Monday, November 15, 2010

Global update : Focus turns from QE to the European debt crisis

Global update
Focus turns from QE to the European debt crisis

In the past week, focus in the financial markets has gradually turned from quantitative easing and a global currency war to the European debt crisis. In the US and UK, economic data continues to surprise on upside. Sentiment is that QE will probably not continue beyond June 2011 in the US, while in the UK it is increasingly the view that gilt purchases will not be stepped up further. In the euro area, it looks as if it will be increasingly difficult for Ireland, Greece, Portugal and Spain to reach their targets for cutting budget deficits. In addition, the German proposal to make debt restructuring part of a permanent debt resolution mechanism for sovereign debt has created renewed concerns about the ability of these countries to push through the current crisis without some sort of default.

No substantial news from the G20 meeting
As expected, there was no major news in the statement from the G20 meeting in Seoul, South Korea on 11-12 November. On exchange rates, it basically repeated the statements from the previous G20 meetings: exchange rates should be more flexible and more in line with market fundamentals and competitive devaluations should be avoided. Discussions about measuring and monitoring external balances were sidelined, as the development of indicators for external imbalances was postponed to next year. However, it is clear that specific targets for the current account – as the US has been pushing for – will not be included. Importantly, the G20 gave the green light for emerging markets to impose capital controls if their exchange rates are overvalued.

Despite the G20 countries’ inability to make firm commitments on exchange rates at the current stage, the difference in the positions between the US and China should not be exaggerated. With inflationary pressure increasing in China, it will increasingly be in China’s own interest to allow its currency to appreciate.

European debt crisis still looking for a sustainable solution
This week all attention has been on the sovereign debt crisis. Spreads have widened in all periphery countries, but the market is particularly alarmed about the increased risk of sovereign debt restructuring in Greece and Ireland. The ECB has purchased government bonds, but in very moderate amounts. It has been far from enough to hinder further spread widening as the market is almost one-sided with many sellers and almost no buyers.

Both the IMF and the EU Commission have said that Ireland has not asked for help. In addition, a German finance ministry spokeswoman said that “Ireland has not asked the EFSF for aid, and we are confident it will implement its (budget) consolidation measures successfully”. Greek budget data showed that Greece is likely to post a higher-thanplanned deficit in 2010 (9.3% of GDP instead of the planned 8.1%).

On a positive note, German exports increased 3.0% in September following a 0.4% decline in August. This is a strong reading that confirms that German exports were on track despite the euro appreciation. A warning signal is that German industrial production data was soft in September just as retail sales and orders have been.

US: More signs of labour market improvement
US jobless claims this week provided more signs that the US labour market might finally be improving. Weekly claims reached the lowest level since 2008 (apart from the temporary decline in July driven by seasonal distortions). The claims data has been going broadly sideways for a long time but this week’s data could be a sign that it is finally heading lower.

The Senior Loan Officer Survey showed further easing of credit standards on loans to both corporates and consumers. Credit standards for mortgage loans were also eased very slightly. It was also positive that there is still a sharp rise in the willingness to make consumer instalment loans. On a more negative note, the survey also showed that demand for loans is quite low on both commercial and consumer loans. This is a sign that
uncertainty is still widespread.

The NFIB small business optimism index increased from 89 in September to 91.7 in October Although still at a very low level, it is slightly encouraging that it is finally starting to move upwards. It might also be a consequence of slightly easier credit standards as tight credit has been a major obstacle for small businesses which cannot tap the bond markets but are dependent on the banks’ willingness to lend.

On the political side, the US has come under fire from pretty much everyone after launching QE2 as the US is accused of trying to weaken the currency and put pressure on other countries – not least emerging markets.

Inflation surges in China
Inflation in China in October unexpectedly surged from 3.6% y/y to 4.4% y/y, see Flash Comment – China: Surge in inflation supports further appreciation . However, the increase in inflation in October was solely driven by higher food prices, which constitutes close to 40% of the average consumer basket in China. Over the past year, food prices have increased by around 10%, while consumer prices excluding food and energy are only up 1.1% y/y. Core inflation in China has actually eased slightly in recent months, consistent with GDP growth being below potential GDP growth in both Q2 and Q3. Other Chinese data released in the past week (e.g. industrial production and retail sales) was slightly weaker than expected, but still suggests GDP growth will accelerate to around 9% q/q AR in Q4 from 7.2% q/q AR in Q3.

Nonetheless, it now appears that the Chinese government will miss its 3% inflation target for 2010 as a whole and possibly also for 2011. With signs that growth is accelerating again, containing inflation will now be the main priority for the Chinese leadership. In the past week, the People’s Bank of China (PBoC) responded by hiking the reserve requirement for major commercial banks by another 50bp. Another hike in the benchmark
lending and deposit rate could be imminent. The increasing inflationary pressure in China also supports our above-consensus call for the pace of appreciation of CNY against USD. With inflationary pressure rising, it will increasingly be in China’s own interests to allow its currency to appreciate.
Full report: Global update : Focus turns from QE to the European debt crisis

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