Friday Thoughts

The diverging economic data between Europe and the US was underscored in recent days.  The US economy expanded 2.5% at annualized rate in Q3 and early indications for Q4, including ISM, regional surveys, strongest auto sales in eight months, and the employment data, are constructive.  To be sure, the data does not point to spectacular growth.  In fact it is still likely to be below trend, which is often thought of to be around 2.75%.   

Whatever disappointment one sees with the headline private sector non-farm payroll growth (104k instead of consensus near 125k) is more than offset with the back-month upwards (+102k), the decline in the unemployment rate (unexpectedly to 9.0% from 9.1%) and easing of the under-employment condition.  

In contrast,data from Europe is recessionary. Today's evidence include the non-manufacturing PMI and German factory orders.  The Oct PMI fell to 46.4, the lowest since July 2009 and the second month below the 50 boom/bust.  The flash reading reported in late Oct was 47.2 and Sept was 48.8.  France, Italy and Spain reported large declines. 

Of note, and consistent with my earlier assessment that Ireland is recovering remarkably well and is a rare success story on the periphery, its PMI rose to 51.5 from 51.4. Small, it is, but the direction and level is important.  Business expectations at 63.4 (from 59.5) is best reading since April.  

Germany reported a horrific factory orders for September, suggesting weakness in output in Q4 and this is underscored by the soft Oct manufacturing PMI.   Sept factory orders plunged 4.3% on the month.  The consensus had expected only a 0.1% decline.  Domestic orders fell 3%, while foreign orders fell 5.4%.  The economic engine of Europe and the world's 4th largest economy is sputtering.  

Two notes from within the dollar-bloc.  The Reserve Bank of Australia cut its growth and inflation forecasts.      It see growth at 4% for 12 months ending next June, that is down 0.5% from is Aug projection.  It sees inflation at 2.0% now rather than 2.5% and the underlying rate at 2.5% rather than 3%.  The market anticipates another rate cut in the coming months.  

Canada issued a disappointing jobs report.  It lost 54k jobs.  The Bloomberg consensus was for a 15k increase.  Full time jobs were slashed by almost 72k, though part time jobs grew almost 18k.  Unemployment ticked up to 7.3% from 7.1%.  The bulk of the job losses were in manufacturing (48.4k after shedding 23.5k in Sept).  There may be some new disruptions in the auto sector due to floods in Thailand.  The construction sector shed 20k workers and this may reflect the cooling off of the commodity-intensive regions and/or the housing boom.  

The Greek vote of confidence, late today, will likely result in a new government and the real issue is whether it is orderly or disorderly.  Orderly at this point would be for Papandreou to survive the vote of confidence and then set the stage for  technocrat/unity government, which he cannot almost by definition head, to prepare for elections, perhaps early in the new year.  The disorderly version would be for Papandreou to lose the vote of confidence and then various parliamentary procedures take place that would boost uncertainty.  

However, as important as Greece is, Italy is threatening to eclipse it.  Italian spreads against Germany are widening sharply.  Italy has reportedly agreed to allow the IMF to monitor the implementation of its economic reforms, starting next week.  This is a serious move.  It is better than sending a German administrator, but this is, in high politics, a blow to Italy and its sovereignty.  The widening spread and volatility of Italian bonds risks triggering a spiral of reactions, including clearers requiring greater margin money/bigger haircut on loans tied to  Italian bond collateral. 

The domestic politic situation is also unraveling.  Two more deputies have defected from Berlucsconi and have joined the opposition.  Eight other previous supporters in Berlucsconi's party have called for a change in government.  Earlier this week the cabinet agreed to decide on limited measures by Nov 15.  Next week, the Chamber of Deputies votes on the 2010 budget report.  This procedural vote failed last month and another loss this now would could also spell the death knell of the Berlucsconi's government.   

There are two potential developments in Italy to monitor.  First, there is talk that Berlucsconi may try to replace his finance minister with Bini Smaghi, but it is not clear that Bini Smaghi would take the position especially in a government that is so precariously holding on to power.  Second, there is talk that the government may seek a bond swap with some domestic institutions, including the government's holdings itself, that would reduce debt servicing costs.  

More about next week shortly...