The relatively calm foreign exchange market and equity market in Asia ended
abruptly in Europe. It is difficult to find the culprit, other than
position squaring in thin markets, but the euro has come off a cent, dragging
the franc. The MSCI Asia Pacific Index gained more than 0.5%, while
European bourses are broadly lower, with the Dow Jones Stoxcx 600 off 0.3% near
midday in London, led by utilities and financials. Fixed income markets
are subdued. Italy's bond auction was adequately received, especially
holiday conditions.
There have been a few developments to note. First Japan's data was
disappointing and this can only bolster the new government's attempt to
stimulate the economy both monetarily and fiscally. Worker cash earnings
fell a whopping 1.1% in November, nearly three times larger than the
consensus. This may have been a factor behind the poor retail sales,
which were flat. The consensus had expected a 0.4% increase. Weak
incomes and domestic demand may have, in turn, weighed on output. In
November, industrial production fell 1.7%, more than three times the
decline expected.
In terms of the weekly MOF portfolio flows, they continue to be consistent
with expectations of a weaker yen. With this assumption, Japanese
investors would, all else being equal, prefer foreign bonds over foreign stocks
and indeed that is exactly what they continued to do--buy foreign bonds and
sell foreign shares. Foreign investors, in anticipation of further yen
weakness, show a continued preference for Japanese stocks over
bonds.
In Europe, the economic news, on the face of it, would seem positive.
Spain, for example, reported a (small) current account surplus in Oct (~865 mln
euros). This is the third surplus of the year and supports our
expectation for reduced imbalances within Europe to ease the Target2
imbalances. Spain reported capital inflows of 12 .1 bln euros
after 31 bln in Sept. Foreign portfolio inflows were 6.3 bln euros after
9.3 bln in Sept. Spain also reported retail sales that had only
fallen 7.8% year-over-year rather than 10% the market expected.
France revised Q3 GDP to 0.1% from 0.2%, but Nov household consumption was a
bit stronger at 0.2%.
In Germany, the first state to report Dec inflation figures, Hesse, reported
a large rise of 0.9% on the month, which lifted the year-over-year rate to 2.2%
from 1.8%. Although following the last ECB's meeting and reports that a
majority had favored a rate cut, what now appears to be a spike in German
inflation would seem to reduce the odds of a rate cut in January.
Turning to the US, we note that any glimmer of hope that Washington will
avoid the worst of the fiscal cliff sees risk-assets (e.g. equities) rally and
the dollar weaken (except against the yen). The market sees the
possibility of one last ditch effort. Today, Obama meets with the top two
officials from both the House of Representatives (Boehner and Pelosi) and the
Senate (Reid and McConnell). Reports suggest the key now turns not so
much on tax increases as the $109 bln in automatic spending cuts. Most
investors still seem to be looking past the near-term uncertainty and assume
that the one way or the other, the full impact of the cliff will be
diminished.
