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Good morning. It’s the last day of November which will have a bearing on short-term trading and the newswires are dominated by the ongoing debt crisis at Dubai World as Dubai returns to work. Given how vile the weather is in London this morning, I’m tempted to fly out and check what is happening for myself!

The latest twists to the Dubai story start with the reassurance on the part of the UAE central bank which set up an emergency liquidity facility for the region’s banks (click here). The Sunday Times ran a story about Abu Dhabi riding to the rescue (click here) which is now the consensus view, namely that Abu Dhabi will stand behind Dubai but will pick and choose both the terms of its support and which entities it supports. In other words, the notion that Dubai is a sovereign default candidate is wrong. So too, however, is the idea that Abu Dhabi has a blank chequebook for every business with ‘Dubai’ in its name. In short, a Dubai default is politically worth avoiding (for Abu Dhabi, and frankly, for the US as well). That doesn’t mean, however, that the spectre of sovereign default is removed. The massive growth of public sector debt in 2009 is a real issue and market confidence is fragile enough to make sure there are repeated fears about how it can be refinanced. The key is to be able to keep interest rates low and in particular to keep rates below nominal GDP growth for a significant period of time so that the real size of public debt levels falls. That’s why G7 central banks are so committed to low rate policies and so grateful that inflation fears are not sending bond yields up. It’s also why I remain nervous about Japan in particular, as the one G7 economy which is going to struggle to keep rates below nominal GDP growth in the face of persistent deflation. And that, finally, is why a stronger yen is so clearly not in Japan’s interests.

Today’s early UK news includes reassurances from banks about small business lending in the UK (click here), further gains in house prices (up 0.2% in November), a further rise in mortgage approvals to a still-low 57,300 and more soft consumer credit data (a net repayment of £600m). UK markets are dominated by month-end flows and sterling is being sold by central banks who are receiving Gilt coupon payments today. In the eurozone, November inflation data is due shortly with a 0.4% level expected. The US sees the Chicago Purchasing Managers’ index for November, expected to dip back to 53.2. The US also saw mixed retail results form the weekend after Thanksgiving with the press reporting that spending was directed at lower-priced items. The week will come to a climax, however, with Friday’s payroll report and expectations have improved in the wake of healthy weekly unemployment claims figures.

As for markets, Japanese intervention, initially verbal but ultimately real, will determine the next move for the yen. If the Swiss National Bank allows the Swiss franc to drift stronger, it will. The dollar’s downtrend remains firmly in place as long as interest differentials are opposing it. I expect further gains in EURUSD now. Sterling is being held back today relative to the euro but looks well supported against the dollar. In equities, the recent pattern of month-end correction and new month rally looks set to continue, although we could see choppy trading this week, given December isn’t an ‘ordinary’ month.

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There is plenty of fear and lots of noise in the markets but little hard news this morning as Dubai stays on the front pages of the newspapers. Holidays in then US (yesterday) and Dubai mean that we are unlikely to get more clarity from Dubai until the start of next week, beyond the short statement from Sheikh Al-Maktoum (click here). This, to my mind, simply fails to answer any of the questions the market is asking, so everyone will speculate about whether the request to re-schedule debt will succeed or lead to default, what other Dubai-based entities could suffer a similar fate, whether it could prove more widely contagious and which banks globally are most exposed.

My first impressions of the Dubai crisis (see yesterday’s blog) have not changed materially. I suspect this is an attempt at a managed, voluntary debt re-scheduling rather than a default. The sums involved are potentially large but are spread widely around the financial system if only because the Dubai ‘story’ was so heavily marketed and widely understood. There is a risk of ‘psychological contagion’ but Dubai was a one-off bubble. Nowhere else has there been so much extravagant construction. The longer-term damage is to the notion of an ‘assumed’ state guarantee. It was taken for granted that Dubai would stand behind its commercial enterprises and that Abu Dhabi would stand behind Dubai. Those kind of assumptions are fairly reasonable to make when times are good, but in troubled times they are tested.  

I see Dubai, therefore, more as a catalyst for market positions to be taken off than as a defining moment in this year’s trends. And month-end risk reduction has been a regular occurrence in recent months. The S&P touched 1,040 on 28 August before correcting to 992 on 2 September. It rallied to 1,080 on 23 September, but slipped to 1,019 on 2 October. October’s 1,101 peak was reached on the 21st and was followed by a correction to 1,029 on 2 November. November saw its high on the 16th at 1,113, and Wednesday’s close was barely below that. The pattern seems clear, and the question it asks is whether the Dubai news and the fact that the end of the year is approaching change anything. Are we going to see more than a sharp but short-lived bout of risk aversion?

The major economic legacy of this is to provide further support for the central banks’ commitment to keep interest rates low and resist the temptation to declare the all-clear for the financial system. I feel it would be terribly premature to do so. And it is the low G7 interest rates which drive financial market trends. Lower US rates are the fuel for asset markets, for non-G7 central bank reserve accumulation and for higher-yielding currency appreciation. And most of all, very low rates are the fuel for the rally in gold. Positions are being shaken out, but as long as the two key underlying fundamentals – gradual if modest economic recovery, and low rates – remain intact, the overall risk rally will not easily be de-railed.

As for economic news, there was none in the US yesterday and none today. The UK saw very upbeat CBI Distributive Trades yesterday and solid John Lewis numbers this morning (click here). In France, the consumer confidence index picked up to -30 from -35, still low but a sharp bounce. It all still points to a gradual economic recovery. Sceptics dismiss it as temporary as they have done consistently. I think the bounce can last a while longer.

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It’s Thanksgiving in the US: a bad day for turkeys but supposedly a celebration. Markets are usually quiet with the US out and the proximity to the end of the year a disincentive to activity. Not so today. The FT describes the overnight FX market trading as ‘febrile and disorderly’.

The new headlines are dominated by the news that Dubai has asked for a debt standstill at Dubai World. This has raised all sorts of fears about default and contagion. I don’t’ think the global economic implications are all that severe for a number of reasons, but these are the kind of stories which prompt risk aversion and reinforce the general belief that while the worst of the crisis is behind us, the global economy (and the financial system in particular) is not out of the woods yet. A few points are worth making.

John Gapper, in his FT column today (click here) observes that this threatened default has emerged, of all places, in an Arab oil state. I would not want to be pedantic on whether Dubai is a state or an emirate within the UAE, but Dubai’s distinguishing economic feature is that it is not oil rich. Investment into Dubai on the basis that there is untold oil wealth ready and able to ensure that money cannot be lost, is risky. Secondly, there is absolutely no doubt – and this is surely well understood – that Dubai saw a property and construction bubble in recent years. Thirdly, what we are going to see tested here is an assumption about the extent of support that is forthcoming to Dubai World from Abu Dhabi. As Moody’s put it yesterday, it ‘…sets a major precedent for a high-profile, seemingly strategic company facing debt repayment difficulties and thus relying on the government for support. A restructuring of its obligations would indicate that the government is prepared to allow a government-related issuer to default on its obligations.’ That raises a wider point. We need to avoid taking implicit support for granted, or simply assuming that it is always there. Investors in bank debt always assumed that major banks would always exercise their right to repay bonds early in order to maintain access to capital markets. That assumption was wrong and sends the subordinated bank debt market into chaos. We have long known that a major feature of the European Union is that individual countries no longer have the ability to ‘print their own money’ or operate quantitative easing in the way the UK and US are doing now. We assume that the EU will always stand firmly behind those economies with weakened finances, but the widening of the yield differential between Greece and Germany makes it clear that many are now unsure of that assumption. Is Abu Dhabi capable of bailing out Dubai World? Absolutely. What will happen? I suspect that the request of a debt restructuring follows considerable behind-doors negotiation with creditors, and that default is still unlikely. That’s just an uninformed opinion, however. What does seem clear to me is that we are slowly learning that you cannot take implicit guarantees for granted.

What events in Dubai have done in these thin markets is to decrease risk appetite. That is sending money into low-yielding, short-dated government bonds and is strengthening the yen and Swiss franc (testing the tolerance of central banks to see their currencies cause further damage to their economies). A short-term but severe correction is being seen in emerging market currencies and equity indices are softer today. Gold, however, is not correcting as it is increasingly seen as a safe haven in this environment.

Meanwhile, economic data remains broadly positive. In the US, the highlight yesterday was a further sharp fall in the number of people registering for unemployment benefit to 466,000 (from 502,000 two weeks ago). That points to a further steady improvement in labour market data. Consumer confidence rose and the new home sales release for October showed a 6.2% increase, which surprised me. Today’s highlight will be the CBI Distributive Trades Survey. But the focus will be on fears about the financial health of Greece and Dubai.

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Sometimes, the press interpretation of an event differs dramatically from the market’s interpretation. So the FT analysis of last night’s release of the minutes of the last US Federal Reserve Open Market Committee policy meeting reads ‘Fed sees risks on low rates policy’ (click here). As Sarah O’Connor says, ‘Federal Reserve officials have expressed concerns that near-zero interest rates could fuel “excessive risk-taking in financial markets” but believe the possibility of such an outcome is “relatively low”’. The market ignores the risk and has focused on the low probability, seeing only a green light to increase bets based on US interest rates staying at current levels for a very, very long time indeed. This morning, we have new highs in the price of gold, a bounce in global equity markets and a new low for the US dollar index.

There is a lot of US data coming out at the moment but I am not sure it will tell us much. This afternoon we see personal income and consumption data for October, that will likely show a solid 0.5% increase in the latter. That demonstrates how the savings rate is not really rising as some expected, but they will point to ‘cash for clunkers’ as a reason. The Fed’s favourite inflation measure meanwhile – the core personal consumption deflator – will probably pick up from 1.3% to 1.4% on an annual basis. Weekly jobless claims data are due on a Wednesday because of the Thanksgiving holiday tomorrow, expected at 500,000. A break of that level would have some symbolic significance but the underlying story is of gradually improving labour market trends. The University of Michigan consumer confidence survey should increase slightly and October New Home sales are probably stuck around a 400,000 rate. I have previously observed that building new homes is less important than clearing excess supply of existing ones at this stage.Durable goods orders are expected to rise about 0.5% but remain firmly in negative territory year-over-year. More important data releases come thick and fast next week when we get our first look at how the economy performed in November.

In the UK, the data highlight this morning was a damp squib. Revised third quarter GDP data were released with a modest uptick from -0.4% to -0.3%. The highlight was that consumption was flat, not falling for the first time since the start of 2008. Some had expected a sharp upward revision, but if that happens I suspect it will come in much later revisions when a fuller picture of the economy is available.

The US holiday tomorrow will probably play a part in today’s markets. The core reflation theme is reinforced however. A weaker dollar, rising equity prices, and fresh highs for gold all seem like sustainable trends. But we will see resistance to the weaker dollar around these levels from Japan (whose debt woes I wrote about yesterday) and possibly from within Europe as well.

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Financial market participants may be desperate to get back to the days of huge bonuses, but there isn’t much of a work ethic in the world’s dealing rooms, to judge by the number of times I am told people are winding down for the end of the year, or to judge by the very poor levels of liquidity. The result is that moves get exaggerated and everyone rushes around trying to fit the news to the markets in order to explain why they have taken place. This morning equity markets are a little weaker and the dollar and yen are a little stronger. Concerns about the sustainability of both Japan’s and Greece’s debt position, about the survival of WestLB, the German Landesbank, have all made headlines as have attempts to slow bank lending in China.

In the US, Europe and the UK the basic debates that drive markets are not changing much on a day to day basis and this lack of liquidity merely exaggerates movements. Inflation is low now but will it return as an inevitable consequence of current monetary policies? Growth is picking up but can it last in the face of inevitable fiscal retrenchment? Asset markets are doing well but what happens when the deluge of government debt now being bought as a safe haven or by a price-indifferent central bank has to find real buyers?

The newest concern is about the sustainability of increased public sector debt. Rating agencies have highlighted the issue and the recent widening of sovereign credit default spreads has triggered concerns. In Europe, this is a very ‘live’ issue, with 10-year euro-denominated Greek government debt yielding 1.7% more at the moment than German debt – a big differential when the German yield is only 3.26%. But where this debate will rage most loudly in the coming months is in Japan. Japan has the lowest yields on its government bonds of all the major economies. It also has the most of it. The OECD forecasts the government debt level to increase to over 200% of GDP in 2011, twice as large as in the US or eurozone. There are some in Japan who would argue that the net debt level is lower and that with a current account surplus of 2.8% GDP, the problem can at least be solved domestically – in sharp contrast to the UK and the US. However, what is clear is that Japan simply cannot afford interest rates to increase much as it rolls this huge debt over. Nominal GDP is expected to fall by 5.8% this year before increasing by 1.8% in 2010 and 2% in 2011. That’s simply not enough to generate tax income to prevent the debt ratio rising further. No surprise then that the Government is becoming more vocal, trying to prompt the Bank of Japan (BoJ) into more expansionary monetary policy – which really means increasing quantitative easing to prevent government bond yields from rising.

I think the Japanese government will have its way in the end. Quantitative easing will increase, yields will remain low and Japan will step up efforts to reflate its way out of the current crisis. But the timing is difficult to predict. At the moment, the markets are watching the BoJ’s relative inaction instead. The yen is not falling but the Nikkei is looking soft, down 13% since its peak at the end of August despite rising equity prices pretty much everywhere else. I’ve attached, mean while, the latest OECD summary on Japan (click here) for those interested and a piece from the Times (click here).

The US news yesterday was a surge in existing home sales, which contrasted sharply with weakness in housing starts the week before. Tax credits and falling prices are helping reduce the overhang of unsold properties, and that is a good thing, helping the market to normalise. It does little for growth near term (building new homes employs a lot of people in the US, selling old ones far fewer, naturally). Today, the focus is on the Minutes of the last FOMC meeting, and any new talk of either expanding quantitative easing or of ‘exit strategies’. I doubt we will get much reaction from markets. In Europe, we have seen a very strong IFO business confidence index in Germany at 93.9, up from 91.9. In the UK, the BBA report on loans notes the highest level of mortgage approvals since January 2008, at 42,238, but the real action comes from the MPC members, including Mervyn King, whoare giving testimony at the Treasury and Civil Service Select Committee (TCSSC). Past form shows that Mr King has tended to be dovish on both rates and the currency on these occasions.

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The debate between reflationists (optimists) and deflationists (gloomsters) rages on. Roger Bootle of Capital Economics has both feet firmly in the ‘Gloomster’ camp, wrote a piece for the Telegraph arguing that ‘the high street is surprisingly defying the gloomsters, but for how long?’ (click here) that captures the mood and the dilemma. The data are coming out better than expected, but the gloomy majority refuses to believe it can last. The better retail mood simply reflects a policy to reflate asset markets and slow down the adjustment in our savings rate. And here, there is an important point to make. There’s a tendency to look at the overall economy’s finances in exactly the same way as people looking at their own finances. After all, economics as a term derives from the Ancient Greek words for ‘house’ and ‘manage’, i.e., housekeeping. But there is a difference. How much I spend doesn’t affect how much I earn. So if I spend more than I earn, I do so either in hope of future income, or in denial of reality. The same is simply not true at an economy-wide level. If we all spend less, fewer jobs will be created and the national income will fall. And the reverse is also true. Good financial husbandry is necessary, running huge deficits is dangerous and the savings rate will have to rise over time. But an over-rapid adjustment would be lethal and the current policy has a chance of making the adjustment less severe, the end outcome better and it appears – so far – to be working. On the subject of animal spirits and the economy Robert Shiller has published an article in the New York Times about psychology and the economy (click here).

The rest of the weekend press took sides on the two big topics which affect all G7 economies – is there or isn’t there an inflation problem (here’s the Sunday Times’s David Smith, and here’s a link to an article about the OECD Outlook which came out Friday). The Times also ran a story responding to the hysteria about the UK PSNB data that were released last week – Treasury hints at hysteria (click here) and this morning’s paper, to provide a polar opposite view from Mr Bootle’s, has an article by Goldman Sachs Chief Economist Jim O’Neill (click here). Readers of this column will know on which side of this debate I sit.

There isn‘t much in the way of earth-shattering economic news to await this week. The ‘flash’ November purchasing managers’ indices for the Eurozone were released this morning showing a further rise to 53.7 for the Eurozone as a whole (from 52.6). That’s the best outcome since 2007. Japan is on vacation today, the US on Thursday (for Thanksgiving). In  the UK we get revised Q3 GDP data on Wednesday, though I don’t think we will see a huge revision from that implausible -0.4% initial release until we see more detailed data. As far as markets are concerned, reflation remains the standout theme. Gold prices continue to hit new highs and though these trades are crowded, the supply/demand imbalance suggests that you could get to much higher levels before a major correction was triggered. There was plenty of talk of an equity correction last week, but it was very mild, in keeping with recent trends. I don’t expect much from this week but the pattern this year has been for equities to rally in the first half of the month, but face profit-taking nearer the end of the month. I would not be surprised to see new highs in early December. In currency markets, persistently low rates in G7 economies have been the core theme. The US dollar has been the weakest of the major currencies in November. High-yielders have shone. Last week’s correction – which saw the yen out-perform – has not altered that picture.

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Yesterday’s retail sales and public sector borrowing data showed us both the bright and the ugly side of the UK economy. The retail sales numbers, which I touched on briefly in yesterday’s blog, saw annual sales volume growth recover to 3.4%, the best since August 2008 before the credit crisis struck. The growth was driven by non-food sales which is encouraging, and was consistent with the more upbeat tone from individual retailers and from surveys. The data have been followed by the weekly John Lewis release (click here). My optimism that a combination of rising real wages (thanks to falling prices in the High Street), better employment trends and a recovery in wealth will support consumer spending in the coming months, is undiminished. However, the state of the UK’s public finances is another story altogether. The October data has prompted all sorts of headlines and added to criticism of the Government. The Telegraph’s story ‘OECD warns Britain risks ‘debt spiral’' captures the mood well enough (click here). The Times’s analysis, warns of tax increases to come (click here).

The call for higher taxes and a rapid tightening of fiscal policy – before economic recovery can take hold – seems pretty daft to me. The latest deterioration in public sector finances is due to the fact that tax receipts are very weak. In October, corporation tax receipts were very poor. Stronger growth will solve that problem and fill the hole far more effectively than increased taxes. However, the greater the pressure to tighten fiscal policy quickly, the greater the need for rates to stay low and the more important it will be to keep quantitative easing measures in place. Concern about public finances is likely to replace concern about the underlying strength of the economy as the focus of attention in the coming months until the data improve. Mind you, it should be added that the UK is not the only major economy with a major fiscal problem. The Economist reports on the US deficit (click here), and also Europe’s problems (click here).

One story from the US which is doing the rounds this morning is worth a mention. US banks, keen to get their capital ratios looking all beautiful in time for the end of the year, are accelerating their buying of US Treasuries and in particular of short-dated Treasury Bills. That is driving yields to zero and in some cases slightly negative (click here for the FT's take on this). At the start of September, 3-month US rates were at 0.33%, but markets priced these to be 1.75% by the end of the first quarter of 2010. Now, the three-month rate is down to 0.27%, a small change but one that is over-shadowed by the fact that the market prices 3-month rates at the end of March below 1%. This partly reflects a shift in expectations about monetary policy which has occurred despite the fact that on the whole economic data and corporate earnings have surprised the market on the upside. But it also reflects the dash for short-dated Treasury assets by the banking sector ahead of the end of their financial year. It is important in a number of ways. Firstly, it tells us that banks’ reluctance to lend will remain in place because of the need to improve the health of balance sheets. Secondly, it tells us that the fuel for asset reflation is still flowing. Asset allocators may be tempted to put their feet up now and get portfolios in the right shape for 2010 after they have taken a break, but with bond yields so low (and credit spreads back at pre-Lehman levels), the pressure to buy into any dip in equity prices or to invest in alternatives (emerging markets, commodities, gold) is getting bigger by the day. Thirdly, rates at these kinds of levels remain an anchor dragging the dollar down. Any bounce we see here is likely to be pretty modest and only the yen, where pressures for increased quantitative easing can only grow in the weeks ahead, looks as bad to me as the dollar (click here for the FT article).

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The US released inflation data yesterday which were something of a non-event (the annual rate rose from -1.3% to -0.2% and the core rate that excludes food and energy rose from 1.5% to 1.7%). They also released housing starts data which were weak at an annual rate of just 529,000. Economists had been looking for 600,000. This indicator seems anchored around 500-600,000, showing no signs of rebound and that is being interpreted by many as a further sign that the economy is going to lose momentum. My first reaction to soft housing starts data is ‘good’. The US has seen a housing boom with too many houses built, too many now being re-possessed, and too many homeowners caught in negative equity. Why on earth build any more? If no houses are built, interest rates are left at zero, the dollar is allowed to fall and tax breaks are maintained to encourage people to buy houses, all of these things will help clear the backlog of unsold homes faster than would otherwise be the case. And that is a good thing. In the meantime, employment needs to be created in other industries while low rates slow the pace at which the savings rate rises. I cannot think of many more counter-productive developments than building new homes, unless doing so is accompanied by a lot of house demolition.

The focus on housing starts in the US does, however, highlight a huge difference between the US and the UK. The UK government has a target to build 240,000 houses a year until 2020 to cope with a growing population (and smaller family sizes) but is going to miss this target. In the last year, UK housing starts are apparently 126,700, down 26% on the previous year. Why does this matter (unless you are in the building industry)? It matters because it makes the current reflationary policies of the MPC and Fed more effective in the UK. I know the UK economy saw a bigger housing bubble than others and has a greater exposure to the (damaged) banking industry, but despite the criticism it is fair to throw at regulators and policy-makers for their part in creating the current crisis, the policy of asset reflation has a better chance of working here than in the US. And a better chance of working than the bearish consensus believes.

Meanwhile, commentators are all talking of ‘double dip’, of asset prices being ‘tired’ and of asset reflation trades being ‘over-crowded’. However, the corrections to date are tiny, with the S&P at 1109 last night, and gold at $1135/oz. Gold bulls are multiplying meanwhile: John Paulson, who made a  fortune shorting the US mortgage market and then another shorting UK bank stocks, has started a gold fund (click here). Gold is interesting because it is supply-constrained. The US is still building too many homes. It is possible to argue that there are plenty of tankers floating around with excess oil inventories. But gold supplies just aren’t growing fast enough. It is also interesting that investors who made their reputation in ‘relative value’ trades, analysing the minutiae of complex instruments, are now trying to exploit major ‘macro’ themes. Less liquidity, the increased cost of capital and increased regulation all make ‘relative value’ trading harder. Huge and growing global imbalances will increase the importance of ‘macro’ trading. Meanwhile, the Telegraph carries an outrageously bullish view of gold (click here).

That is an aside to today’s markets, however. The UK has just released retail sales data for November which posted a 0.4% increase and an upward revision to last month’s data (the weakness a month ago prompted disbelief in this blog, if you remember). Year over year sales volumes are at a very respectable 3.4% while high street prices are still falling at a 0.4% rate (-2.4% excluding food stores). This was good news, as was a further increase in mortgage applications to 61,000 and a jump in the M4 measure of money supply now growing at an 11% rate. The bad news is in the public finances with a huge £11.4billion deficit in October, a record for that month, as taxes fall precipitously. When quantitative easing finishes, gilt yields will certainly go up. I think sterling will benefit, but that is for 2010.

The US sees October Leading Indicators, which no-one ever looks at any more but they paint a very rosy picture; the Philadelphia Fed survey which probably rose from 11.5 and weekly jobless claims which fell to 502,000 last week and point to an improving labour market. The Fed’s Plosser and Fisher are giving speeches and so is the Treasury’s Tim Geithner. The tone of all US policy-makers has been unbelievably dovish of late. Will that be enough to get the reflationary trends moving again ahead of next week’s Thanksgiving Day holiday? Finally, the OECD Outlook has just been published in Paris (click here).

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Yesterday’s UK CPI data showed the annual inflation rate rise from 1.1% to 1.5% putting the trough in inflation behind us. Yet gilt yields fell and market interest rates also backed off slightly. CPI inflation is likely to rise to a level between 3% and 3.5% in January and will stay above the Bank of England’s (BoE) 2% target for most of the year. Yet no-one seems bothered. Forecasts of inflation in 2011 look for a return to this year’s lows and beyond. And to be fair, the rise in inflation is driven by food and energy prices, and will be exacerbated by the ill-judged timing of January’s VAT increase. Beyond that coupled with the ever-present inflation in the provision of public sector services (don’t get me started on Haringey Council!), there isn’t really any inflationary pressure in the economy. (Private sector) wages aren’t going up, globalisation is still driving the price of electronic and other white goods down, and Debenhams is starting its Christmas Sales today.

This is a bit of a quandary for the MPC and for markets over the medium term. On a relatively consensual assessment of the UK economy – i.e., one that looks for very modest growth in 2010 – Mervyn King will write a letter explaining the inflation overshoot in early 2010 and the MPC will simply ‘look through’ the spike. And as inflation falls below target through 2011, you can easily argue that that there will be no need to raise rates until 2012. Why would the MPC tighten in 2011 with inflation less than 1% and fiscal policy being tightened? Take a more optimistic view of the economy, however, and the spike in inflation comes against an improving economic backdrop and causes much more consternation, possibly prompting a rate hike around mid-2010. In short, the outlook for rates is dependent on the scale of an economic recovery about which economists cannot agree at all. It seems a recipe for volatility. My own sense is that discounting will prompt an increase in retail sales in the run-up to the VAT increase and cause the more bearish commentators some pause for thought, at the very least.

The day’s major economic highlight has been the release of the minutes from the MPC meeting on 4-5 November (click here). There was a 3-way split with the BoE’s Chief Economist voting for no increase in quantitative easing, and David Miles seeking an increase of £40billion, whereas the consensus wanted a £25billion increase. That would seem to be mildly hawkish but the economic assessment was more dovish and there was discussion about the rate the bank pays for reserves as well. Sterling’s first reaction has been to fall and the front end of the money market is pushing rate increase expectations even further into the future. We get the CBI Industrial Trends Survey later.

Internationally, the focus is still on Chinese currency policy. Martin Wolf has weighted into the debate in today’s FT (click here), arguing forcibly that China must revalue soon. The Chinese are resisting pressure to revalue, arguing that their decision to peg the renminbi was a response to the global economic crisis and was a factor which was helpful. Echoing G7 talk of ‘exit strategies’, the Chinese say it is too soon to ‘exit’ their current stance. I don’t think change is imminent, but I am certain China will revalue in 2010.

Otherwise, all I hear from investors now is how seasonal factors will drive markets (generally, this is given as a reason for the euro to strengthen from here) and fear of a correction in asset markets. Profit-taking in gold was cited overnight, though the price is $1,146/oz this morning. Fear of correction in equities remains rife too, though S&P futures are at 1107 as I write. The reflation rally continues and everyone is looking or hoping for a correction because they can’t bear to buy at these levels. That’s not a stable state of affairs.

I have posted a longer-term outlook piece on the website for those who want an update on my thoughts (click here).

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The dollar hit a new low for the year on a trade weighted basis; gold hit a new high; and the S&P also hit a new high. In short, reflation is still the dominant theme.

Ben Bernanke, Fed Chairman, was speaking at the Economic Club of New York and his remarks were perceived as dovish overall, ensuring rates remain low for a very long time indeed. He did make positive-sounding noises about the dollar but these were easily disregarded by a market which is getting less interested in toothless talk of a ‘strong dollar’. So when Bernanke says “the flow of credit remains constrained, economic activity weak and unemployment much too high”, or “some important headwinds – in particular, constrained bank lending and a weak jobs market – will likely prevent the expansion from being as robust as we hope”, it is easy to conclude rate hikes are far away in the future. When he adds that “We are attentive to the implications of changes in the value of the dollar” it sounds like the hollowest threat possible (click here for the full text). The FT’s Fed-watcher Krishna Guha has penned an interesting article (click here). Bottom line: the Fed is not concerned about asset bubbles indeed seems to me to welcome them; is keeping rates low for as long as it takes to give the economic revival foundations; and is paying no more than lip-service to supporting the dollar.

I don’t think the dollar can fall in a straight line against a steady flow of positive economic data – yesterday’s data were mixed but showed a sharp rise in retail sales, albeit led by auto sales. But as long as the economic data does not produce a turn in interest rate expectations (and 2-year Treasury yields fell to a measly 0.77% overnight), the dollar’s primary trend is lower, particularly against those currencies where rates are rising. So, the Australian dollar has drifted a little lower this morning as doubts emerge about the pace of tightening by the Royal Bank of Australia, but the primary trend is still towards USD/AUD parity. 7.5% from here. Away from currencies however, the trends are if anything stronger. Gold, as I have written before, causes no policy consternation as a result of its strength and can go higher. Oil prices may be limited by huge stocks but are also in a long-term uptrend and food price inflation will be a recurrent theme. Equities, meanwhile, may earn the wrong kind of profits, but any company paying a dividend is offering an attractive yield to investors and asset allocators will be moving insurance and pension fund money from bonds into equities.

In the UK, Andrew Sentance (MPC member) gave a relatively upbeat assessment of the UK economic outlook but was more dovish on policy. The possibility of further quantitative easing was certainly not ruled out and he said nothing to suggest rate hikes are visible on the horizon (click here for his speech).

The UK sees the release of October CPI inflation data this morning. This will be the first month when last year’s helpful base effects fall out of the annual calculation and a 0.1% monthly increase represents an acceleration in inflation to 1.4% from 1.1%. The old-fashioned retail price inflation measure will likely see inflation rise from -1.4% to -1%. That is not an appropriate rate to target, but is the one which is most relevant in calculating the change in real disposable incomes. Later today we get Eurozone trade data and US PPI inflation (going to -1.8% from -4.8% on an annual basis), and US industrial production, which will probably have increased by 0.4% from 0.7%. A host of central bankers are giving speeches too, from the Bank of England to the ECB to the Fed.

I have posted a longer-term outlook piece on the website for those who want an update on my thoughts (click here).

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Good morning. All eyes today are on President Obama’s trip to Beijing, the potential for growing trade tensions and US concern about the resistance of the Chinese authorities to allowing their currency to appreciate against the US dollar. The President, who has been having a relatively rough time of it at home with his popularity slipping, has a very straightforward objective: he needs to create jobs in the US and needs to be seen to be making progress on protecting US jobs from the cheaper labour costs in Asia. He is, after all, a Democrat President. The need to create employment is the dominant driver of US policy. A further fiscal boost aimed directly at employment certainly cannot be ruled out. Pressure on the Chinese and the rest of Asia goes hand in hand. And until employment is recovering, there is no way given the absence of inflation that policy accommodation will be removed. Commentators can write about the US fuelling the carry trade until they are blue in the face, but the US simply won’t care. The scale of the problem is highlighted in a measure of unemployment which is growing in popularity called U6, which basically includes those who would like to work but aren’t actively looking for jobs (defined as those marginally attached to the labour force and working part-time for economic reasons). This rate is running at 17.5% (one sixth of the labour force). George Magnus writes about the challenge this poses in a piece in the Times today (click here). The structural challenges are a huge topic in themselves but the political implications are simpler – rates stay low, fiscal policy remains loose, the weakness of the dollar is fine by Obama irrespective of platitudes about a ‘strong dollar policy’, and the sooner China revalues the better.  

I don’t think any of this means we will see a Chinese revaluation soon. The Chinese are no keener to tighten policy prematurely than anyone else. They will point to the fall in their trade surplus, the growth of their imports, the increase in consumption of things like cars and so on. We will get some concessions and surely the President will get something to take home. But we won’t get a major move quite yet. We will hear more on this issue however because as the US economy recovers, the labour market is likely to drag and growth is unlikely to return to the stellar performance of recent years. So tensions between the US and China seem bound to increase. And ultimately, renewed renminbi revaluation is preferable to a trade war. The renminbi is very likely to revalue in 2010. Mind you, if your want a much more gloomy (and sensationalist) view, you need only look as far as the Telegraph (click here).

Away from China: The UK has already seen the November Rightmove house price index which has fallen slightly as sellers appear. EC car registrations are up an impressive 11.6% year over year in October. Eurozone October inflation came in at 0.3%. Japanese Q3 GDP rose an impressive 1.2%. The US releases October retail sales data this afternoon, expected to bounce by 0.9% after last month’s sharp fall. Excluding cars, which have been very volatile, the increase is expected at 0.4%. The NY Empire State index is expected to dip to 29 in November after jumping to 34.6 in October. Heartened by low rates, equity markets are pushing higher again and that theme is likely to remain intact. Finally, the price of gold is still pushing higher on the back of reflation, concern about the dollar, fear of a trade war, and helped by the forecasts of falling production.

I have posted a longer-term outlook piece on the website for those who want an update on my thoughts (click here).

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Click here to download Kit Juckes's Macroeconomic Outlook for 2010.

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It is Friday the thirteenth, a day to hide under the duvet – and the weather encourages such behaviour. There are, apparently, never fewer than one and never more than three Friday the thirteenths in a year and since this is the third such event in 2009, it’s a rarity. We won’t see another year with three Friday the thirteenths until 2015.

So much for superstition. This has been a quiet week for economic data. Yesterday’s main news was another fall in the number of people claiming unemployment benefit in the US to 502,000. This is a very heartening trend though two caveats are required. Firstly, while the weekly claims numbers are doing a good job of correlating with the monthly payroll data, the relationship with the unemployment rate has broken down and the unemployment rate is politically more sensitive. The second caveat is that while people are finding new jobs – and hence coming off benefit – the indications are that they are doing so at significantly reduced wages. Still, I am at the optimistic end of the range in terms of expecting good economic data in the US over the turn of the year, though there is clearly momentum building around the idea of a new jobs-focussed fiscal package. This morning, we have seen Q3 GDP data from France, Italy and Germany, all showing increases (0.7% in Germany, 0.6% in Italy and 0.32% in France). They are all positive, but all fell a little short of market expectations. The FT headlines reflect the positive spin that is being put on the data (click here). Eurozone GDP data are due later. This afternoon the US gets import price data for October, looking for a 1% monthly increase but a 5.5% year-over-year fall despite the dollar’s decline. University of Michigan consumer confidence data are also released with a small rise from 70.6 to 71.0 expected. In the UK, we have received the latest High Street indication from John Lewis, very upbeat as has been the recent trend, with a 13.2% increase on an annual basis (click here). There are still plenty of people happy to knock both the UK economy and sterling but the data continue to suggest that the Bank of England’s reflationary policies are slowly taking effect.

Other themes are largely unchanged. The technicians are fretting about ‘double-tops’ in the S&P index and in the EURUSD exchange rate, and recent trends have somewhat run out of steam. I don’t think that means they have ended. With 2-year US Treasury yields back at their lows, the reasons to be short the dollar are unchanged, irrespective of the chatter about Chinese revaluation and talk of the dollar’s fall coming to an end. Nor is the rally in gold going to end against this monetary backdrop. Gold ran out of steam somewhat yesterday, but low interest rates, plentiful liquidity and ridiculous quantities of global currency reserves are a potent mix which can send it higher. Buttonwood in the Economist is a good read on the subject (click here).

I have also posted a longer outlook piece entitled ‘Alphabet Soup’ on the website, for those who want an update of my strategic thoughts into 2010 (click here).

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Once again, the release of the UK Inflation Report (click here) and Bank of England (BoE) Governor Mervyn King’s accompanying press conference have revived expectations of further quantitative easing (QE), pushed the timing of rate hikes further into the future and triggered sterling weakness. I found the reaction somewhat bizarre, frankly. All the more so when I saw the Evening Standard as I left work, with its banner headline ‘Official: Britain is on the way back’ (click here). The Daily Telegraph’s analysis (The Bank of England’s Inflation Report useless) is also worth reading (click here).

The BoE increased its growth forecasts in line with the reality of recent data, did not rule out further QE and stressed a willingness to look through the upcoming spike higher in inflation. Mervyn King once again acknowledged that sterling’s fall helped re-balance the economy. On growth and inflation, the reality is that the growth outlook is improving, albeit from a lower base given the weakness of Q3 GDP. The BoE could not possibly dismiss the official GDP data, so they incorporate them. I think the data are unreliable. I also think that with the employment, housing and consumer spending data all proving more resilient than the bank expects, we can expect a further period of better economic news in the months ahead. And I wonder whether the current insouciance about an inflation overshoot will be as easy to maintain when the data are actually released, particularly if inflation is higher (above 3%) than the BoE’s central forecast and this is accompanied by further positive news on demand. On QE, the notion that King would close the door to further asset purchases seemed ridiculous, so for the market to react in the way it has is odd. The MPC, in increasing the mandate to £200bn, said that they would monitor developments and that implies a further increase is possible. It is critical for the MPC, in fact, to keep its options open. As for rates, my ‘read’ is that the inflation report implies rates need to rise but by less than the forward interest rate market is forecasting. That too seems normal. The forward-looking interest rate curve is not an unbiased estimate of where rates will go, but a price at which people effectively borrow and lend in the future. Because rates can’t really turn negative and because rates are so far below ‘neutral’ levels, there are more people paying up to insure against higher rates than people committing to lend term money at derisory rates. So the one-year out implied rate – currently 1.75% for 3-month Libor – isn’t really where ‘the market’ thinks rates will be.

So, where are we left? Back with the economy, where signs are encouraging. There are no significant economic releases for the rest of this week, but a pick-up in employment and in mortgage approvals seems to me to set the stage for a better Christmas spending season than last year. I expect rate expectations to start firming up again in the New Year as inflation rises and the next Inflation Report (in February) to sound a good bit more hawkish than this one. All of which will be positive for sterling in due course.

Elsewhere, we have seen strong data on employment in Australia this morning (a 24,500 increase in October, where the markets looked for a 10,000 fall), strong Indian industrial production (9.1% year on year in September), and a lot of focus on the PBOC’s Q3 monetary policy report, which was interpreted as acknowledging the case for a higher renminbi (click here). This drove gold to fresh highs, though it has retreated a little since. The report does not imply an imminent change in policy, but it does reflect the gradual shift which will see the renminbi start to rise against the dollar at some point in 2010.

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Good morning. It’s a US Holiday (Veteran’s Day) and the anniversary of the end of World War 1. The US bond market is shut today but the equity market is open. The S&P closed marginally lower, failing to extend a run of higher closes to a seventh day. But in a thin market with no major news (Macy’s results may be the highlight), there is a chance after such a mild dip (a fall of 0.01%) of a further squeeze higher today. Certainly the general reflation theme has momentum with the price of gold hitting a new high this morning (US$1116/oz as I write), taking the Australian Dollar to a new high.

Three themes are worth watching today. The first is the trend in US (and therefore global) market interest rates. These are falling, with the 2-year US swap rate now within a basis point of its mid-May low at 1.138%. The 10-year auction yesterday was absorbed relatively comfortably with yields below 3.5%, despite measures of inflation expectations moving higher. Low (or falling) US market rates are the gravity that pulls the dollar lower and the fuel for asset market reflation everywhere.

The second feature of markets to watch is increasing concern about Japan’s fiscal woes. Just as US bond yields are falling, Japanese yields have been rising – by almost 20bp since early October. That does not reflect any expectation of higher official rates or signs of improving economic activity. Instead, it reflects the size of Japan’s funding need and the weakness of its finances. Yesterday’s observations about the UK’s credit rating from Fitch make headlines (click here for the Telegraph article). As I observed yesterday, since Japan lost its triple A rating it has enjoyed the lowest funding costs amongst the G7 economies and the strongest currency, so the idea that it would be a disaster if the credit agencies (whose standing is arguably even lower than banks) turned the outlook on the UK’s triple-A rating from ‘stable’ to ‘negative’ is slightly silly. However, the real story on credit ratings is the deterioration in Japan’s prospects. But Japan, with a strong currency, a massive current account surplus and deflation, has a way out. Quantitative easing has undermined the dollar and sterling. But that wouldn’t upset the Japanese. And the idea that it would cause inflation fears is unrealistic. Escaping deflation would be a great achievement.

The final topic today is the UK with the Inflation Report due shortly. Labour market data are already out (here’s the ONS link) and showed a small increase in the number of people in employment – a first for over a year. The unemployment rate rose less than expected to 7.8%. The number of people claiming unemployment benefit increased a smaller-than-expected 12,900 and the claimant count measure of unemployment rose to 5.1% from 5%. Along with the news of a further increase in the number of job vacancies in the City, these data continue to show that things are improving slowly, albeit from a pretty terrible place. I’ll write about the Inflation Report tomorrow, but expect it to acknowledge the lower path of growth implied by the poor Q3 GDP data, while stressing the inevitable rise in inflation that we will see in the months ahead (as last year’s VAT rate cut is reversed) is purely temporary.

Finally – and at the risk of making myself green with envy – a mention of the overnight data in China. Industrial production growth accelerated to 16.1% year on year, while retail sales picked up to 15.3%. China is still (economically-speaking) on fire. They will resist remnimbi revaluation for a long time but long term, they will revalue because it is what their economy needs. In the meantime, that kind of growth rate is a powerful driver of global reflation, driving commodity prices up and increasing currency reserves which need to be reinvested.

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There is little in the way of major news at the moment, though plenty of minor news stories to keep markets volatile. The underlying themes are basically unchanged: G20 did not back off from reflationary policies which are very gradually causing economic recovery to take root. Concerns about the durability of that recovery will not be allayed until employment growth recovers in the G7 economies and meanwhile, the non-G7 economies which escaped the worst of the credit crunch and recession are thriving. This is a recipe for equity markets to push higher, albeit somewhat erratically, for gold and other commodity prices to rise, and for higher-yielding currencies to remain well supported. The S&P is back close to the best levels it has made in this cycle and the Dow made a new 13-month high yesterday.

The major overnight news was an e-mailed statement on sovereign ratings from Fitch, the ratings agency who were holding a structured finance conference in Tokyo (click here for more detail). Fitch had some dire warnings to impart about the threats to the Japanese economy from unemployment, deflation and a strong currency, but what caught the eye was the observation that the UK is the major economy whose triple-A rating is most vulnerable. My views on Fitch, ratings agencies and sovereign ratings in particular would take up more space than this blog can offer or than many of you have time to read. Suffice to say: Japan lost its triple-A rating in 1998. Since then, Japan has enjoyed the lowest government bond yields and the strongest currency in the G7. Secondly, a credit rating is a measure of probability of default. The local currency rating of a major sovereign borrower who can print its own money is relatively meaningless. For a corporate entity which cannot print money, default is not usually a matter of choice but for countries it usually is. My third observation on ratings agencies is that their reputations are surely so tarnished that we ought to be capable of ignoring them now. And finally, the news that the UK has seen the biggest deterioration in public finances thanks to this crisis is certainly not ‘news’ at all. Indeed, it is the reason that S&P has a negative outlook on the UK’s triple-A rating, whereas Moody’s and Fitch both have triple-A ratings with stable outlooks. All in all, I think that for anyone to pay any attention at all to this news story is nonsense.

The major news yesterday was, to be fair, of similarly poor quality. On the 20th anniversary of the fall of the Berlin wall, Germany recorded its strongest quarterly increase in industrial production since early 1989 with a 2.9% gain. These data are too volatile to get very excited about, though they come to temper the universal negativity which always surrounds Europe’s economic outlook.

We also received word of the Kraft bid for Cadbury, which was a formal version of the original offer with no increase on the table. That doesn’t mean the bid won’t be increased, however. Kraft needed to make this formal offer by mid-day yesterday. The FT has an interesting interpretation (click here). This morning saw the release of the latest BRC retail sales monitor – ‘Best October sales for seven years’ (click here), and the RICS housing market survey ‘Prices continue to rise with surveyors increasingly optimistic’ (click here). UK trade data show the deficit a little wider than expected at £7.2bn in September, and the German ZEW economic sentiment survey is due later, but no data are due in the US ahead of tomorrow’s Veterans’ Day holiday.

Frederic Mishkin has written an article in today’s FT entitled ‘Not all bubbles present a risk to the economy’ which I have attached and catches the current debate (click here). I think it can be summarised as saying that bubbles filled with over-enthusiasm (champagne), are not dangerous, whereas bubbles filled with credit are. I don’t think we can get away from the fact that any bubbles created now are a by-product of policies required to re-float the G7 economies and will be tackled in due course. As the UK RICS data show, asset reflation is working, and as the BRC data seem to imply, higher house prices do feed through to increased consumer confidence on the UK high street eventually. Those who fret about the dangers of these policies will drive gold prices higher and the upward trend in equity markets will continue.

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The G20 Finance Ministers and Central Bank meeting in St Andrews could have seen the start of a more inclusive, more relevant and more activist period of global policy co-ordination. In the event, they would probably have had more fun and certainly achieved as much if they had spent their time on the Old Course. The IMF prepared a set of papers and ‘principles’ for the meeting (click here). The IMF web page also contains a link to the text of the communiqué, which I don’t recommend reading unless you need help getting to sleep. The IMF’s principles are worth a glance however because they highlight immediately how far away in the future any meaningful policy tightening will be. Principle 1 says ‘The timing of exits should depend on the state of the economy and the financial system, and should err on the side of further supporting demand and financial repair’, which is self-explanatory. Only tighten when it’s absolutely safe to do so. Principle 2 says ‘With some exceptions, fiscal consolidation should be a top policy priority. Monetary policy can adjust more flexibly when normalization is needed’. In other words, tighten fiscal policy first and only raise rates much later. Principle 5 says ‘Unconventional monetary policy does not necessarily have to be unwound before conventional monetary policy is tightened’. This is important in that it differentiates between then unconventional measures, aimed at offsetting the weakness of the banking system, and interest rates, aimed at boosting demand and discouraging saving.

In short, the IMF recommends extreme caution in removing stimulus. The G20 failed to say anything to reverse the dollar’s downtrend and nothing about currency alignment seems to have been discussed at all. What the IMF did report – and was much commented upon – was that the low US rates are funding the global ‘carry trade’ where investors borrow in dollars to buy higher-yielding currencies. The IMF concluded, however, that the dollar remains overvalued (click here). That has increased the sense from markets on this Monday morning that they have a green light to sell the dollar. Trends that took the dollar weaker against gold and higher-rate currencies like the Australian dollar will remain very popular, increasing the risk of correction in due course, but in a week with little economic data these trends will persist for now.

The most vocal critic of these trades is Nouriel Roubini, who wrote an article in the FT last week ‘Mother of all carry trades faces an inevitable bust’ (click here). His views were picked up in the weekend FT and by the Sunday Times as well as the newswires. A new bubble is being created. It is being done on purpose. I prefer to call it a deliberate policy of asset reflation which is less alarmist. I wrote last week about how Halloween is an increasingly popular festival for children who are fascinated by wizards and magic in the Harry Potter era. Mine are watching TV series called ‘Merlin’ at the moment, and this weekend’s episode featured a witch-finder who warned the King that there was sorcery everywhere and set about accusing people. It made me think of Professor Roubuini and his ilk. Witch-finders needed to find witches to earn a living and needed to foster fear of witchcraft to be relevant. Professor Roubini isn’t a charlatan but he has built a reputation on the back of warning of imminent disaster. There is little ‘news value’ in telling people that everything might just be alright. On the same note, here’s a link to the Finance page of the Telegraph this morning (click here). Roger Bootle: ‘Fragile recovery is more in the air than in the economy so far’; Liam Halligan: ‘This isn‘t even the end of the beginning for our economic woes’. Meanwhile the stories for markets to digest today are the suggestion that Barclays will make its best-ever profit, and speculation about whether Kraft will increase its bid for Cadbury today. Both are helping sterling.

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The US Federal Reserve left rates unchanged last night and did not remove the key phrase from its policy statement, saying that they expect to keep rates at exceptionally low levels for an extended period. They also reduced their planned purchases of GSE debt by $25bn to $175bn. The focus of market commentators is on the increased guidance the Fed provided about what variables they will be watching. Low levels or resource utilisation, low inflation and stable inflation expectations are all deemed key variables. Analysts view the detail of the statement and the additional guidance as slightly hawkish, though personally I am not convinced that I have learnt anything new. Of course the Fed is watching ‘resource utilisation’ which presumably includes the unemployment rate as the economy’s most important resource is labour. And of course rising inflation expectations matter. Rates will be at 0-0.25% until late 2010 by which time the inflation picture may be less benign and the unemployment rate will have peaked. The FT’s ‘take’ on the decision (click here) and the statement itself (click here) are worth reading.

The US equity market suffered a late dip and the dollar had a late rally after the FOMC decision. Slightly soft data from the ADP employment survey and the service-sector ISM did not have much impact ahead of the FOMC. Today, we get weekly unemployment claims and third quarter productivity data. Again, not much of a reaction seems likely with the focus on tomorrow’s jobs data. But the speed with which US companies have cut jobs in this cycle is producing an exceptionally strong rebound in productivity (and hence in corporate profits, even if they are the ‘wrong’ kind of profits for some analysts).

The UK released September industrial production data this morning with August revised from -2.5% to -2.6%, but September bouncing by 1.6% – a bigger bounce than expected. Those who thought the August output and Q3 GDP data were ‘rogue’ numbers will have been looking for an even bigger bounce or a revision. The upshot is probably neutral and leaves the focus on the MPC. The UK press commentary on the MPC is worth reading (click here for The Telegraph’s take, and click here for the Times’s article). The consensus looks for a £25-50bn increase in the quantitative easing mandate, with some accompanying remarks, no doubt, about a slower pace of buying and possible pause. I have written (lots) about the case for the MPC both to keep on with easy policy until it is clear the economy is recovering and to maintain as much flexibility as possible, which argues for increasing the mandate. Any sterling weakness that were to follow an increase in the mandate would seem to me a chance to buy, and any fall in Gilt yields a chance to sell.

The ECB also announces the result of its policy meeting today. There is no chance of a move in rates, but any comments in the press conference that point to the timing of an exit strategy from current accommodation would elicit a response. New staff forecasts are due in December and that is probably when we will hear more about a timetable for policy tightening.

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Good morning. It’s Culture Day in Japan, one of those autumnal Bank holidays I wish we could import. Today’s first piece of news was that the Reserve Bank of Australia (RBA) has duly raised rates by a further 0.25%, to 3.5% (click here for their statement). The RBA judge it ‘prudent to lessen gradually the degree of monetary stimulus that was put in place when the outlook appeared to be much weaker’. That implies more rate increases to come with the current 25bp per month pace likely to be maintained. The fact that the 25bp hike was so widely expected, and that we had seen some speculation about a 50bp hike a few weeks ago, explains why the Australian dollar has not reacted more positively. Two weeks ago, interest rate futures markets were priced for 90-day Bill yields (currently 3.93%), to rise to 6%. Now the market has backed off a bit to 5.5% and that shift has undermined the Australian dollar. 5.5% is the average Bill yield in the current decade and the peak yield before this crisis was 8%. Now that we have seen a correction, the Australian dollar will probably find a base and start to benefit once more from its interest rate premium. The Australian dollar has been the strongest of the major currencies in 2009 (the US dollar the weakest) and is positioned to eke out some more gains.

The first of the major US economic indicators for October was released yesterday with the Institute of Management and Supply business sentiment index rising sharply to 55.7 from 52.6, and way ahead of expectations of a rise to 53.0. The report is consistent with a GDP growth rate in the region of 4% and, with a bounce in both inventory levels and manufacturing employment, was pretty solid across the board. Construction spending data for September meanwhile, posted a surprise increase of 0.8% and with Ford reporting very strong results, the signs of economic rehabilitation are heartening. Not that this did much for markets. Stocks were very choppy all day. The focus is on the FOMC meeting tomorrow and the risk that the current better growth won’t be sustainable. On the latter, there is little new to say. The purpose of unprecedented policy stimulus is to give the recovery as much chance as possible to become self-sustaining. But to succeed requires employment to start recovering so that income growth resumes. On the FOMC, the market’s fears centre on the possibility of a change in the language in the FOMC statement (click here to read the last statement). The key phrase is ‘economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period’. The FOMC is nervous about an excessive reaction when they do finally raise rates, so wants to take baby steps in moving towards the exit and changing that wording would be such a step. The markets, skittish as ever and inclined to suffer a pre-Christmas correction, seem set to over-react. In the long run, the main points are that rates are not going up before the second half of 2010 and will only do so when (or if) recovery is entrenched. In the short run, there is a risk of a further (final) lurch lower in asset prices.

In the UK, the focus is on the continued woes of the banking system. There are any number of articles on the subject (click here for The Times’s contribution). My first reaction is that banks can’t lend money they don’t have and need to get new capital from wherever they can, whether that’s the public or private purse. The lack of bank lending in the UK is partly due to lack of demand and partly to lack of supply. The latter is due to the fact that the banks simply don’t have lending capacity, having seen so many loans turn sour. This latest news, which overshadowed some very strong UK PMI data yesterday, makes for very bad PR for UK Plc, but is a necessary step to get money moving around the economy. That’s a good thing even if the cost will leave a bad taste in the mouth for many.

There is a risk today that ahead of the FOMC and the MPC – let alone Friday’s US payroll report – we see investors heading for safety, market volatility remaining high and liquidity remaining poor.

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Welcome to November. A very autumnal weekend saw the growth of Halloween as a retail phenomenon in the UK – clearly supplanting Guy Fawkes night – as well as some very British weather. Meanwhile, on the other side of the world, economic recovery continues apace. HSBC’s China Manufacturing PMI rose to its best level since March 2008 in October reaching 55.2. Japan’s PMI is holding above 50. Taiwan, India and South Korea all saw strong PMI data too (click here for the FT write-up). Asia is the big winner in the post-crash environment: as global trade recovers, global rates stay low and the region finds it has escaped the credit crunch to a large degree. Particularly encouraging throughout the region was the news that China’s import PMI jumped to 52.8 from 50.7. The more China buys, the more the Japanese, Koreans and Taiwanese sell. Meanwhile in Australia the Treasurer announced an upward revision to growth forecasts (click here) and house prices rose to record highs in the third quarter. The RBA meets tomorrow (overnight for us) and seems likely to raise rates by 25bp to 3.5%.

I think Asian out-performance will remain a key driver of financial market trends over the medium term. For now however, markets are more concerned about a slew of major economic data releases and policy meetings. The US focus will be on their purchasing managers’ survey today, expected to rise further to 53.0 from 52.6, and then focus shifts to the FOMC meeting on Wednesday and the Payroll report on Friday. There has been talk of the FOMC changing its policy language slightly in its statement, but I doubt they will take any chances with a fragile economic recovery and even more fragile mood. Certainly I believe rate hikes are still nine months away at the very least. If the Fed’s dovish stance is reaffirmed, and if the monthly payroll data show a decline of fewer than 200,000, I think there’s a chance the current correction in risk assets (stocks, and high-yielding currencies) will represent a buying opportunity before the weekend.

The UK focus is on this morning’s PMI data – which came out very strong, at 53.7 vs 49.9, casting even more doubt on the August industrial production and Q3 GDP data – and speculation ahead of the MPC meeting. Here are three takes on the meeting, for those who are interested: The Times (click here); David Smith (click here); and Hamish McRae in the Independent (click here). My own view is that if I were on the MPC, I would vote to increase the mandate and slow the pace of bond purchases. Surely the MPC will maintain as much flexibility as possible? I think this is now discounted and expect sterling’s recent correction to run out of steam in the first half of the week while gilt yields start to edge higher again. These will continue to be alarmed by the size of the public sector deficit. Eternal bear Roger Bootle’s view on this subject is worth reading (click here).

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