Weekly Economic and Financial Commentary: The U.S. economy continues to generate solid economic growth

*Economic Recovery Remains on Solid Foundation*
* The U.S. economy continues to generate solid economic growth. The
December retail sales and industrial production reports released
last Friday revealed a consumer that is spending a little more
readily and a manufacturing sector that is being re-energized by
growing end demand.
* The outlook also appears fairly bright. The December leading
indicators report released by the Conference Board has jumped more
than 2.0 percentage points over the past two months and has been
gaining ground since last June when the economy hit its summer
lull.
*Strong Economic Data Where It Counts*
The December readings on retail sales and industrial production
painted an increasingly bright picture of sustained economic growth.
While retail sales growth slowed to a 0.6 percent monthly rate in
December from a 0.8 percent gain in November, the threemonth moving
average of retail sales improved to a 14.0 percent annualized growth
rate, showing a clear acceleration in consumer spending in the fourth
quarter. These numbers are strong enough to ensure real consumer
spending growth of nearly 4.0 percent in the fourth quarter. And, it
is not just autos and gas that consumers are springing for. December
also saw solid sales gains in furniture, building materials and
healthcare.

Manufacturing is also getting its mojo back. The manufacturing
component of December industrial production increased another 0.4
percent in December despite a modest deceleration in auto production.
Strong increases in production were noted in information processing,
computer and electronics, consumer goods, materials and energy.

Stronger consumer spending growth, if sustained, could help ignite
another round of business spending growth and more hiring, especially
from smaller businesses that have largely been left behind so far in
this economic expansion. This will help strengthen the virtuous cycle
that often takes shape during economic expansions and help wean the
United States off of government support.

The Conference Board's index of leading indicators for December,
released this week, confirms a sustainable U.S. economic recovery over
the near term. Many of the components that make up the index continue
to support solid economic activity. The December reading got
additional support from an improvement in initial jobless claims,
nondefense capital goods orders, building permits, stock prices,
consumer expectations and the interest rate spread.

Initial jobless claims continue to move lower, slipping to 404,000 for
the second week of January, suggesting labor market conditions
continue to improve in the new year. Jobless claims are now 50,000
below their trend level over the past 52 weeks.

Even the U.S. housing market got a modest dose of good news this week.
December existing home sales jumped to 5.28 million on an annualized
basis in December, a 12.3 percent gain that followed a large 6.1
percent increase in November. This was strong enough to reduce the
months' supply of existing homes to 8.1 months, a marked improvement
in the supply-and-demand balance for the existing home market. The
homebuilders didn't see much improvement in the housing outlook from
their perspective, however. The Wells Fargo/NAHB housing market index
for January held at a low 16.0, and housing starts for December sank
again, down 4.3 percent on the month. Weather could be a contributing
factor to the drop in starts, though residential building remains weak
nonetheless.

!! Consumer Confidence • Tuesday !!
After two consecutive increases, consumer confidence fell 1.8 points
to 52.5 in December as the weak labor market continues to weigh on
consumers' psyche. While confidence is well above its record low of
25.6 reached in early 2009, it was little changed in 2010 and remains
at depressed levels. Both the present situation and expectations
indices fell on the month. With confidence more closely correlated to
the labor market, the stubbornly high unemployment rate will likely
continue to keep confidence low. In fact, the percentage of those who
reported that jobs were "hard to get" continued to climb in December,
while the percentage of those who cited "jobs were plentiful"
declined. Until we see acceleration in the pace of private sector job
growth, we will not see much improvement in consumer confidence.
Previous: 52.5 Wells Fargo: 53.7 Consensus: 54.3

!! New Home Sales • Wednesday !!
New home sales are beginning to gain momentum. Sales have risen in two
of the last three months, but are increasing from very depressed
levels. Consequently, any true recovery in new home sales will be
gradual and will likely not pick up significant traction until next
homebuying season. Moreover, foreclosures and short sales will largely
keep builders on the sidelines until they have a better idea as to
where prices will settle and the oversupply of existing homes whittles
down. According to the Wells Fargo/NAHB Housing Market Index, builders
continue to report little to no improvement in buyer traffic and
expectations for future conditions also remain low. The inventory of
unsold homes continues to slide and remains at a four-decade low. We
expect new home sales to increase 4.8 percent to 304,000 in December.
Previous: 290K Wells Fargo: 304K Consensus: 300K

!! Durable Goods • Thursday !!
Orders for durable goods fell 1.3 percent in November relative to the
previous month. Excluding transportation, durable goods orders were up
2.4 percent in November. Outside of the transportation sector, the
rise in orders in November was broad based, which continues to show
the recovery in the factory sector is becoming self-sustaining.
Moreover, over the past three months, unfilled orders rose at an
annualized rate of 12.8 percent, suggesting that the production
pipeline is filling up. Consistent with the new orders component of
the ISM manufacturing index and regional manufacturing reports, we
expect durable goods orders to increase 1.7 percent in December.
Production in the factory sector should continue to expand further in
the months ahead, which reinforces our expectation that the U.S.
economy will continue to grow in 2011.
Previous: -1.3% Wells Fargo: 1.7% Consensus: 1.5%

*Inflation Becoming More of an Issue for China*
* Following a modest slowdown earlier in 2010, Chinese real GDP
growth stabilized at a high rate in the fourth quarter.
* Unacceptably high inflation is replacing insufficient growth as
the most important risk facing Chinese policymakers today. The
underlying inflation rate rose to a two-year high in December.
* In our "Topic of the Week," we place the U.S.-Chinese trade deals
announced in Washington this week into context.

*Robust Growth Continues in China*
China was very much in the headlines this week. Not only did Chinese
President Hu visit President Obama in Washington, but economic data
showed that the Chinese economy continues to grow at a rapid rate. As
shown on the graph on the front page, real GDP in China rose 9.8
percent on a year-ago basis in the fourth quarter. Following a modest
slowdown over most of 2010, which was due, at least in part, to
increasingly more difficult year-over-year comparisons, it appears
that the growth rate is stabilizing at a high level.

A breakdown of the GDP data into its underlying demand components is
not readily available. However, monthly data suggest that most
spending categories continued to grow at strong rates in the fourth
quarter. Retail spending continued to grow at a year-over-year rate
approaching 19 percent in the fourth quarter, indicating that Chinese
consumers are alive and well. The value of exports was up 25 percent
in the fourth quarter, which is consistent with other indicators of
solid global growth. Loan growth, which slowed sharply after the
Chinese government directed banks to rein in excessive lending,
stabilized in the fourth quarter. Solid loan growth of 20 percent in
the quarter helped to finance the 25-percent growth rate in investment
spending that occurred during that three-month period.

*Inflation Is Priority No. 1*
The inflation data that printed this week brought good news and bad
news. The good news is that the overall rate of CPI inflation dropped
from 5.1 percent in November to 4.6 percent in December as food
prices, which constitute one-third of the Chinese CPI, stabilized (top
chart). The bad news is that nonfood price inflation rose to 2.1
percent, nearing the highs that were reached in 2008. This underlying
inflation rate fell sharply two years ago as the global financial
crisis caused the global economy to careen into recession. If, as we
project, the global economy continues to grow at a solid rate, then a
significant slowdown in the underlying rate of Chinese CPI inflation
does not seem likely. Although the Chinese economy may not be
"overheating," unacceptably high inflation has replaced insufficient
growth as the biggest problem facing the Chinese economy today.

In that regard, Chinese economic policy is tightening. Not only has
the central bank raised its benchmark lending rate by 50 bps since
mid-October, but it has also raised reserve requirements for banks to
record highs (middle chart). The latter step is intended to help
sterilize the country's balance of payments surpluses that contribute
to strong growth in the money supply. In addition, authorities have
allowed modest appreciation of the currency - the renminbi has risen
about 3 percent versus the U.S. dollar since September - that also
helps to tamp down inflation (bottom chart). Although authorities will
probably not allow runaway appreciation of the currency, further
renminbi gains against the greenback are likely in the coming year.
(The currency strategy team looks for the renminbi to strengthen more
than 5 percent against the dollar between now and the end of the
year.)

!! Eurozone PMIs • Monday !!
The 16-member Eurozone economy expanded at a 1.4-percent pace in the
third quarter, marking the fifth consecutive quarterly expansion.
Still, the level of GDP remains roughly 3 percent below the
pre-recession peak.

We expect the Eurozone grew at a slightly faster pace in the fourth
quarter of the year. In addition to decent growth in industrial
production in the fourth quarter, the various purchasing managers'
surveys also remained firmly in expansion territory.

That said, the Eurozone is not without its share of problems at the
moment. The ongoing challenge of the sovereign debt crisis certainly
is not a positive for the outlook in Europe. On Monday (Jan. 24),
January readings for the PMIs will tell us whether the fiscal problems
in a few member countries will be enough to dampen sentiment across
the Eurozone.
Previous: 57.1 (Man.) 54.2 (Services) Consensus: 57.1 (Man.) 54.3
(Services)

!! U.K. GDP • Tuesday !!
The U.K. economy expanded at a 2.9-percent annualized pace in the
third quarter. Available monthly indicators, including the
manufacturing and service sector PMIs, suggest that the recovery
continued in the fourth quarter of 2010, although the pace of growth
may have slowed somewhat. Official numbers are due out on Tuesday.
Consumer sentiment deteriorated in the fourth quarter, though most
analysts still expected only a modest slip in retail sales for
December, thinking that an increase in the value-added tax in January
would bring sales forward into December, softening the decline. The
dip in sales was larger than expected, falling 0.8 percent in
December. Combined with weaker-than-expected industrial production
growth in the quarter, we expect U.K. GDP growth likely slowed to a
2.2-percent annualized pace in Q4.
Previous: 2.9% Wells Fargo: 2.2% Consensus: 2.6% (CAGR)

!! Canadian CPI • Tuesday !!
In 2010 as the Canadian economy outpaced the recoveries in other large
developed economies, the Bank of Canada (BoC) was among the few
central banks in the world raising its key lending rate. The BoC's
primary consideration in setting monetary policy is targeting a core
inflation rate between 1 percent and 3 percent. So when a 0.4-percent
jump in core consumer prices in October lifted the year-over-year
inflation rate to 1.8 percent, some market-watchers became concerned
that rising inflation might force the BoC to raise rates again to
combat rising prices. November data revealed that prices were
essentially unchanged for the month, which allowed the annual measure
to settle to a 1.4-percent rate. Headline inflation for December will
most likely show an increase as food and gasoline prices across Canada
were higher in December. The core rate of inflation will likely stay
near the midpoint of the BoC's target range.
Previous: 2.0% Wells Fargo: 2.1% Consensus: 2.5% (Year-over-Year)

!! Interest Rate Watch !!
Rising Rates: Fundamental Drivers
Treasury benchmark rates have risen in line with the changing
fundamentals and investor and business confidence. Better than
consensus economic releases, the outlook for rising inflation over
time and the renewal of the Bush tax cuts all suggest the case for
rising rates to continue ahead. Moreover, capital markets are also
seeing strength in bond issuance and loan finance - another sign that
economic strength is being financed despite the rise in benchmark
Treasury rates. Higher interest rates often accompany better economic
growth and are not a recoverykiller as some commentators are claiming.

Fundamentals Matter
Declining jobless claims filled in their usual role as an indicator of
an improving economy. Then, along came the continued gains in the
Institute for Supply Management (ISM), better retail sales, better
regional supply management surveys and even the upturn in
architectural billings, which all supported the better growth outlook.
Then, throw in the trade data and estimates of fourth quarter GDP
approached 4 percent and the outlook for 2011 improved in many
surveys.

On the policy front, the Fed is committed to further growth and the
goal of raising the core inflation rate. The commodity notes in the
ISM report also revealed a broader set of increases in basic
commodities, including corn and wheat. According to the University of
Michigan Consumer survey, the one-year inflation expectations measure
jumped to 3.3 percent in early January from 3.0 percent in December.
This is the highest reading since 3.9 percent back in October 2008.

Confidence Shown in Bond Issuance
Renewal of the Bush tax cuts were viewed, by your trusty interest rate
watcher at least, as positive for the economy and, more important, as
a signal policymakers in Washington can get beyond the petty politics.
This confidence is reflected in the strength of high-grade and
high-yield bond issuance. We view this strength as confidence in the
recovery and that the recent rise in rates is not a recovery-killer.

!! Consumer Credit Insights !!
Mortgage Market Activity Update
Mortgage applications for the purchase of a home have faltered
recently, declining in five of the past six weeks likely due to
increasing mortgage rates and tighter credit qualifications.

Application activity, however, is still up over 11 percent since
August. Refinancing activity, on the other hand, has improved in
recent weeks, up over 17 percent since the end of December.
Since bottoming back in November, mortgage rates have risen 13
percent. The rate on a 30-year fixed mortgage is currently around 4.74
percent. Adjustable rate mortgages (ARMs) have not risen as much as
fixed-rate mortgages over the past few months and remain relatively
low. The rate on a one-year ARM is around 3.25 percent.

While many have speculated that the recent rise in mortgage rates
threatens to derail the nascent housing recovery, we believe these
views are overblown. First, mortgage rates are still very low - the
average 30-year fixed mortgage rate from 1990 to 2005 was around 7.50
percent. And second, access to credit remains a much bigger issue than
cost of credit for homebuyers. With nearly 23 percent of homeowners
having negative equity on their home mortgages and tighter
underwriting standards on the part of lenders, many prospective buyers
- or those simply looking to refinance - just do not qualify in
today's credit environment despite the fact that housing affordability
is still near all-time highs.

Deng to Hu: "To Get Rich Is Glorious"
Chinese President Hu's first visit to the United States in five years
was marked by great pomp and circumstance as well as sober
acknowledgements of the challenges to bilateral political relations.
Few expected Hu to follow in Deng Xiaoping's footsteps and don a
cowboy hat and make his way down to Texas for a rodeo. Since the
beginning of Deng's liberalization of the Chinese economy in 1979, the
U.S.-Chinese bilateral trade balance has been on a steep slide in
China's favor, but the imbalance accelerated greatly circa 2002 (about
the time Hu succeeded Ziang Jemin).

Although the bilateral trade deficit with China continues to widen,
the overall U.S. trade deficit has narrowed in recent years to levels
seen in the early 2000s. This pattern reflects China's continued
expansion as an industrial center for consumer goods. Today, many of
the goods Americans imported from Europe or Latin America are instead
being assembled and exported from China. As China's industrial prowess
rises and the yuan remains undervalued, we are likely to see the
bilateral trade deficit continue to widen, especially if China
maintains a weak yuan policy. However, headline trade numbers often
reflect goods that are simply assembled in China, while the parts are
sourced from third-party countries and profits flow to foreign
corporations.

During the summit, Presidents Hu and Obama announced a $45 billion
export deal, but nearly half the value of the deal represents a
"final" approval from Chinese officials for a planned purchase from
Boeing. American companies, such as Boeing and Coca Cola, have had
longstanding relationships with China, beginning with President Deng's
visits to Seattle and Atlanta in the 1970s. While America's largest
companies may benefit marginally from one-off trade deals, the
bilateral trade deficit with China likely will remain large,
especially if the yuan remains undervalued. Therefore, trade tensions
with China probably will remain an issue in U.S.-Sino relations for
some time.

READ MORE - Weekly Economic and Financial Commentary: The U.S. economy continues to generate solid economic growth

Weekly Economic and Financial Commentary

*Moderate Economic Recovery Remains Under Way*
* Economic indicators released during the week continue to suggest a
moderate recovery is underway. The nominal trade deficit narrowed
slightly from a revised $38.4 billion in October to $38.3 billion
in November. The upside risk to the forecast from international
trade, however, will likely by tapered by less inventory building.

* The Fed's Beige Book also noted moderate economic conditions in
most districts. Districts' with higher concentrations of
manufacturing, retail and nonfinancial services sectors saw better
activity.

*Fourth-Quarter Real GDP Brings Brighter Days*
Economic indicators released during the week continue to suggest a
moderate recovery is underway. The nominal trade deficit narrowed
slightly from a revised $38.4 billion in October to $38.3 billion in
November. Exports and imports both nudged higher on the month. Exports
have now risen for the third consecutive month with increases being
driven by solid growth in the rest of the world. While the real trade
deficit widened to $45.2 billion, October's sharp narrowing will help
contribute around 1.5 percentage points to fourth-quarter real GDP.

The upside risk to the forecast, however, will likely by tapered by
less inventory building. Business inventories rose 0.2 percent in
November, which means part of the outsized contribution from
international trade could be offset by less of a contribution from
inventories. Consequently, our estimate for fourth-quarter real GDP
remains unchanged at an increase of a 3.4 percent annual pace. The
Fed's Beige Book also noted moderate economic conditions in most
districts. Districts with higher concentrations of manufacturing,
retail and nonfinancial services sectors saw better activity. As
expected, residential real estate markets remained weak across all
districts and commercial construction remained slow. Labor markets in
most districts appear to be firming somewhat, but with virtually no
upward pressure on wages. Districts also mentioned increasing cost
pressures but only modest pass-through into final prices because of
competitive pressures. This week's producer price index and consumer
price index both corroborate this story. Wholesale prices rose a
morethan- expected 1.1 percent in December with prices further back in
the pipeline continuing to build momentum. The consumer price index,
however rose only 0.5 percent, which suggests very little pass-through
to the consumer.

One of the more disappointing reports released this week was the Small
Business Optimism Survey conducted by the National Federation of
Independent Business. Small businesses play a critical role in the
economy and make up around 45 percent of private-sector employment.

The survey fell 0.6 points in December and showed little to no
improvement in most of its key components. Small businesses remain
pessimistic about the nearterm economic outlook and credit conditions
were tighter on the month. While hiring plans picked up to their
highest level since September 2008, the level remains at historic
lows.

Speaking of jobs, labor market indicators for the week were also less
than encouraging. Initial jobless claims rose by 35,000 to 445,000,
dashing hopes of a quicker-than-expected labor market recovery. On a
trend basis, the four-week moving average rose by 5,000, to 416,500.

While the increase was disappointing, it remains below the average of
around 460,000 since January. The Job Openings and Labor Turnover
Survey also illustrated a sluggish labor market. The hires rate, which
is the rate of hires as a percentage of total nonfarm payrolls fell to
3.2 percent, while the separations rate rose to 3.2 percent in
November from 3.1 percent.

!! Housing Starts • Wednesday !!
November housing starts rose 3.9 percent to a 555,000-unit pace.
Single-family starts in November rose a modest 6.9 percent, while the
more volatile multifamily starts declined 9.1 percent. The slight
increase in housing starts is welcomed news, but the positive reading
was likely due to seasonal adjustment factors as opposed to signaling
a rebound in starts. Single-family housing permits in November were
running below the level of housing starts, which suggests continued
weakness in the housing starts numbers. Our expectation is that
housing starts fell in December to 546,000 units. With a large number
of homes in foreclosure combined with the oversupply of existing
homes, we anticipate continued weakness in housing starts. Our
forecast for 2011 continues to indicate that starts will improve
slightly this year by approximately 680,000 units; however the pace of
starts will likely be agonizingly slow over the next few quarters.
Previous: 555K Wells Fargo: 546K Consensus: 550K

!! Initial Jobless Claims • Thursday !!
Initial jobless claims, a leading indicator of the labor market, have
continued to signal gradual improvement in the unemployment situation.
This week, initial claims rose to 445,000, an 8.5 percent increase
from the previous week. The slight increase is likely due to noise
from temporary holiday workers. Although week-to-week changes may show
some slight increases, the trend as measured by the four-week moving
average continues to indicate a gradual decline in the number of
initial jobless claims. Based on historical trends, the fact that
claims are trending towards the 400,000 level signals that slightly
stronger labor market is on the horizon. Continuing claims have also
shown signs of gradual improvement declining by 248,000 or 6.0 percent
this week. We anticipate continual improvement in the labor market
over the next year with a monthly average of approximately 160,000
jobs created.
Previous: 445K Consensus: 425K

!! Leading Economic Index • Thursday !!
The leading indicator index, which increased 1.1 percent in November,
continues to provide further evidence of modest economic growth. Many
of the leading indicators that make up the LEI have improved.
Specifically, interest rate spreads and the pace of supplier
deliveries helped to boost the index slightly higher in November. The
only component that detracted from the index was building permits,
which have continued to show the weakness in the housing market. As of
the November reading, the LEI has increased for the fifth consecutive
month. Additionally, the six-month trend continues to improve, up 4.4
percent on an annual basis. We anticipate that the positive trend in
the LEI continued in December, increasing 0.7 percent. The overall
improvement should be led by continued positive contributions from all
major categories with the exception of supplier deliveries which were
slightly lower in the previous ISM reading.
Previous: 1.1% Wells Fargo: 0.7% Consensus: 0.6%

*Strong Growth in Latin American Exports*
* The last months of 2010 saw a large increase in exports from Latin
American countries to the rest of the world. Although some of this
increase may be reflecting an increase in commodity prices the
sheer strength and size of the move in export numbers from the
region cannot be explained solely by this increase in prices.

* Growth numbers for the last quarter of the year for the world
economy, but especially for emerging markets, may surprise on the
upside as the export sector in Latin America is not showing any
signs of slowing down, just the opposite.

*Strong Growth in Latin American Exports*
The last months of 2010 saw a large increase in exports from Latin
American countries to the rest of the world. While some of this
increase may be reflecting an increase in commodity prices, the sheer
strength and size of the move in export numbers from the region cannot
be explained solely by this increase in prices.

Although this contention is very difficult to prove, there are some
countries in the region that provide the segmentation regarding
whether exports increase due to price effects and/or quantity effects.
Argentina is such a country and the one we will use for this
explanation. In the case of Argentina, exports increased by 23.3
percent in November 2010 compared to the same month a year earlier.
Out of this increase in the value of exports, the quantity of goods
exported increased by 12 percent while the price of those goods
increased by 10 percent.

Meanwhile, imports of goods, which, of course, are exports of other
countries to Argentina, increased by 53 percent in November,
year-over-year. Of this increase in imports to Argentina the quantity
of goods imported increased by a whopping 39 percent while prices of
these imports rose by only by 9 percent.

For Brazil, exports during December 2010 surged by 52.5 percent
compared to December 2009. Although we don't have the numbers
regarding the composition of this increase in imports, we can deduce
from Argentina's numbers that the increase in the value of exports was
due, fundamentally, to an increase in the quantity of goods exported
by Brazil rather than by only an increase in price effect. By looking
at the breakout in Brazilian exports during December 2010 it is clear
that raw materials were leading the way with metals and petroleum in
the vanguard of the charge. In fact, petroleum exports increased by
192 percent in December 2010 compared to December 2009. However,
petroleum prices increased by only 20 percent during the same period
of time. Meanwhile, iron ore exports surged by 208 percent during this
period with the largest buyers of iron ore being China, Japan and
Germany.

Mexican exports were also strong at the end of 2010, increasing by
25.9 percent in November compared to the same month a year earlier.
Although Mexican exports may have been helped more by the increase in
commodity prices than Argentina and Brazil, Mexican exports were
already growing strongly a year ago and thus they are also benefiting
from an increase in the quantity of goods rather than this being just
a price issue.

The bottom line here is that growth numbers for the last quarter of
the year for the world economy, but especially for emerging markets,
may surprise on the upside as the export sector in Latin America is
not showing any signs of slowing down, just the opposite. And since a
large share of Latin American exports to the rest of the world
comprise raw materials for the production of other goods then it is
clear that even growth for developed countries may also surprise on
the upside once these numbers are released.

!! U.K. CPI • Tuesday !!
Consumer prices in the United Kingdom increased 0.4 percent in
November, lifting the year-over-year inflation rate to 3.3 percent - a
six-month high. The inflation rate has remained at or above the Bank
of England's (BoE) ceiling of 3 percent in each of the first 11 months
of 2010. December consumer prices are due out on Tuesday of next week,
and we expect to see a twelfth month where inflation is above 3
percent. This will increase pressure on the BoE to reign in prices
without snuffing out the recovery.

Prices could be pushed even higher in January by an increase in the
value-added tax - a national sales tax. Prices are not the only
measure influenced by the tax hike. Retail sales for December are due
out on Friday of next week and we may find that U.K. consumers
increased spending in December to get major purchases in ahead of the
higher tax rate in January.
Previous: 3.2% Wells Fargo: 2.9% Consensus: 3.3% (Year-over-Year)

!! German Zew Index • Tuesday !!
The December reading of the ZEW economic sentiment survey suggested an
improving outlook for the largest economy in the euro-zone, despite
indications of an intensifying sovereign debt crisis. This view was
confirmed by the Ifo business climate survey which surged to a record
high in November before slipping by a tenth of a point in December.

Subsequent German economic data have been mixed. November retail sales
figures were a disappointment, but factory orders jumped 5.2 percent
in November. The German PMIs both remain firmly in expansion
territory. Will sentiment deteriorate as a result of the escalation of
the sovereign debt situation? We will find out next week when the
December reading of the ZEW survey hits the wire on Tuesday and the
Ifo survey comes out on Friday.
Previous: 4.3 Consensus: 5.8

!! Chinese GDP • Thursday !!
The Chinese economy expanded 9.6 percent on a year-over-year basis
through the third quarter of 2010. While the outturn was slightly
stronger than the consensus estimate, it marked a slowing in the pace
of Chinese economic growth. Growth was held back by measures
implemented earlier in the year to reign in Chinese lending.

Fourth-quarter GDP data are due out on Thursday of next week and we
expect to see the world's second-largest economy grew at about the
same rate for the full year 2010.

Also due out next week are the latest readings for both retail sales
and industrial production. Both measures are expected to show
double-digit percentage growth on a year-over-year basis.
Previous: 9.6% Wells Fargo: 9.4% Consensus: 9.4% (Year-over-Year)

!! Interest Rate Watch !!
_Recovery Takes Shape: Rising Rates_
While our outlook for sustained economic growth has been in place for
a while, the recent rise in food and energy prices suggest another
force building the case for rising intermediate and long-term interest
rates post-QE2. Disappointing harvests around the world have led to
sharply higher farm prices. Oil prices have also risen due to rising
demand and limited supplies. Increases in food and energy prices are
expected to drive the headline CPI up 2.0 percent in 2011.

Growth at three percent and rising inflation means we have seen the
lows for interest rates in this cycle. Of course, there may be a
temporary dip in rates as expectations adjust, but over the course of
the year longterm Treasury rates are expected to rise.

Yet, we also recognize that this pattern of rising rates during an
economic expansion is actually the typical business cycle pattern. The
challenge is that the rise in rates should be met by an increase in
the expected rate of return on invested capital. Therefore, a rise in
rates that reflects better growth expectations and the end to
deflation concerns would be consistent with continued economic growth
- not a double dip.

Why are interest rate rises key for our view on the economy? Concerns
about U.S. fiscal deficits or the dollar or a rapid rise for inflation
would send a very different signal to the markets and would be met by
a turn to the dark side of economic growth.

We expect U.S. fiscal deficits to decline modestly, but if this turns
out to be too optimistic then the excess demand for credit by the
Treasury will outstrip supply and rates would rise faster than the
expected rate of return on capital; thereby weakening investment
spending and growth.

Similarly, concerns about the dollar or an outsized rise of inflation
would produce a rise in rates not associated with a better economy and
therefore would exert downward pressure on the economy. Credit markets
and interest rates are always a balancing act - for now in our favor.

!! Consumer Credit Insights !!
_Mixed Signals from Small Businesses_
The Small Business Optimism Index dipped slightly to 92.6 in December
from 93.2 in November, which was the highest since the recession
began. On the positive side, capital spending plans increased, while
sales expectations and hiring plans were the highest in over two
years. Dragging down the index were a drop in plans to increase
inventories, a decline in the earnings outlook, a near halving of the
share expecting a better economy and a slight worsening of credit
conditions. The share experiencing an easing of credit conditions was
-11 percent. This says that more small businesses are experiencing
tighter credit conditions on net. While this may not sound good for
the lending outlook, the truth is that this indicator has never been
positive since records began in 1999. In addition, it is off the lows
of -16 percent reached several times in the last couple of years.

Although hiring plans, spending plans and sales expectations rose,
this does not necessarily mean more small businesses will come seeking
a loan. Bank loans on the balance sheets of non-farm, non-corporate
businesses have dropped for seven consecutive quarters through the
third quarter and are down nearly a third from the peak. And although
small business cash reserves are down 15 percent from the peak, they
are still nearly triple levels seen seven years ago. It will likely be
some time before sales are strong enough and cash reserves are low
enough for small business loan demand to rebound.

Are Price Pressures Starting to Emerge?
This week's release of several inflation indicators may raise some
concerns about the onset of a longer-term inflationary spiral. In
short, we do not think this sort of inflation spiral is likely to
occur. The recent increases in the consumer price, import price and
producer price indices reflect upward pressure from two main sources:
energy and commodity prices have been rising steadily over the past
couple of months. While the increase in prices from these two sources
may be putting some strain on household budgets, there is little
evidence to suggest that the food and energy price pressures will
spill over to other goods and services.

We can see from the graph to the right that in the 1970s, core
inflation was highly correlated with headline CPI numbers. The reason
for the tight relationship can be attributed to wage contracts during
this time period. Most of these contracts required wage increases to
keep pace with headline inflation. The result was a spill-over effect
that allowed higher volatility in food and oil prices to spill over
into wages, thus affecting both core and headline inflation readings
by nearly the same amount. The higher costs of food and energy today
are not likely to produce the same effects that were observed in the
1970s. We now see greater separation between the core CPI and the
headline numbers as a result of the reduction in the number of
inflation-adjusted wage contracts. Evidence of this change can be seen
in 2008 when oil prices led to higher headline CPI numbers while the
core values remained relatively stable. The large volatility of food
and gasoline prices underscores the reason for measuring core
inflation. Another key factor that will likely prevent more widespread
inflationary pressure is the high unemployment rate. Today's
employment situation makes spill-over effects on wages unlikely due to
the scarcity of jobs and the willingness of employees to accept lower
wages. Therefore, unless we begin to see the core inflation measure
begin to rise, our outlook for inflation will remain subdued.

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U.S. Review: A Slightly Brighter Outlook for the U.S. Economy - Weekly Economic & Financial Commentary

U.S. Review
A  Slightly Brighter Outlook for the U.S. Economy

• The proposed deal between the White House and some  members of Congress to extend Bush-era tax cuts, reduce payroll taxes  and renew emergency unemployment benefits dominated headlines. GDP growth should get a slight boost in the coming year.  
• Weekly first-time unemployment claims fell by 17,000 to 421,000 in the week ending  December 4, the lowest reading of the year. 
• The U.S. trade deficit  narrowed sharply from $44.6 billion in September to $38.7 billion in October driven by strong export growth. 

U.S. Review : “It’s Beginning to Look a Lot Like Christmas…”

While it was a fairly light week for economic data, the proposed deal between the White House and some members of Congress to extend the Bush-era tax cuts, reduce payroll taxes and renew emergency unemployment benefits dominated headlines. Once the details are ironed out and some semblance of the package passes, most economists agree  that GDP growth should get a slight boost in the coming year. This is indeed good news as the pullback in federal government spending next year was one of the major challenges for economic growth. We now expect real GDP to grow at a 2.6 percent annual pace in 2011 (for more details, please see our report: Annual Economic Outlook 2011).

The increase in economic growth, however, will still not be enough to bring the unemployment rate significantly lower. The unemployment rate should remain stubbornly above 9 percent well into 2012. As economic growth picks up in the coming quarters, much of the upward momentum in the unemployment
rate will likely come from discouraged workers re-entering the workforce due to improving labor market conditions.

While an obstinately high unemployment rate seems daunting (and despite the disappointing November employment report), there are clear signs employment is improving. To help illustrate this point, we turn to five reliable indicators to gauge the strength of employment growth: temporary hiring, length of the workweek, initial jobless claims, the ISM index of employment and job openings relative to the size of employment. All measures have shown signs of stabilizing in recent months.

Weekly first-time unemployment claims fell by 17,000 to 421,000 in the week ending December 4, the lowest reading of the year. The four-week moving average, which is our preferred way to look at the volatile series, fell  to 427,000 the lowest level since August 2008. The decline in the four-week moving average
suggests improved payroll numbers ahead, but we still need claims to drop below 400,000 on a consistent basis for a self-sustaining recovery.

The number of people receiving extended and emergency benefits also dropped last week. We suspect the decline is related to claimants who exhausted all available benefits options. These numbers will probably continue to decline in the weeks ahead, until legislation extending unemployment benefits is passed.

Other data highlighting employment conditions were the Job Openings and Labor Turnover Survey. The job openings rate increased to 2.5 percent from 2.3 percent. The increase brings the number of job openings to 3.4 million and the ratio of unemployed to job openings to 4.4.

Another clear sign the economy continues to grow is the recently released data on the trade balance. The U.S. trade deficit narrowed sharply from $44.6 billion in September to $38.7  billion  in  October  driven  by  strong  export  growth.  All things being equal, we expect the decline in the deficit to have a positive effect on GDP growth in the fourth quarter.

Producer Price Index • Tuesday 
The October Producer Price Index rose 0.4 percent, led by increases in energy prices. The core PPI, which excludes food and energy, declined 0.6 percent in October, which was mostly due to falling prices for light trucks and passenger cars, which were down 4.3 percent and 3.0 percent, respectively. Intermediate goods prices increased in October to 1.2 percent, with core intermediate goods also rising 0.6 percent. Increases were also observed in crude goods which rose 4.3 percent, likely due to increases in commodity prices.

We expect that the November PPI rose 0.3 percent on a monthly basis, and the core PPI edged up as well. With manufacturers unable to pass along higher prices to consumers there may be a negative effect  on profits going forward. Our forecast indicates that the producer price index will rise 3.4 percent in the fourth quarter of 2010 on a year-over-year basis.
Previous: 0.5% Wells Fargo: 0.3% 
Consensus: 0.7% 


Industrial Production • Wednesday 
Industrial production (IP) in October was unchanged, held back by unseasonably warm weather, which resulted in a 3.4 percent drop in utility output. Production in the factory sector rose 0.5 percent in
October due to a 1.6 percent increase in motor vehicle output and a 1.4 percent increase in machinery. Output of business equipment rose 1.1 percent in October and is up 10.1 percent on a year-over-year basis.

In contrast, production of consumer goods has pulled back, up only 3.7 percent year-over-year. Increased
exports are likely helping to boost manufacturing output and will probably offset any drag from the reduction in inventory building.

We estimate that IP increased 0.4 percent in November. Our forecast continues to indicate a slowdown in IP through the end of this year and the first quarter of 2011, mostly due to continued reductions in inventory building.

Previous: 0.0%  Wells Fargo: 0.4% 
Consensus: 0.3%

Housing Starts • Thursday 
Housing starts declined substantially in October, down 11.7 percent. Declines were observed across the board with multifamily starts plunging 44 percent and single-family homes falling 1.0 percent. Building permits rose slightly to 555,000, which is likely the new normal—at least for the time being—for the housing market.

Some good news can be seen in the apartment market where demand has been rising steadily over the past year. We expect housing starts increased slightly to 540,000 in November due to continued low mortgage rates and some payback from the disappointing levels observed last month. Our forecast continues to indicate that housing starts have bottomed out, but new starts are estimated to total only 560,000 in the fourth quarter of this year.
Previous: 519K Wells Fargo: 540K 
Consensus: 550K
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