EU Summit Delays Eurozone Budget Decision Until June

Chinese December flash PMI increases, supporting our case for an ongoing recovery.

EU summit delays decision on eurozone budget and economic reforms to June.

Fiscal cliff talks show limited progress, negotiations likely to extend beyond Christmas.

Markets Overnight
The communiqué from the EU summit suggests that the two most controversial issues put forward by European Council president Herman Van Rompuy – a future eurozone budget and binding economic reform contracts- have been put on hold until the June meeting.

In the US, Boehner and Obama met again Thursday evening but no details of their discussion were provided. House Republican leaders signalled that the negotiations could well drag beyond Christmas but there is also a growing number of Republicans who support to give in on taxes, accepting to raise tax rates for the highest income brackets, and instead focus on spending cuts.

Despite better data from the US showing a more solid gain in core retail sales than expected and initial jobless claims at the lowest level since before the Sandy distortions, risk sentiment was weak. Fiscal cliff concerns and worries about an earlier tightening from the Fed than the previous mid-2015 guidance did weigh on sentiment. This led to weakness in stock markets and the S&P 500 lost 0.6% on the day.

However, the increase in the Chinese flash PMI has lifted sentiment in Asian trade and has sent Chinese stocks higher. The HSBC flash manufacturing PMI for China rose to 50.9 in December from the final reading of 50.5 in November. The increase was driven by the new orders index, while new export orders were weak and dropped back below 50.

This is consistent with our view of a moderate but ongoing recovery in the Chinese economy, with the main risk being a set-back in external demand. See Flash CommentChina: HSBC PMI improves for the fourth month in a row, 14 December.

In US bond markets, the initial steepening of the curve following the FOMC statement Wednesday reversed in Thursday’s trade where the 5-7-year segment rose 4bp and 30-year yields only 0.5bp. It seems that markets are pricing a slightly higher risk of an earlier tightening from the Fed after Wednesday’s FOMC statement, which replaced the calendar-date guidance with economic threshold values. In addition, the chance that markets will start to react more to economic data than before has sent volatility higher.

In FX markets JPY continued to weaken on expectations that the Liberal Democratic Party will win in Sunday’s election, which could lead to further monetary easing from the Bank of Japan.

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