Sunday, January 31, 2010

Weekly Focus : Markets Still Fear A Greek Tragedy

Market movers ahead
  • The ECB's tone is likely to be slightly more positive than at the previous meeting although concerns about Greece could well remain centre stage. We will have to wait for the March meeting for new announcements on the exit strategy and an upward revision of its growth forecast.
  • In the US there is a heavy calendar with the employment report and the ISM indices taking centre stage. We expect the improvement in the manufacturing ISM to continue and for job growth to return to positive territory in January.
  • In Asia focus next week will mainly be on the release of manufacturing PMIs across Asia. Following some weakness in manufacturing PMIs in Q4 09, we expect them to have improved slightly again in January.
Global update
  • Greece's minor debt issuance last week has not eased market fears of a possible Greek sovereign default. Greek yield spreads to Germany have reached new highs over the past week.
  • In the US this week's FOMC statement revealed signs of movement within the committee with the first dissenting vote since the onset of the crisis.
  • In Japan data during the past week suggests growth in Q4 09, but slowing in early 2010.
  • With focus currently on the risk of sovereign default in Europe, we look at the possibility of a debt crisis emerging in Japan.
  • We look at the implications of changes in tax rules for Danish 'blue-stamped' bonds

Market Movers Ahead

There is a heavy calendar in the US next week with the employment report and the ISM indices taking centre stage. We expect the improvement in the manufacturing ISM to continue for the next 2-4 months before reaching its peak and look for an increase to 57 in January. The gap between demand and production has not yet closed and the inventory demand balances in both hard and soft data remain supportive for higher levels. The non-manufacturing ISM index has lagged its manufacturing counterpart as the service sector has not been able to benefit from a strong rebound in global demand to the same extent. We expect this pattern to continue and look for only a modest increase in the index.

Turning to the employment report, we expect that job growth returned to positive territory in January. Labour market indicators such as jobless claims are pointing to a continued improvement in employment and overall GDP growth has rebounded strongly implying that a pickup in job growth is due. We look for an increase of 50K in January non-farm payrolls and an unchanged unemployment rate at 10.0%. Finally, Fed's Warsh and Bullard will speak during the week.

The ECB Governing Council will keep policy rates unchanged at its meeting on Thursday. The tone is likely to be slightly more positive than at the previous meeting although concerns about Greece could well remain centre stage. We will have to wait for the March meeting for new announcements on the exit strategy and an upward revision of its growth forecast. We expect that Trichet will stick to saying that inflation is to remain subdued over the policy-relevant horizon. If anything, concerns about medium-term inflation have diminished since the last meeting.

On Thursday we will also get German industrial orders for December. November was extraordinarily revised up from 0.2% m/m to 2.8% m/m, so there is good momentum, but this is a volatile series and we expect to see a much more modest gain in December. German industrial production in December out on Friday is projected to beat consensus expectations and show a 0.8% m/m increase.

German and Euroland retail sales are projected to post notable gains in December following sharp declines in November. Final manufacturing PMI on Monday and final service PMI on Wednesday are expected to show that recovery remains on track in Italy while Greece and Spain are falling behind.

In Asia focus next week will mainly be on the release of manufacturing PMIs across Asia. Following some weakness in early Q4 09, Asian manufacturing PMIs started to improve slightly in December last year. We expect manufacturing PMIs to have improved slightly again in January in line with recent data showing both strong industrial production and exports across Asia in December. Thus growth in industrial activity and trade appears to have accelerated again late last year and the manufacturing PMIs should give us some idea to what degree it has continued into 2010.

South Korea as the first country will release foreign trade data for January next week. This will be the first hard data to give an idea about the strength of the recovery. Month-on-month we expect exports to decline slightly mainly as a result of extraordinarily strong December numbers.
Bank of Indonesia is (BI) is expected to keeps it leading interest unchanged at 6.5%. Inflation in Indonesia remains muted below 3% and real interest rates remain positive and unlike China, India and South Korea there does not appear to be an urgent need to tighten monetary policy in Indonesia although we do expect BI to start tightening monetary policy in Q2 10.

Denmark: Attention will centre on the release of retail sales data for December. Consumer confidence is back in positive territory, and we have already seen healthy increases in car sales and Dankort card purchases in December, so we expect retail sales to climb 1.6%. We will also get figures for bankruptcies and repossessions in January. Both lag changes in economic activity, so we expect to see continued growth in bankruptcies and repossessions well into 2010. Finally, the week brings figures for industrial production in December. We are gradually seeing signs of improvement in both the domestic and global economy, and this is gradually starting to feed through to industrial production, which increased slightly in November. We expect the recovery to continue into 2010.

Sweden: This week only second tier data is available, PMI (Jan.) and budget balance (Jan.), which should not have more than a temporary effect on financial markets. The dichotomy between survey data and hard data seems to continue which is why we would not be surprised to see new strong PMI data despite hard data – such as industrial production and orders – continuing to sway to a more solemn note.

Another busy week is in store in Norway. As we have stressed many times before, the downside risk in the Norwegian economy is that the downturn in orders in oil-related industries will outweigh the upswing in traditional export industries in the wake of the global economic recovery. We therefore believe the industrial production figures for December and PMI for January to be the most interesting data in Norway in the coming week. We anticipate a moderate increase in industrial production of 0.3% m/m and an increase in the (revised) PMI from 47.2 to 48.5. As something of a curiosity, it is worth noting that the decline in business borrowing has slowed in recent months, going completely against what appears to be the consensus view in the market. As Norges Bank's lending survey for Q4 indicated improvements in both credit standards and demand for credit from businesses, we could soon be looking at a positive surprise in the C2 credit indicator

Global update: The Confidence Game Goes On

The ball is with Greece and the EU
The markets continue to be preoccupied with the risk of a Greek sovereign default. Fears also intensified in equity markets as the situation in the Greek bond market got out of control. Greek yield spreads to Germany widened by 100bp in two days, reaching new highs at close to 400bp. This week there was speculation that Greece had made a deal with China to buy Greek government bonds, but this was denied by the Greek Finance Minister at Davos, saying that it was “completely ludicrous”.

The focus shortly shifted from Greece to Portugal during the week when Portugal presented a revised budget, which showed a higher-than-expected deficit in 2009 (9.3% of GDP) and a not very ambitious one percentage point tightening planned for 2010. Public sector wages will be kept unchanged in 2010, permanent public sector jobs will be reduced further and anti-crisis stimulus measures will be phased out almost fully during 2010. The Portuguese debt is expected to reach 85% of GDP at year-end – up from 77% at the end of 2009. We probably need to see intervention soon from the EU or clear decisive steps from the Greek government to stop this snowball from rolling further. The signals so far have been too mixed to convince markets as EU ministers give conflicting signs on whether Greece would be bailed out if needed. It is now a confidence game and the ball is with Greece and the EU to convince markets that Greece will not default.

The Fed stays put, but signs of movement in the committee
This week's FOMC statement revealed signs of movement within the committee with the first dissenting vote since the onset of the crisis. Otherwise, the statement revealed a slight upgrade in the language on growth but the inflation section was unchanged with deflationary forces remaining the biggest concern. The committee thus restated that rates would be kept exceptionally low for an extended period and there were no changes to the asset purchase programmes either. We still see the first hike coming in November this year but we expect the language in the statement to be gradually changed to prepare the market for this move. On another note, Bernanke was approved by the Senate for another four-year term as Chairman of the Board of Governors.

Also worth noting is that fiscal policy discussions are gradually shifting focus from stimulus to restraint. President Obama revealed a proposal to freeze discretionary spending unrelated to military, veterans, homeland security and international affairs and big entitlement programmes such as Social Security and Medicare. The areas subject to the spending freeze account for c15% of the total federal budget and thus represent only a small step on the way to securing fiscal sustainability. According to the CBO, the budget deficit in FY 2010 would amount to 9.2% of GDP and drop to 6.5% in 2011 assuming no legislative changes to current law occur. This measure probably understates the future outlays as many of the tax cuts enacted in 2001, 2003 and 2009 are likely to be extended.

Data on durable goods orders and shipments continued to show decent gains outside transportation in December. Business investment in equipment and software thus entered 2010 on a strong note. Some data disappointed, though, as home sales fell further than expected and initial jobless claims disappointed. The overall data picture was thus somewhat mixed and is giving less support to markets than in 2009. Investors are in a bit of a waiting position to see where the recovery is going.

German data signal strengthening of recovery
Following the decline in ZEW and a mediocre PMI reading, this week offered more upbeat sentiment indicators. The Ifo expectations index made a surprise increase to 100.6 from 99.1 – the first reading above 100 since September 2007. Construction sector sentiment jumped up and it appears that the German construction sector is finally taking off, fuelled by historically low interest rates. We have been concerned about an early slowdown, but most recent data indicate that Germany is speeding up again. Nevertheless, the German unemployment rate increased from 8.1% to 8.2% in January.

Sentiment indicators from the European Commission also showed further improvement in January in industry, service and retail trade. Consumer sentiment improved too. In addition, the December data were revised upwards. This confirms the picture of a Euroland that entered 2010 with firm growth after a short slowdown in October- November.

Recovery in Japan continues, but appears to lose some steam
Based on the data released for Japan during the past week, it appears that growth in Q4 09 was solid, but that growth is slowing in early 2010. Industrial production and exports in December increased 2.5% m/m and 2.8% m/m, suggesting that the export-led recovery in industrial activity has remains strong. However, production plans for January (+1.3% m/m) and February (+0.3% m/m) and the decline in the manufacturing PMI in January from 53.8 to 52.8 suggest that the recovery in industrial activity will lose some pace in Q1 10.

The picture of improvement in the labour market remains intact. The unemployment rate surprisingly dropped to 5.1% in December and the job-to-applicant ratio improved for the fourth month in a row. The unemployment rate is down from its 5.7% peak reached during Q3 09. Despite an improvement in payrolls, it appears that private consumption is slowing, mainly because the impact from earlier fiscal easing has started to wane. However, the government has just approved another stimulus package and it should start to have an impact in a couple of months. Hence, we see little risk of a double-dip recession in Japan at the moment. We still see GDP growth of around 4% q/q AR in Q4 09, slowing to around 2.5 % q/q AR in Q1 10.

Fears of the implications of monetary tightening in China continue to dominate the market. The Reserve Bank of India (RBI) in the past week took its lead from China and raised its reserve requirement for commercial banks by 75bp to 5.75%. This was slightly more aggressive than expected by the market (50bp expected). In line with market expectations, RBI left its leading repo rate unchanged at 4.75%. Inflation in India has picked up in inflation in recent months, partly driven by higher food prices as a result of widespread droughts in parts of India last year. So far RBI is following the same strategy as the People's Bank of China, focusing mainly on removing some liquidity from the interbank market. However, RBI will soon raise its leading interest rate – we think in March or April and possibly by as much as 50bp.

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