Jury is Still in on Eurozone Nations' Credit

• A fairly quiet week in the US with no tier-1 movers. Main event will likely be negotiations on extending the payroll tax cuts and extended unemployment period.

Agreement is so far not in sight but we believe a deal will be struck last minute. Durable goods orders will give input to investment spending in Q4. They have softened a bit recently, although still showing decent spending. Initial jobless claims will also be interesting to watch following two weeks of sharp decline. If the tendency is confirmed it gives more reason to get more upbeat on the US labour market. We will also get a long list of housing data (NAHB housing survey, existing and new home sales, housing starts, house prices). We expect it to show a further picture of slightly stronger activity, while prices most likely continue to be under pressure.

The two main events in the euro area will be the ECB’s 36-month LTRO and the expected rating agencies’ verdict on the countries in the euro area. The first of two 36- month longer-term refinancing operations (LTROs), with the option of early repayment after one year, will have allotment on Wednesday. Note that there will also be allotment on a 3-month tender on the same day. These tenders are full-allotment at average refi rate over the period. These could potentially improve the liquidity situation for the banking sector and thus alleviate refinancing risks and thereby the speed of balance sheet deleveraging. However, for the banks that are challenged on their capital position, this will not help them in this respect. The introduction of LTROs could also have an impact on yields in sovereign debt markets in particular in the short end as the proceeds from refi operations can be invested in for instance
Italian and Spanish bonds yielding a high carry. However, to what degree this effect will materialize is very uncertain. So far we have seen some decoupling between 2- year and 10-year yields. Draghi this week induced euro area banks to use this facility by saying “we want to make it absolutely clear that in the present conditions where systemic risk is seriously hampering the functioning of the economy, we see no stigma attached to the use of central banking credit provisions: our facilities are there to be used”. This is a sharp change in the tone from the ECB that previously has used the term 'addicted bank' which actually stigmatized these facilities. This change in tone suggests that a large allotment will actually be viewed as being positive for market sentiment.

S&P still has not given its final verdict. A downgrade of France and the EFSF is partly priced into the market. It would be very negative for market sentiment if any of the other triple A countries are downgraded. Also Moody’s has announced that it would reassess its rating, but this is unlikely to happen this year. Another theme that could influence the news flow would be the negotiations about the Greek PSI.

• On the release front we have a thin calendar with German Ifo as the main release. We expect close to an unchanged reading as also the PMIs released this week indicated.

• The Bank of England’s Minutes will most likely show that the MPC remains concerned about the impact of the eurozone crisis but relaxed on inflation. More asset purchases were definitely discussed at the last meeting on monetary policy but it was probably concluded that markets could not have absorbed quantitative easing at a faster pace. We doubt the Minutes will have a big market impact and think January’s meeting will be a lot more interesting, with the likelihood of lifting the ceiling for asset purchases. Even though more QE should weaken sterling, the eurozone crisis dominates and we project EUR/GBP will trade in a 0.83-0.84 range for the rest of 2011.

• In Switzerland, there are few domestic releases in the coming week besides Tuesday’s trade data. The market will be digesting Thursday’s SNB meeting when the central bank decided to keep the EUR/CHF minimum target at 1.20. There were few surprises in the statement and while the SNB did revise lower its inflation forecast, a hike of the 1.20 floor appears less likely now than before Thursday.

• In Asia we have a relatively light calendar next week. In Japan the main focus will be Bank of Japan’s monetary meeting on Wednesday. We do not expect Bank of Japan (BoJ) to announce any additional quantitative easing (QE) in connection with the meeting. However, BoJ will continue to stress increasing downside risk to growth from the European debt crisis and the strong yen and further QE cannot be ruled out.

However, at the moment it could be argued that BoJ is not using the space it has to expand its asset purchases sufficiently. So far it has only used around 50% of the limit for its asset purchases and as seen in the chart the expansion of BoJ’s balance sheet has trailed other major central banks substantially. The policy to stem the appreciation of JPY also appears to remain in place and we think the 75 level against USD will be defended aggressively should USD/JPY decline toward this level. Foreign trade data for November will also be released next week. Preliminary data for the first 20 days suggest exports will drop for the third consecutive month in a row underscoring that the manufacturing recovery in Japan is losing steam. Imports are more resilient and the seasonally adjusted trade balance is expected to stay in deficit for the eight month in a row.

Scandi

• In Denmark, consumer confidence has nosedived in recent months with the escalation of the European debt crisis, and it is hard to see what could turn things around in December, a month that normally brings a dip in confidence anyway. As yet, though, the growing pessimism has not brought a fresh drop in consumption.

Dankort debit card purchases actually indicate an increase in spending since the summer, which suggests that private consumption will rise in Q4. The Danish economy performed particularly poorly in Q3, with the preliminary GDP figures showing a fall of 0.8%. It will therefore be interesting to see whether the revised GDP data confirm this picture. Dwindling public consumption was one of the main drivers behind the fall, and this part of the picture has already been confirmed by other statistics.

• In Sweden, the all encompassing event in the week ahead is undoubtedly the Riksbank’s monetary policy decision (published Tue, at 09:15 CET). We expect a 25bp cut, but see fat tails to primarily 50bp and, to some unfortunate extent also to 0bp. For what it is worth, if we were on the board, we would cut by 50bp in a heartbeat, given the strains in financial markets and the extremely weak outlook for Sweden’s export markets (yes, even including the US and the BRICs). In addition, the fact that the repo rate is only 2% means that there is not much to be had before the Riksbank reaches “the nominal interest rate floor” of 0%. Better to act swiftly and forcefully thus. And even if we would be wrong about our views on future economic developments, in this environment better safe than sorry, means avoiding falling into the liquidity trap. And you can always hike.

• Other interesting events in Sweden the week ahead is concentrated around the National Institute for Economic Research, which not only publishes its monthly business and consumer confidence surveys (both on Wed, at 09:15), but also its most recent forecast (Wed, at 09:30 CET), which is one of the main benchmarks to which we and other forecasters compare.

• In Norway, the week offers unemployment figures from both Statistics Norway (in the form of the LFS) and the Norwegian Labour and Welfare Administration (NAV).

Recent months have seen the labour market levelling off, with employment growth slowing somewhat and unemployment largely unchanged. With job vacancies still growing, and the employment components of leading indicators such as Norges Bank's regional network survey still indicating a net increase in employment, we expect this trend to persist through to the end of the year. We therefore predict unchanged LFS unemployment of 3.3% in October (September-November) and NAV unemployment of 2.4% in December.