Sunday, January 10, 2010

Weekly Focus : Low Inflation Will Ensure Low Interest Rates in the US

Market movers ahead
  • Retail sales and inflation (CPI) figures for December are due in the US. We expect to see a modest increase in inflation (CPI) of 0.2% m/m - equivalent to 2.9% y/y. The rise is mainly attributable to substantial increases in energy prices in the past year.
  • The ECB Governing Council meeting next Thursday will be a rather dull event compared to the exciting December meeting. Policy rates should be kept unchanged and it is unlikely that we will get any new information on the withdrawal of nonstandard measures.
  • In Denmark, current account and trade balance data are due for November. We expect the modest pick-up in exports to continue. November's industrial production numbers are also due for release. Industrial production has disappointed in recent months, and we expect to see a slight decline here.
Global update
  • The global recovery appears to be on track, and the economic data released since Christmas has been positive. Leading indicators continue to look strong globally, although some indicators like OECD leading indicators currently give an early warning of a growth peak in Q1 10
  • Mixed data in the US but growth momentum remains good going into 2010. Housing market data seem to be improving and the ISM manufacturing index for December registered a stronger-than-expected reading, indicating that the economy continued to accelerate into 2010.
  • Unfortunately, Euroland data have disappointed. Industrial orders declined more than expected and retail sales in November slipped back 1.2% m/m.
  • In Japan, economic data released since Christmas have generally been encouraging and suggest that Japan will not slide into a double-dip recession - although growth will slow in Q1 10.
  • We consider the risk of core inflation in the US sinking below zero. Our general expectation is that the fragility of the economic turnaround combined with still low core inflation will make the FED cautious about future rate hikes.
  • We take a close look at the dollar. Has the tide finally turned, so that we will see the dollar strengthening going forward?

Market movers ahead

Global movers
USA: There is a lot of data on the agenda in the coming week of which retail sales and CPI for December are the most interesting. On top of this, the reporting season will kick off with a couple of interesting reports due next week (see calendar).

Despite a strong run-up in the final week of the holiday sales, we expect retail sales to disappoint slightly in December with a flat headline reading. We suspect that some of the strength in the last week of December will be pushed into the January numbers. Excluding autos and gasoline, sales are forecast to decline 0.2% m/m.

Core inflation is on a downward trend and we expect a modest reading of 0.1% m/m and headline CPI of 0.2% m/m but an increase to 2.9% in annual CPI due to base effects. Also worth keeping an eye on is the first University of Michigan reading of consumer confidence for January where we look for further improvement. Finally, the Fed will release its Beige Book this week and the calendar of Fed speeches is crowded. The most interesting speakers will be Lockhart, Evans and the ├╝ber-hawk Lacker.

The ECB Governing Council meeting next Thursday will be a rather dull event compared with the exciting December meeting. Policy rates will be kept unchanged and it is unlikely that we will get any new information on the withdrawal of nonstandard measures. The euro has weakened since the December meeting, so though it is still strong, we doubt that this will be much of an issue. Possibly we will see some strong wording on public finances although a lot has been said already. Trichet might try to hinder moral hazard by indirectly telling Greece that it will not be bailed out if necessary. What would actually happen if a bailout becomes necessary is another story. Nevertheless, we will have to wait until March before we get a really exciting Governing Council meeting again.

Industrial production data for France, Italy and Euroland in November are expected to be upbeat following a lacklustre October. Anything below a 1.0% m/m increase in Euroland industrial production would be a great disappointment to us. We will also get details on inflation and expect that the decline in Euroland core inflation has continued with a minor fall to 0.9%.

In Asia we expect foreign trade data for December to confirm that the recovery in China's exports continues. This view is supported by the continued improvement in new export orders in China's two manufacturing PMIs and foreign trade data for December - so far released in South Korea and Taiwan - has been strong. In addition, China will release new loans and money supply for December next week. New CNY loans is currently growing around 12% 3m/3m AR, which in isolation in not unsustainable. However, because of the tendency in China to front load new loans to early in the year, loan growth is likely to accelerate again in early 2010. In Japan we will particularly pay attention to the release of the Economic Watchers Survey (EWS) for December, to get a better idea of how much Japanese growth will slow early next year. The improvement in Japan's manufacturing PMI in December suggests we should start to see some stabilisation in EWS following the deterioration in recent months. This will be consistent with our view that while growth in Japan is temporarily slowing, we are unlikely to see a double-dip recession.

Global update: Global recovery appears to be on track

On balance the economic data released since Christmas has been positive. Leading indicators continue to look strong globally, although some indicators like OECD leading indicators currently give an early warning of a growth peak in Q1 10, see Business Cycle Monitor: More short-term strength. In particular, the recovery in global industrial activity continues to look strong. Global manufacturing PMI surprised on the upside in December with strong readings in the US, China, Japan and the UK. The global new orders index rose to 58.6 - the highest level since May 2004 - and the global order-inventory balance continues to improve, suggesting further rises in global PMI in the coming months.

Concerns about the sustainability of Greece's public finances continue to weigh on the EUR. In addition concern that sovereign debt in developed markets could become one of the major challenges for financial markets in 2010 was fuelled by the decision by Iceland's president to veto the so-called Icesave bill to compensate foreign depositors in Icesave. It could endanger pay-outs from Iceland's IMF deal and in the worst-case scenario force Iceland to default on its foreign-denominated debt.

Mixed data in the US but growth momentum remains good
Data received since the week leading up to the Christmas holiday has been mixed but has overall confirmed that growth momentum has been good going into 2010. Housing market data showed strong sales of both new and existing homes in November though part of this increase is related to a temporary boost from the perceived end to the first-time homebuyer credit which has since been extended. The huge decline in pending home sales reported this week suggests that there will be some payback in December. Furthermore, the ISM manufacturing index for December registered a stronger-thanexpected reading, indicating that the economy continued to accelerate into 2010. The guts of the report were strong with all major activity-related sub-components increasing.

Furthermore, the report indicated that deflationary risks remain moderate. Based on our indicators for the overall demand/supply balance, we continue to expect further, but more uneven, improvement in the ISM in the coming three to four months. On top of this, durable goods orders and shipments for December suggest that capital spending continued to expand at a rapid pace in Q4 09 and is now tracking an increase of around 8% q/q AR. The non-manufacturing ISM on the other hand showed that the service sector is still lagging behind its manufacturing counterpart. The service industry is generally more exposed to domestic demand and we expect the sector to gain strength over the coming months along with the broadening of the economic recovery.

Finally, the FOMC minutes from the December meeting and recent Fed speeches confirm that the Fed's dovish stance remains intact, despite the recent improvement in economic data. The minutes even revealed that a few members would favour extending the MBS purchase programme beyond Q1 this year, should the economy weaken or the mortgage market deteriorate. In general, the discussion on the outlook for economic growth was relatively downbeat with a lot of downside risk factors mentioned.

Euroland data disappoints
This week we saw that Euroland industrial new orders declined 2.3% m/m in October, i.e. more than consensus expected, but in line with our downbeat forecast (Danske Bank -2.2% m/m, consensus -1.1% m/m). The decline is likely to partly reflect that October was short one working day. German industrial orders for November also came out this week and was a major disappointment, only increasing 0.2% in November after a 1.9% increase in October. The decline was driven by foreign orders and in particular cars while other sectors showed more notable order increases.

Euroland retail sales in November disappointingly declined 1.2% m/m. This is a clear warning that low rates and fiscal stimulus has not been enough to kick-start the European consumers yet. It will be very interesting to see the important December figures. If they fail to show a fairly decent improvement that's a real concern. What is really needed in order to kick-start consumers is a stabilisation of unemployment. Look for that in Q1.

We also got final PMIs, which showed that Italy is jumping forward while Spain is left behind. PMI indicates that we will get growth around 0.5% q/q in Q1. The European Commission's confidence indicators for December were more upbeat than expected. Following the disappointing retail sales figures, this is a welcome glimmer of hope.

Finance minister resigns in Japan
In Japan, Hirohisa Fujii has resigned as Finance Minister due to health reasons and has been replaced by the current deputy prime minister, Naoto Kan. Because Fujii has been very sceptical about the effectiveness of FX intervention, the case for intervention in the FX market has without doubt been strengthened within the government. However, the importance of Fujii's resignation - and Kan's appointment - should not be exaggerated. Kan has been one of the main architects behind the new DPJ government's economic policy. The decision to draw a line in the sand to stem further appreciation of JPY was already made in December. At that stage Japan was probably close to intervening in the FX market and a “Japan in deflation” campaign was started to put pressure on the Bank of Japan to ease monetary policy further. This was to a large degree the work of Kan. Basically this policy remains in place. The government will continue to put pressure on BoJ and intervention is likely should JPY again strengthen significantly.

In Japan economic data released since Christmas has overall been encouraging and suggests Japan will not slide into a double-dip recession - albeit growth will slow in Q1 10. Most importantly the recovery in exports and industrial activity appears to be on track. Industrial production in November increased a solid 2.6% m/m and production plans suggest continued strong gains in production in the coming months. After some moderation in industrial production, growth in industrial production again appears to be accelerating. This view is supported by an increase in the manufacturing PMI from 52.3 to 53.8 following a slight decline in the previous three months. The slight increase in the November unemployment rate from 5.2% to 5.1% was mostly payback for an unusually large drop in the previous three months. Other labour market indicators, such as payrolls and job-to-applicant ratios, suggest the labour market continues to improve.

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