German CPI inflation (December): increasing, but still low
M3 growth (November): broadly flat
The German GfK consumer confidence for January could have rebounded,
after having deteriorated unexpectedly the previous month. Belgian and
Italian business confidence will probably have continued improving in
December, albeit at a slower pace than in November. The same applies to
Italian consumer confidence.
French consumer spending could have gone up again in November, just
like French consumer confidence. EMU industrial new orders will
probably have suffered a setback in October, like the corresponding
German figure. French Q3 GDP is unlikely to be revised significantly.
In the last week of this year, the preliminary results for national
German CPI for December are due to be released. We expect German
consumer prices to have increased by 0.6% month-on-month, which would
correspond to an annual rate of 0.7%. Due to typical seasonal
“Christmas” effects, prices for package tours and accommodation
services will have increased markedly mom. Food prices could have risen
as well. On the other hand, clothing prices are expected to have gone
down. And lower prices for heating oil and gasoline could have dampened
the monthly inflation rate by up to 0.1 percentage points. We are
expecting inflation rates to remain low next year due to the low level
of capacity utilisation and weak aggregate demand.
On 30 December, the ECB will release data on monetary developments
in the euro area. The balance sheet growth of euro area banks remains
constrained as banks continue to reduce their leverage. More over,
corporates have curbed inventories and investments, thereby reducing
their financing needs. Borrowing by private households seems to be
picking up slightly. Taking advantage of low mortgage rates, households
are cautiously returning to the housing market. However, overall loans
to the private sector keep declining; “MFI loans to other euro area
residents” probably fell by 0.8 % yoy in November. M3 growth will have
remained roughly unchanged at 0.3 %. On a monthly basis, money supply
is likely to have crumbled again. Within M3, there has been a
pronounced shift of funds from interest bearing components of M3 – time
deposits in particular – to overnight deposits. This trend probably
continued in November, as market interest rates remained extremely low.
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Trading volumes and data were light this week as markets wound down
ahead of the holidays. In the US, the November housing starts and
building permits data bounced back from the softness seen in October.
The FOMC kept interest rates on hold and slightly sweetened its
economic outlook, although this positive note was somewhat offset by
the second consecutive increase in weekly jobless claims. The dollar
gained steadily for a second week against the euro and the yen as
sovereign debt issues continued to roil the Euro Zone, while gold hit a
one month low below $1,100 on Thursday. The Senate Banking Committee
voted to move the nomination of Fed Chairman Bernanke to a full Senate
vote, but not without another round of Bernanke bashing from the usual
quarters (even after Time named Bernanke the Man of the Year). In the
background, there were dark rumblings: PIMCO's Bill Gross raised his
cash holdings to the highest level since the failure of Lehman in Sept
2008, while BoA/Merrill Lynch analysts discussed the possibility of a
"Valentine's day massacre" market correction in Q1 that could stem from
the end of the Treasury's MBS buying program or other factors, and
Meredith Whitney took another swipe at banks, cutting her 2009-2011 EPS
targets on JP Morgan, Goldman and Morgan Stanley. US equity markets
closed the week out on high volume due to quadruple witching and the
quarterly Q&P rebalancing. Equity indices ended mixed for the week,
with the DJIA down 1.3%, the Nasdaq rising 1%, and the S&P 500
slipping 0.4%.
Little was expected from the FOMC this week, although ahead of the
decision an FT article prompted speculation that, in a nod to the ECB,
the Fed might choose to distinguish between liquidity and monetary
policy, specifically by raising the discount rate from the existing
0.50% level and simultaneously keeping the Fed Funds target rate steady
at 0-0.25%. The discount rate hike never came to fruition, but the FOMC
did alter its policy statement to remind markets that most of its
special liquidity facilities are scheduled to wind down in Q1 2010. As
expected, the Fed funds rate was kept unchanged and the commitment to
keeping rates on hold for an "extended period" was reaffirmed, with the
economic outlook paragraph slightly more optimistic.
Citigroup has wasted no time in scaring up the capital it needs to
pay back the US Treasury. The bank said on Monday that it would sell
more than $20B in debt and equity to repay a portion of its TARP funds,
and had priced a 5.4B share offering at $3.15/share by Thursday
morning. Wells Fargo was right behind Citi, announcing later on Monday
that it would repay its entire TARP stake. It priced an offering of
426M shares at $25/share. Note that a number of regional banks have not
disclosed any plans for repaying TARP as of yet and have lost ground
this week, including SunTrust and Fifth Third Bank. Meredith Whitney
was out this week ripping the more solvent end of the industry, cutting
her earnings estimates on Goldman Sachs, Morgan Stanley and JP Morgan
well below the consensus.
Exxon made a big vote of confidence in the shale gas industry by
announcing a $31B deal to acquire major player XTO Energy. The deal
could begin a new rush to own North American natural gas assets by
major integrated names and may set off significant consolidation in the
energy industry.
Exxon will buy the firm for $31B in Exxon common stock
and also assume $10B in XTO debt. Other leading natural gas names such
as Apache, Devon Energy, Anadarko, EOG, Chesapeake and Nabors gained
steadily this week on news of the acquisition. The deal is not a sure
thing, however. Congress will certainly hold hearings on the move,
while scrutiny of the environmental impact of shale drilling technology
has been growing. Note that Congress is mulling restrictions on some of
these techniques.
Strong earnings from selected tech names helped the NASDAQ
outperform the Dow and S&P500 this week. Adobe, Oracle and Research
in Motion reported better than expected quarterly results and offered
strong forward-looking guidance. Executives from Adobe said demand
improved in the quarter, while over at Oracle management said they
expect the EU to clear Oracle's acquisition of Sun. RIMM's shipment
volume grew more than 20% sequentially and new subscribers were up by
more than 12% q/q. Intel took a hit this week when the FTC sued the
company for using its dominant market position for a decade to stifle
competition and strengthen its monopoly.
Trading in US Treasuries revolved around the FOMC statement this
week. The yield curve hit fresh steepening highs post FOMC, with 2
10-year spread getting as wide as 278bps. Yields have traded in a
fairly wide range over the course of the week, the benchmark 10y Note
ascended though 3.60% for the first time since late summer, only to
retreat to more respectable levels holding near 3.5% as the week drew
to a close.
The Greek fiscal tragedy took more twists and turns this week. The
government announced a number of ambitious debt and deficit reduction
targets early on while the finance minister embarked upon a confidence
building tour of Europe's major financial centers. But in the absence
of any specifics bond markets and rating agencies remain unconvinced.
S&P joined Fitch in downgrading the Hellenic Republic to BBB+ on
Wednesday. The downgrade leaves Moody's flying solo with an A1 rating
two notches above its peers. Should Moody's choose to recalibrate its
rating to be closer to the other agencies, Greek government bonds would
be ineligible collateral for ECB liquidity operations (if and when it
decides to return to pre crisis rules) which would likely set off a
chain reaction of issues for Greek banks. With the ECB making tentative
steps toward the exit earlier this month, the story is clearly not
going away any time soon. Bunds have been the main beneficiary, with
safe haven flows sending the yield to within one basis point of the
3.10% level last tested in April. Greece's 10-year is now a hefty
260bps wider , while 10y UK Gilt yields hit fresh 2009 highs above
their German counterpart near +70bps as polls began to point to a hung
parliament in next year's general elections.
In currencies, trading saw more turbulence in the Euro Zone thanks
to Greece's second credit downgrade and a negative call out of Moody's
on the Irish banking system. Safe-haven flows out of peripheral debt
weighed on the euro throughout the week, while year-end repatriation
flows further aided dollar sentiment. Stresses are starting to filter
down to the European financial sector: a Fitch analyst said European
banks could face rating actions over commercial property losses and the
ECB revised its Euro Zone bank write-down forecast to €553B from €488B
prior for the 2007-09 period. The greenback is at its best levels of
the last three months against the Euro and Swiss Franc thanks to these
stories as well as thinning year-end liquidity conditions. Interest
rate differentials have also played a role in helping the dollar, as
reflected in notably widening yield spreads between the US and both
Europe and Japan.
The technical picture has been constructive for the dollar, with
200-day moving averages were back on the radar, particularly against
the European pairs. The FOMC statement only sustained the dollar's
momentum, with the Fed offering a slightly more optimistic economic
outlook. An alleged 1.4500 option barrier was breeched mid-week
electing some stop loss selling in EUR/USD and triggering a broad
adjustment across the G10 currency regime. Dealers said there were
decent option flows, with a European name buying two-month EUR/USD puts
with strikes between 1.36-1.40 early in the week. EUR/USD tested the
1.4530 level after the German IFO barely registered a 50 reading,
demonstrating the fragility of the economic recovery. EUR/USD tested
just below 1.4300 on Friday, hovering near its 30-week moving avg.
Sterling benefited the most on the initial news regarding Dubai
World debt restructuring as the week began. GBP/USD tested above 1.64
after UK jobless claims declined for the first time since Feb 2008,
although GBP was weighed down following the weaker UK retail sales
data. UK newspaper The Daily Mail noted that the world was losing faith
in the UK's debt load and concerns about the vast quantity of gov't
bonds that would have to be sold over the coming years.
Commentators discussed the Swiss National Bank's slow exit from
expansionary policy this week, strengthening the Swiss Franc. Although
the SNB's Roth confirmed that the bank would continue to work to avoid
franc appreciation, the market had other ideas. The rush to safe havens
weighed on EUR/CHF during the latter part of the week, sending the
cross below the pivotal 1.5000 level. Recall that this was deemed the
"line in the sand" during the initial Swiss currency intervention back
in March on rumors of a coup in Pakistan. The cross was off its Asian
lows of 1.4910 but has yet to regain a foothold above the 1.50 level.
Expectation for a fourth consecutive interest rate tightening by the
Reserve Bank of Australia at its next meeting in February repeatedly
came under pressure from disappointing economic data and dovish central
bank rhetoric this week. Starting on Tuesday, the minutes from the last
meeting revealed a closer than expected decision to raise rates. The
Board saw policy at a "less accommodative setting" after the move,
offering policymakers "greater flexibility" for adjustment going
forward. Despite the recent upside surprise in November jobs growth,
RBA was also more cautious in its employment outlook, noting that the
jobless rate may not have reached its peak. Then on Wednesday,
Australia's disappointing Q3 GDP further downgraded RBA prospects,
pushing February tightening probability below 40%. The Q/Q 0.2% figure
- below the 0.4% expected - marked the lowest rate of growth since Q4
of 2008, while also revealing a greater chunk of economic expansion
coming from the stimulus-infused public sector. Following that GDP
release, Treasurer Swan - an early opponent of RBA tightening - said
the data demonstrates that growth momentum is not yet self-sustaining,
suggesting that Q3 would have been a contraction without the stimulus.
A Bank of Japan interest rate decision on Friday saw monetary
authorities yielding to cabinet pressure with a notable shift to a more
dovish tone, helping spark the regional equity rebound going into the
weekend. Keeping the economic assessment unchanged after consecutive
upgrades, BOJ said it would keep monetary conditions "very easy" amid
signs that the economic recovery would slow until mid FY10. On the
inflation front, BOJ dropped its prior view that the decline in core
consumer prices is likely to keep narrowing, vowing not to tolerate CPI
at or below zero and targeting 1% for price stability. BOJ then
expressed its deflation fighting resolve by pointing out it would
"patiently support the economy" until it comes out of deflation. JGB
yields fell across the board on the dovish BOJ comments, with the 5-yr
note registering a 4-yr low below 0.45%.
The Asian Development Bank maintained China's growth forecast at
8.2% in 2009 and 8.9% in 2010, but raised India outlook for 2009 to 7%
from 6%. ADB also raised the overall developing economies growth target
in the region to 4.5% from 3.9% in 2009 and 6.6% from 6.4% in 2010. The
upgrade follows an upward revision as recently as late September.
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Cautious on further USD upside, but JPY may play catch-up
Fed wearing rose-colored glasses again
Cable likely to reflect the weight of poor sterling fundamentals
Key data and events to watch next week
Cautious on further USD upside, but JPY may play catch-up
The greenback has extended its recovery, bringing the USD rebound
against the EUR to nearly 6% since the 1.5150 high at the end of
November, and erasing all the losses seen in the 4Q. The current
environment continues to develop into a perfect storm against the EUR
in particular, and indeed that is where the dollar has gained the most.
Credit concerns continue to pressure the EUR, with Austria
nationalizing a small regional bank at the start of the week (and
placing the 4th largest bank under surveillance) and a ratings cut to
Greek sovereign ratings coming mid-week. To finish out the week, Friday
saw the ECB increase its forecast of Eurozone bank write downs by a
further 13%. The sharp rebound in the USD has caught global reserve
managers off guard, and anecdotal evidence (market chatter) suggests
they are increasingly pulling back from plans to sell dollars and may
be moving to the other side, looking to sell EUR/USD on any rebound. In
Japan, the BOJ has declared war on deflation and that promises to keep
pressure on Japanese rates in the near-term, increasing the JPY's
appeal as the primary funding currency for carry trades. US rates on
the other hand, look to have peaked in the short-term, with 10-year
yields cresting just above 3.60% and since dropping back to around
3.50%; two year note yields peaked just below 0.90% and have since
dropped back to around 0.75%.
Excessive USD-short position squaring/reduction helped propel the
USD off its lows, but changes in short-term interest rates were the
other principal driver. COTR data from last week (as of 12/8) suggests
much of the USD short positions have been exited (small EUR/USD net
shorts were actually reported) and US rates have stalled in their rise
after the Fed renewed its commitment to exceptionally low rates for an
'extended period.' As such, two of the main sources of recent USD
strength are beginning to fade and this gives us cause to pause on
further USD strength. Additionally, the negative Eurozone news is
somewhat overblown and we think the market has overreacted on the EUR.
Lastly, the USD has risen to levels where longer-term USD bears see an
opportunity to re-enter dollar shorts. The exception is in USD/JPY,
which we think may play catch-up (rising) in the weeks ahead and
dominate price moves into year-end. On the other side, an element of
year-end inertia is at work, and an object in motion (rising USD) is
likely to stay in motion. Overall, we would be extremely cautious on
holding USD longs (except against the JPY, where we remain buyers on
dips) from current levels, but would look to re-buy USD on pullbacks,
looking to re-sell EUR/USD in the 1.4380/1.4430 area, GBP/USD around
1.6350/400. Finally, we would remind traders that holiday-thinned
markets in the final two weeks of 2009 will exacerbate volatility and
increase the chances for potentially erratic price moves, which
suggests adopting more defensive/protective tactics.
On the technical front, we have also reached price levels that
suggest caution on chasing the USD higher from here. In favor of
further EUR/USD weakness, we have decisively broken below the daily
Ichimoku cloud, the base of which is up at 1.4627, suggesting a trend
shift lower. The guiding trend line is a steeply falling line that
starts next week at 1.4395/00, and declines about 60 points each day,
which we will be watching closely as a key to exit EUR shorts. On the
downside, we have identified the 1.4250/4300 as a key zone of
congestion support, with the 100-week sma a key weekly close level at
1.4311. More concretely, just below is the 200-day sma at 1.4181 and
the top of the weekly Ichimoku cloud at 1.4184. The 1.4170/80 level is
also the bottom of the September consolidation range. Overall, current
conditions suggest a scenario where EUR/USD makes a final plunge to the
1.4150/80 area and then bounces/consolidates. In USD/JPY, price is
struggling to close above the daily Ichimoku cloud top at 90.66, but
the outlook remains constructive while above the daily Tenkan and Kijun
lines at 89.14 and 87.90, respectively.
Fed wearing rose-colored glasses again
The FOMC's track record on forecasting should give those that are
looking through the same rose-colored glasses some pause. Recall that
Bernanke and company called the end of the housing market problems back
in early 2007 and were proven dead wrong. The Fed noted in their
January 31, 2007 communique that "some tentative signs of stabilization
have appeared in the housing market." Home prices back then had yet to
dip into negative terrain and over the next two years would fall to
-19% year/year. Two months later, they were forced to renege and noted
that the "adjustment in the housing sector is ongoing." Quite a failure
in forecasting from the body that purportedly has the best econometric
models in the world.
The Fed statement this week showed a notable mark-up in terms of
where the committee sees the US economy at the moment. Most
importantly, they ratcheted up their optimism on the labor market and
were more upbeat on housing. The business picture still looks gloomy
according to the Fed and this is about the only assessment we can agree
on. The short-term risk for the bulls is that the Fed proves to be
overly optimistic - again.
The notion that "deterioration in the labor market is abating" can
be called into question even if we only look at the data from this
week. Initial jobless claims jumped to a higher than anticipated 480K,
but that was only the tip of the iceberg. The real story was the jump
in total continuing claims. Indeed, the tally of those on state and
federal unemployment programs rose to a new record 10.1 million from
9.4 million the prior week. This flies in the face of the decline in
the unemployment rate in November and goes against the Fed's notion
that we are seeing improvement on this front.
On the residential real estate front, the Fed is also more sanguine.
Their view is that the "housing sector has shown some signs of
improvement" of late. The NAHB index (homebuilder sentiment) would beg
to differ. Total activity dropped to 16 in December from 17 last month
and 19 in September. This is the worst print since June, but the bad
news doesn't end there. Prospective buyer traffic, which is a great
indicator of demand, remained depressed at 13 for the third consecutive
month - this number was sitting well above 50 in the rip-roaring
subprime days. Demand will only get thinner if we get a pop in mortgage
yields once the Fed stops buying MBS securities in 1Q.
The one part the Fed looks to have gotten right is that "businesses
are still cutting back on fixed investment". Regional manufacturing
surveys from NY and Philadelphia this week proved that the business
sector remains stressed. The most glaring problem is the major margin
compression that firms are suffering. The NY Empire showed prices paid
in the region rose to 19.7 from 10.5 while priced received slipped to
-9.2 from -2.6. In the Philly district, prices paid soared to 33.8 from
14.9 while received dropped to -1.8 from -1.5. So firms are seeing a
major increase in the prices of things they buy while having to cut
selling prices as they struggle to unload inventories in an environment
where the consumer is in full deleveraging mode. One doesn't have to be
a mathematician to know that this will hurt 4Q earnings in size.
Cable likely to reflect the weight of poor sterling fundamentals
The 1.6% drop in cable since the start of December is far more
moderate than the 4.4% decline that has been registered by EUR/USD. The
EUR's underperformance of both the USD and the pound this month
reflects the weight of sovereign deficit issues which have recently
been dogging the Eurozone. These issues are likely to help the USD
cyclical recovery vs. the EUR and could potentially allow EUR/GBP to
hold its present lower levels going forward. That said the outlook for
the UK remains mired by its own weight set of problems. While better
than expected labor market data over the last couple of months have
brought the first pieces of really good news for the UK since the start
of the recession, the issues surrounding the weighty budget deficit and
slow growth are likely to continue weighing on the pound going forward
and the cable is likely to reflect most of this weakness.
UK November public sector borrowing totaled GBP20.3 bln. The
cumulative total for the first eight months of this fiscal year is
GBP106.4 bln. This compares with GBP 49.3 bln in the same stage last
year and suggests that there is risk that the Chancellor's whopping
full year estimate of GBP170 bln could prove to be overly conservative.
Despite the hefty deficit, the Chancellor was reluctant to announce
many true deficit cutting measures in this month's pre-budget report.
The official reason was that the meager growth outlook needed to be
supported. The fact that the general election will most likely be held
in May 2010 offers another explanation. The markets are unlikely to
reward sterling for the Chancellor's reluctance to face the budget
deficit head-on, nor is the market likely to reward sterling for the
continued poor UK growth backdrop. The upcoming release of final Q3 GDP
is expected to confirm that the UK remained in recession during the
quarter (median -0.3% q/q). Growth is expected to have resumed during
Q4. However, the recent disappointing release of Nov retail sales
(-0.3% m/m) highlights the continued vulnerable position of consumer
sector. The forthcoming release of the minutes of the Dec BoE meeting
should shine fresh light on the MPC's view of economy. In all
likelihood, however, the risk of further QE will remain on the table
until February and there will be little to disregard the view that BoE
rates will remain at their present 0.5% level until the second half of
2010. We would expect GBP/USD to retest the 1.6100 support near-term
and see scope for a move back towards the 200 day sma at 1.6000.
Key data and events to watch next week
Global markets are likely to be in holiday mode next week but there
are still some important pieces of data due out. That coupled with what
tends to be very thin markets this time of year (low volume), could
make for some very interesting price action. Please note that we will
be closing for the Christmas holiday on Thursday, December 24 at 10pm
ET and reopening Sunday normal time.
In the United States, the typically under-the-radar Chicago Fed
National Activity Index is due on Monday. This metric does a good job
predicting expansions and it is worrisome that it has now fallen three
months in a row. The final cut of 3Q GDP is due on Tuesday along with
existing home sales. Wednesday is busy with personal income/spending,
University of Michigan consumer sentiment and new home sales. Thursday
rounds out the week with durable goods orders and the usual initial
jobless claims data.
It is data-light in the Eurozone. Germany sees consumer confidence
on Tuesday and import prices on Wednesday. Meanwhile, France has
producer prices on Tuesday, consumer spending on Wednesday and
employment on Thursday.
The UK has a very thin calendar. The final 3Q GDP cut is up on Tuesday and the Bank of England minutes are due Wednesday.
Japan is busier than most other countries. The Bank of Japan's
monthly report kicks off the action on Monday while Tuesday sees small
business confidence and supermarket sales. The BoJ minutes are the
highlight for Wednesday. Thursday brings employment and consumer prices
while Friday closes out the week with housing starts.
In Canada, only retail sales on Monday and monthly GDP on Wednesday are noteworthy.
It's super-light down under as well with Australia leading index on Monday and New Zealand GDP on Tuesday.
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opinions.
Similar to other markets around the globe, speculation in the
U.S. this past year revolved around when (and to what extent) the
massive monetary stimulus delivered in the prior year would bear fruit.
Ultimately,
investor confidence and desire for risk taking would return in the
first half of 2009, setting the stage for a rebound in economic output
in the second half.
In 2010, the focal point is likely to shift to the likely monetary policy path of the U.S. Federal Reserve.
At
this week's FOMC meeting, the Fed left its overnight rate unchanged at
0.00-0.25% and signaled virtually no change despite recent data that
suggest a further acceleration in U.S. growth in Q4 2009.
With
growth in the U.S. economy to decelerate in the quarters ahead, 2010
could mark the second straight year where the Fed Funds rate is left
unchanged.
The recovery in the Canadian economy is expected
to become more pronounced in the fourth quarter, with growth of around
4% annualized.
Broad-based growth across both the goods and
the services sector can be expected next year, though industries that
are more vulnerable to recessions are likely to see a stronger bounce
back.
Still, several headwinds will persist into 2010,
resulting in a more subdued rebound in economic activity than what
typically takes place after a recession so deep.
UNITED STATES - SPECULATION ABOUT THE TIMING OF FED RATE HIKES WILL OCCUPY THE MARKETS IN 2010
Undeniably, the Fed's decisive action and leadership has been
instrumental in bringing the U.S. - and by extension - other economies
around the world back from the brink. While actual interest-rate
slashing and the unveiling of quantitative easing programs were the
story of 2008, market focus in 2009 was more centered on the question
of when the massive monetary stimulus would bear fruit. Ultimately,
confidence and risk appetite would return with a vengeance in the first
half of this year, followed by a resumption of economic growth in the
second half. Based on the latest data offerings, U.S. real GDP growth
in the world's largest economy is set to accelerate to 4-5%
(annualized) in Q4. Furthermore, the November reading on non-farm
payrolls provided the clearest evidence yet that the hemorrhaging in
the U.S. job market is over. Renewed hiring by U.S. businesses, which
have recently become lean and mean, is a necessary condition for a
sustained recovery.
As we head into the New Year, speculation on the timing of the
Fed's exit from the current period of stimulus promises to be the
dominant theme in financial circles in 2010. Still, the most recent Fed
musings suggest that we remain a long way off from an actual rate hike.
Buzz about imminent Fed hikes is likely to be more of a story for the
second half of the year than the first.
Consider this past week's FOMC meeting, which concluded with a
decision to leave the official rate unchanged at a range of 0.00-0.25%.
The accompanying statement contained few surprises. Unaltered from the
previous meeting were the discount rate, the quantitative easing
framework and the commitment to keep rates “exceptionally low” for an
“extended period”. There was some modest tweaking of the language to
acknowledge that the “deterioration in the labor market is abating”,
although there remained caution about the outlook for household
spending. The Fed reiterated its earlier announcement that the
expirations of most liquidity facilities would be maintained until
February 1st.
The pace at which the Fed will shift its stance in the months ahead
will depend on the pace of recovery in the economy and job markets. In
this week's release of the TD Quarterly Economic Forecast, we argue
that the pace of U.S. growth will likely decline to roughly one-half
its Q4 rate in the first half of 2010 and strengthen only modestly in
the second half. With high unemployment expected to remain a challenge,
U.S. consumers will have limited capacity to ramp up their spending.
And some of the sectors that have been bouncing back from their
recessionary lows - such as exports and housing activity - won't be
able to sustain their recent rapid clip.
The tepid growth on tap for 2010 points to an ongoing abundance of
slack in product and labor markets. Although disinflation pressures
appear to have eased of late - as highlighted in the November CPI
report out this week - the risks will remain tilted towards lower,
rather than higher, consumer price growth in 2010.
In sum, the likely profile of U.S. growth and inflation trends
suggest that the first Fed rate hike won't take place at all in 2010.
In our view, it will be Q1 2011 before Bernanke et al pull the trigger,
which would mark the unusual occurrence of two consecutive years when
the official rate has remained unchanged. This is not to say that bond
markets won't start to aggressively price in higher rates as the Fed
begins to parlay a change in stance. But this is more likely to occur
towards the middle of 2010. In the meantime, the yield curve will
remain extremely steep. What's more, ongoing negative interest-rate
differentials between the U.S. and other countries will also put a lid
on how much the U.S. greenback can strengthen in the year ahead. For
more details, please refer to TD Securities 2010 Outlook and Trading
Themes, available on the TD Economics website.
CANADA - CYCLICALLY SENSITIVE SECTORS TO OUTPERFORM IN 2010
At the start of this year, the outlook for the Canadian economy was
quite gloomy, as it had just entered into the recession. But after
contracting by 3.3% peak-to-trough, we have already begun to see
budding signs of a recovery. As such, the prospects for 2010 are much
brighter.
After posting a tepid - yet positive - 0.4% annualized growth rate
in Q3 2009, several indicators are pointing to robust growth in
economic activity during the final three months of the year. Strength
in the housing market, healthy consumer spending and an uptick in
business sentiment will likely lead to a more convincing 4.1% rebound
in real GDP growth in Q4. This momentum will carry through into 2010,
placing Canada first (along with the United States) among the G-7
nations.
We expect to see broad-based growth across both the goods and the
services sectors next year, though industries that are more vulnerable
to recessions are likely to see more upside during the recovery phase
since these were the areas that were hit hardest on the way down. In
fact, we are already seeing evidence of this trend in the manufacturing
and construction sectors - both of which are very cyclically sensitive.
While we expect these sectors to be among the top performers in
2010, alongside related services sectors - wholesale trade and finance,
real estate and legal services - the picture is not as rosy at it might
seem. Despite the pick-up in manufacturing activity, output levels will
still fall well short of the heights seen during the first half of the
decade, and it could take several years to get back to those levels.
Moreover, much of the growth in the factory sector has stemmed from a
surge in auto and parts production. And this strength is likely to
taper off by mid-year once inventories - which were drawn down by the
Cash for Clunkers program in the U.S. - are replenished. Similarly,
infrastructure spending and momentum in the housing market is likely to
cool by mid-2010, setting the stage for a slowdown in construction
activity. So after emerging from the recession on a high note, growth
in these sectors is likely to slow as 2010 comes to a close.
Elsewhere, growth will be more muted as several challenges will
persist into next year. Though we expect to see Economicsreal domestic
demand advance at a healthy 3% clip in 2010, consumers are likely to
remain cautious in their spending habits given the ongoing weakness in
the labour market - job creation will improve only gradually and the
unemployment rate is likely to remain above 8% throughout the year.
Moreover, while deficit-challenged governments are unlikely to upset
tentative recoveries by cutting expenditures aggressively next year,
the 2010 budgets could begin the process of paring back some stimulus
measures that have been helping to prop up spending.
Perhaps the biggest impediment to the recovery in Canada will be
the high-flying loonie. Despite falling to 93 US cents this week, the
Canadian dollar is likely to remain quite elevated, hovering around
parity with the greenback throughout 2010. This will limit Canada's
competitiveness in foreign markets and hence, export growth. In
addition to an elevated currency, exporters will also be faced with
sluggish demand from the U.S. - where the majority of Canadian goods
are destined - weighing on export growth even more.
All factors combined, the bounce back in economic activity in 2010
will be much softer than what typically takes place after a recession
so deep. But while the recovery may be more subdued this time around, a
recovery will nonetheless take place.
U.S.: UPCOMING KEY ECONOMIC RELEASES
U.S. Personal Income & Spending - November
Release Date: December 23/09
October Result: income 0.2% M/M, spending 0.7% M/M; core PCE deflator 0.2% M/M, 1.4% Y/Y
The U.S. economic recovery is clearly gathering traction, and there
are encouraging signs that the U.S. households are beginning to slowly
regain their appetite for spending, buoyed in large part by the
improving economic outlook. In November, we expect personal income to
rise by its largest margin since May, with a 0.6% M/M surge, boosted in
large part by the massive spike in aggregate hours worked. Personal
consumption expenditures should also be quite strong on the month,
posting its sixth monthly advance in seven months, with a 0.6% M/M
gain. Evidence of the strength in personal consumption expenditures has
been seen in the corresponding retail sales report, which rose by 1.3%
M/M in November, providing an upside risk to this call. On the
inflation front, the core PCE deflator is expected to rise by a modest
0.1% M/M, with the annual pace of core PCE inflation rising to 1.6%
Y/Y, from 1.4% Y/Y in October. In the coming months, we expect the core
PCE deflator to ease as the growing economic slack in the U.S. economy
dampens core consumer price pressures.
U.S. Durable Goods Orders - November
Release Date: December 24/09
October Result: total -0.6% M/M; ex-transportation -1.3% M/M
TD Forecast: total 0.5% M/M; ex-transportation 1.5% M/M
Consensus: total 0.3% M/M; ex-transportation 1.0% M/M
As the U.S. economic recovery takes shape, we anticipate that
durable goods orders will regain some positive momentum in November,
with the new orders expected to rise by 0.5% M/M, following the 0.6%
M/M drop the month before. Much of the improvement should come from a
bounce-back in orders for machinery, who posted a big 8.5% M/M drop in
October. Weak aircraft orders should be a source of drag on the
headline number during the month, and excluding transportation, orders
are expected to rise by a more profound 1.5% M/M. In the coming months,
as the economic recovery gathers further traction, we expect orders to
stay in positive territory as U.S. businesses replenish their depleted
capital stock in anticipation of the pick-up in demand.
CANADA: UPCOMING KEY ECONOMIC RELEASES
Canadian Retail Sales - October
Release Date: December 21/09
September Result: total 1.0% M/M; ex-autos 1.1% M/M
TD Forecast: total 0.6% M/M; ex-autos 0.0% M/M
Consensus: total 0.8% M/M; ex-autos 0.5% M/M
Given a fairly robust domestic economy and a booming housing market,
Canadian households have kept the cash tills busy in recent months with
retail sales activity rising at a 1.0% M/M or better pace in 4 of the
last 5 months. Much of this recent upward momentum in spending has come
from strong motor vehicle sales, while home furnishing-related
expenditures have also provided favourable support. This momentum is
expected to continue in October, with strong motor vehicle sales
expected to bolster headline retail sales up a further 0.6% M/M.
Additional upside support should come from expenditures on housing
related items, on account of the buoyancy in Canadian housing market
activity. Excluding autos, retail sales are expected to be flat, while
real retail sales should be modest. In the months ahead, with Canadian
labour market conditions expected to be mixed, consumer spending growth
should be stop-and-go, but more often “go”.
Canadian Real GDP - October
Release Date: December 23/09
September Result: 0.4% M/M
TD Forecast: 0.3% M/M
Consensus: 0.3% M/M
The Canadian economy is slowly emerging from the deep economic
recession, supported in large part by the boom in housing market
activity and strong consumer spending. In October, we expect the
economy to record its second consecutive monthly advance with a modest
0.3% M/M gain. Strong manufacturing and housing market activity should
provide the key support for economic activity during the month, while
residential construction should also add favourably to GDP. Overall, we
expect both goods-producing and service-producing sectors of the
economy to grow. In the coming months, the Canadian economic recovery
should remain intact, as the significant monetary and fiscal policy
stimulus administered to the Canadian economy gathers traction, though
the recovery is likely to be both slow and fragile.
PDF Format TD Bank Financial Group The information contained in this report has been prepared for
the information of our customers by TD Bank Financial Group. The
information has been drawn from sources believed to be reliable, but
the accuracy or completeness of the information is not guaranteed, nor
in providing it does TD Bank Financial Group assume any responsibility
or liability.
U.S. Review
Recovery Continues: Jump in Fourth Quarter GDP
Economic recovery continues with gains this week reported
in industrial production, housing starts and leading indicators. There
was, however, a bit of a cautionary breeze coming from an inflationary
direction.
Our anticipated inventory correction appears to
be showing up in the fourth quarter; when GDP is reported in January,
it will likely be up more than 4 percent. Gains in net exports and
retail sales this week also support the case for a strong GDP release.
Recovery Continues: Jump in Fourth Quarter GDP
Economic recovery remains the baseline outlook. This week gains
were reported in industrial production, housing starts and leading
indicators. There was, however, a bit of a cautionary breeze coming
from an inflationary direction. Industrial production rose 0.8 percent
with manufacturing alone up 1.1 percent with improvement in motor
vehicles, machinery and computer sector output. Over the past three
months at an annual rate, industrial production, a coincident
indicator, is up more than 8 percent, consistent with an economic
recovery that began in the third quarter. Capacity utilization has also
risen over the past five months, consistent with gains in profits over
the second half of this year. Our outlook is for a gain of 3 percent
for industrial production in 2010 compared to a decline of 9 percent
this year.
Housing starts rose to 574,000 in November compared to average
starts of 540,000 in the second quarter. Leading indicators for housing
are also positive. Expected buyer traffic is up in response to the
first-time home buyer tax credit. Single-family permits are running
ahead of starts which suggests starts are sustainable at current
levels. Yet, we remain cautious. Our outlook is for just 660,000
housing starts in 2010 - not the 1.3 million of 2007. Household income
growth remains modest and credit standards are tighter. Household
expectations for home prices and the state of the market remain very
subdued. The calculus of home buying and finance has changed.
Leading indicators increased 0.9 percent in November and are up
more than 9 percent over the past six months. These are very good
signals for continued economic recovery. Over the last three months,
there has been solid improvement in the average workweek, jobless
claims and consumer goods orders. On the financial side there have been
gains in stock prices, the money supply and interest rate spreads.
These broad-based improvements suggest continued growth. However,
leading indicators do not tell us the pace of this growth. We expect
growth of more than 4 percent in the fourth quarter with gains led by
inventories, trade and federal and consumer spending. But after the
inventory adjustment, which may continue in the first quarter, the pace
of growth will be subpar due to the ongoing economic adjustments to
realign demand and financial realities.
Inflation: A Note of Caution
This week's consumer price report introduced an element of caution
that we had expected. Inflation, while "low" is not flat. Over the past
year, core goods CPI is up 2.6 percent compared to a year ago. The
overall CPI is up 1.8 percent compared to 1.1 percent a year ago. With
two, three and five year Treasuries all yielding below three percent
these inflation numbers suggest negative, real after-tax rate of
returns for investors. Meanwhile, average hourly earnings are up just
2.2 percent suggesting that rising inflation will put a damper on real
income growth. Finally, rising inflation brings into question if the
Fed can maintain its 2.0 percent inflation target in the face of
political pressure to keep monetary easing with unemployment above nine
percent.
U.S. Outlook
Personal Income • Wednesday
Personal income rose a modest 0.2 percent in October and is now up
1.2 percent at a three-month annualized rate. Despite weak income
growth, personal consumption expenditures were up 0.7 percent in
October due at least in part to a bounce-back in auto sales. We expect
consumer spending rose 0.6 percent in November. Sustainable consumer
spending requires income and therefore job and wage gains. While the
four-week moving average for jobless claims continues to decline, at
467,500 it remains above the level needed to add jobs to the economy.
Jobless claims would need to drop below 400,000 on a sustained basis
for nonfarm payrolls to post consistent gains. Further, while layoffs
have subsided, hiring has not picked up. Firms tend to hoard labor in a
recession due to concerns about the cost and availability of skilled
labor as the recovery begins.
Previous: 0.2% Wells Fargo: 0.4%
Consensus: 0.5%
New Home Sales • Wednesday
Sales of new homes regained their footing in October, increasing
around 6 percent to an annual pace of 430,000, after uncertainty around
the scheduled expiration of the first-time home buyer tax credit likely
pushed sales lower in September. The recent extension and expansion of
the tax credit will likely help support sales in coming months, but we
expect a retracement in November. New home sales are measured based on
contract signings and home buyers needed to sign a contract well before
the tax credit expired. We expect new home sales likely fell 3.5
percent in November to an annual pace of 415,000. Inventory levels of
unsold homes have continued to improve and have reached levels not seen
in nearly 40 years. Once sales rise on a consistent basis, the
sustained low levels of inventory suggest a pick up in new construction
in coming months.
Previous: 430K Wells Fargo: 415K
Consensus: 440K
Durable Goods • Thursday
New orders for durable goods fell 0.6 percent in October driven by
a significant decline in defense orders. While the "headline" tends to
be extremely volatile on a month-to-month basis, the three-month annual
rate of new nondefense capital goods orders excluding aircraft is a
better gauge of manufacturing activity. That figure has remained
positive for five consecutive months. Recent gains in industrial
production and the ISM Manufacturing Index suggest a similar trend in
new durable goods orders in November. We expect orders rose 1.8 percent
in November. Furthermore, the continued depletion of inventories and
expected increase in shipments suggest manufacturing activity will
continue its positive momentum in coming months.
Previous: -0.6% Wells Fargo: 1.8%
Consensus: 0.3%
Global Review
"Poor Mexico, so far from God, so close to the United States!"
The most important risk rating agencies have been lowering
Mexico's credit ratings. Weak fiscal sector revenues and an extreme
reliance on revenue from the state owned petroleum monopoly, PEMEX, is
problematic. Oil production continues to fall due to lack of investment.
Some blame the problems on the weak U.S. economy, but Mexico has the
solution to its problems within its country limits, not outside of them.
"Poor Mexico, so far from God, so close to the United States!"
Mexicans always call upon this famous quote from a former president
of Mexico, Porfirio Diaz, to explain away the problems they face
internally. And once again during this crisis, we have been hearing
Mexican analysts complaining about their close ties with the U.S.
economy. They cite this as the reason the economy has deteriorated
during the past couple of years. And at some level they may be right,
as Mexicans have put almost all their eggs in one basket. Their economy
is so tied to the U.S. economy that if the U.S. economy sneezes, the
Mexican economy catches pneumonia. For example, almost 90 percent of
Mexican exports are destined to the U.S. consumer and/or producer
market.
Production and demand for automobiles, one of the most troubled
sectors in the United States is a big determinant of Mexican economic
strength. In some way Mexicans have little leeway on choosing who
invests and what industries come to the country. The majority of the
investment coming into Mexico is dedicated to producing for the U.S.
consumer market. In good or normal times, this was a sure thing.
However, lately the U.S. consumer market has not served the Mexican
economy well. The closeness of both economies and their interdependence
has aggravated the economic situation south of the border. But that is
the end of the "blame the U.S. bandwagon."
Much of the responsibility for Mexico's troubles today has Mexican
roots. The reforms necessary to protect their economy from a weak U.S.
economy have been postponed and delayed for almost a century. Mexico's
inability to collect taxes from its citizens and businesses is at the
heart of today's problems. Without taxes coming from the state-owned
petroleum monopoly, PEMEX, tax revenues collected by the Mexican
government amount to approximately 10 percent of GDP compared to almost
20 percent for the United States and much more for other developed
economies.
Meanwhile, the constitutional prohibition for private capital to
invest in the Mexican petroleum industry has hampered the ability of
the Mexican economy to take advantage of surging petroleum prices over
the past several years. In fact, Mexican petroleum production has been
declining and there are no prospects for this situation to change any
time soon even though the country has huge amounts of proven reserves
in the ground. PEMEX has no money to extract them. In fact, PEMEX is
one of the few petroleum companies in the world that consistently loses
money.
Thus, Mexicans should not be surprised at the latest downgrades
being handed out by risk rating agencies and markets should not be
surprised if problems in the country continue for the near future.
Mexico's problems are not just its high fiscal deficits as many argue.
Mexico's problems are not only due to its closeness or its dependence
on the U.S. economy. Mexico's problems also stem from its inability to
collect taxes and guarantee and secure the payment of its debts. Only
the political system can fix those problems.
Global Outlook
Canadian Retail Sales • Monday
Canadian retail spending fell off a cliff last year as the global
economy went down the tubes. On a year-over-year basis, overall retail
sales were down 3.8 percent in September. However, sales are growing
again on a sequential basis, and are up 5.6 percent from their nadir
last December. Part of the increase in the overall level of retail
spending reflects the country's cash-for-clunkers program that lifted
auto sales earlier this year. That said, retail sales excluding autos
have also risen this year, and data that will be released Monday will
show whether the trend remained intact.
Real GDP in Canada rose only 0.4 percent (annualized) in the third
quarter, but the quarter ended on a strong note as GDP grew 0.5 percent
(not annualized) during September. GDP data for October, which are on
the docket on Wednesday, will show how the last quarter of the year
started.
Previous: 1.0% (month-on-month change)
Consensus: 0.8%
French Consumer Spending • Wednesday
French consumer spending strengthened in September and October, and
data that are slated for release on Wednesday will show whether
November made it three-in-a-row. The market expects a 0.5 percent gain
following last month's 1.1 percent increase. This pace is decidedly
improved from a year ago, up at least 3 percent. France will print data
on producer prices on Tuesday of next week, giving us a feel of
inflation further up the supply chain. The market expects a small 0.1
percent increase, month over month, but prices remain down
significantly on a year-over-year basis.
Italian retail sales for October will also print on Wednesday,
along with consumer confidence data for December. An improved consumer
outlook would bode well for the rest of the year's sales data.
Previous: 1.1% (month-on-month change)
Consensus: 0.5%
Japanese Unemployment Rate • Thursday
The unemployment rate in Japan rose to 5.7 percent in July, the
highest rate since records began in 1953, but it has subsequently
fallen to 5.1 percent. Although some of the drop in the unemployment
rate reflects a small increase in employment, the decline in the labor
force over the past few months has also helped to pull the rate lower.
Therefore, the consensus forecast anticipates that the unemployment
rate edged higher in November.
Data on consumer prices in November will print on Friday. Prices
fell 2.5 percent in October, the sharpest rate of deflation that Japan
has experienced. Although the rate of deflation should slow in November
- on a year-over-year basis oil prices were higher in November 2009
than they were 12 months earlier - nobody is looking for runaway
inflation in Japan anytime soon.
Previous: 5.1%
Consensus: 5.2%
Point of View
Interest Rate Watch
FOMC: "Extended Period" Stays
This week's Federal Open Market Committee (FOMC) minutes indicated
that the Fed will keep the federal funds rate on hold at the current
0-25 basis point range for an "extended period." This is consistent
with our annual outlook which looks for the FOMC to maintain its
current policy at least through the first half of 2010.
Three factors support the FOMC's decision at this time. First, we
agree with the FOMC that economic activity has "continued to pick up."
In fact, we anticipate that fourth quarter GDP could exceed 4 percent
given the inventory adjustment and better trade and retail sales data.
We also agree with the FOMC that household spending "appears to be
expanding" and that the housing sector "has shown signs of improvement."
Second, inflation, as expressed by the FOMC "will remain subdued
for some time" given its reason that "substantial" resource slack
remains as indicated by "elevated" unemployment and low capacity
utilization. Our outlook is for the core personal consumption deflator
measure of inflation to remain below 2 percent next year and for
unemployment to remain above 10 percent.
Financial Market Improvements
According to the FOMC "financial market conditions have become more
supportive" of economic growth. We agree. In our weekly meetings,
reports continue to suggest that corporate high-grade and high-yield
issuance has improved over the past three months. Credit default swap
rates also remain low.
But the Real Test is Ahead
As the economic recovery proceeds and Treasury continues to issue
debt interest rates will rise at the long end. The real test for policy
and the markets will be if/when the Fed ends MBS purchases by the end
of the first quarter/mid-year next year.
Consumer Credit Insights
Flow of Funds/Employment Pluses
Turnarounds in household financial and job situations suggest an
improvement in the quantity and quality of consumer credit next year.
On the financial side, household asset values have improved. Financial
assets, which are about 60 percent of household assets, have risen over
the past two quarters with gains in the equity market leading the way.
Meanwhile, household real assets have also improved although they
remain below levels of a year ago. Real estate assets remain about 30
percent of all assets.
Meanwhile, household liabilities have declined dramatically over
the past two years. Both home mortgage credit and consumer credit have
shrunk dramatically with mortgage credit registering its first declines
since the early 1980s.
Employment Turnaround: Income Gains
Meanwhile, recent declines in jobless claims and improvements in
housing and manufacturing surveys suggest that job gains are
increasingly likely by the second quarter of next year. Our outlook is
for positive gains beginning on a sustained basis by the second quarter.
Positive job gains are usually associated with a longer work week,
higher hourly earnings and therefore real income gains given the
current low level of inflation. On net, this suggests positive consumer
spending and an increase in consumer credit demand ahead.
Topic of the Week
Labor Markets Troubles to Persist in Recovery
Recessions have many consequences for the economy, and in this
cycle the disruption of the labor market has been one of the most dire.
The economy has shed more than 7 million jobs to date, and adding those
jobs back will be an arduous process. Further slowing the recovery are
the unusual length and depth of the recession, such that a return to
employment levels seen before the bust will not occur over our forecast
horizon, significantly underperforming previous recovery timelines.
While there are many reasons for this outcome, part of the labor
market's troubles stem from the secular decline of manufacturing
employment that has defined the sector since the late 70s. More than 2
million of the jobs lost over the course of the recession have been in
the manufacturing sector; our concern is that they are not coming back.
This is a national story, but certain parts of the United States feel
the implications of the demise in manufacturing employment more acutely
than others.
Pennsylvania is an area where manufacturing has historically been
more important than it has been to the national economy, but the
state's dependence on the sector (now just 10 percent of employment)
has diminished as other sectors have increased in importance. The
flexibility of an economy can be a valuable asset - indeed it has
allowed Pennsylvania to add jobs in education & health services and
other service sectors, offsetting some of the loss from manufacturing.
This adjustment is essential, as most of the 90,000 manufacturing jobs
that have disappeared in Pennsylvania over the past two years are
likely not coming back - employment growth will emanate primarily from
service industries, while manufacturing employment will continue to
erode. Labor market weakness will persist for longer than we would
like, but adjusting to new economic realities will smooth the
transition from recession to recovery. For a more detailed look at
Pennsylvania's labor market, please see our recently published report,
"Pennsylvania Economic Outlook: Spotlight on Jobs."
Wachovia Corporation http://www.wachovia.com
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Financial market review - foreign exchange
The US dollar was the star performer of the week once again as the
DXY dollar index reached its highest level since September and
registered its third consecutive weekly gain. Sterling outperformed
against the G-10 currencies except the Canadian dollar and the US
dollar despite a sharp sell-off towards the end of the week following
poor retail sales data. EURGBP posted five consecutive increases to end
the week at 0.88860. Commodity currencies were once again hit the
hardest with the Australian dollar the worst performer.
Sterling experienced a fairly volatile week due to a raft of key
economic releases. The CPI report released on Tuesday kept sterling
supported earlier in the week, coming in a touch above consensus,
rising 0.3% in November, taking the annual rate to 1.9%. It was the
unexpected decline in the claimant count measure of unemployment on
Wednesday that really gave sterling a push, however, sending GBPUSD to
an intra-week high of 1.6411. Adding to the upside news was a downward
revision of 7k to October's rise in benefit claims to 5.9k. While the
fall is an encouraging sign, it is too early to call a sustained
turnaround in unemployment data. Our cautious view on the UK economy
was reflected in the retail sales report on Thursday. Volume retail
sales unexpectedly contracted 0.3% in November. The annual rate slowed
to 3.1% from 3.7%. The report was even more disappointing given the
general expectation that consumers would bring forward expenditure
ahead of the increase in VAT on 1 January. Sterling plunged on the
report to a low of 1.6080 versus the US dollar - a fall of three cents
in 24 hours, exacerbated by thin trading conditions. GBPUSD rebounded
modestly to end the week at 1.6087. EURGBP drifted lower all week,
driven by euro weakness.
The US dollar index continued its upward break this week and is now
5.1% above the recent lows. Commodity currencies have taken the brunt
of the pain with AUD down 2.4%, NZD down 1.9% and the euro down 1.8%
over the week. While some of the dollar strength can be attributed to a
fall in risk appetite stemming from sovereign risk concerns on Greece's
downgrade, interest rate differentials have begun to turn in favour of
the US dollar and we are starting to see the dollar gain on positive
data surprises. Producer prices surprised to the upside in November
while industrial production also reported an encouraging rise of 0.8%.
Wednesday's CPI report showed inflation remains subdued. Core CPI was
unchanged at 1.7% in the year to November although the headline rate
jumped to 1.8% from -0.2% on base effects but in line with
expectations. Apart from a fall in the Empire manufacturing, survey
evidence was positive with a stronger Philly Fed and an improvement in
the leading indicators index. The FOMC meeting on Thursday did not
deliver any surprises with no change to the Fed funds target rate.
Minor changes in the Fed statement showed a slightly more positive
outlook for the economy and confirmation that many of the liquidity
schemes would not be renewed down in February as planned.
The eurozone was dominated by the downgrade of Greece this week.
The action weighed on the euro which suffered losses this week against
all the major G-20 currencies except for SEK, NZD and AUD. The
technical break below the euro's upward trend line versus the US dollar
continued and the currency pair looks set to revert back to its 200 day
moving average (1.4180).
Interest rate market review - bonds, cash and swaps
Government bond yields in the US and the UK fell for the first time
in three weeks after technically oversold conditions and a decline in
equities triggered a sharp retreat in yields on Thursday and Friday.
For gilts, disappointing November retail sales aided the cause for
lower yields and this offset the upward pressure from stronger CPI and
unemployment data. Strong demand for fixed income paper on Friday led
yields to close the week at the lows with UK 10y yields settling below
3.80% and 5y swaps at 3.11%, with the yield curve a touch flatter. UK
3-month libor ended the week 0.5bp lower at 60bps.
UK and US yields extended last week's move to the upside over the
early part of the week, with 10y gilt yields touching 3.92%, the
highest level since late July. Stronger than forecast UK November CPI
and US November PPI data were blamed for the move upwards in yields
over the early part of the week. UK CPI rose to 1.9% y/y from 1.5% y/y
in October, topping consensus forecast of 1.8%. RPI rose 0.3% y/y vs
-0.8% y/y, turning positive for the fist time since January. We expect
annual CPI to top 3% in Q1 and average 3.2% in the first half of 2010
before easing back in the latter part of the year. Stronger than
expected unemployment data added to the case for higher yields on
Wednesday when it emerged that employment rose in November for the
first time since February 2008. The claimant count total fell by 6,300,
bringing the two-month average to -200. The ILO unemployment rate rose
to 7.9%. Average earnings picked up to 1.5% y/y from 1.2%. The data
squeezed 5y swaps to an intra-week high of 3.21% and 10y yields to
3.92%.
The tide turned on Thursday when UK retail sales surprised with a
0.3% drop in November vs consensus of a 0.5% gain. Demand for
short-dated gilts was also boosted when the FTSE-100 posted its biggest
one-day drop in three weeks (-1.7%). Weak November M4 data on Friday
cast doubts on the effectiveness of QE with regards to increasing
nominal spending, and this should keep speculation of a further
increase in QE in the new year alive. The £850mn 2027 index-linked gilt
auction drew modest demand on Wednesday and was covered 1.59 times,
below the 1.64 cover of the July auction. Corporate sterling issuance
completely dried up this week and is not expected to resume until early
in the new year.
US Treasury yields also rose for the best part of the week but
reversed on Thursday and Friday from oversold levels and on flight from
soft equity markets as the S&P-500 retreated below 1,100. The Fed
kept rates on hold at 0-0.25% as expected on Wednesday and said it will
let liquidity schemes expire in February as planned. The Fed sounded
more upbeat on the economy and reiterated that inflation is likely to
stay subdued. Strong November PPI data boosted yields but the rise in
10y yields above 3.60% was promptly reversed by a benign outcome for
November core CPI (unchanged at 1.7% y/y). Corporate issuance was
fairly light with JP Morgan ($1.5bn, 30y) Windstream ($1.1bn, 2017) and
ANZ ($1.25bn) among the principal names coming to market. 5y swaps
ended the week 2bps lower at 2.62%. The 2y/10y curve spread touched a
277bps high.
In the euro zone, the last ECB one-year tender attracted bids for
96.9bn euros, with just over 220 institutions bidding for funds at an
indexed rate. The German IFO survey rose to 94.7 in November vs 93.4.
Bunds attracted good support throughout the week as news from Greece
emerged. Participants are not convinced of the country's debt reduction
plan and switched out of peripheral paper into bunds. 5y swaps fell
below 2.60% to 2.58%, the lowest for the year. 2y yields dropped below
1.15% to a 3-month low. Greece raised funds by selling 2bn euros of
2015 floating rate notes in a private placement at 250bps
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The data flow in the US should be relatively light. Key
movers will likely be data on new and existing home sales in November.
Forecasts are pointing toward improvement in the November data, but we
still expect some weakness in sales data to materialise over the coming
months.
In the first week of next year, the US dataflow intensifies, with the ISM surveys, non-farm payrolls and FOMC minutes
Nothing
much of interest is expected out of the eurozone, although on December
23 we get industrial new orders. The data are awaited with some
excitement following the downbeat October numbers.
In Denmark, GDP data for Q3 09 are due out. We expect GDP to contract by 0.2% from Q2 09 to Q3 09, or 6.2% y/y.
Global update
In the past week, European news headlines have been dominated
by developments in Greece and the nationalisation of the Austrian bank
Hypo Group Alpe Adria. S&P downgraded both Greece and Hypo Group in
the past week.
Recently, the financial markets have focused
increasingly on a potential further strengthening of the US dollar.
Since December 1, the dollar index is up 4.5%.
US growth has shifted into a higher gear and should continue to strengthen heading into 2010.
The
Tankan business survey for Q4 painted a mixed picture of the Japanese
economy. On the one hand, it suggested very solid GDP growth in Q4 09,
while on the other it indicated that GDP growth could slow
substantially in Q1 10.
Focus
We highlight some of the main themes that will shape market
developments in 2010, including the strength and sustainability of the
recovery and central bank exit strategies.
We also throw the spotlight on public debt levels in the euro area and the future challenges posed by large and growing debt.
Market movers ahead
Global movers
The data flow in the US during the weeks surrounding Christmas is
expected to be relatively light. Most interesting in the coming week is
expected to be data for new and existing home sales in November. The
forecast looks for improvement in the November data, but we still
expect that some weakness in sales data will materialise over the
coming months as the dynamics from first-time home-buyer credit
reverses. Elsewhere initial claims data and durable goods data will
provide some updated information about the state of the business
sector. Durable goods orders have been on the weak side lately and we
expect to see some payback in November, which would be welcome news for
the investment outlook. In the week between Christmas and New Year, the
final Michigan Consumer confidence and Chicago PMI are the most
noteworthy events. Consumer confidence is expected to improve on a
favourable cocktail of continued gains in equity markets, lower
gasoline prices and slightly better job prospects.
In the first week of next year the dataflow intensifies with the
ISM surveys, non-farm payrolls and FOMC minutes. It remains too early
in the data cycle to gauge the exact outcome of these data, but we note
that the recent soft reading on the Empire survey is causing some
concern about our view for a continued improvement in the ISM in the
near term. It seems that Euroland is on Christmas holiday for a two
full weeks. At least if judged by the amount of interesting data to be
published - i.e. not much. On December 23 we get industrial new orders.
October was a disappointment with much downbeat data - not least
because the month was short of one working day. Industrial orders in
Germany dipped in October and we expect to see a small dip in Euroland
orders, although they are still trending upward. On December 29 we
receive preliminary German inflation figures. HICP is projected to
increase from 0.4% to around 0.8%. Last, but not least, the ECB provide
us with data on monetary developments for November. M3 growth would
likely stay pretty flat at just above zero. M1 growth will rise from
12% to 13%, but this is just base effects. M1 growth is now firmly on a
downward trend. We will also keep an eye on the monthly loan flows. We
anticipate improvements following last month's disappointing
retrenchment.
In Japan most economic data for November will be released between
Christmas and New Year's Day. Recently several business surveys have
suggested Japan GDP growth might slow substantially in Q1 10 driven
primarily by a slowdown in private consumption, as the impact from
fiscal easing has started to wane. Hence, we will pay particular
attention to the labour market data. If the improvement seen in recent
months in the labour market continues, Japan should be able to avoid a
contraction in private consumption, as the improvement in labour
incomes should start to compensate for some of the negative impact from
fiscal policy. Because the decline in the unemployment rate has been
unusually large in recent months, we expect the unemployment rate to be
unchanged in November, but both employment and the job-to-applicant
ratio should improve further in November. The other big theme in Japan
currently is whether the BoJ should step up is non-conventional easing
to fight deflation.
However, deflationary pressure has actually not
been increasing in recent months. Deflationary pressure has been easing
in recent months and it will now start to show up in the year-on-year
inflation rate, which we expect to increase to minus 1.6% y/y in
November from minus 2.3% y/y in the previous month. The increase in
inflation is not only due to base impact from lower energy prices last
year. As seen the chart underlying inflation has been increasing in
recent months. Hence, the price development should really not be the
main concern in Japan. However, the possibility of a substantial
slowdown in growth in early-2009 is a concern
Global update: A Bumpy Ride Towards Year-End
A bumpy ride towards year-end
This week, European news headlines have been dominated by S&P's
downgrade of Greece and the nationalisation of the Austrian bank Hypo
Group Alpe Adria. Once again this should serve as a reminder that the
crisis is contained, but not over. In the meantime, the potentially
biggest game changer in the financial markets over the past few weeks
could be the strengthening in the USD.
Since 1 December, the dollar
index is up 4.5% - now trading at its highest level since September.
Whether this shift is related to year-end unwinding of short-funded
carry positions or whether it reflects a more permanent shift in
investor sentiment towards the USD is probably too soon to tell. While
we expect the USD strength to be temporary for now, the recent
development bears watching as a continued and more permanent
strengthening of the USD would have implications for the real economy,
for investors and for policy choices down the road.
Elsewhere, the data picture continues to support our forecast for
strong momentum in global growth heading into 2010. That said, there
are now more evident signs that the pace of expansion is peaking in
several places in Asia, as this week's decline in the Japanese Tankan
highlights. In this respect, Asia still seems to be leading the global
cycle and should face slower growth already in Q1. We expect a similar
pattern to materialise in Europe and the US, but not before later in H1.
Still solid but more mixed US data
Over the past month, data has confirmed that US growth has shifted
to a higher gear with growth rates around 4% heading into 2010. That
said, last week's data has been more mixed regarding the H1 outlook.
Indeed, it seems as if hard data is picking up, while soft and more
forward-looking data has been more mixed.
Evidence from the US business sector confirms this picture. While
the November data for industrial production revealed that the
manufacturing sector outside autos is gathering speed, the local
business surveys indicators have been mixed, so far. Also, in housing,
hard and soft data have diverged. The NAHB survey weakened in December,
while housing permits picked up in November. Despite the more flattish
tendency in permits and starts over the past few months, the outlook is
for an increase in residential construction by 15-20% in Q4 and
similarly in Q1.
The huge slack in the economy is becoming increasingly evident in
inflation data. Leaving out the spurious behaviour of auto prices, core
PPI and core CPI are clearly trending lower at the moment. Indeed, the
November data underpins our expectations that core CPI inflation will
dip below 1% during 2010.
The Fed meeting this week did not add
much new information regarding the policy outlook. The FOMC upgraded
its assessment of the economy but did not change the outlook for growth
and inflation. Once again, it was communicated that the exceptionally
low level of interest rates will remain in place for an extended
period. We continue to expect that the Federal Reserve will not hike
before Q4 10, but that the central bank will probably begin absorbing
excess reserves by the middle of next year.
Greece, Austria and the rest of Euroland...
This week all eyes have been on Greece…again. On Sunday, the Greek
prime minister announced the measures the Greek government plans to
implement in order to cut the deficit. These include a 10% cut in
social security spending next year, introduction of a capital gains tax
and a 90% tax on private bankers' bonuses. He also vowed to fight
corruption and tax evasion, which he sees as Greece's biggest problems.
The aim is to cut the deficit by 4% next year and then bring the
deficit down to below 3% in 2013. The market did not take much comfort
from the announcement and on Wednesday evening S&P followed in the
footsteps of Fitch and downgraded Greek sovereign debt from A- to BBB+.
The spread to Germany on Greek 10-year government bonds increased to
more than 250bp.
Another focus of attention this week was Austria. On Monday, the
Austrian government took over the bank, Hypo Group Alpe Adria - a major
lender in the former Yugoslavia and in deep financial trouble. This
reignited concerns about Austrian banks' substantial exposure to
Eastern and Central Europe, which had been a theme at the beginning of
the year. This is probably not the last bank to default or be
nationalised. We would expect to see market jitters if and when larger
financial players go belly-up.
With so much going on, key figures did not take centre stage. ZEW
declined, but this was not much of a surprise. On a positive note
Euroland and in particular German PMIs surprised on the upside. The
PMIs are signalling strong growth for Q1, that we are very close to a
peak in unemployment and that the ECB should still be on hold, but now
with a bias towards hiking rather than cutting. We expect to see a
first hike from the ECB in August next year.
Tankan suggests Japanese growth to slow in early 2010
The Tankan business survey compiled by the Bank of Japan (BoJ) was
mixed. On the one hand it suggested very solid GDP growth in Q4 09,
while on the other it suggested that GDP growth might slow
substantially in Q1 10. While Tankan is consistent with our forecast of
4.0% q/q AR growth in Q4 09, it suggested that there might be
considerable downside risk to our 2.0% q/q AR forecast for Q1 10.
Business sentiment is mainly deteriorating for smaller enterprises
within services, supporting the view that the slowdown in early 2010
will mainly be driven by a slowdown in private consumption as the
impact from fiscal easing has started to wane. We expect growth in
private consumption to slow to 1% q/q AR from close to 4% q/q AR in
both Q2 and Q3 this year. However, based on recent business surveys, we
cannot rule out the possibility that private consumption will contract
in Q1 10.
The DPJ government has approved a new stimulus package; however, it
is unlikely to have any major impact until Q2 10. Hence, we are likely
to enter a period where the economic numbers will be very mixed and the
markets will start to question the sustainability of the Japanese
recovery. Hence, we cannot rule out the possibility that BoJ will step
up its non-conventional easing further, most likely by increasing its
purchase of government bonds. We think this will happen if growth slows
below 1% q/q AR and the labour market starts to deteriorate again. This
is not our main scenario, as the recovery in exports and industrial
activity appears to be on track and the slowdown in private consumption
should prove temporary.
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Incredibly equity indices continue to hover close the this year's
highs, five consecutive weeks of tiny ranges, and many range-bound for
a fourth consecutive month. However BRIC indices sold off this week:
the China Enterprise index hardest hit off 5%, Shanghai Composite 4%
and Hang Seng 3% on fears for the property sector because bank lending
might be reined in considerably next year. Brazil's Bovespa formed a
'bearish engulfing' weekly candle as it lost 4.3% from this year's peak
while Mumbai's Sensex closed at the mid-point of Q4's range. The US
dollar strengthened against most currencies, the Euro at $1.4300 and
CHF 1.0500, hardest hit the Australian dollar off 2.6% on the week at
$0.8800. Fixed income and money market yields are a bit lower, most
bonds retracing all or much of the previous week's move, JGB's the best
performers along with several Index-Linked issues (Germany 2016 new
record low 0.745% and France 2015 0.668%). In fact some are suggesting
these, like front month money-market futures which have traded through
central bank targets, are priced for Armageddon. Commodities mixed
again, some sidelined, Base Metals with a steady bid tone, Softs the
stars. London Cocoa futures at £2,350 per tonne – a 32-year high with
the 1977 record of £3,512 still holding - and Sugar a record $680.70
per tonne on supply concerns. While Crude Oil remains steady around
$74.00 per barrel, January Natural Gas Futures rallied to $5.926 per
MMBtu from $4.432 at the start of this month.
Political and Economic Developments
Monday the Austrian government nationalised Hypo Group Alpe Adria
and rumours swirled that the country's fourth largest, Volksbanken, was
on a 'watch list'. This sent the line of fire back onto the troubled
conditions in Eastern Europe and the Baltic states though whether this
had anything to do with the Czech Republic's 25 basis point cut to
1.00% on Wednesday is unclear. Norway simultaneously surprised with a
25 basis point hike to 1.75% while a dovish Reserve Bank of Australia
noted that its (unchanged) target at 3.75% was probably the new
'normal' (which many had assumed to be 4.75%).
November UK jobless dropped by 6.3K keeping those out of work at
5.0%, admittedly the highest since 1997. This probably has something to
do with Retail Sales dropping by 0.3% in the same period, another
disappointment to struggling retailers who are already offering 20% and
50% discounts on some items. Meanwhile supermarkets are desperately
trying to offload own-brand champers at supposedly half price – at
£14.99 per bottle! Yeah, right.
Underlying Themes
The idea that financial decisions are made in January, and held come
hell or high water until the end of the year, is asinine. Myopic,
especially when the one-year straight-jacket is then overlaid with the
mantra that shares are the best investment in the five-year plus time
horizon. Beware those with 20:20 hindsight, the creeps and the crooks.
General themes for next year will probably be similar to ones faced
over the last two, viz: the banking system is not fixed and will not be
for a very long time. The value of any asset is only what someone else
will pay for it, and at times there may be no buyers at all. Despite
ultra-low central bank targets for interest rates, spreads will remain
wide and some will not be able to get credit at all. Eventually we will
see which governments find they are no longer able to raise the money
they need, who is the first to realise this and who is the last man
standing the only things that count. Only the very best quality assets
are worth looking into, and having a steady job is probably the best
one of all.
What to watch for next week
Monday early Japan October All Industry Activity Index, November
Trade Balance, Convenience Store Sales and December Bank of Japan
Monthly Report with German November Import Prices and December IFO due
from this day. Tuesday Japan November Supermarket Sales, December Small
Business Confidence and German January GfK Consumer Confidence; then UK
and US final Q3 GDP, US October House Price Index and November Existing
Home Sales. Wednesday Minutes from the Bank of England's MPC, October
Index of Services, November BBA Mortgages, Eurozone October Industrial
New Orders, US November PCE, Personal Income and Spending, New Home
Sales and final December University of Michigan Survey. Thursday
Minutes from the Bank of Japan, Q4 Business Outlook Survey and US
November Durable Goods Orders. Friday Japan November Jobless, Household
Spending, Vehicle Production, Housing Starts, Corporate Service Prices,
Construction Orders, National CPI and Tokyo December CPI.
Positioning and Technical Analysis
Holidays: Wednesday the 23rd the Emperor's Birthday holiday in
Japan, then Christmas Eve and Christmas Day, Boxing Day for many on the
26th and 28th take us into the following week with New Year's Day on
Friday the 1st January 2010. Ignore the markets and enjoy spending time
with friends and family. Try not to over-indulge and to piece together
the bigger picture.
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