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.