Saturday, December 11, 2010

Weekly Focus: Global update : US: less fiscal drag in 2011

Increasing confidence in growth 
On balance news on the economic front continues to be encouraging. In the US the
implications of agreement to extend the Bush-era tax cuts will be that the drag on growth
from fiscal policy will be less in 2011. In Asia data now consistently suggest that China’s
growth is again is accelerating and the rest of Asia is poised to follow. However, in
Europe the debt crisis remains a concern. PIIGS spreads have widened slightly and the
euro has weakened slightly, as the ECB has not continued its aggressive bond buying
from last week and the Euro Group so far has not suggested that available resources for
the bailout funds will be increased.

US: less fiscal drag in 2011
Early this week, Obama reached agreement with Republicans and Democrats in the
Congress on the outline for a deal to extend the expiring Bush-era tax cuts. The package
includes an extension of the Bush tax cuts for two years, which had been widely
expected, but also included other elements which were more surprising. Most important
an extension of jobless benefits for long-term unemployed through 2011 and a payrolls
tax cut that replaces the expiring “making work pay” tax cut enacted in 2009.
If the deal goes through Congress in its current form it will lift personal disposable
income in 2011 beyond what we had expected. According to our calculations this could
potentially boost private consumption growth by 0.5pp compared with our present 2011
forecast. This also implies that the fiscal drag in GDP growth in 2011 will moderate from
about 1.5pp under the former budget to around 1.0pp.  Given the temporary nature of the
tax cuts there will be a payback in 2012. However, at that time we expect the US
economy to be in a better position to withstand the drag.

On another positive note, initial jobless claims continued to show moderation thereby
extending the downward trend in place over the past four weeks. This supports our view,
that the disappointing employment report in November was likely a "blip" in data rather
than a new trend for the US labour market.

Mixed message from the eurozone 
In the eurozone the markets were hoping for the ECB to continue the more massive
government bond purchases initiated while Trichet gave his press briefing last Thursday.
The ECB failed to maintain its pace and sovereign spreads began to widen again on
Monday. Last Sunday the Belgium finance minister argued for an increase in the size of
the European Financial Stability Facility (EFSF). The IMF has also argued that there “is a
strong case for increasing the resources available for this safety net”. This increased
hopes for bold moves from the Eurogroup and the Ecofin council, which met Monday and
Tuesday. However, after the Eurogroup meeting on Monday the head of the Eurogroup,
Juncker, said that the fund is large enough "for the time being" and that the Eurogroup
had no new measures to announce. German Chancellor, Angela Merkel, is also strongly
against increasing the EFSF and against  eurobonds. The message from several ECB
sources is that the ECB would not like to take all the risk and would like to see

governments take more action – for example, by increasing the size of the EFSF. Indeed
ECB governing council member, Mario Draghi, said Thursday that the main
responsibility for dealing with the debt crisis lay with individual governments and
signalled that the ECB should not undertake massive government bond purchasing. So the
battle about how to solve the crisis will continue and sovereign debt markets will remain
fragile. Sovereign spreads narrowed slightly during the week – in particular at the long

The Irish government announced its budget on Tuesday. The main measures were already
well flagged in the bailout agreement. Spending cuts constitute two-thirds of the total
package, with a 4% cut in unemployment payments and some pensions, coupled with a
continued downsizing of the public sector. The government seems to have the necessary
support to have the Budget approved by parliament. However, the full legislative process
lasts until February, German industrial production rose strongly in October, but German manufacturing new
orders disappointed as it failed to offset the previous month’s sharp decline. This causes
some concern about whether the slowdown we have seen in H2 10 will continue into

China’s import and export surge  
In November  China’s seasonally adjusted export and imports surged 9.4% m/m and
13.4% m/m respectively, see: Flash Comment - China: Exports and imports surge in
November. Data distortions probably explain a part of the extraordinary strength in the
November data and there will likely be some payback in December. Nonetheless the
turnaround in China’s exports and imports looks genuine. First, it is consistent with the
recent development in China’s manufacturing PMI. Particularly China’s manufacturing
PMIs have indicated at strong pick-up in China’s import growth (see chart) Second, data
from other Asian countries that have released November foreign trade data (Taiwan and
South Korea) have also been strong. Exports to all China’s major export destinations
showed improvement in November, but particularly China’s exports to the rest of Asia
excluding Japan improved. This suggests that demand within Asia again appears to be an
important driver for growth in Asia after some weakness since the start of 2010. There are
also signs of renewed strength in the property market, albeit not alarmingly so, as yet.

House prices in November increased 0.6% m/m following a 0.1% m/m increase in the
previous month. Hence, the Chinese data now consistently indicates that growth again is
accelerating and with inflation expected to increase to around 5½% y/y in early-2010,
there is an urgent need to make monetary policy less accommodative in China. In our
view a rate hike is just around the corner.

In  Japan GDP growth in Q3 was revised higher from 3.9% q/q AR to 4.5% q/q AR
mainly because business investments was stronger than in the first preliminary estimate.
However, data continue to suggest that growth will slow sharply in Q4. In October
domestic machinery orders declined 1.4% m/m following a sharp 10.3% m/m drop in the
previous month, suggesting business investment might contract in Q4.

Scandi Update 
Denmark: Exports and industry weakening 
Statistics Denmark last week released export and industrial production figures for
October. Unfortunately, they did not make for pleasant reading, with exports down 2.5%
m/m and industrial production slumping 4.8% m/m.
The tumbles in both exports and industrial production follow a period of very decent
growth. Danish industries’ sales of commodities and services have thus risen by 26%
since the low in June 2009, while industrial production has increased by 11% since the
trough in September 2009.

The big question now is whether this fall marks the end of the impressive growth seen
over the past year. Unfortunately there is much to suggest that this might well be the case.
While it is true that growth is currently surging in Denmark’s largest export markets
(Germany and Sweden), many challenges remain. The debt crisis is still lurking in the
wings and may well come to play an unsavoury leading role on the economic stage in the
not-too-distant future. And even if the debt crisis does not develop into a full-blooded
drama, fiscal policy will still have to be tightened in many European countries, which will
tend to dampen demand in Danish export markets.

Moreover, the pronounced slide in Danish competitiveness over the past few years could
well mean that exports will not pick up by as much as the growth in Denmark’s export
markets would normally suggest.
Hence there is much to suggest that both industrial production and exports will continue
to lose momentum in the coming months. This serves to underline that the road to
recovery for Danish industry is still long – and dangerous.

Sweden: Inflation adds to reasons for rate hikes 
On top of super-strong GDP growth (Q3 was the third quarter in a row with Swedish real
GDP growth at on average 8% SAAR), inflation also gained momentum in November,
posting 1.9% y/y on both headline and core inflation. The main reasons were rising
mortgage rates and electricity prices, none of which was a surprise. This means inflation
too is currently 0.2-0.3 percentage points above the Riksbank’s inflation forecast and we
expect to see some continued upside versus the Riksbank’s current forecast over the next
couple of months. Underlying inflation fundamentals, however, remain quite favourable.

Economy-wide unit labour costs (ULC) plunged in Q3, down 3.0% y/y, which is the
lowest reading since at least 1994. The main reason is the 4.6% y/y surge in productivity,
but record-low nominal wage growth (1.6% y/y) also contributed. This extreme is likely
to moderate over the next year as new wage claims will be higher, but productivity may
remain high as employers are likely to remain wary about new hirings as the global
economic outlook still remains fragile. Hence, a repetition of the 2002-05 ‘productivity
miracle’ does not seem that unlikely. Moreover, the SEK is set to remain strong or
continue to appreciate, implying stable to lower import prices, as long as the Riksbank
continues to raise rates in Sweden relative to other countries. In the short term, there are
nonetheless signs suggesting higher inflation to a large extent stemming from non-core
items such as commodity food prices, soaring energy prices and higher mortgage rates.
The Swedish budget balance in November turned out to be close to the Debt Office’s
forecast. Hence, there is no change to the ‘rock solid’ outlook for government finances,
implying a small surplus already in 2011.

Norway: 2004 revisited  
As we approach the end of 2010, the situation in the Norwegian economy is beginning to
resemble the tail end of 2003. Inflation is low, but economic growth is seriously picking
up. The latest figures show core inflation remaining at 1% y/y, while the Norges Bank
regional network indicates that quarterly growth in mainland GDP will reach almost 1%
for the second consecutive quarter – and employment and investment expectations are
rising at the same time. What distinguishes the current situation from 2004 is that house
prices are very high – also in terms of consumer prices and wages – and household
indebtedness is significantly higher than seven years ago. This of course makes pursuing
a low interest rate policy to ensure higher inflation more risky than in 2004. We believe
this distortion in the risk picture will force Norges Bank to move sooner and more
robustly than the market is pricing in at the moment.
Full report: Weekly Focus: Global update : US: less fiscal drag in 2011

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