The Week Ahead: not meaningful recovery expected in US Labour market

This is an excerpt from out latest Top Down Outlook:

ISM Manufacturing Index (Monday 1) – The ISM manufacturing index has been above the 50 ceiling since August ’09, indicating a comeback by the manufacturing sector. In December the index rose to 55.9 – the highest since May ’06 – highlighting the manufacturing sector’s momentum-gathering recovery at the tail end of the year. We expect the index to slightly edge down in January to 55.3 as the economic outlook is still clouded with uncertainty. However, the outlook for the manufacturing sector is likely to remain positive in the short term, driven by the reinvigorated global economy and a slight improvement in internal demand.

Construction spending (Monday 1) and pending home sales (Tuesday 2)– Both construction spending and pending home sales fell markedly in November. Construction spending figure is likely to further tumble in December (our estimate: -0.8% m/m) as the non-residential sector will no doubt continue its descent. Having slumped by 16% m/m in November, pending home sales may rebound by 4% m/m in December as the federal tax credit to first-home buyers has been extended through June.
ISM non-manufacturing (Wednesday 3) – The ISM Non-manufacturing Index was highly volatile in the last few months as the uncertainty on consumer spending outlook remains high. We expect the index to edge up to 54 in December, indicating the recovery in the widest US economic sector is likely to continue into early 2010, albeit at a subdued pace.

Labour market (Friday 5) – Non-farm payrolls came in worse than expected in December, declining by 85k. However, the contraction was the lowest since January ’08; with the exception of November ‘09, when non-farm payrolls increased by 4k. Two current sources of data showed that the labour market may at least be close to bottoming out. Indeed, in the last few weeks, prospects for bottoming out in the short term came from a batch of data: initial jobless claims have been trending downwards since August ’09, the “jobs hard to get” sub-index in the Conference Board Consumer Confidence Index fell to 48.6 in December and employment sub-index in the ISM Manufacturing Index remained above 50 for the third consecutive month in December. However, we still expect a slight contraction in non-farm payrolls in January: -10k. The unemployment rate is likely to remain stable at 10% and we do not expect a sustained improvement in the short term. The unemployment rate surge was less than forecasted in the last few months as the number of discouraged people leaving the labour workforce rose strongly. Should the labour market outlook improve, these people are likely to return to actively seeking work.

The KOF leading indicator likely to show Swiss economic recovery to continue

The KOF leading indicator rebounded for eight consecutive months and reached 1.68 in December – a 23-month high. The global economic upturn should push the KOF index even higher in early 2010 on rosier outlooks for Swiss exports. However, the index’s pace of recovery has decelerated in the last few months as uncertainties emerged on the sustainability of the current economic recovery. The KOF index is likely to increase to 1.82, a level consistent with a higher-than-expected long-term average growth of the Swiss economy in the coming six months.

Australian Dollar/Japanese Yen outlook

It was an extremely volatile week for the whole of the asset classes in our Top Down Portfolio, with major international equity markets erasing early year’s gains, commodity prices falling and carry trades losing momentum. The only exception was the NOK/SEK exchange rate, which was little changed ahead of the 3 February Norges Bank monetary policy meeting that may see the CB hiking rate to 2%. Our base scenario is that the Bank will not tighten until the March 24 monetary policy meeting.

Three main events triggered an increase in risk premiums on major international financial markets: 1) early signals that China may tighten monetary policy following robust GDP growth in Q4 (10.7% y/y); 2) the Obama administration’s plan to limit the size and trading activities of financial institutions prohibiting banks from running proprietary trading operations solely for their own profit and sponsoring hedge funds and private equity funds; 3) lower than expected corporate results in the US.

As regard our investment portfolio, a higher risk premium prompted a fall in the Australian Dollar against the Japanese Yen. The decline in commodity prices and the unwinding of carry trades were the main triggers of the Australian Dollar’s drop. Compared to 5 December, when we built our first Top Down Portfolio, the AUD/JPY exchange is little changed, having given back previous gains (we do not consider the positive return coming from interest differential).

Although uncertainty surrounds the short term outlook, we believe that the AUD/JPY exchange rate will likely appreciate medium term. Indeed, the Australian Central Bank, after lifting interest rates three times in 2009, is widely expected to continue its tightening policy in 2010 as labor market strength may increase inflationary pressures, with a further rate hike during the 3 February monetary policy meeting that is a clear possibility. Moreover, while the markets were disappointed by signals of a more restrictive monetary policy in China, which dragged down commodity prices (a variable well-correlated with Australian Dollar exchange rate) estimating that it will trigger lower economic growth, we believe that this decision is the consequence of both strong economic growth and the Chinese Authorities’ willingness to curb excessive credit growth, preventing bigger problems in the months ahead. By contrast, in Japan the Central Bank should continue to implement an expansionary monetary policy for a long time in the face of a persistently sluggish demand and prolonged deflation.

Only an increase of the Vix Index (used as a proxy of risk premium on international markets) above 30 will lead us to abandon our bullish stance on the AUD/JPY. Indeed, since 1998 a strategy based on buying the AUD/JPY when the Vix index was below 30 and selling the exchange rate when the VIX was above 30 has gained a total return of 38%.

IFO index preview

In December, the IFO index rose for the ninth consecutive month to 94.7, from 93.9 in November. We expect the IFO’s upward trend to continue into January, albeit at a slower pace: our estimate is for an increase to 95.1 – the highest since July ‘08. The current situation index should rise from 90.5 to 91.4, while the expectations index should remain unchanged at 99.1, as economic recovery is likely to weaken in the months ahead. Should our estimate prove correct, the IFO should remain slightly below the long-term average (95.5), indicating a continuance in the economic recovery in early 2010.

Will the Fed strengthen the US Dollar?

An excerpt from out weekly Top Down Outlook

Over the last week the Euro exchange rate declined versus the major international currency : the Euro fell by 1.66% versus the US Dollar, by 0.53% versus the UK Sterling and by 2.61% versus the Japanese Yen. More limited was the fall against the so-called commodity currencies (Australian Dollar, Canadian Dollar, New Zealand Dollar and Norwegian Krone), as they felt the negative effect of lower commodity prices due to both the uptrend in the US Dollar and the tightening of monetary policy in China.

The Euro’s fall was mainly triggered by the negative pieces of news coming from Greece. Last week, the country’s Government Bond yields hit their highest since the adoption of the Euro: the two-year note jumped to 4.23% and the 10-year bond to 6.17%. The spread between the Greek and German Bund widened to almost 300bp and the credit default swap rose to 345bp. Investors drove higher Greek Government Bond yields amid fears that the Greek Government might struggle to sell its debt to fund the deficit – the biggest within the European Union – and questioned the country’s ability to implement the deficit-reduction plan presented to the European Commission on 15 January.

Under the plan, Greece will slash spending and raise revenue by about €10bn this year, bringing the deficit/GDP ratio down to 8.7% by year-end. The deficit/GDP ratio is seen falling to 3% by 2012. According to the plan, the Greek Government should sell more than EUR53bn in debt this year (16bn in Q2).

Further uncertainty over the Greek economic outlook is also provided by the numerous statements made by many European authorities, according to which the European Union will not bail out Greece (Finance Minister Papaconstantinou said during the past week that a rescue package won’t be needed), hence suggesting that the European Union is likely to adopt a tough stance towards Greece not to encourage moral hazard among other European countries with ballooning national debt (i.e. Spain, Portugal and Ireland). A we have pointed out in the 11 January Global strategy weekly (“A good start for 2010”), although we believe that there is little chance that Greece will default in the next few years and that the European Union will not take action to help derail a default, we believe that the country’s negative outlook will continue to weigh on the Euro going forward.

However, other factors are penalising the Euro. The economic data published in early 2010 confirmed our view that the pace of the recovery will be more moderate in the Euro zone than in the US. The 2009 German real GDP figure published on Wednesday 13 provides a clear example: GDP contracted by 5% in 2009 against consensus estimates of -4.8%. This indicates that Q4 GDP may have been much weaker than previously expected, with a flat GDP that seems the most likely outcome in Q4. The Zew index, published last week, declined for the fourth consecutive month in January, showing that economic growth may soften sharply in the coming quarters. Next week, attention will focus on the German IFO index for January, due for publication on Tuesday 26. Although the business confidence index is expected to edge up, the increase is likely to be slim, confirming that economic recovery is losing momentum due to the imminent ending of the fiscal measures that have sustained the economy in the last few months. The latest economic data released in US, particularly in the real estate sector, offered evidence that also the US economic upturn is clouded in uncertainty. However, as we have suggested in last week’s Global Strategy Weekly (“What is the yield spread telling us?”), all leading economic indicators show that the economic recovery continue into the months ahead.

Next week, the FOMC monetary policy meeting will take centre stage. Although we do not expect major surprises on the interest rate outlook, we believe that the Federal Reserve might slightly upgrade its economic estimates, albeit confirming that the economic activity will stay sluggish for some time. Though confirming that the Federal Reserve will not hike rates any time soon (at least not until H2 ’10), an upgrade in economic outlook by the Fed will likely bring investors to increasingly discount the possibility that the Fed and not the ECB will be the first Central Bank to tighten in 2010.

Overall, we reiterate our view that the Euro might continue to trend downward against the US Dollar: we stick to our recommendation to sell the EUR/USD with a medium/long term target of 1.17, in line with the fair value of the EUR/USD exchange rate based on the PPP calculated by the OECD.

UK inflation hedged up and unemployment rate improved

Inflation in the UK climbed by 2.9% y/y in December, scaling 1% more than in November. This sharp increase was due to 1) the base effect in energy prices; 2) the reversion of last year’s temporary VAT reduction; 3) the decline in Sterling. The reversion of last year’s VAT reduction and the Sterling’s depreciation are likely to push up prices again in January. However, the effect of the former is highly uncertain, since it depends on how retailers will respond. With consumer spending still weak, the possibility of raising prices is limited. Inflation may surpass 3% in January, consequently calling for the BoE Governor to report to the Chancellor explaining the reasons for the increase of the CPI above the inflation target (2% with a 1% tolerance). With inflation expected to weaken throughout the year as spare capacity continues to put downward pressure on inflation, we believe that the BoE will not change its monetary policy stance in the short term.

The UK unemployment rate fell at its fastest pace since April 2007 as the economy showed signs of emerging from its worst recession on record: the widely-watched claimant count measure of unemployment in December fell by 15,200, much larger than the 4,600 decline forecasted by the consensus. The 7.8% UK jobless rate swam underneath the 10% figure submerging both the USA and the Euro zone. The trend towards more favorable employment conditions is likely to continue in the next few months, though at a very slow pace. Indeed, the UK’s economy is likely to exit from recession in Q4 and grow at a very moderate pace throughout 2010.

The Week Ahead in US: Fomc meeting and Q4 GDP on the spotlight

This is an excerpt from the "Top Down Outlook" we will publish over the week end.

Existing home sales (Monday 25), New home sales (Wednesday 27) – While the worst of the crisis appears to be behind the real estate sector, a return to a healthy growth rate is not on the horizon. With the labor market failing to reverse the two-year negative trend and foreclosures expected to rise in the months to come, we do not expect a rebound in the real estate sector over the short term. The drop in the NAHB housing market index signaled that real estate’s recovery may remain soft in the coming months due to competition from foreclosed homes on the market. After falling to 355k in November, we expect new home sales to increase to 366k, while existing home sales may rise from 6,54m to 6,69m, as the steady two-year decline in housing prices may continue attracting bargain hunters.

Consumer confidence index (Tuesday 26) – Having increased to 52.9 in December from 50.6 in November, we expect the Conference Board’s consumer confidence index to slightly edge down in January to 52.4. Notwithstanding the strong equity markets and the stabilization of the housing markets, we believe that only a strong turnaround in the labor market may push consumer confidence further upward. The index will indicate a moderate increase in consumer spending in the next few months.

FOMC meeting – interest rate decision (Wednesday 27) – No major pieces of news are expected from next week’s FOMC’s monetary policy meeting. Indeed, the FOMC is widely expected to maintain the target range for the Federal Fund rate at 0 to 0.25%. The Federal Reserve may continue its somewhat optimistic position on the economic outlook, particularly with regards to the business investment outlook, but may also continue to indicate that economic activity is apt to remain weak for the time being. The FOMC is also likely to elaborate on the removal of QE measures. We expect the Fed to maintain its view that “economic conditions, including low rates of resource utilization, subdued inflation trends and stable inflation expectations are likely to warrant exceptionally low federal fund rate levels for an extended period of time”. With capacity utilization well below historical average, unemployment at 10%, and core CPI expected to remain below 2% for a long period of time, we believe that the Fed will not raise rates before the end of H1 ’10, and that the subsequent tightened monetary policy will be very gradual (we pencil in the Fed fund rate at 1% by the year’s end).

Durable goods orders (Thursday 28) – Durable goods orders rose by 0.2% m/m in November, albeit the sharp decline in the transportation component (-5.5%). Orders ex-transportation rose by a solid 2% m/m, underlining the positive trend in durable goods orders in recent months. We project the positive trend to continue in December, in line with indications from the ISM new-orders sub-index, which rose to 65.5 in December – the highest since December ’04. We forecast durable goods orders to increase by 1% m/m. However, when compared with December ’08, orders would decline by 2.4%. December durable goods orders are likely to strengthen the view that US economic recovery will continue into early 2010. However, should our estimate prove correct, total durable goods orders would remain 27% below the September ’06 peak, indicating that US economy is still running well below its potential.

Gross Domestic Product (Friday 29) – Having grown by 2.2% in Q3, US real GDP is expected to increase by 4.2% in Q4. This economic rebound is likely to be driven by total investments, which we project to grow by 1.7% q/q. Real personal spending is likely to rise by 0.4% q/q, having so far risen by 0.4% in October and by 0.2% m/m in November. Inventories are likely to contribute positively to total growth, while the contribution from net trade is likely to be slightly negative. In 2009, the GDP may have dipped by 2.5%

Chicago PMI (Friday 29) – In December, the Chicago PMI index rose to its highest mark since May 2007, indicating a strong recovery in industrial production. While we expect the industrial production recovery of recent months' to continue into early 2010, we project the Chicago PMI to slow down to 58.3 in January. The Chicago PMI would anticipate an increase of January’s ISM index, due for publication the following week.

What is the yield curve telling us on financial markets

In the post What is the yield curve telling us about economic recovery we have analysed the development of the yield curve and its messages as regards the economic outlook. In the following post, we are going to explore the messages of the yield curve development on financial markets. This is an excerpt from our latest Top Down Outlook:

Considering that the slope of the yield curve is a reliable indicator of economic direction, it is interesting to assess the predictive power of the yield curve relating to major financial markets. As a first step, we should look at the S&P500 returns as a function of different assumptions about the yield curve steepness. Since 1953 a strategy consisting in buying the S&P500 when the yield curve is positive and exiting the equity market and investing in T-Bill when the yield curve is inverted has produced a 7.7% average annual compound return against +7.3% of a buy and hold strategy - without considering the returns delivered by T-Bill when no position has taken on equity markets. The average monthly return stands at 0.74% when the yield spread is positive and at -0.2% when it is negative.

However, equity markets recorded their highest returns when the spread between the long term rates and the short term rates was above 1% but below 2%. In this case the average monthly return was 1.3%. When the yield spread is above 3% as it is now (this has occurred in 64 months since 1953, 10% of the total), the S&P500 sees a 0.5% monthly return. For this reasons, should the yield spread remain above 3%, we would expect a positive performance for the S&P500, though lower than the historical average monthly return (+0.65% since 1953).

The slope of the yield curve also has a reliable predictive power for the returns delivered by all other international equity markets. For example, since 1993 the German Dax Index has brought a 1.2% average monthly return when the spread between the long term rates and the short term rates was above 1% and a 0.2% return when the spread was below 1%.

Finally, we should consider the predictive power of the yield slope with respect to the government bond market. A very steep yield curve has been usually followed by a decline in long term rates and an increase in short term rates. This relation is not a major surprise. Indeed, we have showed that a very steep yield curve has been traditionally followed by robust economic growth. This has prompted many Central Banks into monetary tightening, hence pushing up short term rates, which are closely correlated with the overnight rates set by the Central Bank, but into lowering long term rates as investors start discounting more moderate economic growth and growing inflationary pressures. A similar pattern has also appeared in the German Government bond market. Overall, we are looking for a flattening of the yield curve both in the US and in the Euro zone in the months ahead.

What is the yield curve telling us about economic outlook?

In our weekly Top Down Outlook we have analysed the development of the yield curve and its messages as regards the economic outlook

The onset of the New Year has failed to lessen investor uncertainty concerning the ongoing economic recovery and equities uptrend. Based on a recent economic commentary by the Cleveland Fed economist Joseph Haubrich, we have used the yield curve as a forecasting tool to try understanding what might happen to the economy in the months to come. Indeed, since the 80s, a large number of academic studies have suggested that the yield curve is a reliable predictor of recessions: for example, before each of the last seven recessions, including the last one, short term interest rates (3 month T-Bill) rose above long term rates (10y T-Bond), producing what economists call yield curve inversion. Although the yield curve has made a poor job in forecasting the magnitude of economic growth, it is a great forecaster of the direction of the economy. More generally, the rule of thumb is that an inverted yield curve indicates a recession in about a year, a flat curve indicates weak growth and a steep curve indicates sharp growth. The recent slope of the yield curve offers ample evidence that the pace of recovery is unlikely to moderate in 2010. Between December 2009 and early January 2010 the slope of the yield curve increased to almost 380bp, up from November’s 335bp and from October’s 332bp.

The outcome of past academic studies also enables us to calculate the likelihood of a recession in the 12 months ahead using the steepness of the yield curve. In particular, we are using a probit model, which exploits the normal distribution to convert the value of a measure of the yield curve steepness into a probability of recession one year ahead. The model developed by the NY Fed economists Estrella and Trubin (“The yield curve as a leading indicator: some practical issues”) suggests that the current yield spread is in line with a 0% chance of recession in the coming 12 months. Another meaningful probit model was developed by the Fed economist Jonathan Wright in the paper “The yield curve and predicting recessions”. This model uses both the yield spread and the level of the Fed fund rate to determine the probability of recession. According to Wright calculations, the predictive power is higher than that of the yield spread alone. Even under this model, the chances of another recession in the subsequent 12 months appear to be close to 0%.

Are we sure that a recession will not occur in 2010? An argument against taking too much comfort from the positive slope of the yield curve was provided by Paul Krugman, who had previously predicted a 30/40% chance of a recession materializing in 2010. In his NY Times blog, Krugman said that, given that the Federal Reserve cannot cut rates from here, long-term rates must be higher than short-term rates because they are like an option: short rates might move up but they cannot go down.

Krugman reinforced his view highlighting that in Japan the yield curve was positively sloped all the way through the lost decade.

However, unless the US economy experiences a lost decade, as it occurred in Japan - a possibility that we do not rule out but that we consider thin - the yield curve message should be taken seriously. Only signals of a new recessionary phase before the Fed begins to raise rates will bring us to reconsider the yield curve as a forecasting tool.

The predictive power of the slope of the yield curve is not limited to the US economy. In a paper published in 1996 (“Does the term structure predict recessions? The international evidence”) BIS’s economists Bernand and Gerlach highlighted that home country yield curves have predicted recessions in 8 countries. Hence, based on most recent data, no major developed countries will likely slip into recession in 2010. The steepness of the yield curve also gives us useful indications of the corporate profits outlook. Indeed, a considerable gap between the 10 year T-Bond and 2 year T-Bill has been usually followed by a sharp increase in corporate profits in the subsequent three years (see chart below). Obviously, this does not come as a surprise considering the above-mentioned yield curve ability to anticipate economic growth.

Bank of Canada outlook: rates expected to remain unchanged

Bank of Canada: interest rate decision (Tuesday 19) – During next week’s monetary policy meeting, the Bank of Canada is widely expected to leave rates unchanged at 0.25%. We also estimate that the BoC will confirm its view that rates should be held steady until the end of Q2 ’10. The Canadian economy showed signs of picking up in Q4 (latest data on employment, retail sales and housing activity came in better than expected) strengthening the view that economic activity will gather momentum in early 2010. The Consumer Price Index is expected to show volatility in commodity prices, but overall inflationary pressures should remain subdued as the output gap will not close before the end of the year. With inflationary pressures subdued and the Canadian Dollar strengthening against the US Dollar, we see the possibility that the BoC will maintain rates longer than projected by the Bank and longer than our interest rate rule would prescribe. Indeed, we believe that unless there is a weakening of the Canadian Dollar, which is overvalued by almost 15%, the BoC is unlikely to tighten monetary policy ahead of the Fed (we predict the Fed will not raise rates before H2 ’10). However, our interest rate rules indicate that, should economic recovery be stronger than expected or inflationary pressures less subdued than forecasted, the BoC has the possibility to hike rates considerably (e.g. to 2%) before the end of 2010. In this case the Canadian Dollar may strengthen considerably against other major international currencies, mainly against the US Dollar.

A quick recap of last week data in Europe

An excerpt from the lastest Top Down Outlook

Euro Zone

As widely expected, the ECB decided to leave rates unchanged at 1% during the monetary policy meeting last week. At the press conference the ECB president Trichet did not contradict the possibility that rates are likely to remain unchanged at least until the end of H1 ’10 and then gradually increase to 1.5% by the end of 2010. Trichet pointed out that economic activity in the Eurozone continued to expand towards the end of 2009, although a number of supporting factors are only of a temporary nature. The level of uncertainty is very high. Inflation is expected to remain at about 1% in the short term and expectations concerning inflation over the medium to long term are firmly held. Far-reaching risks associated with the economic outlook and inflation are on the whole balanced. Trichet also emphasized that the ECB will continue to support the credit market, but will gradually phase out the extraordinary liquidity measures. As for Greece, Trichet shunned the hypothesis that the country will leave the Eurozone and that much work remains to be done.

A mixed batch of data came out over the course of last week. On the negative side, the worst indications came from actual GDP growth in Germany during 2009: GDP contracted by 5% in 2009 as against market expectations of -4.8%. This means that Q4 GDP may have been much weaker than previously expected and a flat GDP seems the most likely outcome in Q4. The public sector deficit was at 3.2% in 2009, slightly below market expectations of 3.5%. Italian industrial production was also lower than market expectations in November, rising by 0.2% m/m as against market expectations of 1% m/m. Compared to November ’08, industrial production contracted by 5.2%. On the positive side, both French industrial production and the business confidence index came in better than expected. However, this may be the result of the French recovery being slower than that of the other major European economies.

Data published during the last week were in line with expectations of the European economy coming out of recession very gradually.

UK

Macroeconomic data published during the last week came as a reminder that economic recovery in the UK is likely to be subdued in the short term. Even if industrial production rose more than expected in November (+0.4% m/m as against market expectations of +0.3% m/m), this was the result of the increase in the mining and utilities sectors, while manufacturing production unexpectedly stalled for the second consecutive month. The lower than expected figures in the manufacturing sector indicated that in Q4 the UK economy should come out of recession, but that the growth rate may remain very low. As regards the real estate sector, a sign of caution came from the RICS house price balance: in December the number of estate agencies reporting that prices rose exceeded those reporting declines by just 30%, down from 35% in November. The data shows that the property market lost momentum in December.

Sweden

Inflation rose higher than expected in December: +0.2% m/m as against market expectations of 0.0%. Prices increased by 0.9% compared to December ’08, the first positive year-on-year change since March ’09. After adjustment for the direct effect of the decrease in interest rates, the December rate of inflation was 2.7 per cent. Even if they were higher than expected, the December figures on CPI do not alter our view that the Riksbank will mantain rates unchanged until at least H2 2010.

Norway

In December, inflation was substantially in line with market expectations, rising by 0.2% m/m and 2% y/y. Price rises in electricity and airline fares contributed most to the monthly growth, while the year on year change was mainly due to price increases in fuel and lubricants. CPI-ATE remained unchanged at 2.4% y/y. The December figures did not help determine whether the Norges Bank will increase the rate again in February or March (our base scenario).

The week ahead: leading indicator should indicate US recovery will continue in the months ahead

This is an exerpt from our weekly Top Down Outlook:

NAHB housing market index (Wednesday 20) – Notwithstanding the improvement over recent months, the real estate sector remains very weak. This was reflected in the NAHB housing market index, which fell from 17 to 16 in December. With the labour market failing to reverse the negative trend of the last two years and foreclosures expected to rise in the months to come, we do not expect a rebound in the real estate sector over the short term. The NAHB housing market index is likely to remain unchanged at 16 in January.

Leading indicators (Thursday 21) – The leading indicator are likely to continue the upward trend of recent months, rising by 0.6% m/m in December. The steep yield spread and the fall in weekly jobless claims are likely to be the major contributors to an increase in the leading indicators. The leading indicators should anticipate that the US economic recovery is likely to continue in the next six months.

Philadelphia Fed (Thursday 21) – The Philadelphia Fed went up for the fifth consecutive month in December, rising to 20.4 – the highest level since April 2005. We expect the index to continue its upward trend in January, rising to 27. The Philadelphia Fed should indicate that industrial production recovery will continue in early 2010 as global economic recovery gathers momentum and the weakness of the US Dollar boosts exports.

ECB monetary policy meeting preview

At the December monetary policy meeting, the ECB began to apply its exit strategy from non-conventional lending measures, indicating that the December LTRO would have been the last one and that the last 6m LTRO shall be in March. However, ECB President Trichet underlined that the decision on non-conventional lending measures does not imply anything with respect to the Refi rate perspective. Thursday's ECB monetary policy meeting promises nothing particularly newsworthy: the ECB is widely forecasted to leave the rate unchanged at 1% with no further decisions on QE exit strategy on the cards. We estimate that the Refi rate will stay unchanged at least until the end of H1 ’10, and our base scenario is for the rate to end up at 1.5% in 2010. Even though the new ECB projections on economic growth and inflation are in line with a rising Refi rate (to 2% by the end of 2010), we do not expect the ECB to tighten monetary policy unless the Fed implements an exit strategy as this would strengthen the Euro against the US Dollar.

US data preview: 11 January week

This is an excerpt from our Top Down Outlook - The Macro view

Trade balance (Tuesday 12) – Following unexpected improvement in October, shrinking from USD35.7bn to USD39bn, the trade balance deficit is expected to widen to USD36.4bn in November. In view of consumer spending rebounds in recent months, imports are likely to increase more than exports notwithstanding a weak US Dollar and global economic recovery.

Retail sales (Thursday 14) – November retail sales rose above market expectations (1.3% m/m versus +0.5% m/m), indicating strengthened consumer spending in Q4. In light of the December rally by consumer confidence indexes (the Conference Board index rose from 50.6 to 52.9) and evidence that the labour market is bottoming out, we expect retail sales to continue their recent upward trend in December, albeit at a slower pace. Retail sales may increase by 0.4% m/m (+5% y/y), in line with the ex-auto data (+4.8% y/y). The increase in retail sales should anticipate a persistent consumer spending rebound in the short term. However, we expect consumer spending growth to remain subdued in the medium term as the deleveraging process of the household sector is far from over.

Consumer price Index (Friday 15) – After eight months of negative year-on-year change, base effects in the energy sector led headline inflation, turning positive in November (+1.9% y/y). Energy related base effects (oil prices fell by 55% in the period September/December 09) are likely to drive inflation up in December and early 2010, which is likely to edge up to 2.8% y/y. Nevertheless, inflation is expected to increase by a moderate 0.1% when compared to November, since consumer spending remains substantially weak. We expect core inflation to rise by 0.1% m/m and by 1.8% y/y. Inflation is likely to rise in the next few months as economic activity improves, though we expect inflationary pressures to remain subdued in the face of slack capacity utilization.

NY Empire Manufacturing Index (Friday 15) – The Empire Manufacturing Index, the first relevant US business confidence index to be published monthly, fell from 23.51 to 2.55 in December, indicating the possibility that the manufacturing sector’s upward trend may be reaching an end. However, this negative prodigy was denied by other business confidence indexes that posted strong increases in December (the ISM manufacturing index advanced from 53.6 to 55.9). The Empire Manufacturing index is likely to reverse the huge decline in January, rising to 21.7 and bolster estimates that manufacturing production may continue rising early in 2010.

Industrial Production and capacity utilization (Friday 15) – The whole of leading indicators released over the past few weeks anticipate that industrial production’s positive momentum is likely to continue in December and early 2010. The Conference Board leading indicator rose in November for the ninth consecutive month and the ISM manufacturing index remained well above the 50 threshold in December. Moreover, factory orders rose in November for the third straight month. We expect industrial production to increase by 0.7% m/m. Capacity utilization should edge up from 71.3% to 71.7%; a subdued level indicating slight inflationary pressures going forward.

Michigan Sentiment Index (Friday 15) – With equity markets extending on an upward trend the past few months and the labour market showing tentative signals of bottoming out, the Michigan sentiment index may rise from 72.5 to 72.8, anticipating a strengthening of consumer spending in the upcoming months. However, the index will remain well below the long term average (89.6), indicating that consumer spending recovery may nevertheless remain subdued.