well. It was a rollercoaster, with EUR/USD oscillating between 1.4800
support and 1.5000 resistance for the better part of the week. The
S&P 500 meanwhile continued to find interest on either side of the
pivotal 1100 level. It seems that EUR/USD 1.50 and the S&P 1100 go
hand in hand as both remain extremely challenging technical and
psychological levels. Indeed, both have only closed above those crucial
levels three times this year - euro in October and stocks just this
week. It should not surprise anyone that the correlation between these
two since the beginning of the second half of 2009 has been a stellar
92%. Don't look for much to change on this front anytime soon.
In this vein, we look for any reversal in the risk trade to elicit a
significant turn lower in euro. The fact that stocks could not pull off
any sustained rally this week despite what was better than expected
data should be concerning for the bulls. US retail sales early in the
week were strong at the core level, with the control number (ex autos,
gasoline and building materials) increasing by 0.5% in October - on the
heels of similar increases the prior two months. But equities did not
rally in earnest that day until Fed Chairman Bernanke left no doubt
that rates were not going up anytime soon. Even more surprising was the
-1.3% collapse in equities witnessed on Thursday. That day saw a steady
initial jobless claims read of 505K and a much better Philly Fed
manufacturing index (which was even stronger in the details). The fact
that the market cannot seem to rally on good news makes us think that
the risk of a short-term correction is more likely than not.
Currency markets to remain beholden to the risk trade
Bullion's bull-run still intact
Sterling takes a hammering, focus on 3Q GDP and public finances
Key data and events to watch next week
Currency markets to remain beholden to the risk trade
The moves this week should convince anyone that had any doubt, that
the correlation between equity markets and currencies remains alive and
well. It was a rollercoaster, with EUR/USD oscillating between 1.4800
support and 1.5000 resistance for the better part of the week. The
S&P 500 meanwhile continued to find interest on either side of the
pivotal 1100 level. It seems that EUR/USD 1.50 and the S&P 1100 go
hand in hand as both remain extremely challenging technical and
psychological levels. Indeed, both have only closed above those crucial
levels three times this year - euro in October and stocks just this
week. It should not surprise anyone that the correlation between these
two since the beginning of the second half of 2009 has been a stellar
92%. Don't look for much to change on this front anytime soon.
In this vein, we look for any reversal in the risk trade to elicit a
significant turn lower in euro. The fact that stocks could not pull off
any sustained rally this week despite what was better than expected
data should be concerning for the bulls. US retail sales early in the
week were strong at the core level, with the control number (ex autos,
gasoline and building materials) increasing by 0.5% in October - on the
heels of similar increases the prior two months. But equities did not
rally in earnest that day until Fed Chairman Bernanke left no doubt
that rates were not going up anytime soon. Even more surprising was the
-1.3% collapse in equities witnessed on Thursday. That day saw a steady
initial jobless claims read of 505K and a much better Philly Fed
manufacturing index (which was even stronger in the details). The fact
that the market cannot seem to rally on good news makes us think that
the risk of a short-term correction is more likely than not.
Trading began on a positive note this week, as indices pushed out to
a fresh 13-month highs despite the slide in the November Empire
Manufacturing data on Monday. Equity indices were flat mid week as
October housing starts declined to their lowest level since April, and
building permits came in to the downside and corporate news remained
fairly light. On Wednesday the Baltic Dry Index rose to its highest
levels since last September, another milestone of the Asian recovery.
But things fell apart on Thursday as equity weakness in Asia on
concerns of a growing asset bubble carried through into European and US
trading, firmly knocking US equities off their highs. Light volume and
the weekly jobless claims data were a contributing factor, as the data
came in very modestly higher. Bleak earnings from Dell and USD strength
kept equities weak into the close on Friday. For the week, the Nasdaq
composite led the way down, weighed on by a note from Merrill
downgrading the tech sector, including such heavyweights as Intel and
Microsoft: the Nasdaq dropped 1.0%, the S&P 500 declined 0.2%,
while the DJIA eked out a 0.4% gain,
The week commenced with markets squarely focused on the first
official remarks from Fed Chairman Bernanke since the FOMC meeting two
weeks ago. The advanced text of his speech to the NY economics club
appeared heavy on strong US dollar rhetoric, providing some hope for
the weary greenback. This rhetoric was quickly dismissed as it became
clear that a continued low inflation outlook coupled with a dismal
employment picture will force the Fed to keep rates low for an extended
period of time. In the Q&A session, the Chairman acknowledged that
the Fed needs to deal with the possibility of developing asset bubbles,
but noted he has yet to see any "large misalignments" in US valuations.
The weaker-than-expected US Producer Price Index and Industrial
Production data only confirmed Bernanke's comment that significant
challenges still face the US economy and prompted many to speculate
that the FOMC's long period of low borrowing costs might get even
longer. As PIMCO's Bill Gross wrote in his monthly outlook this week,
the US needs another 12 months of 4-5% nominal GDP growth before the
Fed dares exiting the "0% foxhole, mini-bubbles or not."
Many participants took Bernanke's comments to mean the door will
remain open to the notion of the US Dollar as a funding currency and
the accompanying expansion of risk appetite. The Fed's Yellen only
added strength to this argument (and raised some eyebrows) when she
said on Wednesday that the US stock market is not overvalued and credit
spreads do not reflect a bubble. In addition, the Fed's Bullard gave
markets a history lesson, warning that the FOMC did not begin rate
increases until two to three years after the end of each of the past
two recessions. The comment was misinterpreted and immediately sparked
rumors that Bullard had said the Fed would be "on hold" until 2012,
providing bearish dollar momentum and boosting spot gold to yet another
all-time high.
Financial market review - foreign exchange
The pound has recorded a split performance this week. It fell
against the low yielding currencies (Japanese yen, US dollar, euro and
Swiss franc) and rose against the commodity currencies (Canadian,
Australian and New Zealand dollars) and the Swedish krona.
GBP/USD closed the week at $1.6519, pulling back from the 3-month
high ($1.6878) recorded on Monday, but remains firmly within its
5-month trading range of $1.57- $1.7050. GBP/USD rallied during the
early part of the week, supported by the slightly stronger inflation
report, which showed consumer price inflation picking up to 1.5% in
October (this marks a medium term turning point in the index). Sterling
was under pressure in the second half of the week as the public
finances report showed the UK government had borrowed £11.4bn in
October (in a month that usually generates a surplus for the
government). The retail sales report, which indicated sales up 3.4%
y/y, was insufficient to offset the negative impact on sterling from
the public finances report.
The USD performed well this week – in the G-10 currency space it
lost out only to the Japanese yen. A stronger than expected inflation
report and below consensus housing data (building permits and housing
starts) helped trigger a rally in the US dollar. Over the week, other
economic data were also softer than expected. Industrial production,
capacity utilisation, NAHB housing market index and US leading
indicators all provided a downside surprise. This left the S&P500
unable to sustain its rally above 1,100 and ends the week at 1,087.
Falling equity markets are an environment in which the USD has excelled
over the past year. This week has been no different, with the USD index
rallying 1.4% off the 2009 low (recorded on Monday) to close at 75.6.
U.S. Review
Economic Recovery: Different Pace, Different Shape
The leading economic index signals modest growth will
continue into next year. Yet, the pace of that growth is consistent
with a below-average recovery compared to the first year of prior
recoveries as well as a possible longer-term downshift in trend growth.
Housing starts were clearly disappointing to the “V”-shaped recovery
crowd. “Core” retail sales are up modestly compared to the first year
of the 2002 recovery, and the outlook for holiday sales is weak. Still,
inflation data which may start exceeding the market’s benign
expectations suggest that we remain cautious.
Doesn’t Look Like a Duck…Doesn’t Quack Like a Duck
The leading economic index increased 0.3 percent in October and has
risen for the past seven months. This implies modest growth will
continue into next year. Yet, two elements of the gain don’t quite look
like the usual recovery. One, the pace of the improvement fell sharply
from the one percent average monthly gain over the prior six months.
Second, the components of the gains reveal government efforts (money
growth, the yield curve) that are more reflective of short-term
government efforts than longer-term sustainable private sector
recovery. Our outlook for the next two quarters is for sub-par growth
of 2.4 percent. In many aspects this recovery does not look like the
typical recovery. On the real economy side, housing starts and retail
sales do not fit the typical strong pattern of prior recoveries. These
indicators are clearly disappointing to the “V”-shaped recovery crowd.
U.S. industrial production falls by 0.1% in October M/M but still poised for strong growth in the fourth quarter.
U.S. housing starts fall by 10.6% M/M in October, reversing somewhat the strong rebound seen through the third quarter.
U.S. headline inflation rested at -0.2% Y/Y in October, poised to turn
positive again next month, while core inflation has remained stickier
than the spare capacity in the economy might suggest.
Bernanke's speech makes rare comments about the U.S. dollar, saying
that the Fed is watching it “closely” and speaking to the strong dollar
that more typically is made by the U.S. Treasury.
As
base-year effects reverse, Canadian headline CPI inflation for October
rises to 0.1% Y/Y from -0.9% Y/Y. Despite economic slack, core
inflation jumps to 1.8% Y/Y from 1.5% Y/Y - though a slowdown in core
prices is expected in coming months.
Confirming
expectations for output growth in September, Canadian manufacturing
shipments rose 1.4% M/M in September, and the inventory-to-shipments
ratio abated. However, Canada's inventory contraction continues.
At odds with the broader economy, Canadian existing homes sales rose a
further 5.1% M/M to 45.8k units in October, following the 3.0% M/M in
September, now up 41.5% Y/Y.
Growth in the average price
of resale homes accelerated to 20.7% Y/Y in October from 13.7% Y/Y in
September, and, controlling for the geography of sales, prices grew
14.0% Y/Y in October, up from 9.3% Y/Y in September.
UNITED STATES - INFLATION FAITH
The fourth quarter has gotten off to a slow start for the economy.
Industrial production for October fell by 0.1% from September while
housing starts fell by 10.6% over the same period. Given the strong
growth in the industrial sector in the third quarter, the level of
production in October still remains well above the third quarter level
so a healthy growth rate for the overall economy in the fourth quarter
remains likely. The weakness in housing, on the other hand, would
suggest some retrenchment in the construction sector after a phenomenal
rebound in the third quarter, but a large part of the fall in October
came from the volatile multifamily starts so it's likely too early to
read too much into these numbers.
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.
Bernanke: Fed's commitment to price stability supports strong dollar
US interest rates set to remain exceptionally low until beginning of 2012?
US data confirm doubts about strength of economic recovery
Bundesbank signals gradual unwinding of unconventional measures
EUR-USD was over 1.49 for most of the week, despite the fact that
the majority of US indicators turned out weaker than expected, which,
according to the pattern of the last few weeks, should in fact have had
a dampening impact. In addition, Fed president Ben Bernanke revealed
that he was relatively sceptical about the US recovery, thus confirming
that the US central bank would maintain its accommodative monetary
policy stance for a long time to come. At first, as in the two previous
weeks, the euro was buoyed by rising equity markets. But then they
plummeted in the second half of the week on mounting risk aversion.
Subsequently, the dollar and the yen strengthened against the euro. At
Friday's fixing, EUR-USD was back around last Friday's level again at
1.4863.
Overview
A week with many subtle changes in a series of different markets
and instruments. Most notable was the continuing trend to lower
interest rates, new record low yields set on benchmark 2-year Swedish
Treasuries (0.555%), US 2-year interest rate swaps (just under 1.00%),
and Brazil’s USD 2014 bond (3.595%). Many money market futures
contracts rallied yet again to new record highs and the effect rippled
out through to longer dated paper, Swiss 10-year Conf testing the
psychological 2.00% and US TNote futures at their highest since late
May. Several equity indices inched their way to new highs for this
year, the Dow Jones Industrial Average to 10,438, before drifting back
to close roughly unchanged or slightly lower on the week; the Nikkei
225 a notable exception as it dropped for a fourth consecutive week to
close on its 200-day moving average at 9,500, the lowest since July,
dragged down by banking stocks. The US dollar strengthened a little,
Aussie and Kiwi hardest hit, the Yen again the exception trading at a
low of 88.63, perilously close to January’s low and key support at
87.00 yen. In fact discontent with the greenback’s weakness has led to
mutterings from authorities in Chile and China, South Korea and Taiwan,
while Brazil slapped another 1.5% tax on foreigners converting US ADR’s
into local shares. Metals remain well bid, spot Silver leading by
rallying to $18.83 per ounce, Gold to another new record $1152.55, and
LME 3-month Copper at $6,985 per tonne higher than it has been since
September (likewise Baltic Dry freight rates). Other commodities are
mixed at best, though CBOT Wheat at 583.5 cents per bushel is at its
most expensive since June.
The Federal Reserve's Senior Loan Officer Survey shows a
significant improvement from a year ago. On the flipside, credit
remains tight and demand remains weak for most credit products except
prime residential loans.
U.S. imports advanced by 5.8% M/M
in September, led by aircraft and crude oil purchases abroad.
Meanwhile, exports climbed by a lesser 2.9% M/M, also led by aircraft
sales. The resulting trade deficit widened to -$36.5 billion from
-$30.8 billion a month prior.
University of Michigan
consumer confidence index for November disappoints, falling for a
second month to 66.0 as expectations worsen. Markets were looking for a
print of 71.0 near September's 70.6.
Canadian dollar up over two cents in the week from 0.93 USD to 0.95.
Housing starts continue to rebound, rising to 157,300 units with multiples leading the way.
New home prices up for the third straight month, rising 0.5% M/M in September.
Canadian
merchandise trade deficit shrinks in September on stronger exports to
Europe. Exports rise 3.4% M/M in constant dollar terms, while imports
fell 0.6% M/M.
Risk assets and the USD are at a critical juncture
US retail sales on the radar
MPC minutes could bring clarity to the issue of BoE QE
Cable continues to find buyers on dips
Key data and events to watch next week
The risk rally extended gains this past week as optimism over the
global recovery beat out concerns that rising unemployment may lead to
continued sluggishness. The USD, meanwhile, finished out roughly in the
middle of the week's range after testing near to its recent lows
against the EUR and other currencies. The optimists took heart from G20
nations vowing to maintain stimulus efforts until a more solid recovery
was underway, while the USD took a drubbing after the IMF told us what
we already know, that the USD is being used as a funding currency.
Unfortunately for the bulls, the G20's pledge was largely hollow, as
fiscal stimulus efforts in many countries are mostly winding down and
initiatives to extend them seem fiscally unavailable. The early week
rally in risky assets faltered mid-week, but managed to stage a minor
comeback on Friday. In the process, recent highs in the S&P 500
were briefly surpassed, but they held on a weekly closing basis.
Similarly in FX, recent USD lows were tested and recent highs in other
currencies were tested and briefly surpassed in some cases, only to see
the USD recover into the end of the week.
US indices hit fresh 13-month highs this week and the DJIA managed
to close above 10,250 as risk appetite flared up worldwide. Equities,
gold and oil rose in tandem through the first half of the week, with
crude testing $80 and gold making all-time highs above $1,120. With
little US economic data on tap, markets were propelled by strength from
Asia and Europe, especially reports of improving GDP performance in
both regions. In China, PBoC vice governor Ma reiterated that China
would be able to achieve 8% GDP growth this year, while continental
Europe's biggest economies officially emerged from recession. An
unexpected build in US crude and gasoline inventories data on Thursday
took the wind out of crude in the latter part of the week, helped along
by some firming in the US dollar. Potentially troubling results from
two high-profile US data reports weren't able to stop equities on
Friday. The September US trade deficit grew 18% sequentially, for the
fastest rise in the series since early 1999. Traders preferred to
concentrate on imports, which surged at the quickest monthly rate in
nearly 15 years, although Goldman Sachs warned the data suggests a
likely downward revision to Q3 GDP. Meanwhile the preliminary
University of Michigan consumer sentiment index for November came in at
66.0, down from 70.6 in October and below expectations. For the week,
the DJIA gained 2.5%, the S&P 500 climbed 2.3%, and the Nasdaq rose
2.6%.
In the G-10 currency space the pound produced a mid table
performance this week. The pound rose against the low yielding
currencies (US dollar, euro, Swiss franc and Japanese yen) whilst it
lost ground against the commodity currencies (Norwegian krone,
Australian, New Zealand and Canadian dollars) and the Swedish krona.
It appears, the pound’s woes emanated from the Bank of England’s
Quarterly Inflation Report, where it emerged that assuming implied
market interest rates, inflation is forecast at 1.6% in two years time,
well below the 2% target. This induced a sharp rally in short sterling
interest rate futures contracts and left it under pressure.
Additionally, Bank of England governor King reiterated that a weaker
currency would help to rebalance the UK economy away from imports,
towards exports. GBP/USD weakened by 1.4% following the Inflation
Report.
China took centre stage in the past week. Economic data
showed an encouraging picture of a rebalancing of the recovery from
public demand towards private demand and exports.
Pressure for Yuan appreciation is rising from many sides.
US credit is still being tightened but the pace is slowing down.
Euroland has left the recession with Germany taking the lead. More
positive growth data is in the pipeline in the coming quarters, forcing
ECB to revise up their growth forecasts.
The Danish budget for 2010 was expensive in our mind and on the border of what should be advised.
In Sweden, industrial production data was revised substantially to show
that industrial production had bottomed a few months ago rather than
continuing down.
Market movers ahead
US retail sales take centre stage next week. The US
consumer is at the centre of the sustainability debate and hence the
data will be important for sentiment surrounding the recovery. Also
look out for speeches by Fed chairman Bernanke and vice president Kohn.
Euroland inflation data to show a further decline in core inflation.
Data on Q3 GDP in Japan should show another decent increase of 3.9% q/q.
Little news out of Scandi. Swedish data on house prices and unemployment are the main ones to watch.
As far as US monetary policy is concerned, the answer to this
question became fairly clear this week. The weak labour market data had
already prompted speculation that an exit from the ultraloose monetary
policy was still a long way off. This week, comments from several US
policymakers confirmed this impression, pushing the dollar down
further. EUR-USD rose to 1.5048, thus coming within a whisker of
hitting a new 15-month high, but dropped again later to 1.49. The
British pound also lost ground, after BoE governor Mervyn King had not
ruled out additional quantitative measures. Cable fell by over 2.5 US
cents temporarily to 1.6516, but strengthened again towards the end of
the week to almost 1.67.
Both the composition and pace of the recovery raises core issues for any business strategy for the year ahead.
Longer-term and high unemployment compounds the credit/workout risks for consumer and real estate debt.
High
unemployment keeps the Fed on hold and further distorts market pricing
of risk both in the global carry trade and inflation premiums. Finally,
high unemployment also creates political risk as policy makers
introduce more programs that put a premium on quick band-aids and not
long-term cures.
Unemployment Is High and Fed Funds Are Low, and You're Confused on Which Way to Go
Both the composition and pace of the recovery raises core issues for
any business strategy for the year ahead. Straight line forecasting is
out. A wide range of possibilities are in. Our November outlook
reinforces the view that the pace of growth in 2010 will be below that
of the first year of a typical economic recovery, and that the
composition of growth will favor contributions from federal spending
and inventory building with subpar performances from consumer spending
and business investment.
Overview
Money market futures have clearly got the message that interest
rates are likely to stay low for a very long time, most rallying to new
contract highs – highest Dec09 Fed Funds future at 99.870. For those
whose memories are shorter than ours we would like to point out that
front month Euroyen futures traded between 99.850 and 99.950 from April
2001 to February 2006. Two-year Treasuries are trading close to record
lows, yields on five-year paper dropping the most this week, and
ten-year JGB’s reversing dramatically from 1.485% to 1.350%. Equity
indices are hovering precariously at this year’s highs, Sweden and the
Dow Jones Industrial Average inching to new ones for the year, and
China’s ‘B’ share index (dollar denominated) soaring by 15% on renewed
rumours of a merger with the bigger (and more expensive) ‘A’ share
index. The US dollar lost ground against all currencies except the
Brazilian real, whose Finance Minister said it was overvalued, with
Sweden and Eastern Europe doing best. Most metals continue with a bid
tone, spot Palladium rallying to $356.75 per ounce, highest since
August 2008, and spot Gold to a new record $1122.85.
Import prices (Oct): annual rate much less negative
UMI consumer sentiment (Nov): slight improvement
Initial jobless claims went down by 20k in the week ending 31
October. This was the lowest level since the second week of January,
but jobless claims above 400k continue to signal job cuts in the US
economy. We expect initial jobless claims in the week ending 7 November
to have risen slightly to 515k after their marked decline.
Global financial markets this week will focus on industrial
production and trade data. Generally, the trend appears to be that
industrial output in Europe is finally recovering after the severe bout
of destocking earlier in the year and at the end of 2008. However the
UK appears to be lagging at present. Trade data will show that deficits
remain wide, but that there is some modest narrowing underway. UK
financial market attention will be focused on the Quarterly Inflation
Report, where we look for justification for the MPC decision to leave
rates on hold and increase QE by £25bn.
Strong UK data last week and the decision by the MPC to expand
quantitative easing (QE) by less than expected supported the pound.
Ahead this week, positive BRC retail sales and RICS house price reports
may provide further succour in the short term. However, there is risk
of a more dovish BoE Inflation Report on Wednesday which may again show
inflation undershooting the target in the medium term. A continuing
wide negative output gap and constrained credit conditions are the
factors that the MPC cited in its letter to the Chancellor last week
requesting extension of QE to £200bn. Assuming these arguments appear
in the Quarterly Inflation Report this week, the inflation projection
could show CPI inflation below target over the 2-year horizon, even
with a continued loose policy stance. But the Governor also warned of
the risk that consumer price inflation could rise sharply in the early
part of 2010. This suggests that the shape of the inflation profile may
shift from the last QIR in August, see chart below, to show a rise near
term but a fall below target longer term. Labour market data are also
due on Wednesday. For all the talk that the extra £25bn of QE announced
last week will be the last, much still depends on the outlook for
economic activity. Although recent indicators point to a return to
growth in Q4, it is still not clear how strong growth will be in 2010
if policy accommodation is reversed.
U.S. Review
Almost Everything Is Improving Except Hiring
Nonfarm employment fell by 190,000 jobs in October, with
declines as broad based as in recent months. The unemployment rate rose
to 10.2 percent.
The ISM manufacturing index rose 3.1
points to 55.7 in October, led by a 7.6 jump in the production
component. The employment index rose above 50 for the first time in 14
months.
Productivity surged during the third quarter, with
rebounding manufacturing output and broad based cutbacks in the service
sector accounting for most of the increase.
Almost Everything Is Improving Except Hiring
This week’s busy schedule of economic reports brought mostly good
news, even if it did end on a somewhat disappointing note. Several of
the more leading indicators of economic growth posted strong gains,
suggesting that the recovery process is well underway. We still suspect
that the second quarter shutdown and third quarter restart of motor
vehicle output is responsible for much of the swing in economic
activity. The near doubling in motor vehicle production casts a broad
shadow over the entire economy and is lifting orders and production in
a number of industries.
U.S. ISM indexes paint a muddled picture of the U.S.
recovery. Manufacturing index jumps to 55.7 from 52.6, while
non-manufacturing dropped slightly to 50.6 from 50.9.
FOMC
statement keeps to the script, leaving interest rates at “exceptionally
low levels” and expecting them to remain there “for an extended
period.” Statement also adds flavour on the conditions that would lead
the Fed to change its mind: resource utilization, inflation trends, and
inflation expections. We comment on the prospects for all three.
U.S. payrolls shed 190,000 jobs in October and the unemployment rate
tops 10.2%, its highest level since 1983. Upward revisions to past data
add 91,000 to payrolls.
U.S. weekly jobless claims drop by
3.5%. Continuing claims also drop, likely reflecting expiring benefits
more than renewed job growth.
U.S. nonfarm productivity
rises by a better than expected 9.5% Q/Q annualized in the third
quarter - its fastest pace since 2003.
Canadian labour market sheds 43,000 jobs in October; unemployment rate rises to 8.6%.
Value of building permits in Canada rose 1.6% in September.
G20 and Eurozone Fin. Min.'s may lend USD verbal support
Bank of England set to revise up near-term inflation forecasts
QE could be phased out by February
Somber US employment report makes for ominous outlook
Key data and events to watch next week
News that the US unemployment rate rose to a 26-year high of 10.2% failed to dent risk appetites as seen in stocks, at least in the immediate aftermath on Friday (more on the data below). Commodities, however, did register the pain of rising unemployment and the implicit hit to demand, with the CRB index dropping to its lowest level this month, and now down about 5% from the Oct 21 high. JPY-crosses also responded appropriately to the downbeat labor market news, erasing most of the week's gains. The USD, however, failed to see much strength overall. In a sense, that's to be expected after the Fed reaffirmed its commitment to maintain exceptionally low rates for an extended period of time, a decision which was reinforced by the soft jobs news. But there's also the 'risk on/risk off' correlation, and while stocks managed to rebound, the USD remained under pressure.
Global PMI increased to 55.7 in October indicating a further strengthening of global growth in the next couple of quarters.
Signs of a recovery in domestic demand are emerging, but the markets are still questioning the sustainability of the recovery in the developed countries.
BoE expanded asset purchases slightly less than expected and was slightly more optimistic in its rhetoric on the economy. BoE is not likely to deliver more QE.
ECB kept rates on hold and was slightly more hawkish than expected. Trichet signalled that the 12-month auction in December could be the last with full allotment.
Fed made no changes to its policy and continued to signal exceptionally low rates for an extended period.
Market movers ahead
In US focus is on Fed's Senior Loan Officer Opinion survey and Michigan Consumer confidence.
In Euroland Q3 GDP, IP and ZEW are on the agenda.
Asia will have a busy week, with most important indicators being published in China.
In Sweden CPI and industrial data are on the agenda.
In Norway CPI and PPI data as well as a couple of Gjedrem speeches will attract attention.
Economic data and a lack of surprises from the Fed helped US equity markets break two weeks of downward momentum this week. Anticipation ran high ahead of Wednesday's FOMC decision as market participants speculated whether the Fed would change its commitment to keeping rates low for an "extended period" of time. The comment remained untouched and another key line was changed to read household spending is "expanding" (rather than the "seeing signs of stabilization" verbiage in the prior statement). In the latter half of the week, investors obsessed over three days of US employment data. Wednesday's October ADP employment report showed slightly more job losses than expected, although the numbers declined by the smallest month-over-month loss since July 2008. On Thursday the weekly jobless claims numbers hit their lowest levels since the very beginning of 2009. On Friday, the annualized October unemployment rate popped over 10% and the decline in Oct nonfarm payrolls was bigger than expected. But traders took some comfort from the August and September nonfarm payroll revisions which were bumped up by a total of about 90 thousand jobs, contributing to an improving three-month moving average. After all the data was out on Friday, PIMCO's Paul McCulley said he expects job creation to be a "very slow slog." Front month crude ended the week just above where it began, at $77.50, while gold pushed out to another record high of $1,100 on Friday. For the week, the DJIA, Nasdaq Composite and S&P 500 Index each gained about 3.2%.
In the G-10 currency space, the pound ended the week in the middle of the league. The pound did manage to rally against the US dollar, with GBP/USD closing the week 0.7% higher at $1.6582. Sterling fell slightly against the euro, ending at €1.1169. UK economic data have been strong this week. Industrial and manufacturing production data as well as manufacturing and services PMI surprised higher, giving GBP/USD a boost throughout the week.
The Bank of England increased its quantitative easing programme by £25bn, bringing it to a total of £200bn. The latest gilt purchases will occur over the coming three months. The slowdown in the pace of asset purchases, provided support for sterling in currency markets. Implied volatility, in GBP/USD and EUR/GBP, fell sharply after the Bank's announcement. 1-month volatility had reached a 4-month high prior to the announcement.
The US dollar has had a disappointing week, giving up most of last week's gains – the USD index is less than 1% away from the 2009 low. The US manufacturing and service sector ISMs remained above 50, suggesting further expansion during October. This was positive for equities and provided some downward pressure on the USD. The Federal Reserve kept the target rate unchanged (0-0.25%) and there was little modification to the accompanying statement – as such, its impact on the USD was negligible. The US labour market report indicated that the unemployment rate rose to 10.2% in October, the highest since 1983. This weighed on the USD, pushing the USD index approximately 0.4% lower.
Overview Alternating up and down days this week as many instruments hover at 50-day moving averages and/or longer term trendlines – while waiting for today's important US Jobs report. Much talk of investors looking to increase holdings of 'risky' assets, explaining spot Gold's rally to a new record $1097.25. Gold, risky? Since 1970's move to floating exchange rates it has been shown to be the only store of wealth to retain its purchasing power. Equity indices recovered some of last week's losses and likewise most currencies, though the Nikkei 225, Australia's and Egypt's dropped for a second consecutive week losing 6%, 7% and 10% respectively. Baltic Freight Rates are rallying again, Panamax to its best level this year, though tanker rates remain extremely depressed. Short-dated and Index-linked Treasuries stick close to record low yields so the long end is buffeted by speculative flows and fears.
Political and Economic Developments
For a second consecutive month the Reserve Bank of Australia raised its key rate by 25 basis points to 3.50% while on the other hand Iceland cut theirs 150 bp to 13.00%. Sweden and the Fed left their rates at record lows saying the time to remove stimulus measures was not yet, so that SEK two-year Treasury yields dropped to a new record low 0.616% and front month Eurodollar interest rate futures rallied to new contract highs. The Bank of England and the ECB also kept rates on hold, the former adding another £25B to the Quantative Easing programme and warning that inflation would rise quickly over 2.00% near term due to petrol and VAT hikes. Note: Fannie Mae reported an $18.9B loss in Q3 after losing $15.2B in Q2! Mr. Trichet noted that credit demand had waned so that over the year lending to the non-financial sector shrank by 0.3% and that he was very happy the Lisbon treaty had been ratified. He must have repeated his mantra of inflation expectations being 'firmly anchored' almost a dozen times, without a hint of irony that EZ16 CPI has ranged from +4.0% to –0.7% Y/Y in the 12 months to July 2009. Eurozone September Retail Sales dropped –3.6% Y/Y, the biggest annual drop after February's record –4.6%.
US Unemployment jumped to 10.2%, 15.7 million people and the highest since 1983. A total 17.5% of US citizens are out of work and discouraged from seeking employment, while the workweek remained at a record low 33 hours. Moody's reports October global speculative-grade defaults rose to 12.4%, higher than 1991's 12.2% and last year's 3.00%, the worst since the 1930's; US junk bond defaults rose to 13.4%.
Fed: Interest rates to remain at exceptionally low levels for an extended period
BoE: Asset purchase scheme extended again
ECB: Less liquidity needed due to financial market recovery
During the course of the week, the euro firmed somewhat against the dollar. After the ECB had concluded the series of central bank meetings, EUR-USD was around 1.4870 on Friday lunchtime, marginally stronger than a week ago.
This week, particularly important indicators were released in the US. The data painted a mixed picture, however. The ISM manufacturing index, for instance, improved from 52.6 to 55.7. This is the highest level since April 2006 and suggests that Q4 GDP growth could turn out to be as high as in Q3. For the first time in a long time, the employment components signalled an increase in jobs. The ISM non-manufacturing index told a different story, however: it rose less than the previous month, because the employment component, which was already weak, fell sharply to 41.1. Like the ADP private employment figures, the official labour market report for October is thus likely to show significant job losses again of about 200,000, but this would be still an improvement over September.
FOMC: more favourable economic assessment, but no change in accommodative stance
Labour market report (Oct): no significant improvement
The first regional October manufacturing surveys painted an ambiguous picture: the Philadelphia Fed index declined by 2.6 points and the Richmond Fed index halved to 7, but the New York Empire manufacturing index jumped from 18.9 to 34.6 - its highest level since June 2004, and the Chicago PMI rebounded too, rising about eight points to 54.2. We forecast that the ISM manufacturing index, which fell slightly to 52.6 in September, will have remained stable in October, partly due to a lack of support from the automobile sector after the Car Allowance Rebate System ended.
The ISM non-manufacturing index rose markedly by 2.5 points in September, thus breaking through the expansion threshold for the first time since September 2008. We expect the ISM non-manufacturing index to have improved again in October, albeit only slightly, to 51.5. It would therefore have remained below its manufacturing counterpart.
In August, pending home sales jumped by 6.4% mom and were up 29% from their January low. This significant upward trend appears to have been mainly connected with the special tax credit for first-time home buyers, the deadline for which is approaching (1 December). Thus we predict that pending home sales, which have lead actual sales contracts for existing homes by one to two months, could already have fallen back slightly by 0.5% mom in September. However, the Senate is currently preparing an extension of the first-time home buyer tax credit until 30 April 2010.
Construction spending increased by 0.8% mom in August, due to a 4.2% mom increase in residential construction, which seems to have bottomed out since summer, although it is still 26.2% lower than the previous year. But the downward trend in commercial construction intensified in the third quarter, and was 35% lower in August 2009 than in August 2008. Residential construction will have risen again in September, as indicated by the first GDP estimate for Q3. But the weakness in commercial construction will have continued, and thus total construction spending is only likely to have remained stable in September.
We expect factory orders to have gone up by 0.8% mom in September. It is already known that durable goods orders increased by 1.0% mom, but non-durable goods orders will probably have risen less strongly than in August, due to the drop in gasoline prices.
Not surprisingly, September domestic vehicle sales plummeted after the Car Allowance Rebate System (CARS) had ended, from an annualised 10.2m to a mere 6.8m. Given the current setback in consumer confidence indicators, we predict that domestic vehicle sales will have remained unchanged at best in October.
The FOMC is expected to leave the fed funds rate at 0-0.25% at its November meeting. According to a Taylor rule estimate based on the unemployment rate and the PCE core deflator, the fed funds rate should be negative by now, as shown in the graph. Furthermore, due to disinflation at the core level and rising unemployment, the calculated rate is still heading downward. Although the FOMC statement could hint that the Fed is preparing an exit strategy, it will probably reiterate that economic conditions are likely to warrant exceptionally low levels of the fed funds rate for an extended period. The committee's economic assessment could have brightened up again somewhat, but, is likely to state that, owing to substantial resource slack, inflation is expected to remain subdued in the foreseeable future.
According to the GDP release, non-farm business gross value added was an annualised +4% qoq in Q3, and as aggregate working hours could have fallen by about 2.5% qoq, we estimate that non-farm productivity will have risen by an annualised 6.5% qoq in Q3, about the same rate as in Q2. The annual rate would then accelerate from 1.9% to 3.5%. Labour compensation might not have increased by much more than 2% qoq, which would lead to a drop in unit labour costs of about 4.5% qoq (-3.3% yoy, after -1.2% yoy) in Q3.
Initial jobless claims only fell by 1k to 530k in the week ending 24 October, but the 4-week moving average declined for the eighth week in a row, to 526,25k. The drop in continuing claims was even sharper: since their peak at the end of June, continuing claims have gone down by about 1.1 million, but this exaggerates the improvement in the labour market, because the average length of unemployment now exceeds the maximum 26-week period of regular entitlement to unemployment benefit, and so many unemployed people will no longer be statistically captured. We expect the moderately declining trend in jobless claims to have continued; they could have fallen to 525k in the week ending 31 October.
If the results of the preliminary benchmark revision to the monthly data are taken into account, the US economy has now lost roughly 8m jobs since the onset of the recession. In September, nonfarm payrolls dropped unexpectedly by 263k, which was much more than the 201k jobs lost in August. The deterioration was mainly due to the service industries, and jobs were cut in almost 70% of all sectors. Jobless claims are slowly trending downwards, but consumers' labour market assessment deteriorated and fell to a 25-year low in October. Nevertheless we forecast that non-farm payrolls will have declined at a somewhat slower pace of -220k in October, as September's government job losses are unlikely to have been repeated. The ADP estimate for the change in private nonfarm payrolls was -254k in September, compared to -210k in the official labour market report. Given the still relatively high level of jobless claims, which ADP uses for the fine-tuning of its figures, we predict that ADP's estimate of private sector job losses will have reached -230k in October. The unemployment rate could have gone up further to 9.9% - a level last seen in 1982. If employees working part-time for economic reasons were also taken into account, the degree of labour market underutilization would be almost twice as high. If average hourly earnings went up by a mere 0.1% mom again, the annual rate would decrease to a five-year low of 2.2%.
Wholesale inventories went down by 1.3% mom in August, but we expect the depletion of inventories to slow down in the near future. However, wholesale inventories might still have fallen by about 1% mom in September, not least due to CARS.
Consumer credit has decreased by almost $100bn so far this year, and it dropped by $12bn in August. The deleveraging is expected to have continued at a somewhat slower pace in September, and consumer credit could have declined by $10bn.
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RBA: Case for 50bp hike next week still solid but rates on hold for much of 2010.
Australian data: house prices, retail sales, dwelling approvals, trade previewed.
Some subtle shifts from the RBNZ.
US FOMC to leave rates and statement unchanged.
ECB on hold; BoE to also leave rates unchanged but QE extension likely.
US data: ISMs, construction, jobs data due.
Key economic & financial forecasts.
Australia: Case for 50 bp Hike Next Week Still Solid - but Rates on Hold for Much of 2010
The Reserve Bank Board meets on November 3. Markets and most economists expect the Board will choose to follow the 25bp rate hike which was delivered on October 6 with a further 25bp's following the November meeting.
After flirting with up to 50% probability of a 50bp rate hike at various times over the last month, markets are now giving it only a 10% probability.
We beg to differ. Our analysis of the rhetoric of the Governor's speeches and the October Board Minutes indicates a more urgent approach to policy than implied by market pricing.
The case for a larger than expected increase is always strongest at the early stages of the tightening cycle. The risks of tightening too much are at their lowest when rates are at record lows; the risks of tightening too slowly are also high when policy is at its most stimulatory since imbalances are more likely to emerge.
Imbalances emerging
Those imbalances are most apparent with goods and services inflation and asset price inflation.
The report from Australian Property Monitors that house prices increased by 3.7% in the September quarter - the strongest gain in six years - to be up 7.1% for the year is likely to be unnerving for the Bank. Record increases in house prices when rates are near record lows would not sit well with a central bank.
The goods and services inflation story should also be of concern to the Bank.
That was demonstrated with the print of the September quarter CPI last Wednesday.
The importance of the inflation number clearly relates to the Bank's current forecast that underlying inflation will bottom out at 2.0% in 2010 from the current level of 3.5%. The evidence from the number is that over the last 12 months, despite a substantial slowing in the economy and a near collapse in headline inflation, the average measure of quarterly underlying inflation has been 0.86%qtr. The September quarter read of 0.8% qtr shows precious little slowing - hardly consistent with the current extremely expansionary stance of monetary policy.
True, over the year underlying inflation has come down from an average of 1.16% for the previous four quarters (Q4-07 to Q3-08), but the major factor behind that shift down has been petrol prices; rents; deposit and loan facilities; and house building costs. Weakness in these components also explain the bulk of the collapse in headline inflation to 1.3%. These components, however, are already turning.
In the September quarter petrol prices rose by 4% after falling by 22% over the previous 12 months; house purchase cost inflation increased from -0.5% in March to 1.1% in September; rent pressures eased further from 1.7% in March to 1.2% in September but the pace of slowdown in rents has clearly moderated substantially; deposit and loan facilities, which fell by around 20% over the previous three quarters, rose by 3% in September.
Certainly other components of the CPI may now take over to drive the next down leg in inflation which the Bank patently needs.
Presumably these pressures will come from demand-related sources and the rise in the currency. However the evidence in the September release was not encouraging.
Scrutiny of the details of the September quarter print shows that there were significant upside surprises on demand-driven price components - housing; clothing and footwear; furniture and major appliances; cars; sports equipment; toys games hobbies. With an average increase in the AUD of 6.5% in the September quarter following a 9% rise in the June quarter it appears that importers have been able to take advantage of demand conditions to restore margins. That hardly augurs well for the Bank's current forecast that underlying inflation will fall from 3.5% to 2% next year.
Indeed the September release is almost certain to force the Bank to raise its low point forecast for underlying inflation next year from the current 2.0% to 2.5% at best - any lower number would lack credibility given the Bank's assessment that growth will return to trend in 2010 and strengthen thereafter. (Chart 1)
A more credible estimate of, say, 2.75% would be untenable. A central bank would hardly forecast that the low point in its inflation profile would be well above the middle of the 2-3% "on average over the cycle" target zone.
So why wouldn't the Bank choose to accelerate its tightening process at the safest possible time when rates are near record lows? The answer is presumably because the Bank is much more sanguine about the risks we describe above than we assess it to be and, after all, the art of picking near term movements in rates is to best understand the current thinking of the Bank.
Strong rhetoric
In that regard we can only rely on recent public Statements; speeches and reports from the Bank. Sanguine is hardly the description of sentiment in those communications.
The Reserve Bank Governor's speech delivered on October 15 on "The Conduct of Monetary Policy in Crisis and Recovery" and the October Board Minutes have emphasised to us the urgency the Bank sees for the need to be moving rates back to more normal levels. While the Governor's Statement following the 0.25% increase in the cash rate on October 6 noted, "it is now prudent to begin gradually lessening the stimulus provided by monetary policy" the Minutes did not include the key word "gradual".
Extensive analysis of the Governor's Statement highlighted the word "gradual" as the key message word. Surely if the Bank wanted to entrench that thinking it would have repeated that word in the Minutes - yet it was significantly absent.
This could reasonably be interpreted as a very intentional decision to raise the alert that the situation had become more urgent.
The language from that speech was certainly strong, "If we were prepared to cut rates rapidly, to a very low level, in response to a threat but were then too timid to lessen that stimulus in a timely way when the threat had passed we would have a bias in our monetary policy framework".
We also note that, quite unusually for a central banker, he was prepared to question the veracity of the official inflation forecasts: "In fact, in late 2009, we are still to see whether inflation will be consistently back to target over a period of time. We think it will be, but, as yet, that remains a forecast." Our analysis above certainly endorses that sentiment.
The Board Minutes went further, "The balance of risks was now such that the current very expansionary setting of policy was no longer necessary and possibly imprudent".
Our read of the Bank's current mood differs from the market's. The market, presumably, is interpreting this strong language as no more than deliberate justification for beginning the tightening cycle before any other major central bank rather than providing any future guidance.
Recent overseas developments must also be raising the Bank's level of anxiety. Since the Governor's speech and the release of the Minutes annual growth in China has been restored to 9% and today we see the print of GDP growth in the US of 3.5% (annualised for the September quarter) - the first positive since June 2008 and well above market expectations.
We see the case for the bank tightening by 50bp's on November 3 to be followed by a further 25bp's on December 1. That will restore the overnight cash rate to 4%.
Outlook for 2010
Another couple of 25bp increases can be expected in the first half of 2010 with the cash rate to reach 4.5% by around May. With rates back to more normal levels and lead indicators such as consumer and business confidence and housing finance approvals (driven by both weakening demand and constrained credit supply) softening we would anticipate a pause for the remainder of 2010.
Note however, that our forecast peak in 2010 is still well below current market expectations of 5.25%.
Chart 3 explains our view. It sets out our estimate for the household debt servicing ratio under the scenarios of our rate forecast and the market view.
We assess that if market pricing for the cash rate is correct then the household debt servicing ratio will exceed 2008 levels when the RBA cash rate reached 7.25% and proved to be so crippling for Australian households. As discussed we expect that confidence; house prices; and new lending would have reacted well before that peak eliminating the need for the Bank to press on in its tightening cycle through the second half of 2010.
Bill Evans, Chief Economist
Footnote:
There are precious few precedents for the market expecting a 25bp hike and being wrong with a 50 being delivered, but there is one. In February 2000 following the first move in a new tightening cycle of 25bp's in November 1999 the market was certain that a second 25bp would be delivered. In the event the RBA delivered 50bp's. This was partly driven by a sudden change in the international environment - not dissimilar to today's surprise jump in US GDP. Of course the base was much higher than today with the rate going from 5% to 5.5%.
Since then there have been 16 rate hikes and all have been by 25bp's - but rates have never been this low and, as discussed, potential imbalances and official rhetoric have never been as strong.
New Zealand: Week ahead & Data Wrap
Suspended sentence
The RBNZ's decision to leave the cash rate on hold at 2.50% came as no surprise, but the focus was on whether they would alter or replace the 'bias' sentence at the end of the statement.
In recent statements, the RBNZ have noted that "we continue to expect to keep the OCR at or below the current level through until the latter part of 2010." Our view was that, with the recovery unfolding rapidly, the RBNZ would give themselves more flexibility with a statement along the lines of "it is appropriate to keep the OCR at low levels for a considerable period". This would have both given them some breathing room in terms of the timing of rate hikes, and recognise that even a few hikes would still leave the OCR at abnormally low levels.
In the event, there were some cosmetic changes but the thrust of the statement was broadly unchanged. The first change was that the last vestiges of an easing bias were removed, with "at or below the current level" becoming "at the current level". The second change was that "the latter part of 2010" became "the second half of 2010". Arguably these words are synonymous, but compared to the interest rate projections in the September Monetary Policy Statement, which were consistent with no hikes until Q4 2010 at the very earliest, the latest statement allows for the possibility of hikes by Q3 next year.
The RBNZ acknowledged the continuing improvement in both global and domestic activity. But once again they raised concerns that the recovery is being skewed towards domestic demand and away from exports - without shedding any light on what this means on balance for monetary policy. Our view is that since domestic demand bore the brunt of the recession, while exports held up relatively well, the recovery will inevitably be skewed towards those sectors that have the most ground to make up.
The emphasis on keeping the cash rate unchanged for an extended period leaves an important question unanswered: what happens when they do start raising rates? Recent comments from the RBNZ have given us the strong impression that they lean towards moving rates late and hard, rather than early and gradually. This was touched upon in the September MPS projections, which indicated a fairly steep tightening profile beyond late 2010 - putting the 90-day rate at 5%, and rising fast, by the end of the forecast horizon in early 2012.
This approach would seem to put the RBNZ at odds with many other central banks that favour a pre-emptive approach - especially in light of the fact that policy rates are still at 'emergency' settings, when the emergency has passed. The RBA and Norges Bank have begun raising rates on this basis, ECB officials have commented on the need to act early, and there's even speculation that the Fed will look at rewording its commitment to low rates at next week's review.
This week's statement was also notable for the way that the RBNZ explicitly placed themselves in opposition to market pricing for rate hikes next year - before the statement, interest rate markets were picking January next year for the first rate hike; this timing has since been pushed back to March. That's still significantly earlier than what the RBNZ has signalled, but it doesn't mean that the market is deliberately challenging the RBNZ. On the contrary, our experience is that the speculative market has had some sympathy for the RBNZ's view, but traders have been repeatedly cleaned out as the domestic data has turned out stronger than expected.
We expect the data to maintain that generally positive tone over coming months, and we remain of the view that by March the RBNZ will have seen enough to be convinced that it's time to start moving policy away from 'emergency' settings. The RBNZ do have some time on their side, with the economy running below capacity and inflation comfortably within the target - but we don't think that latitude extends to the second half of next year.
Turning to this week's data releases, business confidence was a touch lower in October, but still near its highest in ten years. The details of the survey showed further improvements in expected profits and investment and export intentions, although employment intentions remained broadly flat. Confidence was also a little less broad-based than in September - most sectors were more cautious, perhaps due to the recent strength of the currency, but the construction sector was remarkably fired-up.
That confidence will be needed to propel the pickup in residential construction that we think is needed over coming years. Building consents rose another 3.3% in September, with a strong lift in apartment consents from unusually low levels. However, consents are still running at less than half of the peaks reached in early 2004.
The September trade deficit of $424m was in line with our expectations, although both sides of the ledger showed the effects on prices from the stronger NZ dollar. Milk powder exports were also held back by seasonally low production and the sharp rundown in stocks earlier this year.
Next week's data is centred on the labour market. The various wage measures (Tues) are likely to remain subdued, reflecting their status as a lagging indicator. We expect the unemployment rate (Thurs) to rise from 6.0% to 6.5%, though this will be the last major quarterly increase. Hours worked are expected to rise, as employers respond to the recovery initially by increasing the hours of existing workers.
Three major central banks meet to discuss monetary policy this week. Arguably of most interest to us will be the Bank of England's decision on whether or not to extend its programme of asset purchases in the light of recent disappointing Q3 GDP data. In the US, attention will be focused on the FOMC's policy statement, where we expect the Fed to repeat that the interest rates are likely to remain at low levels for an extended period. October non-farm payrolls data are also published this week, following September's disappointing outturn. Finally, the ECB looks set to leave its key refinancing rate on hold, with markets becoming more focused on possible 'exit strategies' for unconventional, rather than conventional, monetary policies.
The Bank of England's Monetary Policy Committee (MPC) announces its policy decision this week. We look for Bank Rate to remain on hold at 0.5%. Perhaps the key economic data release since October's MPC meeting has been the preliminary estimate of Q3 UK GDP, which registered a 0.4% quarter-on-quarter contraction, against expectations of modest growth. Activity was some 5.2% lower than in Q3 last year, compared with a 4.8% annual decline envisaged by the Bank in its August Inflation Report. So an extension of its asset purchase programme (i.e. quantitative easing, or QE) seems, at the very least, likely to appear on the Bank's agenda this month. For choice, we look for an increase of £25-£50bn on top of the existing £175bn total of asset purchases. Interestingly, October's MPC minutes showed that the Bank attributed at least some of the upswing in 'riskier' assets to the impact of its QE policy to date. This being so, we acknowledge that an extension in the asset purchase programme could drive markets even higher and cause concern at the Bank. Beyond this, we get important economic data in the form of October's PMI surveys. For manufacturing, we look for a reading of 49.8 compared with 49.5 in September, while in services our forecast stands at 54.7 versus a previous outturn 55.3. Thursday sees the release of September's industrial production data, where we envisage an outturn of +0.7% m/m. The recent preliminary Q3 GDP data, pointed to an increase of around 0.6% m/m, but any significant shortfall in industrial production would, in isolation, hint at a downward revision to GDP. The next estimate of GDP is published on 25 November.
In the US, continuing economic uncertainty makes it likely that the Fed will maintain the target range for the federal funds rate at 0.0%-0.25%. And despite the recent return to growth in Q3, we think it may be too soon for the Fed to abandon its language that exceptionally low levels of the federal funds rate are likely for an "extended period". Indeed, the recently-released September FOMC minutes noted that while the economic outlook had improved, "the level of economic activity was likely to be quite weak and resource utilization low". Needless to say, rising unemployment poses a serious threat to the nascent US recovery. This week sees October's non-farm payrolls report, where we see employment falling by 200,000 after September's disappointing decline of 263,000. As in Europe, this week features the latest round of purchasing managers' surveys, with October's US ISM manufacturing report expected to register an improvement to 53.0 from 52.6, based partly on last week's firm Chicago PMI data. We expect the non-manufacturing survey, due on Wednesday, to register 51.5 from 50.9 previously.
The ECB also announces its monetary policy decision this week, where we envisage an unchanged refinancing rate of 1.0% and a policy stance that remains 'appropriate'. Given the dataflow over the past month, we think it is unlikely that Jean-Claude Trichet will have changed his view that the euro-zone recovery will proceed at a 'gradual' pace going forward. Furthermore, he seems poised to reiterate his support for a strong US dollar policy, with markets watching closely for any more references that the ECB might 'co-operate as appropriate' with the US authorities on currency movements. Perhaps most importantly, it will be interesting to see whether Mr. Trichet elaborates on Council Member Axel Weber's recent comments that the ECB may not offer one-year Long-Term Refinancing Operations next year. In terms of regular economic data, the final readings for October's euro-zone PMI surveys are scheduled for release this week, along with retail sales data (see calendar).
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German industrial new orders will probably have increased again in September, just like the ifo assessment of the business situation and order books.
The Purchasing Managers' Indices for the German and EMU manufacturing sector in October are unlikely to be revised significantly.
This week, Bundesbank president Axel Weber made some interesting remarks about the ECB's exit strategy. He said the ECB's liquidity measures were a way of neutralising disruptions in financial markets, particularly with regard to refinancing the banks. When the situation in financial markets eased, these measures would no longer be necessary, according to Mr Weber. He appears to think that this could soon be the case. Presumably, other members of the ECB governing council share Bundesbank president Weber's opinion. As far as next week's ECB council meeting is concerned, however, we are expecting the policy stance to be left unchanged. The central bank will probably restrict itself to gradually becoming more upbeat in its assessment of the macroeconomic situation and gently hinting that exit will be necessary “at some point”. But in December at the latest, when its commitment to provide unlimited liquidity runs out, the ECB will have to say to what extent it intends to continue the unconventional measures.
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This week's GDP report signals recovery. Federal spending, as well as tax credit programs for housing and autos, were big positives. The issue going forward will be what the sustainable pace of growth is once the fiscal and monetary stimulus goes away.
Once again, a jobless recovery appears to be the story for at least the next three months. This pattern where jobs lag growth has become the norm in recent cycles. This suggests that personal income growth and thereby consumer spending will be improve slowly and be subpar relative to the past.
Growth Improves, Final Sales Build Case for Recovery - Recovery is Here, Just Hold the Champagne for Now
Third quarter GDP rose 3.5 percent with significant positive contributions from personal consumption, housing, federal spending and inventories. For consumption and housing the improvements reflect tax credit programs. Inventory gains also added nearly one percentage point. Therefore, final sales continue to improve and this provides the underlying demand for growth. However, our expectations are for moderate growth - not a boom.
Sustainable consumer spending requires income and thereby job and wage gains. The latest jobless claims data suggest that jobs remain scarce and that wage gains are likely to be very limited as well. Residential investment and equipment spending are also expected to gradually improve. Federal spending stimulus will also add to growth in the fourth quarter this year and the first quarter next year. Therefore, our expectation is that the recovery is sustainable and we anticipate that growth will be at 2.4 percent next year. Inflation remained low in the third quarter with the core PCE deflator up just 1.4 percent, which should allow the Fed to leave the funds rate unchanged for now.
Jobs: Lagging the Recovery Again?
Jobless claims remain stubbornly high at 530,000 consistent with continued jobs losses in the fourth quarter. The emerging pattern in recent economic recoveries is that jobs increasingly lag the recovery. In part, productivity gains in manufacturing have allowed businesses to build output and put existing equipment and plants to work without adding workers right away. Firms hoard skilled labor in a recession and therefore keep workers on the payroll even if they are not always busy. Firms do this because of their concerns about the cost and availability of skilled labor as the recovery begins. For the outlook, the jobs issue becomes an income issue and therefore a challenge to getting the economy up to speed. With weak consumer income gains the pace of consumer spending is also likely to be limited. Our view is that real disposable income will grow just 1.2 percent in 2010 compared to 2.2 percent in 2007. We expect personal consumption to rise just one percent in 2010 compared to 2.6 percent in 2007. Such modest gains in consumer incomes and spending suggest that the demand for auto and mortgage credit will also be subdued relative to the past. This has been noted in the Senior Loan Officer Surveys published by the Fed.
Fundamental Rethink for America?
For our society, modest gains in housing and autos may be reflecting a longer-term change in consumer habits. The deleveraging/increased saving by the consumer suggests that the pace of consumer spending may indicate a slower pace of gains in local property taxes and state income taxes - clearly a challenge to state and local budgets. Slower housing starts and more modest home price appreciation suggests a challenge to the massive housing/home improvement/suburbanization infrastructure that America has built up since World War II. The pace of gains for income and jobs in many states may have to be rethought if the American consumer adopts, or is forced to adopt, a more financially conservative hair shirt.
U.S. Outlook
ISM Manufacturing • Monday
The Institute for Supply Management's "headline" manufacturing index remained in expansionary territory for the second consecutive month in September. Both the Chicago purchasing managers' index and Empire Manufacturing Index rose significantly in October suggesting the "headline" ISM will remain in expansionary territory. The forward-looking new orders index has remained well above the threshold of 50 for three consecutive months and will likely remain in expansionary territory. With inventory levels still lean, the spread between the new orders and the inventories indexes continues to suggest further gains in production are likely in coming months. The employment index should remain below break-even suggesting continued job losses in the manufacturing sector for the rest of this year. This is consistent with our estimate of a jobless first year of recovery.
Previous: 52.6 Wells Fargo: 53.8
Consensus: 53.0
Nonfarm Productivity • Thursday
Nonfarm productivity will likely post its second solid gain in the third quarter. Productivity surged in the second quarter after growing at an anemic 1 percent annual rate since the recession began. Slow labor productivity growth is typical during recessions as output contracts and businesses aggressively cut costs. Productivity growth is very cyclical, however, and tends to spike the quarter after the recession ends as output picks up and hours worked continue to fall. Productivity growth should remain elevated well into the first year of recovery. With economic growth rising at 3.5 percent annual rate in the third quarter and hours worked continuing to decline, we expect productivity will surge to an annual rate of 7.0 percent in the third quarter. Unit labor costs should remain at fairly low levels suggesting no inflationary pressure.
Previous: 6.6% Wells Fargo: 7.0%
Consensus: 5.8%
Employment • Friday
Nonfarm employment fell by 263,000 jobs in September producing a net loss of 7.2 million jobs since the recession began. While job losses continue to mount, the pace of declines has moderated. Weekly first-time unemployment claims peaked in March and are down 21 percent from their high suggesting layoffs have likely subsided. Job openings, however, have fallen 50 percent from their exceeding the peak-to-trough decline for the last recession. It appears businesses are in no rush to hire until economic growth is sustainable. Hence, we expect nonfarm employment likely dropped by 225,000 jobs with the unemployment rate reaching 9.9 percent in October. Nonfarm employment is likely to continue declining into 2010 and the unemployment rate will probably not top out until the middle of next year.
Sustainable Recovery in Korea Appears to be Underway
Real GDP in South Korea rose at an annualized rate of 12.3 percent in the third quarter, the second consecutive quarter of double-digit growth. Although the outturn was flattered by less de-stocking, which cannot lift GDP indefinitely, a self-sustaining recovery appears to be taking hold in Korea.
Will authorities tighten policy now that prospects for continued growth appear favorable? Benign inflation means that the central bank does not need to slam on the brakes, but we look for it to begin normalizing rates early next year.
Sustainable Recovery in Korea Appears to be Underway
Data released this week showed that real GDP in Korea rose at an annualized rate of 12.3 percent in the third quarter, marking the second consecutive quarter in which the Korean economy has expanded at a double-digit rate (see graph on front page). At first glance, one could dismiss the strong growth in the third quarter as nothing more than a short-lived inventory swing. Korean businesses slashed inventories earlier this year when they were convinced that the economy was on the cusp of a very deep recession, but they ended up cutting too deeply. Although businesses continued to pare stocks in the third quarter, the less rapid pace of inventory liquidation helped to lift GDP growth by more than 11 percentage points. Won't the economy roll over again when the frenetic pace of restocking comes to an end?
Probably not, because a closer look at the GDP details shows that a sustainable recovery appears to be taking hold. For starters, consumer spending grew nearly six percent during the third quarter, which follows the 16 percent increase registered in the previous quarter. A widely followed measure of consumer confidence has shot up since the spring as the labor market has started to recover. Earlier this year, employment growth was negative on a year-over-year basis. However, payrolls are starting to increase again, helping to boost income. After reaching an eight year high of 4.0 percent in June, the unemployment rate has subsequently declined steadily (top chart).
In addition, growth in fixed investment spending was up nearly four percent in the third quarter. Some of the increase likely reflects temporary infrastructure spending that the government has put in place, but private sources of investment appear to be recovering. Construction spending edged lower in the third quarter, which represents some payback for strength observed during the two previous quarters, but business spending on machinery and equipment rebounded in the third quarter. Moreover, economic recovery in the rest of the world, especially in other Asian countries, to which Korea sends 50 percent of its exports, is helping to stimulate growth in Korea. On a year-over-year basis, real export growth has now returned to positive territory (middle chart). The sequential GDP growth rate in the third quarter would have been even stronger had imports not shot up 30 percent.
Growth in Korea clearly will slow in the quarters ahead. No economy, especially an advanced one like Korea's, can continue to post double-digit growth rates ad infinitum. As noted above, however, a self-sustaining recovery appears to be taking hold, and we look for solid Korean GDP growth over the next two years. So will prospects of continued growth cause Korean authorities to tighten policy? The global economic meltdown led the Bank of Korea (BoK) to slash its main policy rate from 5.50 percent to 2.00 percent between October 2008 and February 2009. Although the BoK won't cut any further, a rate hike doesn't look imminent either with the rate of CPI inflation currently benign (bottom chart). That said, most analysts, we included, look for the BoK to begin normalizing rates by early next year.
Global Outlook
Bank of England Policy Meeting• Thursday
The probability is rather low that the Bank of England reduces its main policy rate from 0.50 percent, where it has been maintained since early March. However, in the wake of weaker-than-expected GDP data, which showed the economy continued to contract in the third quarter, there is a fair chance that the MPC announces an increase in its program to purchase government and corporate bonds that is currently targeted at £175 billion.
Earlier in the week, the purchasing managers' indices for the manufacturing (Monday), construction (Tuesday) and service sectors (Wednesday) will provide anecdotal evidence of how these sectors fared during October. "Hard" data on industrial production in September are slated for release on Thursday before the Bank of England's decision is announced. A bounce-back from the sharp decline that occurred in August would be welcome news.
Current Policy Rate: 0.50% Wells Fargo: 0.50%
Consensus: 0.50%
ECB Policy Meeting • Thursday
The European Central Bank has maintained its main policy rate at 1.00 percent since May, and there is very little chance that the Governing Council will decide to change the rate on Thursday. The press conference that ECB President Trichet will host after the policy meeting will be of more interest. Perhaps the statements that Trichet will make will give investors some insights into the stance of policy going forward.
The final PMIs for the Euro-zone manufacturing and service sectors in October will be released earlier in the week, but major revisions to the indices, which both showed significant improvement relative to September, are not expected. Germany will release "hard" data on factory orders on Friday.
Current Policy Rate: 1.00% Wells Fargo: 1.00%
Consensus: 1.00%
Canadian Employment Report • Friday
Despite some conflicting signals on the direction of the Canadian economy at present, Canadian employers have added over 50,000 workers to their payrolls over the last two months. On Friday of next week we will find out if the recent strength in the labor market has legs when the Canadian jobs report for October will be released. The consensus is expecting a modest gain. If we do see an increase, it would be a welcome sign of stability in income for Canadian consumers, which could be supportive of consumer spending during the economic recovery.
The Ivey PMI, a key measure business sentiment, will print on Thursday. In September, the index climbed to its highest level since the summer of 2008, so a modest pullback after recent gains would not come as a complete surprise.
Previous: 30.6K
Consensus: 10.0K
Point of View
Interest Rate Watch
Interest Rates: Uncertainty as We Move Back to Real Market Pricing
For decision-makers, the major risk over the next six months is the transition from today's government-subsidized interest rates to the unknown true free-market rates as the Federal Reserve ends its purchases and the Obama administration potentially proposes a sustainable fiscal policy.
Monetary policy has generated an excess supply of credit to mop up the excess supply of autos and housing. This excess credit supply is reflected in very low nominal interest rates which are unsustainable over time. Moreover, real interest rates are very high relative to a flat path for real GDP. This relationship gives rise to a debt burden that increases faster than income. In today's economy the thrust of fiscal policy is so strong that the monetary authority could lose its handle on inflation even if the central bank retains control over the monetary base.
Excess supply of credit is also evident in the very low Ted spread that is reminiscent of the spreads that existed prior to the Lehman. Risk spreads have not normalized because such normalization would certainly have taken account of greater risk given the current state of an uncertain economic recovery and the likely subpar pace of any such recovery. This suggests that spreads are too narrow relative to risk. Other yield spreads also appear distorted. For example, high grade bonds spreads have declined but the Federal Reserve has bought about ten percent of Treasury issuance in recent months. Pricing distortions are even more prevalent in MBS and ABS.
Risks abound as rates and spreads are seriously distorted by government intervention and do not represent free market pricing. For decision-makers there are two challenges - first, there is no clear indication of what the free market yield spread is and second, there is no clear indication how quickly the Fed will withdraw.
Consumer Credit Insights
Recent Evidence Supports Moderate Consumer Gains - No Boom
Consumer confidence, jobless claims and new home sales data support the outlook for a moderate gain in consumer spending - not the boom that would be typical of past recoveries. The recession is over - yet the recovery will likely be modest. Federal programs have helped in the short-run but there appears to be limited follow-on from such programs.
Consumer confidence fell in October and has not improved in three months. The core issue appears to be the lack of jobs. The jobs hard to get series has risen the last two months while the jobs plentiful series has declined. This picture is corroborated by the jobless claims data. Claims have stopped declining and have stalled at the 530,000 mark. This level is consistent with at least 200,000 job losses in the payroll survey as well as a continued rise in the unemployment rate.
The outgrowth of job uncertainty is reflected in the new home sales data. Sales of new homes fell in September as the expiration of the first-time home buyer tax credit probably altered the timing of sales. However, one element in the consumer confidence data suggests a deeper problem. Consumer buying plans for a new car fell to an all-time low. There is no follow-through on car buying and home buying from one-time federal subsidies without job creation and that still appears to be months away. The recovery is here but the pace of recovery will disappoint.
Topic of the Week
Stimulus Helps to Push Up Q3 GDP
As noted in the domestic section of this report, real GDP grew at an annualized rate of 3.5 percent in the third quarter. Over the past few quarters, there have been various stimulus programs that have been enacted and these measures showed up in the overall growth number. For starters, consumer purchases of durable goods shot up 22.3 percent. Remember "cash for clunkers"? This program was clearly behind the strong growth in durable goods purchases last quarter. Residential construction soared 23.4 percent, the first positive outturn in this series in nearly four years. The $8000 tax credit for first time homebuyers undoubtedly contributed to the upturn in housing starts over the past few months. In addition, non-defense expenditures by the federal government rose 6.8 percent.
However, it would be a mistake to claim that the third quarter's growth rate reflects nothing more than the temporary effects of fiscal stimulus that soon will fade. For example, non-durable consumer spending was up 2.0 percent and expenditures on services rose 1.0 percent. Business spending on equipment and software edged up 1.1 percent, and exports grew 14.7 percent. It is difficult to make the case that all of these categories were impacted significantly by fiscal stimulus. Moreover, the less rapid pace of inventory liquidation also helped to lift overall GDP growth.
Fiscal stimulus clearly helped to push up growth in the third quarter, but it is not the entire story. In our view, the economy will be hard pressed to register 3 percent GDP growth over the next few quarters. Consumer spending and residential construction will clearly be weaker in the fourth quarter now that "cash for clunkers" has ended and the home buyer tax credit is winding down. However, exports should continue to post decent growth and business fixed investment spending should also remain positive. The inventory swing will also add positively to growth. Although the pace of growth likely will be sluggish, we nevertheless look for continued recovery.
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