The momentum increases

In the run-up to the EU Summit this coming Friday, Europe is working on numerous fronts in an attempt to regain the trust of markets. Italy has unveiled a raft of austerity measures a day earlier than planned. German Chancellor Merkel meets with French President Sarkozy again today in an attempt to iron out their differences.  

The ECB also meets later this week, and markets are now positioned for a further 25bp easing of key rates but are just as keen to hear some firmer commitments with respect to bond purchases.   There were promising signs last week suggesting that the ECB’s overly rigid approach is softening, something which should be welcomed.   Overall, there is a great weight of expectation on the outcome of this week’s meetings.   Weekly data has shown that short positions on the euro remain at extreme levels, so at present the single currency is positioned for disappointment.

Guest post by FxPro


Italy pushes ahead on austerity. The new Italian PM will present his austerity measures to parliament today, having revealed the measures a day earlier than expected.   No doubt this was designed to stave off pressure on Italian bond markets at the start of the week; 10yr yields traded a near 1% range last week.   The budget includes around EUR 20bln of austerity measures with a further EUR 10bln of initiatives designed to boost Italy’s long-term growth rate, low growth having dogged the country long before the credit crisis first kicked off four years ago.

America’s growing army of discouraged workers
. For the optimists, the sharp decline in the unemployment rate last month to 8.65% (from 9.01%) is a sign that the US labour market is finally emerging from its slumber. Together with another impressive jump in household employment (up a further 278K last month, an average increase of 321K over the past four months),   it appears that things are getting rosier. Even the underemployment rate is falling, to 15.6% in November, down from 17.0% a year ago. However, do not be fooled. It is worth noting that much of this superficial improvement reflects the fact that more and more Americans are simply choosing to drop out of the labour force. In November, another 487K dropped out of the workforce; now 86.6m people are officially ‘not in the labour force’, compared with total employment of 140.6m. Four years ago, 79.2m were categorised as not in the labour force; six million people have now lost their job over this period. All this time, the average duration of unemployment keeps on rising, now 40.9 weeks, up from 17 weeks in November 2007. Some may like to think things are getting better in the US labour market – a more accurate interpretation is that it is still terrible – and getting worse – for the army of unemployed and discouraged workers.

Merkel’s final push for fiscal union. In a major speech before the Lower House of the German Parliament in Berlin on Friday, the German Chancellor presented her case for greater eurozone fiscal union. In a wide-ranging address, Merkel stated that: 1) economic and fiscal integration was now firmly on the European agenda (it will definitely be the lead item at next Friday’s EU Summit); 2) the crisis fight was a marathon rather than a sprint 3) confidence in both the ECB and the courts must be upheld, ECB credibility must be protected; 4) euro bonds are ‘unthinkable’ without fiscal union 5) joint euro bonds will develop on their own 6) the aim of the EU Summit is to win EU treaty change on fiscal union. In contrast to the claims of many commentators, Merkel is not opposed to Eurobonds, but rather will only consider the once a properly functioning fiscal union is in place. Critical in terms of achieving her vision of fiscal union is convincing France to give up national sovereignty on fiscal decisions. Germany seems prepared to do so to some extent, but nationalistic France is much more hesitant. Key to resolving this thorny question will be Merkel’s meeting with Sarkozy later today.

PBOC policy is definitely shifting. Unsurprisingly, the PBOC’s approach to policy is shifting quite rapidly, from one frightened about inflation to one now more worried about sustaining growth. In recent days, the PBOC started the process of easing credit by reducing bank reserve requirements by 0.5%; there is plenty of potential for more of the same here over coming months. The central bank has also conceded that property prices are at a turning point, and that property lending is slowing. Overnight, Shanghai Securities News reported that home transactions in the city slumped by 53% in the year ended November. With growth definitely slowing, property prices declining and inflation moderating, before too long the PBOC will be reducing key interest rates as well.

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