Weekly Focus : Greece Remains Top of the Agenda

Market movers ahead

• The main US event next week is the FOMC meeting. In line with the market we expect no changes to policy measures. In the statement the growth and inflation sections will probably only see incremental changes.
• In Euroland the next week offers further insights from the German Ifo index, which is projected to show a modest decline in the expectations component from 99.1 to 98.8. Furthermore, keep an eye on the Portuguese budget for 2010, which will presented on Tuesday.
• In Asia the Japanese government continues to put maximum pressure on Bank of Japan (BoJ) to step up its deflation fight. Particularly, the government would like BoJ to step up its purchases of government bonds.

Global update

• Market focus remains on concerns over the situation in Greece.
• Talks of new banking regulations have spooked the markets.
• Strong Chinese data have triggered further monetary tightening from the Chinese authorities.

Focus

• The US Treasury continues to issue huge amounts of debt. We take a look at the implications for the supply of US Treasuries.
• We take a look at the Danish tax reform.

Market movers ahead

Global
The main US event next week is the FOMC meeting. In line with the market we expect no changes to policy measures. In the statement the growth and inflation sections will probably only see incremental changes. If anything, we believe that the assessment of housing could be downscaled a bit. Focus will be on the wording of the forward looking part of the statement. While it is still too early for the FOMC to start fiddling with the 'extended period' language, the section describing the purchase programmes could see some changes.

Recently it has been debated how much mortgage rates will jump when the Fed stops purchasing mortgage bonds. Hence, it will be interesting to see if the Fed applies a more open-ended language on this issue.
On the economic data calendar the December durables report and the advance Q4 GDP numbers are key events. Durables goods reports have been strong recently and point to a solid pick-up in equipment and software spending in Q4. The Q4 GDP is estimated to print a solid 4.6% q/q AR driven by 2.8pp contribution from inventories and a pick-up in equipment and software spending. With the inventory stabilisation arriving a bit earlier than expected, the GDP growth profile changes a bit. We now have the peak in Q4 and a gradual slowing of the growth pace during 2010 (chart).
Obama delivers State of the Union address Wednesday.

In Euroland the next week offers further insights from the German Ifo index, which is projected to show a modest decline in the expectations component from 99.1 to 98.8 while current conditions should continue to improve from 90.5 to 91.9 when published on Tuesday. The European Commission's confidence indicators due out Thursday are expected to show modest improvements in industry and consumer sentiment while service sector confidence might retreat somewhat. German unemployment on Thursday is projected to remain unchanged at 8.1% while Euroland unemployment on Friday could edge up to 10.1%. Money supply on Friday is likely to show a modest decline in M3 growth from -0.2 m/m to -0.5 m/m. Keep an eye on the monthly net loan flows. Improvements here would be very comforting for the ECB. Focus on Greece will remain although there are no important events for Greece in the calendar.

In Asia the Japanese government continues to put maximum pressure on Bank of Japan (BoJ) to step up its deflation fight. Particularly, the government would like BoJ to step up its purchases of government bonds. We do not expect any new easing measures from BoJ in connection with this week's policy board meeting.

However, the statement and press briefing might give an indication whether the political pressure is starting to have an impact. Particularly attention should be paid to whether BoJ starts to express increasing concern about deflationary expectations among households. If it does, it will be a sign that BoJ could step up quantitative easing further.

Monetary tightening will be the main focus in the rest of Asia in the coming months. In India we expect Reserve Bank of India (RBI) to follow Peoples Bank of China (PBoC) and raise its reserve ratio for commercial banks by 50bp to 5.50% next week. Inflation measured by wholesale prices surged past 7% in December and it now appears a done deal that RBI will start tightening this week. However, we do not expect RBI to raise its leading interest until March or April, when a 50bp rate hike looks increasingly likely.

Global update: Politics set the agenda

Banks feel the heat along with Greece
The week has been dominated by politics. In the US; President Obama announced a farreaching proposal to regulate the banking sector, which sent shares of large Wall Street banks tumbling. Obama called for banks to be banned from engaging in proprietary trading unrelated to customer business and owning or investing in hedge funds and private equity funds. The proposal still needs congressional approval and with Republicans responding coolly, the proposal will most likely undergo moderations before it is passed.

Earlier in the week, the Democrats lost their seat in Massachusetts to the Republicans. The Republicans thereby broke the Democratic Party's 60-vote majority, and ensured that the minority has enough votes to block legislation. This will not only make it harder to get the proposal on banking regulation through Congress, but also the healthcare reform is likely to face intensified headwind.

In the eurozone, the fiscal problems in Greece continue to be top of the agenda. Although the newsflow has been limited, confidence in Greece's ability to restore public balances declined further this week. The fears over the fiscal situation are weighing heavily on the euro, which touched the weakest level versus the dollar since July last year.

Toppish data and disinflation in the US
The past week delivered another mixed batch of housing data. The NAHB declined from an already very low level, thereby indicating some downside risk to the new home sales in December. This setback is most likely reflecting a negative payback from the firsttime- home-buyer tax credit, which boosted sales in the autumn. In the coming months we would not be surprised to see a further decline in both existing and new home sales.

However, for residential construction there was good news with permits rising 10% in December. Housing starts were depressed by cold weather and blizzards in December and should see a comeback in the next few months. The recent setback in new homes sales is more a medium-term than a short-term concern for the residential construction outlook. In the short term there is room for a further 15-20% increase in housing starts just to catch up with sales, but if new home sales do not revive during H1 the residential construction recovery risks fizzling out.

Although manufacturing production was soft in November, the forward looking evidence points toward continued solid growth. The Empire index rose to 15.9 in December from a revised 4.5 in November, while the Philadelphia Fed index softened slightly from 22.5 to 15.2. We continue to think that the manufacturing recovery has a bit more upside in terms of the business surveys, although most of the improvement in the ISM index is behind us now. A peak in the cycle will probably arrive during the spring, when we also expect the economy to start losing some momentum from the 4-5% growth pace around year-turn quarters.

The disinflationary trend continues with both annual core PPI and CPI inflation slowing in December. One again core CPI was boosted by used cars due to the lagged effects from the clunkers programme. Going forward, we expect core PPI and CPI inflation to continue lower due to the lagged impact of the collapse in raw material prices, declining unit labour cost and a levelling out of auto prices. Indeed this should keep the FOMC busy on deflation concerns for quite a while.

Markets have turned on the heat on Greece
This week the spread widening between Greek government bonds and German Bunds has been massive. It is key that the Greek government quickly begins to show more than good intentions. As Mr. Weber warned Thursday “Actions speak louder than words”. We do not think that a Greek default is an option for the EMU.

It is likely to be highly contagious and it would undermine the whole project. Nevertheless, other EU countries and the EU institutions continued to send mixed signals this week. On Thursday the most influential Greek think-tank publicly urged the government to take tough measures.

The ZEW and PMI indicators disappointed with headline declines. German ZEW expectations declined as financial sector sentiment has been negatively affected by concerns about the possibility of a Greek default, which could have a dramatic domino effect. We believe that the angst will fade in the coming months and ZEW expectations could then rebound strongly. The PMI data were a mixed bag with service PMIs showing a disappointing setback, while we still get some pretty upbeat signals from manufacturing orders. PMI continues to signal that the ECB will remain on hold. We expect a first hike in August, but this is contingent on the assumption that the current fears about sovereign defaults will soon decline. The PMIs have signalled for a long time that France will show the way out of the crisis, but Germany is now catching up. We continue to expect that Germany will rebound most strongly this year.

Data support China's shift in monetary policy
In China data released in the past week confirmed that inflationary pressure is increasing and that Peoples Bank of China (PBoC) will need to shift its focus in monetary policy from mainly supporting growth to containing inflation and preventing bubbles from emerging on the property market. CPI inflation and property prices in December accelerated sharply to 4.1% 3m AR and it now appears we will have to revise our inflation forecast for 2010 above 3.5%. In addition the property market has heated up substantially in recent months, with property prices in December increasing 14.9% 3m AR.

However, it is too early to conclude that the Chinese economy is overheating. GDP growth in Q4 increased only slightly to 9.5% q/q AR from 9.3% q/q AR in the previous quarter. This is substantially slower than the 14.3% q/q AR registered in H1 09 and is close to the GDP growth rate we regard as sustainable for China in the long run. Despite very strong export numbers for December industrial production only increased slightly in December, underlining that the improvement in exports is largely being offset by slower investment demand as the impact from the government's massive fiscal stimulus starts to wane.

China has already started to tighten monetary policy with several administrative measures to curb bank lending in addition to removing some liquidity in the money market by - among other things - raising the reserve requirement for commercial banks. We expect PBoC to start raising its leading interest rate and resume the gradual appreciation of CNY in Q2 10.

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