Support for the Eurozone if Deflation Risks Emerge?

ECB member Bini Smaghi endorses QE for the eurozone if deflation risks emerge

Jobless claims drop to the lowest level since April 2008 pointing to a payroll growth close to 200,000

Republican Senate leader McConnel yesterday broke rank and called for an end to the tax deadlock fuelling hopes for a deal will be struck before the 31 December deadline

Markets Overnight

In a remarkable  FT Interview ECB member Bini Smaghi said that if deflation risks emerge in the eurozone QE should be used. According to Bini Smaghi QE is appropriate in countries facing a liquidity trap that may lead to deflation. He even dared to indirectly criticize the German tough stance on QE by saying that policy should not “hide behind lawyers to avoid taking action”. Even though Bini Smaghi will leave the ECB by the end of December, he was extraordinarily outspoken, which underlines that the support to the current tough ECB resistance to QE might not reflect the view of all ECB members.

The positive data surprises continued in the US yesterday. Unemployment claims fell by 4,000 to 364,000 last week, which is the lowest level since April 2008. The number of applications has dropped by an impressive 40,000 over the past three weeks. We are now close to a level in weekly claims that is consistent with a payroll gains of approximately 200,000. The stronger labour market probably helped to boost consumer optimism and the University of Michigan consumer indicator jumped to a six-month high in December.

However, the economy grew less than expected in Q3, by 1.8% annual rate compared to 2.0% in the previous estimate, but note that the leading  indicator from the Conference Board signals that growth will strengthen going forward. The indicator rose 0.5% in November after a gain of 0.9% in October. The current US numbers are very encouraging and it is certainly difficult to see any effect of the European debt crisis. In fact, it seems that the market is starting to share our 2012 view that the US economy can surprise positively despite the current eurozone recession.

The  political  stand-off regarding the payroll tax cuts  between  President  Obama and especially Republican House Speaker Boehner has been intense the last couple of days. However, overnight House Republicans backed down and agreed to extend the payroll tax cuts for the first two months of 2012 (ABC News). It ends the risk of a sudden tax rise on 1 January. If no  deal had been struck it  could  have shaven off 1.0% of US growth alone in the first quarter. The agreement is seen as a clear victory for President Obama.

The US numbers boosted risk appetite and US equities extended a third weekly gain in December. S&P500  and Nasdaq both  rose by 0.8%.  The combination of strong US numbers and falling crude oil stocks is boosting  oil prices, and WTI is trading close to USD100 a barrel. We continue to see  upside risks to oil prices in 2012.  EUR/USD is slightly higher overnight. With “softer” ECB rhetoric and a political agreement in the US it looks like a new positive day.

Global Daily

Focus today: We have an array of interesting releases from the US today. The durable goods orders reading is expected to be strong (2.2% m/m), which yields some hope for an improvement in investments. Also personal income and spending  are worth keeping an eye on. The  PCE core (the  Fed’s preferred inflation indicator)  increases have recently been showing a decreasing pattern and consensus this time is for a minor increase of 0.1% m/m. New home sales are expected to be strong in line with existing home sales published earlier this week. There are no important releases in Europe today.

Fixed income markets:  The bunch of tier-2 US data released today will probably not have any big impact. Instead the markets will be focusing on the US Congress efforts to extend the payroll tax cut and unemployment benefits that  will  expire by year-end. A two-months extension  should be moderately positive for risk sentiment and  lead to somewhat higher rates and steeper curves in the US, with some rub-off effect on the EUR swap curve. The 3M Euribor fixing declined 0.6bp yesterday, in a sign that the combination of ECB rate cuts and liquidity measures is having an impact. We continue to see room in the short end of the EUR swap curve, as the declining fixings and further rate
cuts from the ECB feed through. Strategically, this should also leave room for the 2-10 EUR curve to steepen over the coming 3-6 months, barring European macro data stabilizing during H1 next year. We will watch this trade opportunity more carefully early next year.

FX markets: We look for an positive day for risk currencies and with WTI oil close to USD100 a barrel and the remarkable QE comments from ECB member Bini Smaghi we could see some further upside to EUR/USD today - even though low activity ahead ofChristmas should limit moves in the FX market today.

The higher oil prices are also lending support to CAD. USD/CAD has been trading below 1.02 this morning. In our  FX Top Trades that we published  on 14  December we have CAD as one of our top-pick currencies. In our view it will benefit from a US recovery and high oil prices. We will keep a close eye on the Canadian GDP numbers that will be published this afternoon.