Macro Musings

The investment climate is characterized by the continued accommodative monetary stance by the three key central banks, the Federal Reserve, the European Central Bank and the Bank of Japan. Although there is a slew of economic data that will be released in the coming days, and a BOJ meeting, it is unlikely to alter the widespread understanding that the ECB and BOJ may take more measures later, the Federal Reserve is likely maintain the current course until at least the end of Q1 14.  

The fact that the Vice Chairman of the Federal Reserve did not run away from the central bank's course that she herself help establish, and did not signal a desire to change course immediately, was some how seen as revealing or newsworthy by many pundits.  She delivered what any one in her position would have, and she did it with aplomb.   Much of the subsequent commentary, especially those that claimed, in some fashion, implied that she represents Bernanke's third term, do much injustice to the situation and the people.  

As the circumstances change, the policy response can be expected to change. Partly based on the expectation the fiscal drag in 2014 will be around a third or 1.0% less than this year and partly on the cumulative effect of more people working, we expect the US economy to strengthen and provide a basis on which the Fed can begin to slow its asset purchases.  

Nevertheless, more immediately, the week's economic data is unlikely to encourage investors to bring forward the tapering into this year.  Even anything, the unexpectedly weak import price index ( -0.7% in Oct and the Sept series revised to a 0.1% gain instead of 0.2%, pushing the year-over-year pace to -2.0% from -1.0%), points to downside risks to measured inflation.  The consensus expects the Oct CPI to match its 3-year low of 1.0%.  

Meanwhile, retail sales slowed marked in Q3, where cumulative monthly gains of 0.5% were recorded, after 1.4% in Q4 and are expect have begun off Q4 on a soft note.  The government closure may have exacerbated the weakening trend in Oct; in which case some rebound should be expected in Nov.  The FOMC minutes appear to have in part been superseded by Yellen's confirmation hearings, but perhaps some color can be added to what it means that the Fed is awaiting more economic progress and its views of the fiscal threat.  

The Empire Survey last week (Nov -2.21 vs consensus of 5.0 and an Oct reading of 1.52) warns that the economy may have downshifted in Q4.  The Philly Fed report this week is expected to confirm the absence of a post-closure lift to the economy.  

There are two other developments that should be on investors' radar screens.  First, last week the hearing on Detroit's bankruptcy concluded and the judge's decision is awaited.  There is no good outcome.  If the judge does not allow the municipality to have the protection (from creditors) that bankruptcy proceedings allow, there will be a wave of lawsuits as the creditors seek to recover their $18 bln (Detroit's liabilities).  Yet, if Detroit is granted protection, which would allow it to cut pensions of city workers, it would violate the city's constitution, which explicitly bans pension cuts.  

Second, the free-trade agreement called the Trans-Pacific Partnership (the largest trade agreement in history) is in jeopardy.  Reports indicate that 151 House Democrats were joined by 23 Republicans in signing a letter that informed President Obama that they were reluctant to grant him trade promotion authority ("fast-track").  This authority allows the executive branch to negotiate a trade agreement and then Congress votes up or down in its entirety.  No major trade agreement in the last few decades has been agreed upon without it.  

Just as the US data is unlikely to alter views of the trajectory of QE, euro zone data do not have the heft to change perceptions that the ECB is going to have to do more if it wants to arrest the disinflation forces before they morph into outright deflation.  The main economic report in the week ahead is the preliminary Nov PMI.  A small uptick is expected to 52.0 from 51.9 in October on the composite reading.  This is seen consistent with around 0.2% Q4 GDP.  

As we argued before, despite the expansion of GDP, it probably behooves investors and policy makers to continue to regard the euro area as in recession.  Although Q4 GDP looks to be the third consecutive quarter of expansion, an broader assessment is required to pinpoint the economy's location in the business cycle. While many people cite the two-consecutive quarterly declines as indicative of a recession, we note that even the official arbiters of the US business cycle eschew such simplistic definitions.  For example, the latest unemployment report showed a new cyclical and record high of 12.2% for September.  The Oct report is due on November 29.  

German surveys ZEW and IFO will bookend the week.  While offering some headline risk, the surveys are unlikely to alter perceptions that Europe's largest economy is chugging along at an uninspiring pace of around 1% (Q3 GDP 1.1%).    Its 1.2% year-over-year CPI also belies arguments that ECB monetary policy is too ease for it.  The increase in house prices, that the BBK recently cited, has other drivers.  

The euro area trade and current account figures will be reported on Monday.  They will help drive home the point that the austerity in the periphery is not being offset by increased activity in the core. The result is a increasingly large external surplus.   It follows on the heels of last week's decision by the EU to investigate the Germany current account surplus.

The descent of Italy's Berlusconi took another step.   The center-right has formally split.  Berlusconi has re-launched his Forza Italia party, while his long-time deputy, and deputy prime minister in the Letta coalition government, Alfano has created a new center-right party.  Reports suggest this new party will be supported by as many as 37 Senators and 23 MPs.   

There are two immediate implications.  First, it leaves little doubt that Berlusconi will be evicted from the Senate, following his tax evasion conviction, probably before the end of the month.  This will not be as disruptive as it appeared a couple months ago.  Second, and related, the Letta government may be more stable than previously perceived.  

While it is tempting to suspect this can lead to a relative out performance of Italy, we are closely watching developments which warn that the capital flow patterns see in recent months are changing. Spain and Italy were market darlings, with both their stock and bond markets easily out performing. However, in the last few weeks this has ceased.  Over the past month, Spanish and Italian equity markets are off 3%, while the DAX is up 3.5% and Dow Jones Stoxx 600 is up 1.5%.  In the bond markets, the 15 bp decline in Italian's 10-year yield has clearly lagged behind other European bond markets.  Spain's 10-year yield has fallen almost 23 bp and is on the low side with the euro area.  

A similar reversal of recent flow patterns is seen in Asia to some extent. Both Taiwan and South Korea experienced large foreign inflows into their equity markets in October.  In the first half of  November, both reported a net outflow of about $675 mln by foreign investors.    

We note that the MSCI Emerging Market Equity Index fell about 6.5% from Oct 30 through the middle of last week.  In the second half of last week, it recovered by 3% and appears poised for additional gains in the coming days.  It closed a little above 1005 before the weekend.  Technically, there is potential toward 1018, before more formidable resistance is encountered.  

Japanese investors, who have been net sellers of foreign bonds this year, has swung to the buy side, with net purchases for five consecutive weeks (through Nov 8) for a total of around $35 bln.  They have been net buyers in 8 of the past ten weeks.  For their part, there is renewed interest by foreign investors in Japanese equities.  The four-week average has risen to about JPY202 mln, which is the second highest since July.  With the capital gains tax set to jump from 10% to 20% on January 1, investors are urged to stay attentive to signs of domestic profit-taking ahead of it.  

Surveys show that an overwhelming majority of Japanese businesses do not expect the BOJ to reach its 2% inflation target in the next fiscal year.  Most economist expect the BOJ to take additional steps.  However, there is unlikely to be an sense of urgency at this week's BOJ meeting.  Oct trade data may be more interesting.  The trade deficit has yet to improve on a trend basis, but export growth is accelerating.  

Using monthly data, exports rose 1.5% on average in Q1, 7.1% in Q2 and 12.8% in Q3. Exports are expected to have accelerated in Q4 and we note that the yen, on a trade-weighed basis has now fallen to new 5-year lows.   Of course, the other half of the trade balance, imports, are also rising rapidly and this reflects both energy imports and the yen's depreciation.    

To round out the economic reports, we note that minutes from the Reserve Bank of Australia and the Bank of England will be reported in the new week.  Both have likely largely been superseded by subsequent central bank reports.  In Australia,  the detailed quarterly statement on monetary policy is likely to be reflected in the minute.  It was left the door ajar to additional easing and the Oct labor report was disappointing (a loss of 28k full-time jobs and Sept's gain was revised away).  In the UK, last week's Quarterly Inflation Report likely stole whatever thunder the minutes contain.  

Canada will reports its Oct CPI figures at the end of the week.  The headline pace is expected to fall back below 1.0% for the first time in four months.  The core rate is likely to edge lower to 1.2%. Canada also report Sept retail sales.  The 12- and 24-month averages are identical at 0.2% (by comparison the US monthly average is 0.3% and 0.4% respectively.  

Finally, we bring to you attention news that New Zealand's government will sell-off 20% of Air New Zealand (leaving it with a 53% stake).  The stock will likely be suspended pending the results of the sale.  The value of the stake is estimated at around NZ$362 mln (or $302 mln).  The shares are up 27% this year.  This will likely be understood within the context of Prime Minister Key's larger privatization effort that has already included parts of a couple of energy companies.  The effort is expected to continue into 2014.  The government plans on using the proceeds from the privatization to pay down debt and fund infrastructure spending.     The impact on the New Zealand dollar is likely to be minimal at best.