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Directionless Drift Marks Eventless Session

There was precious little in terms of actionable news in the overnight session, which means that, like a broken record, Europe falls back to contemplating its two main question marks: Greece and Spain, with the former once again making noises about the "inevitability" of receiving the Troika's long delayed €31.5 billion rescue tranche. The chief noise emitter was Italian Finance Minister Vittorio Grilli who said he was "confident that euro-region finance chiefs will reach an agreement on aiding Greece when they meet next week." He was joined by Luxembourg Finance Minister Frieden who also "saw" a Greek solution on November 20. Naturally, what the two thing is irrelevant: when it comes to funding cash flows, only Germany matters, everything else is noise, and so far Schauble has made it clear Germany has to vote on the final Troika report so Europe continues to be in stasis when it comes to its main talking point. In fundamental European news, there was once again nothing positive to report as Euro-area exports fell in September as the region’s economy slipped into a recession for the second time in four years. Exports declined a 1.1% from August, when they gained 3.3%. Imports dropped 2.7%. The trade surplus widened to 11.3 billion euros from a revised 8.9 billion euros in the previous month. Global trade, at whose nexus Europe has always been at the apex, continues to shrink rapidly. Elsewhere, geopolitical developments between Israel and Gaza have been muted with little to report, although this will hardly remain as is. Providing some news amusement is Japan, where the LDP opposition leader Shinzo Abe continues to threaten that he will make the BOJ a formal branch of the government and will impose 2% inflation targeting, which in turn explain the ongoing move in the USDJPY higher. This too will fade when laughter takes the place of stunned silence.

What macro traders are focusing on, via SocGen:

It is premature to conclude that the pre-election rhetoric of Japan's LDP leader Shinzo Abe has turned the trend around in G10/JPY but it has added welcome distraction from a market that remains largely hamstrung by the euro debt crisis. A turn lower in the US macro data, with some though not all blame laid at the door of storm Sandy, the phase of risk aversion that has characterised equity markets may not be over. With the S&P extending towards 1,350, a year-end rally looks further away than ever, and with chart technicals for example in EUR/JPY still pointing lower (see graph), one may be tempted to fade this week's burst through 103.00. The estimated EUR5bn of Greek T-bills that expire today will be repaid with the money raised at new bill auctions earlier this week, but in the background we are nowhere near closer to resolving the stalemate between the EU and the IMF. That is something for the Eurogroup meeting next week, but proposals now being floated to help out Greece include lowering interest rates and longer maturities on loans. No progress that we know of has been made on the IMF's wish for the EU to come forward with a ‘real fix' to lower Greece's debt burden. At stake over the coming days is how the EU can formulate proposals that deal with a haircut or loss without losing face with the electorate, an issue that for Germany in particular could be hard to swallow ahead of next year's ballot.


The focus today data wise is on the US where we get the latest TIC capital flow data and industrial output. The SNB's Jordan is scheduled to make a speech in Zurich that could be a heads up before the next policy meeting on 13 December.

More on the overnight summary from Jim Reid:

The shorter business cycle theory officially claimed Europe yesterday with GDP declining for the second quarter albeit at a mild -0.1% QoQ rate . To be fair the last 5 quarters have come in at +0.1%, -0.3%, 0.0%, -0.2% and now -0.1% so although an official technical recession can now be declared we've been pretty much on the edge of this for a year now in Europe with many member countries already experiencing recession. Of the 24 countries that are in the G20 and/or the EU-12, all but 3 of them have had at least one negative quarter of growth now in the last year or so. The lucky 3 without are China, South Korea and the US. The basis of the shorter cycle theory that we launched in our 2010 long-term study was that we were about to embark on a period of massively constrained fiscal and monetary policy relative to that seen in the previous 25-30 years.

So the big two without a negative quarter are China and US. To be fair China still has a lot of control over its own destiny in the short-term  so the theory was only meant to be applied to the over-levered developed world were rate were already floored close to zero. This leaves the US as the shining beacon amongst its Western peers (in the G20+Euro sample) as the only one without a negative quarter of growth since the recovery from the GFC. So is the US the exception to our theory? To be honest at the time we launched the theory we didn't differentiate the US from its peers and expected it to be as susceptible to the shorter cycle theory as all the others. However one would have to say that they have been pretty successful at disputing our lack of flexibility assumption as they've squeezed out every last bit of fiscal and monetary stimulus possible since the GFC. The Fed is moving towards 'QE infinity' and 2012 will be the fourth highest peace time US budget deficit in the 220 year history we have data for with no prizes for guessing which years made up the 1,2 and 3 spots! Even with this extraordinary stimulus this remains the second weakest nominal US GDP recovery of the 17 we have quarterly data for back to 1921. Only the 1927 recovery that was unfortunate to run into the 1929 stock market crash was weaker. So although the US has avoided a negative growth quarter, activity has been fairly anaemic by historical standards.

Bringing this forward to today's markets, the fiscal cliff outcome will likely have a big say as to whether we end up being right or wrong about shorter cycles in the US. If we can maintain deficits close to current levels over the next year or so then we may be proved wrong for the US and the cycle will again be notably longer than average. So a lot arguably rests on this issue. Finally its worth bearing in mind that if the US had a deficit in line with the average in Europe it would almost certainly be firmly in recession now. So that extra deficit flexibility has made all the difference.

On to markets now, it was another weaker day for risk assets not helped by escalating tensions in the Middle East. Indeed the conflict seems poised to escalate with BBC reporting that the Israeli government may begin ground operations in Gaza imminently to neutralise the threat of further rocket attacks. Palestinian militants fired over 200 rockets on Thursday, causing three fatalities, while three rockets also hit near the city of Tel Aviv.

This is the first time Tel Aviv has been threatened by missiles since the first Iraq war. Geopolitical concerns aside disappointing Q3 revenues from Wal-Mart and Target as well as a Sandy-distorted US Philly Fed survey (-10.7 v +2.0 expected) and initial jobless claims number (439k v 375 expected) all weighed on sentiment. This was also the largest week-on-week rise in claims since Hurricane Katrina. Interestingly though Sandy-effects didn’t show up in yesterday’s Empire State manufacturing survey (-5.2 vs. -6.2 prior month and -8 expected) although today’s IP report today will likely show a modest contraction in October.

All this saw the S&P500 (-0.16%) end lower for the third consecutive day and also on track to finish lower for the second consecutive week. We’ve seen a meaningful retracement in US equities with the index now 7.7% off its post-QE3 highs in mid-September. Indeed as we noted yesterday the risk tone has been stalling since QE3 and given the financial world's addiction to central bank liquidity it is ironic to see the QE3 announcement marking the 2012 peak in various asset classes. Commodities have also performed poorly with the S&P GSCI index, Copper and Brent all peaking on the day after QE3 was announced and have fallen 8.7%, 9.3%, and 6.6% respectively. Interestingly Gold is down around 3.2% over the same period. This leaves core rates as the major outperformer over this period with the UST 10yr yield down 29bp to around 1.58% overnight.

Staying on the Fed, Bernanke’s speech on the housing and mortgage market yesterday noted that the housing market is still plagued by tight credit and underwater borrowers. He also added that the Fed will do what it can to support the housing recovery. Ironically, data from Freddie Mac yesterday showed that the average 30-year fixed mortgage rate fell to a record low 3.34% last week, beating the previous record of 3.36% set on the 4th of October.

Back to the markets, Asian equities are on track to finish the week on the back foot. Chinese equities are leading the losses overnight (Shanghai Composite –1.20%) weighed by news that many Chinese cities are considering property taxes. Chinese equities remain one of the underperformers this year with YTD price returns of around -8.5%. The newly formed Politburo Standing Committee has been very much silent since President Xi Jinping’s inaugural speech yesterday. Elsewhere, the KOSPI (-0.57%) and ASX200 (-0.29%) are both lower.

After having rallied +1.9% yesterday the Nikkei is up by another 1.95% today as  investors digest on the return of opposition leader Shinzo Abe after early elections. The JPY is holding steady at 81.05 against the Dollar overnight after having traded 1.15% lower yesterday. Mr Abe is well known for his aggressive stance on monetary easing and has called for the BoJ to shower the economy with unlimited stimulus.

Our Japanese research team believes that a victory by the opposition Liberal Democratic Party (LDP) appears likely given that (1) the LDP continues to outpoll the ruling Democratic Party of Japan (DPJ) by a considerable margin, (2) 300 of the 480 lower house seats are single-seat constituencies that tend to strongly favor the most popular party, and (3) rapidly emerging minority parties may have insufficient time to rally their forces. They therefore expect Shinzo Abe to become PM for a second time.

European headlines took a backseat yesterday given the geopolitical tension in the Middle East and US fiscal cliff worries. On Greece, Merkel said that she expects next week's Eurogroup/ECOFIN (Nov 20th) meeting to decide on the next steps for Greece in terms of a disbursement and debt sustainability. On the latter, the Sueddeutsche Zeitung reported that EU leaders are considering retroactive interest rate reductions to Greece's debt, with the EFSF/ESM potentially funding Greece below its own funding costs. The difference would be subsidized by Euro-area governments, because the EFSF/ESM is forbidden from lending at below own-cost rates. Greece issued an additional EUR937m of one- and three-month T-bills yesterday, bringing the proceeds from this week's auction to EUR5bn ahead of today's T-bill maturities.

Turning to the day ahead, Obama meets with the four top leaders of congress (John Boehner, Mitch McConnell, Nancy Pelosi and Harry Reid) at the White House at 10:15am USEST in the first formal “fiscal cliff talks” so we may see more headlines after that. There will be little in the way of top tier data with the most notable release being October IP in the US.