Global Markets

At the end of a week in which cautious optimism about the global economic outlook largely usurped worries about the Eurozone sovereign debt crisis, financial markets are focused on the outcome of the Chinese Central Economic Work Conference.  Following intense speculation that official interest rates might be raised as soon as this weekend, the People’s Bank of China on Friday announced the sixth increase this year in the reserve requirement ratio (RRR).  The 50 basis point hike will take effect on December 20 and will see the RRR for the larger banks rise to a record 18.5 percent and for the smaller banks to 15 percent.

At the time of writing, the meeting is expected to conclude on Sunday and markets will be alert to any guidance on prospective interest rate developments.  The latest move on the RRR does not preclude a near-term hike in the official cost of borrowing although some may interpret Friday’s action as a possible compromise, reflecting an inability to secure a consensus on rates.  In any event, with November seeing CPI inflation break above 5 percent, annual retail sales growth hit nearly 19 percent and industrial production expand more than 13 percent on the year, the chances are that the PBoC has some way yet to travel down the monetary tightening path.  

In fact, the contrast between the expected monetary tightening in China and the steady hand approach of the G7 central banks effectively sums up the outperformance of the East Asian bloc as a whole. Just last week the Asian Development Bank estimated growth in the region’s emerging economies at some 8.8 percent this year and forecast a still very robust 7.3 percent rate in 2011.  If correct, the area will be instrumental in ensuring that the global economic recovery remains on track. 

Indeed, the likelihood of any near-term hike in official borrowing costs in the Europe and the U.S. seems as remote as ever. In European markets contagion worries have eased a little.  Notwithstanding a downgrade to Irish sovereign debt, the safe passage through parliament of the first stage of the Irish budget helped local bond spreads to narrow to below 500 basis points for the first time since early November.  That said, the approaching Christmas break was probably responsible for much of the relative calm that characterized trading in the peripheral EMU markets last week and it should be noted that borrowing costs in these states remain unacceptably high for what is, after all, a common currency zone.  In fact, underlying tensions remain high, as testified in recent ECB activity.  Hence, the Central bank made its largest purchase of bonds in the week to December 3 since the beginning of July.

Sentiment was not helped by an announcement from the Eurozone finance ministers that they saw no reason to put more money into the European Financial Stability Mechanism’ €750 billion rescue fund hardly helped matters.  Much the same could be said of Germany’s very vocal refusal to even entertain the idea of a sovereign bond issuing agency for EMU area.  As a means of increasing the depth of the EMU government bond market while at the same time underlining the determination of member states to make the euro work, the proposal has much merit.  However, any such move would almost certainly boost the cost of German funding.  Against this fractious political backdrop, doubts will inevitably persist as the policymakers try to muddle their way through instead of seeking a long-term solution.  In this environment, the debt crisis will remain a dark cloud hanging over European financial markets.  To this end, outside of some supportive rhetoric, expect little to emerge from the upcoming EU leaders’ meeting (Thursday/Friday) that comes anywhere close to addressing the real issues.

Price action in U.S. financial markets last week was initially dictated by reaction to comments from Fed Chairman Bernanke that raised a serious question mark over the self-sustainability of the domestic economic recovery.  Certainly the remarks gave a sizeable boost to speculation about an increase to the current US$600 billion QE 2 ceiling.  However, sentiment changed sharply in midweek on news on an apparent deal between President Obama and Republicans to extend the Bush era of tax cuts by a couple of years.  The potential boost to U.S. economic growth saw stocks and the currency rally strongly while Treasuries were sold aggressively.  The yield on the benchmark 10-year bond rose some 30 basis points on the week to 3.32 percent.  Overseas share markets responded very positively too.  Looking into next week in addition to a raft of important economic data, all eyes will be on the last FOMC meeting of the year although few anticipate any significant moves on the policy front.  

Meanwhile, in the commodity markets metals continued to see good demand, particularly copper, lead and tin.  By contrast, gold lost a little of its shine with prices dropping about 2 percent on the week as the stronger U.S. dollar encouraged some profit-taking following recent large gains.   Oil prices drifted lower ahead of the OPEC oil ministers meeting this weekend.  Most see production quotas being left unchanged with the producers seemingly happy with prices in the US$70 to US$90 a barrel range.  However, there has been some talk that Saudi Arabia could increase output for fear that the recent rise in fuel costs might harm the economic recovery in the G7. The International Energy Agency said on Friday that world oil demand in 2011 would probably be stronger than originally expected.

Global Stock Market Recap

Europe and the UK

European stock markets traded in a volatile fashion but within a relatively tight range over the week.  Most ended with modest gains as sentiment was boosted by hopes for extended tax cuts in the U.S. together with a modest diminution of debt-related contagion worries. France was the stand out market, with the CAC up nearly 3 percent over the period, well ahead of the UK FTSE (1.2 percent) and German DAX (0.8 percent).  Peripheral markets also made ground with the Spanish Ibex up 2.3 percent and the Italian MIB 1.8 percent better off.  Financial stocks and commodity-linked shares tended to outperform. Economic data were mixed, although in general positive, but were largely ignored. 

Bank of England

The BoE MPC matched market expectations and left Bank Rate unchanged at 0.5 percent at last Thursday’s meeting.  Also as anticipated, the central bank elected to maintain the current Stg200B cap on its quantitative easing programme.  The benchmark rate has been held at this level since March 2009 but recent outcomes have reflected a majority vote and in both October and November, masked a 3-way split.  Indeed, there is a very strong likelihood that December's decision was not unanimous either with the majority of members ignoring probable calls from Andrew Sentance for a 25 basis point hike and from Michael Posen for an increase in the QE facility.  This should be confirmed in the minutes, due for release on December 22.  When presenting the Bank’s new Inflation Report last month, Governor King admitted to extremely high levels of uncertainty about the economic outlook.  This in itself made any near-term shifts in policy all the less likely.

Asia Pacific

Asian stock markets traded nervously ahead of an anticipated tightening of monetary policy in China. The Shanghai Composite eventually ended unchanged on the week but only thanks to improved sentiment on the global economic outlook.  In Japan, the Nikkei ended just 0.3 percent higher on worries about the longer-term implications of yen strength but, in line with most of the region, made solid progress on Thursday after news of the U.S. tax compromise.  South Korea in particular responded well to hopes for stronger US domestic demand and the Kospi closed 1.5 percent to the good.  In Hong Kong, the Hang Seng nonetheless lost ground on Chinese interest rate concerns ending the week 0.7 percent lower.  In Australia, the all ordinaries was generally underpinned by higher commodity prices and mining stocks were in demand.  A surprisingly strong November employment report also helped to see the benchmark index finish 1 percent higher over period.

People’s Bank of China

Friday’s decision by the PBoC to raise the RRR by 50 basis points hardly came as a surprise but there is still considerable speculation about a near-term move on official interest rates.  For the moment, the key rate remains at the 5.56 percent level to which it was raised in November.  However, with mounting evidence of the economy overheating, it may not be there for long.  Indeed, the PBoC could well be forced to tighten policy again soon anyway if the impact on liquidity of the usual December drawdown of fiscal deposits is to be contained.  With the market’s appetite for the central bank’s sterilisation paper having clearly waned, either another increase in the RRR or a full-blown interest rate hike could well be required to stem the tide.  Already new financial data show lending over the first eleven months of the year totaling some CNY7.44 trillion and so within touching distance of the CNY7.5 trillion full-year target. 

Reserve Bank of Australia

The Reserve Bank left its key cash rate unchanged at 4.75% on Monday.  The decision, which had been widely anticipated, followed a 25 basis point tightening at the last policy setting meeting on November 2 and reflected recent signs of slowing economic growth and cooling inflationary pressures.  In particular, annual CPI inflation eased from 3.1% in the second quarter to 2.8% in the period just ended and so moved back beneath its 3% target ceiling over the business cycle.  However, while the RBA expects inflation to be little changed over the next few quarters, it also sees upside risk, especially should the real economy grow as officially forecast.  That said, the strong gains made by the local currency this year are seen exerting some downward pressure on prices going forward.  Indeed, financial markets interpreted the explanatory statement that accompanied the rate decision as being indicative of no move on official interest rates until at least the second quarter of next year. 

Reserve Bank of New Zealand

There were no surprises from the Reserve Bank which left its benchmark Official Cash Rate (OCR) unchanged at 3.0 percent on Wednesday.   More significantly, revisions made by the central bank to its economic forecasts suggest that the New Zealand monetary authorities may be a little more cautious about its tightening timetable next year.  Indeed, the RBNZ Governor said that interest rates were now projected to rise to a more limited extent over the next two years than signaled in his September Statement.  Economic growth has moderated, household spending is weak and the housing market still slowing.   However, on the positive side, economic activity in the Asia Pacific region was seen expanding robustly and already strong export commodity prices were still rising.  The construction sector was expected to benefit from rebuilding work following the earthquake that hit Canterbury earlier in the year.  Analysts are split over whether the next rate hike of the cycle will be delivered in March 2011, or deferred until the second quarter.

Currencies

The U.S. dollar began the week on a soft note, reflecting both the disappointing November employment data and the weekend’s decidedly dovish comments from Fed Chair Bernanke.  However, the promise of extended tax cuts prompted a sharp midweek rally that saw strong gains against both the euro and yen. By the end of the week the greenback was higher against most of the majors, including gains of 1.4 percent versus the euro and 1.5 percent versus the yen. Nonetheless, rising commodity prices helped the NZ$ to climb 2.4 percent over the period and encouraged the C$ to test parity once more against its US counterpart. Early bearish sentiment towards the A$ was turned on its head by a surprisingly strong November employment report.  Regional Asian currencies were mixed, most giving back some of their recent gains but the MYR strengthened by around 0.5 percent on rising rubber prices.

Selected currencies — weekly results

Indicator scoreboard

Germany

Following their surprisingly steep 4.0 percent drop in September, manufacturing orders rebounded with a slightly smaller than expected 1.6 percent monthly gain in October.  Annual workday adjusted growth accelerated to 17.9 percent from 14.1 percent last time.  Significantly, the October advance in total orders was largely due to the domestic market where demand was up fully 2.4 percent on the month.  Within this, capital goods fared especially well, expanding 3.9 percent from September for growth of 2.8 percent over the last couple of months.  Basics were up 1.6 percent from the end of last quarter and although consumer and durable goods orders dropped 1.9 percent, this was after a 2.6 percent bounce last time.  Foreign orders advanced a more modest 0.8 percent on the month, although within this, the Eurozone posted a 0.9 percent contraction and that after a near-14 percent slump in September.  The upward trend in manufacturing orders looks to have flattened out somewhat in recent months but the immediate outlook for the sector remains positive.  Indeed, the Bundesbank is now forecasting the output gap created by the last recession to be closed by the end of next year.  Importantly, the self-sustainability of the economic recovery has been enhanced by the shift towards domestic demand.  Exports will continue to play a very important role over the next couple of years but compared with many of its EMU neighbours, Germany is much better placed now to withstand any further external shocks

 The goods producing sector performed well in October.  Industrial output was up a much stronger than expected 2.9 percent on the month and so easily reversed September’s slightly steeper revised 1.0 percent decline.  As a result, annual workday adjusted growth jumped from 7.7 percent at the end of last quarter to a more than respectable 11.7 percent.  The October spurt was led by the capital goods sector where production rose fully 4.6 percent on the month after a flat performance last time.  However, there were solid gains too in intermediates (2.9 percent) and consumer non-durables (2.7 percent).  Non-durables lagged with a 0.4 percent increased on September and energy was down 0.3 percent but activity in the construction sector climbed 1.3 percent.  Over the last couple of months manufacturing output grew 1.1 percent.  Moreover with the November Ifo sentiment index hitting a new high in mid-quarter and the PMI up at 58.1, the outlook for November looks to be equally positive.  Fourth quarter real GDP is starting to shape up quite nicely.

 There were no revisions to the flash estimate of inflation last month.  Hence, consumer prices still rose a stronger than originally expected 0.1 percent on the month to stand 1.5 percent higher on the year. Harmonised prices were similarly confirmed as having increased 0.1 percent from October and 1.6 percent from November 2009.  The monthly rise in the CPI was driven by higher prices for food (0.9 percent), clothing and footwear (0.8 percent) and energy (light heating oil 1.9 percent, motor fuel 0.9 percent).  However, gains here were almost offset by falling charges in leisure and entertainment (1.0 percent), hotels and restaurants (0.9 percent) and communications and media (0.3 percent).  The underlying inflation picture remained tame with core prices (CPI excluding energy) unchanged on the month and just 1.1 percent firmer on the year.  The November results will come no surprise to the Bundesbank which does not see domestic inflation becoming an issue for ECB policy.  Just last week, the German central bank forecast annual increases in the HICP of 1.1 percent this year, 1.7 percent next year and 1.6 percent in 2012.  Core inflation was seen at only 0.7 percent this year and at 1.1 percent and 1.5 percent in 2011 and 2012 respectively.

France

The quarterly jobless data showed unemployment holding steady on the mainland at 9.3 percent in the period just ended.  The stability here was mirrored in the total figure (9.7 percent) which includes overseas territories.  Chances are that the labour market is now over the worst but a return to pre-crisis levels is still likely some way off with the full impact of fiscal tightening yet to be fully realized.  Still, with the real economy amongst the best performers in the region, employment prospects in France are probably rather better than in many of its EMU neighbours.  Jobless claims in October pointed to a slight increase in payrolls at the start of the fourth quarter.

The seasonally adjusted merchandise trade deficit narrowed from a downwardly revised €4.2 billion at the end of the third quarter to €3.4 billion in October, the smallest monthly shortfall since February.  The sharp improvement masked a contraction in both sides of the balance sheet with nominal exports falling 1.2 percent on the month and imports down a much steeper 3.6 percent.  However, the October shrinkage in the bottom line saw the red ink in the last three months (€12.5 billion) decline by 2.1 percent compared with the third quarter and by nearly 7 percent versus the second quarter.  The French authorities will be very keen to see this latest development become the start of a new positive trend in the external accounts.  Net exports provisionally subtracted some 0.3 percentage points from quarterly real GDP growth in the period just ended.

Italy

Output in the goods producing sector slipped 0.1 percent on the month in October.  Annual workday adjusted growth was 2.9 percent.  In fact the monthly fall would have been steeper but for a 2.3 percent bounce in energy output.  Production of consumer goods dropped 1.0 percent from September and output in the capital goods category shrank 0.4 percent.  Intermediates fared rather better with a 0.6 percent monthly advance.  The persistent weakness of the consumer sector is highlighted in the annual growth figures.  Hence, while output of both the capital goods (7.9 percent) and intermediates (3.9 percent) is well above the respective year ago levels, production in the consumer goods sector was still down 1.8 percent.  According to ISAE, confidence in manufacturing industry posted a useful bounce in November but the PMI dropped to within two points of the 50 growth threshold.  With October production already more than 1 percent below its third quarter average, the likelihood is that the fourth quarter is going to struggle.

Growth in the Italian economy was a little stronger than originally reported last quarter.  The first revision to the flash estimate added an extra 0.1 percentage points to both the quarterly gain (now 0.3 percent) and annual advance (now 1.1 percent).  However, the minor adjustment still leaves the smallest quarterly rise in total output since real GDP began expanding again in the fourth quarter of last year and annual growth remains anaemic.  The first look at the GDP expenditure components revealed a sluggish 0.3 percent quarterly increase in private consumption but a more respectable 0.9 percent advance in fixed investment.  Within the latter, spending on machinery jumped 2.2 percent and construction was up 0.6 percent.  However, investment in transportation dropped fully 2.2 percent.  Government spending dipped 0.2 percent from the second quarter and with exports (2.8 percent) easily outpaced by imports (4.7 percent), net foreign trade subtracted fully 0.5 percentage points from the bottom line.  Total domestic demand added a solid enough 0.8 percentage points to quarterly growth but with inventory accumulation worth some 0.5 percentage points of this, the composition of GDP still leaves much to be desired.  Certainly there is little in these accounts to boost hopes for a significant acceleration in growth in the current period.

United Kingdom

The manufacturing sector enjoyed a period of unexpectedly robust growth at the start of the third quarter when output rose a solid 0.6 percent on the month.  With September’s advance being revised up a tick to 0.2 percent, annual growth jumped from 4.9 percent to 5.8 percent.  The monthly pick-up manufacturing output was the best performance since March and meant that over the last three months, production in this sector has risen a healthy 1.1 percent.  Eight of the thirteen sub-sectors registered an increase while two saw declines.  The strongest performers were transport equipment (2.6 percent), machinery and equipment (2.5 percent) and electrical and optical industries (0.8 percent).  The most significant monthly fall in production was in food, drink and tobacco (1.1 percent).  By contrast, sharply lower output in the erratic mining and quarrying area (4.2 percent) and also in energy (1.0 percent) saw total industrial production down 0.3 percent on the month and just 3.3 percent higher on the year.  Nonetheless, after a 1.0 percent quarterly advance in the third quarter, manufacturing looks to have carried considerable momentum into the current period and, once again, should provide a handy contribution to overall real GDP growth. Certainly business surveys have boded well for November, especially the manufacturing PMI which, at 58.0, reached a 14-year high.

The new CBI survey shows a marked improvement in the manufacturing sector at the turn of the month.  Of special note, the headline orders book index jumped fully 12 points to minus 3, its best reading since June 2008.  Businesses were also significantly more optimistic about the outlook.  Hence, the 3-month ahead production forecast index rose 9 points to 13, reflecting anticipated gains in both domestic and, especially, overseas demand.  The export measure advanced 11 points to 4, its highest level since August 1995.  However, amongst all the good news the CBI also warned of significant inflationary pressures.  Their 3-month forward forecast for factory gate prices edged down a notch but at 16, was still uncomfortably high.  This will not be wasted on the BoE MPC or UK financial markets.

Asia/Pacific

Japan

Economic growth was revised a little firmer last quarter with real GDP now estimated to have expanded 1.1 percent versus the previous period, up from 0.9 percent in the preliminary report.  The revision reflected stronger private sector inventories and higher business investment.  On an annualised basis, growth was 4.5 percent or 0.6 percentage points stronger than last time, while the annual gain was revised up from 4.1 percent to 4.9 percent.  On a quarterly basis, domestic demand added 1.1 percentage points to bottom line growth within which household consumption contributed 0.7 percentage points. Private non-residential investment and private inventories each added 0.2 percentage points.  Public demand had no net impact and a 0.4 percentage point contribution from exports was offset by an equivalent subtraction by imports.  Meantime revisions to previous quarters saw the decline in economic activity in the fiscal year ended last March steepened from 1.8 percent to 2.4 percent courtesy of significantly weaker household spending and public consumption.    

Australia

 The labour market proved rather stronger than generally anticipated in November.  Employment rose some 54,600, its largest increase since January and almost double the advance registered in October.  Moreover, full-time jobs were up fully 55,100.  At 66.1 percent, the participation rate hit a record high and at the same time, the jobless rate slipped a couple of notches to 5.2 percent, although this still failed to make up for the 0.3 percentage point jump last time.  The employment gain was all the more surprising in the wake of recent figures that revealed a sharp slowdown in economic growth in the quarter just ended and a 1.1 percent monthly fall in October retail sales.  Should payrolls continue to expand at November’s pace over coming months, full employment could be reached by the first or second quarter of 2011.  Such a development would inevitably add to upside pressure on wages.  

China

 The merchandise trade surplus narrowed to $22.9 billion in November from $27.2 billion at the start of the quarter.  However, both nominal exports and imports saw new record highs.  Annual export growth accelerated to nearly 34.9 percent, up from just under 23 percent in October while imports grew 37.7 percent compared with a 25.3 percent rate in October.  The November data left the average surplus for the fourth quarter some 14 percent above the third quarter mean and suggests that net trade will provided a useful boost to current quarter GDP growth.  Over the year so far, the black ink stands at $170.4 billion and so broadly on course to match last year’s outturn ($196.1 billion).

Annual growth of industrial output edged up to 13.3 percent in November from 13.1 percent in October.  The acceleration was largely attributable to stronger growth in non-metal minerals (18.0 percent), transport equipment (18.1 percent), machinery (17.4 percent) and crude oil (11.8 percent).  There was also a sharp pickup in cement (17.3 percent) and in motor vehicles (27.6 percent).  The data set the scene for another strong quarterly rise in total output in the current quarter.

CPI inflation picked up to an annual 5.1 percent rate in November, a 0.7 percentage point increase on the October pace and more than 2 percentage points higher than in June.  Most of the main categories saw prices rising at a more rapid rate with food (11.7 percent) increasing especially steeply.  The National Development and Reform Commission said that the December CPI would slip below 5 percent but expects prices to remain at elevated levels during the first quarter of 2011.  Base effects alone in December should subtract around 1 percentage point from the annual rate.

Annual retail sales growth edged a tick stronger to 18.7 percent in November.  The headline gain reflected stronger purchases in both the urban and rural areas with particularly marked advances registered by grain and food oil (31.8 percent), building and decoration materials (33.5 percent) and gold, silver and jewelry 67.0 percent.

Americas

Canada

The unadjusted headline PMI edged up just 0.8 points in November to 57.5.  The rise failed to make up for a near-14 point slump at the start of the quarter but with seasonal factors negative, the underlying position in November was probably rather better than first appearances suggest. Indeed, amongst the components the employment sub-index was up 3.1 points from October to 54.8 and so equaled its best reading since May.  Inventories fell sharply (41.7 after 46.4) but prices continued gain ground albeit at 60.0, not as rapidly as last time (63.8).   

The trade deficit narrowed from C$2.31 billion in September to a smaller than expected C$1.71 billion at the start of the current quarter.  The improvement reflected a 3.1 percent monthly increase in exports that more than offset a 1.2 percent advance in imports. The real trade balance also moved in the right direction as export volumes increased 3.0 percent over the period while real imports were up just 1.7 percent. Within total nominal exports, shipments to the U.S. were up 0.4 percent from October which, with imports expanding 1.7, percent saw the bi-lateral surplus narrow from C$1.43 billion to C$1.13 billion.  Net exports to the EU swung from a shortfall of C$0.18 billion to a surplus of C$0.20billion. Amongst the major export categories industrial goods and materials jumped nearly 14 percent on the month and were supported by renewed gains in agricultural and fishing products (7.5 percent), autos (3.5 percent) and forestry products (1.8 percent).  However, there were declines in energy products (2.6 percent) machinery and equipment (2.5 percent) and in the other consumer goods category (7.2 percent).  Within imports, energy products (8.3 percent) produced the strongest monthly showing and there were more modest gains in autos (1.5 percent) and other consumer goods (1.2 percent.  The shrinkage in the red ink provides some reassurance after a string of poor monthly trade data but net foreign trade looks unlikely to provide much help to GDP growth for some while yet.

Bottom line

With the Christmas break rapidly approaching, financial markets can take heart from a 2010 performance that was probably a good deal better than many dared hope.  Still, several of the issues that clouded the outlook at the start of the year remain unresolved and the medium term prognosis is still shrouded in uncertainly.  The preference for risk-aversion may not be as strong as it once was but few investors currently seem prepared to move out of safe haven assets in an aggressive way.

Outside of the U.S. the highlight of this week’s economic calendar will be the UK November labour market report and retail sales together with the breakdown of the EMU November HICP.  In Germany the December Ifo survey will attract significant attention, as will the outcome of the Swiss National Bank policy meeting on Thursday.  The EU leaders’ summit at the end of the week is unlikely to excite.  In Asia the new BoJ Tankan survey will be the main focus while Canada sees October manufacturing sales. 

Looking Ahead: December 13 through December 17, 2010