Asian manufacturing improves, Spain's deficit larger than expected

Manufacturing in Asia improved a little in December.

In Japan, the manufacturing sector returned to growth in December with the Markit/JMMA manufacturing PMI rising to 50.2 from 49.1 in November.

China's manufacturing sector shrank again in December but at a slower pace. HSBC's manufacturing PMI for China rose to 48.7 from 47.7 in November.

The debt crisis in Europe, though, continues to be a threat to the global economy. Reuters reports the latest development in Spain:

Spain's new government said on Friday that this year's budget deficit would be much larger than expected and announced a slew of surprise tax hikes and wage freezes that could drag the country back to the centre of the euro zone debt crisis.

In its first decrees since sweeping to victory in November, the centre-right government said the public deficit for 2011 would come in at 8 percent of gross domestic product, well above an official target of 6 percent.

US data positive, Italy borrowing costs fall again

US economic data on Thursday continued to come out positive.

Pending home sales jumped 7.3 percent in November to the highest level since April 2010.

Initial claims for unemployment benefits rose but the four-week moving average fell to a 3½ year low.

The Institute for Supply Management-Chicago business barometer slipped only slightly to 62.5 in December from 62.6 in November.

As usual, however, the news from Europe was not as good.

Lending to the euro zone's private sector fell 0.1 percent in November to its lowest rate in over a year. Annual M3 growth rate slowed to 2.0 percent in November from 2.6 percent in October.

In Italy, Istat's manufacturing sentiment index fell to 92.5 in December, the lowest in two years, from 94.0 in November.

Investors are not showing much more confidence in Italy. The government managed to sell 7 billion euros of debt on Thursday at lower yields than at the previous auction but the yield on its 10-year security remained relatively high at 6.98 percent.

Still, Italy's government did better than Hungary's. The latter managed to raise less than half the amount it had planned at its debt auction.

Italy's borrowing costs fall but so does the euro

The Italian government's debt auction on Wednesday proved quite successful. The Treasury sold 9 billion euros of six-month bills at a rate of 3.251 percent, down from 6.504 percent at the last auction. It also sold 1.7 billion euros of zero-coupon notes due in 2013 at 4.853 percent, down from 7.814 percent at the last auction.

Markets still ended the day down however. The euro fell, hitting a 10-year low against the yen, while the S&P 500 fell back into the red for the year. Despite the successful sale of short-term debt, Italy's 10-year yield ended the day practically unchanged at 7.0 percent.

The weakness in markets was at least partly attributed to a report from the ECB on Wednesday showing that its balance sheet had soared to a record 2.73 trillion euros after its lending to euro-area banks jumped 214 billion euros to 879 billion euros last week.

There were few economic reports on Wednesday apart from Japan, which reported a 2.6 percent fall in industrial production in November as a result of the floods in Thailand. A survey of forecasts by companies showed that output was expected to recover and grow by 4.8 percent in December and 3.4 percent in January.

Other reports from Japan on Wednesday showed that core consumer prices fell 0.2 per cent in November from a year earlier, household spending fell 3.2 percent and retail sales fell 2.3 percent. The unemployment rate was 4.5 per cent in November, unchanged from the previous month.

US consumer confidence jumps, house prices fall

US economic data on Tuesday were mixed.

The Conference Board's consumer confidence index continued to recover in December. It rose to 64.5 in December from 55.2 in November.

However, house prices remained in a downtrend in October. A report from Standard & Poor's/Case-Shiller showed that house prices in 20 major metropolitan areas declined 1.2 percent on an unadjusted basis.

There was no major economic report from Europe on Tuesday.

However, the ECB did report that banks deposited €411.813 billion in its overnight deposit facility on Monday, a new all-time high, suggesting ongoing distrust among banks in inter-bank lending markets.

Stocks rally strongly, just like in middle of last bear market

Stock markets resumed their rallies last week.

In the United States, the Standard & Poor’s 500 Index rose 3.7 percent to 1,265.33 last week. The gain erased the year's decline and left the index 0.6 percent higher than at the beginning of 2011. It is now 7.2 percent below this year's peak on 29 April.

For the week, the STOXX Europe 600 rose 3.5 percent to 241.86. The index is now 12.6 percent above this year's low of 214.89 on 22 September. However, unlike the S&P 500, it remains in negative territory for the year as last week's close left it 12.3 percent lower than at the beginning of 2011. The index also remains 16.9 percent below this year's peak on 17 February.

Stock markets have made strong rallies from the lows set just a few months ago. This might be the typical year-end rally.

Or investors might simply be breathing a bit easier after the turmoil in the middle of the year. After all, there appears to have been some progress, albeit limited, among Europe's policy-makers to deal with its debt crisis. Economic data in recent weeks have also not shown much further deterioration among the major economies.

Still, the debt problem in Europe remains a major threat to markets and economies. Greece is still widely considered to be insolvent while Italy remains in distress, with its 10-year yield rising again last week to touch 7 percent.

And to put the recent rally in perspective, markets also made similar rallies in the middle of the last bear market in 2007-2009. However, they then collapsed dramatically about a year or more into the bear market when Lehman Brothers failed.

So the rally in stocks over the past few months does not necessarily mean that the correction is over.

Economic data mixed, markets positive

US economic data on Friday were mixed.

Personal consumption expenditures and income both rose just 0.1 percent in November. Adjusted for inflation, personal consumption expenditures rose 0.2 percent while disposable personal income was unchanged.

Durable goods orders jumped 3.8 percent in November due to a surge in aircraft orders. Excluding transportation, orders rose 0.3 percent. However, excluding defence and aircraft, orders fell 1.2 percent.

New home sales rose 1.6 percent in November to the highest level in seven months.

Elsewhere, France reduced its GDP growth estimate for the third quarter to 0.3 percent from 0.4 percent.

In Asia, Fitch has lowered its 2012 growth forecast for the region's emerging economies to 6.8 percent from 7.4 percent. A 9.6 percent fall in Singapore's manufacturing output in November from a year earlier provided the latest evidence of a slowdown in Asia.

Worries about an economic downturn prompted an unexpected interest rate cut from Russia on Friday. Bank Rossii cut its refinancing rate to 8 percent from 8.25 percent.

While economic reports were mixed on Friday, markets remained positive. Stocks rose, with the S&P 500 rising for a fourth consecutive day by 0.9 percent and giving it a 0.6 percent gain for 2011. The STOXX Europe 600 rose 0.9 percent. Copper rose 1.6 percent.

US third quarter GDP growth revised lower but momentum being maintained

A report on Thursday showed that US third quarter GDP growth has been revised down to a 1.8 percent annual rate from 2.0 percent due to a sharp reduction in the estimate for healthcare spending.

Other reports on Thursday showed that the US economy maintained growth in the fourth quarter.

The Chicago Fed National Activity Index decreased to minus 0.37 in November from minus 0.11 in October but the three-month moving average remained unchanged at minus 0.24.

Initial claims for state unemployment benefits dropped 4,000 to 364,000 last week, the lowest level since April 2008.

The Thomson Reuters/University of Michigan's consumer sentiment index rose to 69.9 in December from 64.1 in November.

And the momentum in the economy looks likely to be maintained into early next year after the Conference Board's index of leading economic indicators rose 0.5 percent in November.

Meanwhile, in the UK, third quarter growth was revised up to 0.6 percent from 0.5 percent but the second quarter GDP was revised down to show no growth.

In Japan, the government on Thursday lowered its economic growth forecast for the fiscal year to March 2012 to 0.1 percent from 0.5 percent. The economy is forecast to grow 2.2 percent in fiscal year 2012, down from its previous forecast of between 2.7 percent and 2.9 percent.

ECB three-year scheme sees demand from banks, spurs talk of QE

The European Central Bank's new three-year long term refinancing operation (LTRO) appears to have met a need. From Bloomberg on Wednesday:

The 523 euro-area lenders took a record 489 billion euros ($638 billion) from the Frankfurt-based central bank in 1,134- day loans today, more than economists’ median estimate of 293 billion euros in a Bloomberg News survey. That equals about 63 percent of the European bank debt maturing in 2012, according to Goldman Sachs Group Inc. analysts.

Edward Harrison thinks that “the LTRO is really the ECB equivalent of QE3”.

He is not the only one to think so. From Bloomberg:

John Taylor, founder of currency-hedge fund FX Concepts LLC, said the European Central Bank three-year loans to euro- area banks is a form of quantitative easing and the euro is destined to slide next year.

“This is QE in another form,” referring to the monetary policy the Federal Reserve used in undertaking of purchasing debt to keep long-term rates low, Taylor said in an interview on Bloomberg Television’s “Inside Track” with Erik Schatzker. “Three-year money at a low price -- you can give it back after a year - it’s a giveaway. What scares me is what the hell are they going to do with it? They’ll buy Spanish and Italian debt.”

The euro did eventually end down on Wednesday but Spanish and Italian note yields rose.

Nevertheless, Floyd Norris thinks that, for all the tough talk from ECB president Mario Draghi, he may have done “enough to stem the European crisis for at least a few years”.

Still, it will probably take a while for confidence to fully return to the euro area. Consumer confidence for one deteriorated in December to the lowest since August 2009.

With market attention on Wednesday focused on the ECB's latest operation, the Bank of Japan's monetary policy meeting generated relatively little interest. The BoJ left interest rates unchanged but said that the country's economic recovery “has paused”.

Indeed, Japan's exports fell 4.5 percent in November from a year earlier, worse than the 3.8 percent fall in October. The trade deficit widened to 684.7 billion yen in November from 280.2 billion yen in October.

Meanwhile, the US economy continues to generate positive reports, the latest being a 4.0 percent increase in existing home sales in November.

Markets rally on positive reports

Markets jumped on Tuesday, with the S&P 500 rising 3.0 percent and oil gaining 3.6 percent.

Markets were buoyed by positive news around the world.

In the US, housing starts increased 9.3 percent in November to the highest rate since April 2010.

Europe also provided good news for a change.

In Germany, Ifo’s business climate index rose for a second month to 107.2 in December from 106.6 in November, its biggest rise since February. Meanwhile, GfK reported that German consumer confidence for January was unchanged from the previous month.

UK consumer confidence has been weak recently. Nationwide reported that its consumer confidence index rose to 40 in November from 36 in October but remained at its second-lowest reading in the survey's seven-year history. GfK NOP's consumer confidence index fell to -33 in December from -31 in November, its lowest reading since February 2009.

However, despite the weak consumer sentiment, UK retail sales rose in December, the CBI distributive trades survey's reported sales balance jumping to +9, the highest since May, from -19 in November.

In European financial markets, there was relief as Spain exceeded its debt sale target on Tuesday and sold bills at lower yields than in the previous auction.

Also adding to the positive news flow for markets was a cut in interest rate by Sweden's central bank. The Riksbank lowered its seven-day repo rate 25 basis points to 1.75 percent.

Kim Jong-Il dies but European debt crisis lives on

North Korean leader Kim Jong-Il has died, to be replaced by his son Kim Jong-Un.

Stocks were mostly down on Monday, with South Korea's KOSPI falling 3.4 percent in reaction to the news on Kim Jong-Il's death.

Other markets were mostly weighed down by Europe's debt crisis as Belgium’s 10-year yield jumped nine basis points on Monday following its credit rating downgrade by Moody’s last week.

Adding to uncertainties of a resolution to the crisis, European finance ministers on Monday managed to raise only 150 billion euros for the IMF to fund the latter's efforts to help indebted countries, short of the 200 billion euro target. Prospects for meeting the target were dented by Britain's decision not to contribute.

Meanwhile, the US has continued to recover from its own crisis following the bursting of the housing bubble. A report on Monday showed that the National Association of Home Builders/Wells Fargo housing market index rose for a third consecutive month to 21 in December from 19 in November.

The news on the UK housing market on Monday was not so positive. Rightmove reported that asking prices for homes in England and Wales fell 2.7 percent in December.

Bloomberg: China debts dwarf official data

While the world is today mainly focused on the debt crisis in Europe, Bloomberg has looked at another potential debt problem: the accumulation of local government debt in China.

Debt accumulated by companies financing local governments such as Tianjin ... is rising, a survey of Chinese-language bond prospectuses issued this year indicates. It also suggests the total owed by all such entities likely dwarfs the count by China’s national auditor and figures disclosed by banks.

Bloomberg News tallied the debt disclosed by all 231 local government financing companies that sold bonds, notes or commercial paper through Dec. 10 this year. The total amounted to 3.96 trillion yuan ($622 billion), mostly in bank loans, more than the current size of the European bailout fund.

Much of the debt was used to fund the building boom that helped China's economy pull through the last global recession relatively unscathed. However, they could weigh on China's future growth.

The findings suggest China is failing to curb borrowing that one central bank official has said will slow growth in the world’s second-largest economy if not controlled. With prices dropping in China’s real estate market, economists warn that local authorities won’t be able to repay their debt because of poor cash flow and falling revenue from land sales they rely on for much of their income.

An indication of the weakening of the property market, at least in the residential sector, came on Sunday when the National Bureau of Statistics reported that new home prices dropped in November in 49 of the 70 cities tracked by the government, up from 34 in October. Five cities saw prices rise in November, down from 16 in October.

No inflation for US, no solution for Europe

Inflation is not a concern in the US at the moment. Especially with the CPI coming out flat in November.

Rather, Europe's debt problem is the dominant concern.

Unfortunately, Fitch Ratings is not optimistic that a solution to the problem can be reached. From Reuters:

The credit rating agency Fitch said on Friday it thought a comprehensive solution to the euro zone's debt crisis was beyond reach, putting six euro zone economies including Italy on watch for potential near-term downgrades.

It reaffirmed France's top-notch triple-A rating but even here said the outlook was now negative, meaning it could be downgraded within two years.

Moody's went one step further and actually cut Belgium's credit rating from Aa1 to Aa3 on Friday.

Global economic data weak except in the US

Economic data on Thursday were mixed.

The Bank of Japan reported a fall in the sentiment index for large manufacturers in December to minus 4 from 2 in September.

In China, manufacturing activity shrank in December but at a slower pace, with HSBC's manufacturing PMI rising to 49.0 in December from 47.7 in November. Another report showed that China's foreign direct investment in November fell 9.76 percent from a year earlier, the first year-on-year decline since July 2009.

In the UK, retail sales fell 0.4 percent in November while the Confederation of British Industry survey's total order book balance fell to -23 in December from -19 in November.

In the euro area, private sector activity shrank again this month but at a slower pace. Markit's composite PMI rose to 47.9 in December from 47.0 in November. The services PMI rose to 48.3 from 47.5 and the manufacturing index rose to 46.9 from 46.4.

As has been the trend recently, the best economic data on Thursday came from the US. Initial claims for unemployment benefits dropped 19,000 to 366,000 last week, the lowest since May 2008. Industrial production fell 0.2 percent in November but this was after a 0.7 percent increase in October. Furthermore, the Philadelphia Federal Reserve said its index of business conditions rose this month to its highest since March while the New York Federal Reserve reported that business activity in New York state is at its highest since May.

Commodities plunge

Markets fell on Wednesday, with commodities being hit especially hard. Bloomberg reports:

The Standard & Poor’s 500 Index fell 1.1 percent to close at 1,211.82 at 4 p.m. in New York. The Stoxx Europe 600 Index lost 2.1 percent. The euro weakened as much as 0.7 percent to $1.2946 before trimming losses to trade at $1.2981... Ten-year U.S. Treasury yields lost seven basis points to 1.89 percent, while 30-year German bund rates reached a euro-era record low of 2.38 percent...

Oil in New York declined 5.2 percent to $94.95 a barrel as the Organization of Petroleum Exporting Countries agreed to raise its production ceiling, moving the group’s supply target nearer to current output levels. Silver plunged 7.4 percent, gold lost 4.6 percent to $1,586.90 an ounce and copper sank 4.7 percent. Only lean hogs rose among 24 commodities tracked by the S&P GSCI Index, sending the gauge down 4.1 percent for its biggest drop since September.

At least the fall in commodity prices should ease inflation concerns. Import prices in the US had increased 0.7 percent in November while India's inflation rate read 9.11 percent in November, albeit slower than 9.73 percent in October.

Inflation is apparently not a concern at Norway's central bank, which lowered its overnight deposit rate on Wednesday to 1.75 percent from 2.25 percent, the biggest cut since May 2009.

Indeed, economic reports on Wednesday suggest that weak economic growth is the primary concern.

Industrial production in the euro area fell 0.1 percent in October, its second consecutive monthly decline.

The number of people out of work in the UK rose to its highest level in more than 17 years in the three months to October.

Lending and money supply growth in China slowed in November. At its annual economic planning meeting, China's leaders agreed to guarantee steady growth while maintaining policies to "make housing prices return to a reasonable level".

Fed leaves monetary policy unchanged as retail sales slow

The Federal Reserve's monetary policy meeting ended relatively uneventfully on Tuesday, the FOMC deciding not to take new action.

“The economy has been expanding moderately, notwithstanding some apparent slowing in global growth,” the FOMC said in its statement following the meeting.

That expansion looked a little shakier on Tuesday though after the latest report on US retail sales showed only a 0.2 percent increase in November, the smallest in five months. Furthermore, that increase is before taking into account inflation.

Having said that, inflation has become less of a concern these days. Even the UK is finally seeing a decline in its inflation rate, which fell for a second consecutive month in November to 4.8 percent from 5.0 percent in October.

Markets fall after Moody's and Fitch assess EU debt plan

The agreement at the European Union's debt summit last week does not seem to have impressed two of the ratings agencies. Reuters reports:

Moody's Investors Service said on Monday it intends to review the ratings of all 27 members of the European Union in the first quarter of 2012 after EU leaders offered "few new measures" to resolve the crisis in a summit on Friday.

Fitch Ratings said the summit, in which leaders agreed to draft a new treaty for deeper economic integration, failed to provide a "comprehensive" solution to the crisis, thus increasing short-term pressure on euro zone sovereign ratings.

Markets reacted negatively. The S&P 500 fell 1.5 percent on Monday while the STOXX Europe 600 fell 1.9 percent. The euro weakened while European bond yields rose.

Economic data on Monday had also been negative.

The OECD reported that its composite leading indicator fell 0.3 point to 100.1 in October.

Japan's Cabinet Office reported that its consumer confidence index fell 0.5 point to 38.1 in November, its first decline in seven months.

Elsewhere in Asia, India reported that its industrial production fell 5.1 percent in October from the previous year, a sharp reversal from the 1.9 percent increase in September and the first decline in output in more than two years.

Despite Europe deal, markets and economies remain at risk

Stock markets were relatively flat last week despite decent gains on Friday following the agreement by European Union leaders on measures to be taken to resolve the region's debt crisis.

On Friday, the leaders agreed on several short-term measures to alleviate the debt crisis. Up to €200 billion will be provided to the International Monetary Fund to help it finance European governments. The European Stability Mechanism will come into force a year early in July 2012, thus running concurrently for a period with the European Financial Stability Facility, whose leverage "will be rapidly deployed".

For the medium and longer term, the 17 eurozone countries agreed to sign an intergovernmental treaty to enforce fiscal discipline. This may be extended to nine of the other EU countries who are not members of the single currency. The remaining non-member, the United Kingdom, opted out of the agreement.

The treaty, to be signed not later than March 2012, will require that government budgets stay in surplus or be close to balance, with automatic consequences for the governments whose budgets fail to do so.

The EU deal helped stocks finish the week on a positive note. The Standard & Poor's 500 Index rose 1.7 percent to 1,255.19 on Friday while the STOXX Europe 600 Index rose 1.2 percent to 240.51.

However, for the week, stock markets were mixed. The S&P 500 rose 0.9 percent last week, its second consecutive weekly gain, but the STOXX Europe 600 Index fell 0.1 percent.

The market gains on Friday only partially reversed falls on Thursday after European Central Bank President Mario Draghi had disappointed investors by saying that the ECB was not prepared to prop up the bond market by buying government bonds.

“We have a Treaty,” Draghi told reporters at a press conference after the ECB's monetary policy meeting. That Treaty “prohibits monetary financing” of governments.

The S&P 500 fell 2.1 percent on Thursday while the STOXX Europe 600 fell 1.5 percent.

Draghi's comment confirmed John Hussman's view expressed in his article last month “Why the ECB Won't (and Shouldn't) Just Print”. Indeed, in his latest article, “Hard-Negative”, Hussman says that for the ECB to buy distressed European debt, there must not only be an agreement on fiscal union among euro-area members but also explicit EU Treaty amendments including changes in the ECB's restrictions and mandate.

“In any event, the problem for bailout-hungry investors is that they will be deeply disappointed if they expect Mario Draghi to turn into Ben Bernanke,” says Hussman.

The title of Hussman's latest article, however, mainly referred to market and economic conditions, of which he is pessimistic.

“Based on a wide variety of evidence and its typical market implications over an ensemble of dozens of subsets of historical data, the expected return/risk profile of the stock market has shifted to hard-negative,” says Hussman.

As for the economy, Hussman continues to estimate “a very high probability of oncoming recession” in the United States.

He points out that this is also the view of Economic Cycle Research Institute Chief Operations Officer Lakshman Achuthan. The latter said in a recent discussion on Bloomberg that while the latest data on US gross domestic product indicate decent growth, these could be revised down. Furthermore, forward-looking indicators are pointing to a deceleration in the economy.

In the meantime, we already have reports showing that the eurozone economy may already be in recession. Markit Economics reported last week that its composite index based on surveys of purchasing managers in the euro area read 47.0 in November. This was up from 46.5 in October but below the contraction threshold of 50 for the third consecutive month. Markit estimates that the eurozone economy may be contracting at a rate of around 0.5 percent in the fourth quarter.

Even fast-growing China has not escaped a slowdown. Last week, it reported that industrial production rose 12.4 percent in November from a year earlier, slower than the 13.2 percent increase in October.

And over the weekend, China reported that exports rose 13.8 percent in November from a year earlier, slowing from a 15.9 percent increase in October. With imports rising 22.1 percent, the trade surplus narrowed to $14.5 billion.

Weakening growth around the world highlights the risk remaining after last week's events. While markets may have reacted positively to the EU agreement on Friday, investors will have to deal with the fact that with the easy solution of an ECB bailout now off the table, the euro area's debt crisis will continue to simmer even as the world's major economies tip closer towards recession.

Europe agrees on debt deal

The euro area inched a little closer to a solution to its debt crisis on Friday. The New York Times reports:

European leaders, meeting until the early hours of Friday, agreed to sign an intergovernmental treaty that would require them to enforce stricter fiscal and financial discipline in their future budgets. But efforts to get unanimity among the 27 members of the European Union, as desired by Germany, failed as Britain refused to go along...

The European Council president, Herman Van Rompuy, said that in addition, the leaders agreed to provide an additional 200 billion euros to the International Monetary Fund to help increase a “firewall” of money in European bailout funds to help cover Italy and Spain. He also said a permanent 500 billion euro European Stability Mechanism would be put into effect a year early, by July 2012, and for a year, would run alongside the existing and temporary 440 billion euro European Financial Stability Facility, thus also increasing funds for the firewall.

Markets mostly responded positively to the news. The S&P 500 rose 1.7 percent on Friday while the STOXX Europe 600 rose 1.2 percent. US and German bond yields rose while most other European bond yields fell.

Also helping markets was a report showing that the recovery in US consumer confidence has continued this month. The preliminary Thomson Reuters/University of Michigan consumer sentiment index climbed for a fourth straight month to 67.7 in December from 64.1 in November. Another economic report showed that the US trade deficit narrowed in October on declines in both exports and imports.

Japan, China economies show signs of slowing

The economic reports out of Japan today and yesterday were quite negative.

Today, the government reported that it had revised down its estimate of third quarter GDP growth from 1.5 percent to 1.4 percent.

Growth could slow in the fourth quarter. Also today, a report showed that sentiment among manufacturers is deteriorating, the business survey index of sentiment at large manufacturers falling to minus 6.1 for the fourth quarter from 10.3 in the third quarter.

Yesterday's reports had also pointed to a slowing economy.

The current account surplus fell 62.4 percent from a year earlier in October, with the trade balance in deficit after exports fell 2.7 percent while imports surged 21.3 percent. Meanwhile, core machinery orders fell 6.9 percent in October.

The weakening economy is already affecting sentiment in the service sector. Another report yesterday from the economy watchers survey showed that the sentiment index for current conditions fell to 45.0 in November from 45.9 in October. The index for future conditions fell to 44.7 from 45.9.

In China, there have also been signs of a slowdown.

A report today showed that the inflation rate in China eased to 4.2 percent in November, well below the 5.5 percent recorded in October and the lowest rate since September 2010.

Another report today showed that industrial production rose 12.4 percent in November from a year earlier, slower than October's 13.2 percent rise. Urban fixed-asset investment rose 24.5 percent during the January-November period, down from 24.9 percent in the January-October period.

Retail sales, however, rose faster in November, increasing by 17.3 percent from the previous year, compared to a 17.2 increase rise in October.

ECB announces more liquidity-enhancing measures but not more bond-buying

The European Central Bank announced new measures to ease the financial crisis on Thursday after its monetary policy meeting but did not include the one that many most wanted. Bloomberg reports:

European Central Bank President Mario Draghi cut interest rates and offered banks unlimited cash for three years while damping speculation the ECB will buy more government bonds to stem the region’s debt crisis.

Policy makers meeting in Frankfurt today reduced the benchmark rate by a quarter percentage point to 1 percent, matching a record low. They also loosened collateral rules so that banks can borrow more from the ECB and announced two unlimited three-year loans. The measures “should ensure enhanced access of the banking sector to liquidity,” Draghi said at a press conference.

For full resolution of the debt crisis, Draghi threw the ball back into governments' courts.

“All euro-area governments urgently need to do their utmost” to deliver fiscal sustainability, Draghi said. He denied his Dec. 1 remark that “other elements” could follow a push toward fiscal union was a signal the ECB could step up its bond-market intervention, saying he was “kind of surprised” it had been interpreted that way.

The disappointment with the ECB's reluctance to buy bonds was evident in markets on Thursday. Stocks fell, with the S&P 500 falling 2.1 percent and the Stoxx Europe 600 declining 1.5 percent. The euro fell against the US dollar while Italian and Spanish 10-year bond yields rose.

The Bank of England's monetary policy meeting on Thursday was uneventful, with the BoE keeping its interest rate and quantitative easing programme unchanged.

German industrial production rises

The German economy appears to have had a good start to the fourth quarter. Following a report on Tuesday that factory orders rose 5.2 percent in October, Wednesday brought news that German industrial production rose by a better-than-expected 0.8 percent that month.

Italy was not so fortunate. Industrial production there fell 0.9 percent in October.

It was similarly negative in the UK, where industrial production fell 0.7 percent in October.

Even as European economies turn down, Japan's economy is also looking shaky. Its index of coincident economic indicators rose 1.3 points in October but the leading index was flat.

EFSF credit rating at risk, German factory orders jump, RBA cuts rates

Standard & Poor's has warned that the European Financial Stability Facility may lose its AAA credit. Bloomberg reports:

“We could lower the long-term credit rating on EFSF by one or two notches if we were to lower the AAA sovereign ratings, which are currently on creditwatch, on one or more of EFSF’s guarantor members,” S&P said in a statement today.

Despite this threat, markets were mostly little changed on Tuesday. The STOXX Europe 600 fell 0.3 percent but the S&P 500 rose 0.1 percent, the latter boosted perhaps by reports that eurozone lenders are considering strengthening their bailout funds.

Meanwhile, third quarter GDP growth in the euro area was confirmed at 0.2 percent on Tuesday.

While eurozone growth is expected to weaken in the fourth quarter, the German economy appears to have entered the current quarter with surprising strength. Factory orders jumped 5.2 percent in October, the most in 19 months and well above expectations for a 1.0 percent increase.

Still, some central banks are not taking chances with the situation in Europe. The Reserve Bank of Australia lowered its benchmark interest rate by 25 basis points to 4.25 percent on Tuesday, its second consecutive cut. However, the Bank of Canada left its interest rate unchanged at 1.0 percent.

Euro area gets new budget plan as well as downgrade warning

The euro area took another step towards resolving the debt problem. Reuters reports:

The leaders of France and Germany agreed a master plan involving treaty change on Monday to impose budget discipline across the euro zone...

President Nicolas Sarkozy and Chancellor Angela Merkel said their proposal included automatic penalties for governments that fail to keep their deficits under control, and an early launch of a permanent bailout fund for euro states in distress.

They said they wanted treaty change to be agreed in March and ratified after France wraps up presidential and legislative elections in June. "We need to go fast," Sarkozy said.

They need to go fast indeed after yet another credit rating warning.

Standard & Poor's said it had told 15 of the 17 euro zone countries, including Germany, France and four others with the top AAA credit rating, that it might downgrade them en masse within 90 days, depending on the outcome of a crucial EU summit on Friday.

The timing of the reports is ironical; a move towards fiscal union for the euro nations, and then a move to downgrade them all together.

Meanwhile, data on Monday showed that the eurozone economy is already shrinking. Markit's composite PMI for the euro area rose to 47.0 in November from 46.5 in October but remained below the 50 mark that indicates contraction despite the services index rising to 47.5 from 46.4.

Eurozone retail sales did rebound by 0.4 percent in October after having fallen 0.6 percent in September.

In the UK, the services sector has performed better. The Markit/CIPS services PMI rose to 52.1 in November from 51.3 in October.

However, the British Retail Consortium reported that retail sales grew just 0.7 percent in November over the previous year, down from 1.5 percent in October. Like-for-like sales fell 1.6 percent.

In the US, the services sector showed slower growth in November. The Institute for Supply Management’s non-manufacturing index fell to 52.0 in November from 52.9 in October.

And notwithstanding the resilience in the ISM's manufacturing index reported last week, factory orders declined 0.4 percent in October after having fallen 0.1 percent in the previous month.

Indeed, John Hussman thinks that the US economy is still headed for recession. From his latest article:

As of last week, a simple average of 20 of these binary recession indicators continued to show a preponderance of signals still in place - a condition that has never been observed except alongside a U.S. recession...

In short, recent U.S. economic reports have improved modestly from the clearly negative momentum that we saw in late-summer. Unfortunately, the underlying recessionary pressures we observe are largely unchanged. When we take the present set of economic evidence in its entirety, we see very little evidence of a meaningful reduction in recession risks. Indeed, the evidence from the rest of the world, both developed and developing, reinforces the expectation that the global economy is approaching a fresh contraction.

Hussman also has some words regarding the resolution of the eurozone debt crisis through a German or ECB bailout.

Europe doesn't face a liquidity problem. It faces a solvency problem. What investors really want isn't just for someone to buy distressed European debt, but for someone to buy that debt and willingly take a loss on it so the money doesn't ever actually have to be repaid. That isn't going to happen easily. Short of major fiscal improvements in Europe (which appear increasingly hopeless in the face of an oncoming recession) any solution will have to explicitly or implicitly impose losses on someone. In my view, the best "someone" is the investors who willingly made the loans in expectation of earning a spread, and who knowingly took a risk.

The worldwide hope among these investors is that the "someone" taking the hit will instead be the German people, but Germany remains resolutely against printing permanent new euros in order to effectively redeem the debt of Italy and other countries. Despite hopes that the ECB will suddenly shift its policy on this, I continue to expect that any ECB purchases of distressed European debt will follow an agreement on European fiscal union, and that even if initiated, will be on a smaller scale than investors seem to hope. Without airtight fiscal credibility among distressed Euro-area countries, whatever debt purchases the ECB makes will be almost impossible to reverse.

Economies in US and euro area diverging

The past week saw more data showing that the United States and the euro area economies are on divergent paths as far as their growth is concerned.

In the US, data on Friday showed that employment continued to recover in November. The economy gained 120,000 jobs and the unemployment rate fell to 8.6 percent from 9.0 percent in October. The November unemployment rate was the lowest since March 2009.

In contrast, data from the euro area last week showed that the unemployment rate there rose to 10.3 percent in October from 10.2 percent in September. The October unemployment rate was the highest since June 1998.

US manufacturing has also held up relatively well. The Institute for Supply Management's manufacturing PMI rose to 52.7 in November from 50.8 in October.

In contrast, Markit's manufacturing PMI for the euro area fell to 46.4 in November from 47.1 in October, falling further below the 50.0 mark that indicates contraction. The November PMI was the lowest since July 2009.

Confidence is also returning in the US. The Conference Board's consumer confidence index rebounded sharply to 56.0 in November after having plunged to 40.9 in October.

In the euro area, however, confidence has continued to deteriorate. The European Commission's consumer confidence indicator fell to minus 20.4 in November from minus 19.9 in October while the broader economic sentiment indicator fell to 93.7 from 94.8.

Based on data available thus far, the US economy looks likely to maintain growth in the fourth quarter.

For the eurozone economy, however, it looks like the fourth quarter will mark the start of a recession.

US unemployment rate falls, Europe prepares yet another plan

US employment continued to recover in November. Bloomberg reports the latest employment report:

Job gains in the U.S. picked up last month and the unemployment rate unexpectedly fell to the lowest level since March 2009, a decline augmented by the departure of Americans from the labor force.

Payrolls climbed 120,000, after a revised 100,000 increase in October, with more than half the hiring coming from retailers and temporary help agencies, Labor Department figures showed today in Washington. The median estimate in a Bloomberg News survey called for a 125,000 gain. The jobless rate declined to 8.6 percent from 9 percent. Revisions to prior reports added a total of 72,000 jobs to payrolls in September and October.

Some of the underlying numbers were not as good though. Average hourly earnings fell 0.1 percent and the average work week for all workers was unchanged at 34.3 hours.

In Europe, the news on Friday continued to provide some hope for stabilisation of the debt crisis. Bloomberg reports:

A European proposal to channel central bank loans through the International Monetary Fund may deliver as much as 200 billion euros ($270 billion) to fight the debt crisis, two people familiar with the negotiations said.

At a Nov. 29 meeting attended by European Central Bank President Mario Draghi, euro-area finance ministers gave the go- ahead for work on the plan, said the people, who declined to be named because the talks are at an early stage...

... Draghi yesterday hinted at a stepped-up crisis- fighting role as long as governments move toward a “fiscal compact” that ensures healthy public finances.

German Chancellor Angela Merkel laid out elements of that strategy today, calling for European treaty amendments to create automatic, court-enforced sanctions on countries that overstep limits of 3 percent of gross domestic product on deficits and 60 percent of GDP on debt.

Global manufacturing shrinks

Global manufacturing activity shrank in November. The global manufacturing PMI fell to 49.6 in November from 49.9 in October.

In the euro area, the manufacturing PMI fell to 46.4 in November, the lowest level since July 2009, from 47.1 in October.

The UK manufacturing PMI fell to 47.6 in November, the lowest level since June 2009, from 47.8 in October.

Even China's manufacturing sector is signaling contaction. The China Federation of Logistics and Purchasing manufacturing PMI fell to 49.0 in November from 50.4 in October. The final HSBC China manufacturing PMI for November came in at 47.7, the lowest level since March 2009.

US manufacturing was the outperformer. The ISM manufacturing PMI actually increased to 52.7 in November from 50.8 in October.

In another positive sign for the US economy, construction spending climbed 0.8 percent in October.

Markets rally as central banks go into action

Markets surged on Wednesday, with the S&P 500 rising 4.3 percent and the STOXX Europe 600 rising 3.6 percent.

The rally in markets occurred after the world's major central banks went into action on Wednesday.

From Reuters:

The U.S. Federal Reserve, the European Central Bank and the central banks of Canada, Britain, Japan and Switzerland said in a joint statement they had agreed to lower the cost of existing dollar swap lines by 50 basis points from December 5.

Other measures included setting up bilateral swap arrangements between the central banks so that any bank could tap additional liquidity in their own currencies if necessary. The swap arrangements are good through Feb 1, 2013.

Earlier in the day, the People's Bank of China had announced that it would reduce the reserve requirement ratio for banks by 50 basis points.

The surge on Wednesday took markets further away from the year's lows that they had been driving towards last week. However, Brendan Conway and Steven Russolillo at MarketBeat warns the bulls not to get too comfortable.

Central-bank interventions like Wednesday’s move ... have a record of jolting stocks higher... But the underlying, and usually troubling, reasons for the banks’ actions tend to trump the action itself in the long run.

For example, the Federal Reserve triggered a series of sharp, brief stock-market rallies with its newly aggressive posture in late 2007 and most of 2008. The central bank cut the fed funds rate from 5.25% to a range of zero to 0.25% over the span of Sept. 18, 2007 to Dec. 16, 2008, with stocks chopping higher before reversing with even bigger drops.

Indeed, eurozone economic data on Wednesday gave further reasons for caution. Inflation remained at a three-year high of 3.0 percent in November while the unemployment rate rose to 10.3 percent in October, the highest in more than 13 years.

Economic data were somewhat better elsewhere though.

In the US, a report from ADP Employer Services showed that private employment increased 206,000 this month, the Institute for Supply Management-Chicago Inc’s business barometer increased to 62.6 in November from 58.4 in October and pending home sales increased 10.4 percent in October.

Canada's economy grew at a 3.5 percent annualized pace in the third quarter, rebounding after a 0.5 percent contraction in the previous quarter.

In Japan, industrial production rose 2.4 percent in October. However, the Markit/JMMA Japan Manufacturing PMI fell to 49.1 in November from 50.6 in October.

Euro area to boost rescue fund as economic confidence weakens

Eurozone ministers took another step on Tuesday towards resolving the debt crisis. Reuters reports:

Euro zone ministers agreed on Tuesday to ramp up the firepower of their rescue fund but couldn't say by how much and raised the possibility of asking the IMF for more help after Italy's borrowing costs hit a euro lifetime high of nearly 8 percent...

The 17 ministers agreed on a detailed plan to insure the first 20-30 percent of new bond issues for countries having funding difficulties and create co-investment funds to attract foreign investors to buy euro zone government bonds.

Confidence in the eurozone economy has been weak though. The European Commission's economic sentiment indicator fell to a two-year low of 93.7 in November from 94.8 in October.

In contrast, confidence in the US continues to recover. The Conference Board's consumer confidence index rose to 56.0 in November from 40.9 in October.

There were mixed data from Japan on Tuesday. The jobless rate jumped to 4.5 percent in October from 4.1 percent in the previous month but household spending continued to improve, falling just 0.4 percent in October from a year ago compared to a 1.9 percent decline in September.

Markets rally, OECD growth projections and US credit rating outlook cut

After two weeks of declines, markets started this week with a strong rally. The S&P 500 rose 2.9 percent while the STOXX Europe 600 rose 3.8 percent. Italian 10-year yields fell 3 basis points to 7.23 percent.

While investors unwound some of their bearishness on Monday, OECD economic projections are still catching up with the deteriorating outlook. In the OECD's latest economic outlook, member nations are collectively projected to grow 1.9 percent this year and 1.6 percent next year, down from 2.3 percent and 2.8 percent predicted in May.

The OECD says that the euro area is already in a "mild" recession, and its debt crisis represents the "key risk" to the world economy.

Data from the US on Monday suggest that its economy is doing better, with new home sales rising 1.3 percent in October.

However, the US has its own debt problem. On Monday, Fitch Ratings maintained its AAA credit rating for the US but lowered the outlook to negative, citing the recent failure by a congressional committee to agree on a deficit reduction plan.

Equities move back towards lows as debt crisis worsens

The rally in equities that had started around late September and early October has broken down rather dramatically over the past two weeks.

The Standard & Poor's 500 Index closed on Friday at 1,158.67. Over the last two weeks, it fell 8.3 percent and is now 15.0 percent below its 2011 peak of 1,363.61 on 29 April.

The STOXX Europe 600 Index closed on Friday at 221.54. Over the last two weeks, it fell 8.1 percent and is now 23.9 percent below its 2011 peak of 291.16 on 17 February.

The lows set in September and October are now potential support levels for the indices. The S&P 500's Friday close left it 5.4 percent above its low of 1,099.23 on 3 October. The STOXX Europe 600's Friday close was just 3.1 above its low of 214.89 on 22 September.

Driving equities lower, of course, is the European debt crisis.

The debt crisis in Europe has taken a serious turn for the worse, with the core eurozone countries now being swept into the maelstrom as well.

Belgium's credit rating was cut one level to AA+ by Standard & Poor's on Friday.

The yield on Italy's 10-year note hit 7.26 percent last week despite the European Central Bank being in the market to buy Italian bonds.

A debt auction by Germany last week saw bids for just 3.889 billion euros out of a maximum target of 6 billion euros. Germany's 10-year bund yield rose 30 basis points to 2.26 percent last week.

The rise in bund yields amid falling stock prices is unusual. Throughout the development of the debt crisis, bund yields had mostly moved in the same direction as stock prices, reflecting the former's safe haven status.

The divergence of this relationship from its recent past suggests that Germany is no longer perceived as a safe haven. Indeed, there may no longer be a safe haven in the euro area.

Italy's borrowing cost jumps, Belgium's credit rating cut

There was no respite for Europe as the week drew to a close.

Italy's borrowing cost jumped at Friday's debt auction. Italy paid 6.504 percent to sell 8 billion euros of six-month bills, almost twice the 3.535 percent a month ago and the highest since August 1997.

Meanwhile, another eurozone sovereign rating has been downgraded. Standard & Poor's cut Belgium's credit rating one level to AA+ on Friday.

Despite the continued deterioration in the sovereign debt situation, European stocks managed to advance on Friday, the STOXX Europe 600 Index rising 0.7 percent to 221.54. That still left the index down 4.6 percent this week.

US stocks fell though. The S&P 500 declined 0.3 percent to 1,158.67 to end the week down 4.7 percent.

Economic data released on Friday were not any kinder to Europe. Italian retail sales fell 0.4 percent in September, its fourth consecutive monthly decline. Meanwhile, Insee's consumer confidence for France fell to 79 in November, a level not seen since the last recession, from 82 in October.

Europe did not have a monopoly of negative news on Friday. Japan reported a return to deflation as consumer prices excluding fresh food fell 0.1 percent in October.

European bond yields rise, confidence improves in Italy and Germany

Markets continued to reel on Thursday. Stocks were modestly lower, the MSCI All-Country World Index edging down 0.2 percent.

However, European sovereign bond yields continued to climb. Italy's 10-year yield rose 14 basis points to 7.11 percent while Portugal's 10-year yield jumped 90 basis points to 12.21 percent after Fitch Ratings cut the country's credit rating to BB+. Even Germany saw yields rising, its 10-year yield climbing five basis points to 2.20 percent.

Economic data on Thursday were mixed.

Italian consumer confidence unexpectedly improved in November, Istat's consumer sentiment index rising to 96.5 from 93.3 in October.

Also improving in November was German business confidence, the Ifo index rising to 106.6 from 106.4 in October. German GDP growth for the third quarter was confirmed at 0.5 percent.

UK GDP growth for the third quarter was also confirmed at 0.5 percent but factory orders deteriorated further in November with the Confederation of British Industry industrial trend survey showing that total order book balance fell to -19 from -18 in October.

Europe's debt crisis and its inevitable impact on the rest of the world means that central banks are mostly now in easing mode. The People's Bank of China announced on Thursday that it will cut the reserve requirement ratio for more than 20 rural credit cooperatives nationwide by half a percentage point to 16 per cent.

US income and consumer sentiment up but other economic data weak

US personal income rose 0.4 percent in October, the biggest increase since March, according to a Commerce Department report released on Wednesday. With the personal consumption expenditure price index dipping 0.1 percent, real disposable income increased 0.3 percent in October, the largest gain since May 2010.

Personal consumption expenditure slowed though, rising just 0.1 percent.

Another report on Wednesday showed that US consumer sentiment continued its recovery in November though. The Thomson Reuters/University of Michigan consumer sentiment index rose to 64.1 this month from 60.9 in October.

However, US durable goods orders fell 0.7 percent in October, with orders for commercial aircraft plunging 16.4 percent. Excluding transportation, orders rose 0.7 percent. Orders for capital goods excluding defense and transportation fell 1.8 percent.

Manufacturing also appears to have slowed in China. An earlier report on Wednesday showed that HSBC's China purchasing managers' index dropped to 48.0 in November, the lowest since March 2009, from 51.0 in October.

The situation looks worse in the euro area, where industrial orders fell 6.4 percent in September, the biggest decline since December 2008.

There appears to have been little improvement since. The eurozone manufacturing PMI fell to 46.4 in November from 47.1 in October. A rebound in the services PMI to 47.8 from 46.4, however, helped the composite PMI rise to 47.2 in November from a 28-month low of 46.5 in October.

Prospects for improvement in the eurozone economy appear to be receding with signs on Wednesday that contagion in the debt crisis may now be starting to threaten even Germany. From Reuters:

The German debt agency could not find buyers for almost half a bond sale of 6 billion euros. That pushed the cost of borrowing over 10 years for the bloc's paymaster above those for the United States for the first time since October.

"It is a complete and utter disaster," said Marc Ostwald, strategist at Monument Securities in London.

Disaster or not, the new securities were sold at a yield of 1.98 percent, down from 2.09 percent in October.

US third quarter growth cut, eurozone consumer confidence falls

The estimate for US third quarter GDP growth has been cut to 2.0 percent from 2.5 percent, according to a report on Tuesday from the Commerce Department. However, the cut was mainly due to a drop in business inventories. Excluding inventories, the economy grew at an unrevised 3.6 percent pace.

Unfortunately, the situation in Europe continued to deteriorate. On Tuesday, Spain sold three-month bills at an average yield of 5.11 percent, more than twice the 2.292 percent rate at the previous auction on 25 October. Belgium’s 10-year yield reached a nine-year high.

It is not just market confidence in eurozone sovereign debt that has declined. The European Commission reported on Tuesday that its consumer confidence index fell to minus 20.4 in November from 19.9 in October.

Markets fall as US debt committee fails

Markets fell sharply on the first trading day of the week with the MSCI All-Country World Index dropping 2.3 percent.

Markets fell as US lawmakers failed to agree on a plan to cut the budget deficit. Reuters reports:

Lawmakers abandoned their high-profile effort to rein in the country's ballooning debt on Monday in a sign that Washington likely will not be able to resolve a dispute over taxes and spending until 2013...

"Despite our inability to bridge the committee's significant differences, we end this process united in our belief that the nation's fiscal crisis must be addressed and that we cannot leave it for the next generation to solve," Republican Representative Jeb Hensarling and Democratic Senator Patty Murray said in a joint statement.

There was no immediate impact on US credit ratings. Standard & Poor’s noted that $1.2 trillion in spending cuts will be triggered automatically while Moody’s Investors Service said the deliberations were “not decisive”.

Economic reports on Monday had been mixed.

US existing home sales rose 1.4 percent in October. The Chicago Fed National Activity Index rose to -0.13 in October from -0.20 in September but the three-month moving average fell to -0.27 from -0.16.

Earlier in the day, Japan had reported a trade deficit for October after exports fell 3.7 percent from a year earlier. Imports rose 17.9 percent in October from a year earlier.

Will the ECB print?

Many analysts think that the way to solve the euro area's debt problem is for the European Central Bank to buy up the sovereign debt of distressed countries. For example, Steve Liesman wrote last week:

Like a good horror movie, accepting the possibility for the Euro disaster to be averted at this point requires a healthy suspension of disbelief. In fact, so much disbelief must be suspended that it would make the Exorcist seem like a documentary.

The fix, of course, is for the European Central Bank to print money and monetize the debt.

He is not sure that this will happen though.

You can only believe in this ending to the story if you ignore the issue that it may be illegal. The treaties governing the creation and operation of the ECB say it is not supposed to buy sovereign bonds or do anything not in furtherance of its mandate, which is price stability...

However, John Hussman thinks that not only is it unlikely to happen, it might not even solve the problem.

Over the past week, we've heard all sorts of propositions that the European Central Bank (ECB) "must" begin printing money to bail out Italy and other countries, because "there is no other option." There are three basic difficulties with this idea. The first is that ECB buying might help to address immediate liquidity issues of distressed European countries, but it would not address long-term solvency issues, and would in fact make them worse. The second is that the ECB, under existing European treaties, has no such authority, and the prohibitions against it are very explicit. Changing that would be far more difficult than many market participants seem to believe, because it would require an explicit and unanimous change in the EU Treaties that AAA rated countries such as Germany and Finland vehemently oppose. The third difficulty is that even if the ECB was to buy the debt of distressed European countries with printed money, the inflationary effects would likely be far more swift than anything we've seen in the United States. This would not "save" the euro, but would simply destroy it by other means.

Meanwhile, as Europe's debt crisis drags on, yet another government has fallen. From Reuters:

Spain's center-right opposition stormed to a crushing election victory on Sunday as voters punished the outgoing Socialist government for the worst economic crisis in generations.

The People's Party, led by former Interior Minister Mariano Rajoy, won an absolute majority in parliament and is expected to push through drastic measures to try to prevent Spain being sucked deeper into a debt storm threatening the whole euro zone.

US leading index rises, Italian and Spanish bond yields fall

The Conference Board’s index of U.S. leading indicators rose 0.9 percent in October, the biggest jump since February, after a 0.1 percent increase in September.

The stream of positive US economic data recently has led economists to raise their forecasts for economic growth for the fourth quarter. From Bloomberg:

Economists at JPMorgan Chase & Co. (JPM) in New York now see gross domestic product rising 3 percent in the final quarter, up from a previous prediction of 2.5 percent. Macroeconomic Advisers in St. Louis increased its forecast to 3.2 percent from 2.9 percent at the start of November, while New York-based Morgan Stanley & Co. boosted its outlook to 3.5 percent from 3 percent.

“The incoming data on consumption, business spending and residential investment all point to GDP growth in the fourth quarter tracking 3.3 percent,” said John Herrmann, senior fixed-income strategist at State Street Global Markets in Boston.

One risk for the US economy comes from Europe's debt crisis.

The U.S. would not be able to “escape the consequences of a blowup in Europe,” Federal Reserve Chairman Ben S. Bernanke said in El Paso, Texas on Nov. 10. “The world’s financial markets are highly interconnected.”

Federal Reserve Bank of New York President William C. Dudley said in a speech yesterday that while recent economic reports have shown improvement, that shouldn’t be a signal for the Fed to relax its efforts to boost the economy...

“We also continue to face significant downside risks, mostly related to the stress in the euro zone,” Dudley said.

The risk of a "blowup" in Europe receded just a little on Friday after European Central Bank purchases reportedly helped push down Italian and Spanish bond yields.

However, the ECB would prefer that more action come from governments instead. Bloomberg reports:

European Central Bank President Mario Draghi pushed back against politicians and investors asking him to do more to end the sovereign debt crisis, expressing impatience with leaders’ failure to act.

The ECB would quickly lose credibility if it departed from its primary role of keeping prices stable, Draghi said in a speech in Frankfurt today. “Where is the implementation” of government pledges to bolster the region’s rescue fund, he asked. “We should not be waiting any longer.”

Economic data mixed, markets fall

Economic reports on Thursday were mixed.

In the US, applications for jobless benefits decreased 5,000 to 388,000 in the week ended 12 November. Housing starts fell 0.3 percent in October but this was much better than economists had expected, and building permits jumped 10.9 percent. However, the Federal Reserve Bank of Philadelphia’s general economic index decreased to 3.6 in November from 8.7 last month.

In the UK, retail sales unexpectedly rose 0.6 percent in October but Nationwide's consumer confidence index fell 9 points to 36 in October.

Markets were mostly weak on Thursday. Bloomberg reports:

U.S. stocks and commodities slid and the euro erased an earlier gain as concern grew that Europe’s debt crisis will worsen and lawmakers will fail to agree on plans to cut the American deficit. Treasuries gained.

The Standard & Poor’s 500 Index lost 1.7 percent to close at 1,216.13 at 4 p.m. in New York, with losses accelerating as it fell below levels watched by traders including its average over the past 100 days. The euro was little changed at $1.3459 after climbing as much as 0.6 percent. The S&P GSCI Index of commodities slid 2.9 percent, the most since September, as silver and gasoline tumbled at least 4.5 percent.

Concerns over contagion in Europe's debt crisis remain elevated after Spain and France had to pay higher yields at their latest debt auctions.

Spain sold 3.56 billion euros ($4.8 billion) of 10-year bonds at 6.975 percent, while France sold 3.33 billion euros of 2016 notes yielding 2.82 percent. Demand at Spain’s auction was 1.54 times the amount sold, the lowest since 2008, according to data compiled by Bloomberg.

Central banks dovish

The Bank of Japan left interest rates unchanged at 0.1 percent on Wednesday as widely expected. It warned that Japan's economy will "face an adverse effect from the slowdown in overseas economies and the appreciation of the yen as well as from the flooding in Thailand".

Somewhat less expected was a signal from China's central bank of a possible end to monetary tightening. From AFP/CAN:

"The People's Bank of China will at an appropriate time and in moderate degree pre-emptively adjust and fine-tune (the monetary policy)," it said in a statement, adding it would do so according to changes in the global economy.

There could also be further monetary easing in the UK after the unemployment rate hit 8.3 percent in the three months to September, the highest in 15 years, and the Bank of England cut its growth and inflation forecasts.

A 0.1 percent fall in consumer prices in October in the US also raises the probability of the Federal Reserve easing monetary policy.

Not that the US economy isn't growing. Other economic reports on Wednesday showed that industrial production grew 0.7 percent in October while the National Association of Home Builders/Wells Fargo housing market index rose 3 points to 20 in November, the highest reading since May 2010.

However, Fitch Ratings warned on Wednesday that US banks could be adversely affected by Europe's debt problem.

Indeed, the debt problem suggests that the European Central Bank itself could ease monetary policy again, notwithstanding the fact that eurozone inflation held at 3.0 percent in October.

Eurozone economic outlook dim

The eurozone economy barely grew in the third quarter. From Reuters:

The euro zone economy grew just 0.2 percent in the third quarter as solid growth in Germany and France was dampened by countries at the sharp end of the debt crisis and economists expect a slide into recession by early next year.

Growth from July to September was the same as in the second quarter, but the outlook for the last three months of 2011 is dim, with the region's deepening debt crisis weighing on sentiment and consumer confidence.

"The economic slump will accelerate in the coming months," said Christoph Weil, economist at Commerzbank. "We expect real GDP to already fall in the closing quarter of 2011 at a rate of 0.25 percent on the third quarter," he said...

"We expect the economy to contract significantly in Q4, and the recession looks likely to last into next year. The question of exactly how deep and long the recession is depends on whether policymakers act decisively to contain the crisis," said Nick Kounis, economist at ABN AMRO.

Meanwhile, the debt crisis shows no sign of abating. Italy’s 10-year yield climbed 37 basis points to 7.07 percent on Tuesday. Spreads of French, Belgian, Spanish and Austrian 10-year yields over bunds all climbed to euro-era records. Italian, Spanish, Belgian and French credit-default swaps also surged to records.

Contagion continues to widen. Edward Harrison notes that the default probability for Netherlands crossed the 10 percent threshold on Tuesday.

In stock markets, the STOXX Europe 600 fell 0.6 percent but the S&P 500 rose 0.5 percent.

US stocks gained partly as a result of positive US economic reports on Tueday. Retail sales rose 0.5 percent in October after having risen 1.1 percent in September. The New York Fed's general business conditions index rose to 0.6 in November from minus 8.5 in October. The producer price index fell 0.3 percent in October.

Inflation has also showed signs of moderating in the UK. A report on Tuesday showed that consumer price inflation eased to 5 percent in October from September's three-year high of 5.2 percent.

Italian, Spanish yields set euro-era records, eurozone industrial output falls

Italy has a new prime minister in former European Commissioner Mario Monti. However, investors remained cautious about the country, forcing Italy to pay a euro-era high rate of 6.29 percent to sell €3 billion worth of five-year bonds on Monday.

Investor nervousness was evident throughout financial markets on Monday. Stocks fell, both the S&P 500 and the STOXX Europe 600 losing 1 percent. The euro weakened 0.9 percent to $1.3628.

The Italian 10-year yield increased 25 basis points to 6.70 percent. Spain's 10-year yield also increased 25 basis points to 6.11 percent, pushing its spread versus German bunds to a euro-era record high.

Weak economic data added to the negative news from Europe. Industrial production in the euro area fell 2.0 percent in September, the biggest decline in 2½ years.

Japan's economy returns to growth

The Japanese economy grew in the third quarter as it recovered from the effects of the earthquake and tsunami in March.

The Cabinet Office reported today that the Japanese economy grew 1.5 percent in the third quarter. This marks a return to growth in real gross domestic product following three consecutive quarters of declines.

Exports helped drive the return to growth in the third quarter. Exports grew strongly by 6.2 percent, recovering from a 5.0 percent decline in the second quarter following the disruptions to the economy caused by the earthquake and tsunami in March.

The growth in exports enabled net exports to contribute 0.4 percentage point to third quarter growth, its first positive contribution in five quarters.

Domestic demand also contributed to growth in the third quarter as it increased by 1.0 percent.

The strong growth in the third quarter was, to a large extent, a rebound from the effects of the earthquake though. Other recent economic indicators show that growth is likely to slow in subsequent quarters.

Last week, another report from the Cabinet Office showed that its index of leading economic indicators fell 2.2 points in September, its second consecutive monthly decline. The index of coincident economic indicators fell 1.4 points in September.

Also last week, the Economy Watchers Survey showed that the diffusion index for current conditions rose to 45.9 in October from 45.3 in September but that is still significantly below its recent peak of 52.6 in July. Meanwhile, the index for future conditions fell to 45.9 in October from 46.4 in September, its fourth consecutive decline.

Meanwhile, a strong yen and a weak European economy are factors that are likely to weigh on the Japanese economy. Also, another natural disaster, this time flooding in Thailand which is seriously disrupting economic activity there, could have an impact on Japanese companies that have manufacturing facilities there.

So while the Japanese economy has largely recovered from the disruptions of the earthquake, its growth outlook remains fragile.

China new loans jump but working age population to shrink

Friday brought signs that China may be easing credit restrictions. The People's Bank of China reported that new loans issued by banks rose almost 25 per cent in October to 586.8 billion yuan from 470 billion yuan in September.

China is obviously concerned about the fallout from the European debt crisis. However, China has to be careful about raising debt levels in an economy where the working age population will soon start to decline. Mamta Badkar at Business Insider draws on a Nomura report to highlight these as well as other demographic statistics:

• China's population will peak in 2025.
• Its working age population will rise from 971 million in 2010 to 996 million in 2015 but then shrink to 960 million in 2030.
• Its old age dependency ratio will surge from 11.3 percent in 2010 to 23.9 percent in 2030.

Already, there are signs that China's factories are being hit by higher wages even as demand from Europe and the US slows.

This may be a sign that China's deflationary impact on the rest of the world is coming to an end.

Italy successfully sells debt but European economic recovery stalls

Markets remained nervous over Europe's debt problems on Thursday despite a relatively successful Italian government debt auction which saw 5 billion euros of one-year bills sold at a yield of 6.087 percent. The STOXX Europe 600 fell 0.4 percent but the S&P 500 managed to recover 0.9 percent.

US stocks were boosted by positive economic data on Thursday. The trade deficit shrank 4 percent in September after exports rose 1.4 percent while imports rose 0.3 percent. Initial claims for unemployment benefits fell by 10,000 to a seven-month low of 390,000 last week.

In contrast, data from Europe had been negative. French industrial production fell 1.7 percent in September while Italian industrial production plunged 4.8 percent.

The European Commission has acknowledged the worsening outlook for Europe in its latest economic forecast.

EU growth will remain at a near standstill during 2012 and return to slow growth in 2013. Unemployment is forecast to remain at the current high levels.

All main indicators point to a stalled recovery with considerable downside risks.

No economic growth is now expected in the current and coming quarters. Consequently, GDP is forecast to grow at a rate of only ½% in the EU and the euro area in 2012. Some acceleration is expected in 2013, when growth is set to reach 1½% in the EU and 1¼% in the euro area. While growth rates will differ across the Union, no group of countries will remain unaffected by the slowdown.

Despite the deterioration of the economic outlook in Europe, the Bank of England, which had expanded its quantitative easing programme last month, took no further action on Thursday at its monetary policy meeting.

Meanwhile, Asia's economy may also be slowing.

China reported on Thursday that its exports rose 15.9 percent in October from a year ago, down from 17.1 percent in September. Imports, though, rose 28.7 percent in October compared to 20.9 percent in September.

Japan, which had been recovering from the earthquake and tsunami in March, reported on Thursday that its consumer confidence index was unchanged in October from the previous month while core private-sector machinery orders fell 8.2 per cent in September.

Italian yields surge as wider contagion threatens

After holding up relatively well in recent day, stock markets finally succumbed to the worries over European debt on Wednesday. The S&P 500 plunged 3.7 percent, its worst drop in almost three months. The STOXX Europe 600 fell 1.7 percent.

The trigger for the declines was a surge in Italian bond yields. The 10-year yield rose 48 basis points to 7.25 percent and the two-year yield surged 82 basis points to 7.20 percent.

The situation looks dire, according to some analysts quoted by Bloomberg.

“The contagion effect is no longer a risk, it’s a fact in Europe,” Stephen Wood, who helps oversee about $163 billion as the New York-based chief market strategist for Russell Investments, said in a telephone interview...

Italy may be “beyond the point of no return” in becoming the next victim of Europe’s debt crisis even if the government implements austerity measures to reduce debt, Barclays Capital analysts say.

Still, Marc Chandler thinks that Italy actually has enough resources to pay its debt and that the problem is “primarily one of confidence not solvency”. Nevertheless, a “policy response must be forthcoming in short order or the contagion will overwhelm everything else”.

As it is French and Spanish bond yield spreads versus Germany joined their Italian counterparts in hitting record levels on Wednesday.

The debt crisis may already be hurting confidence in the real economy in France. The Bank of France's sentiment indicator for industrial activity fell to 96 in October from 97 in September while its index for the services sector fell to 95 from 96.

Meanwhile, outside Europe, there were mixed data on sentiment in Japan on Wednesday. The Cabinet Office's economy watchers survey showed that the sentiment index for current conditions rose to 45.9 in October from 45.3 in September. The index for future conditions, however, fell to 45.9 from 46.4.

Other reports on Wednesday showed that China's economy may already be slowing. Industrial production rose by 13.2 percent from a year earlier in October, its slowest rate of increase in a year. Inflation moderated to 5.5 percent in October from 6.1 percent in September.