A weighted average of 7-10 year sovereign yields in 12 Eurozone markets – calculated by Datastream using debt weights – is at its highest level since 2008, having surged by 100 basis points since early September. This represents a substantial tightening of financial conditions warranting a monetary policy response ideally combining a large cut in official interest rates with country-neutral QE aimed partly at reversing the yield rise.

Commentators surprised at the euro’s resilience against the US dollar may be neglecting the extent to which bond prices have taken the strain of the crisis – the EMU-12 7-10 year bond price index has fallen by 7.9% since the early September yield low versus stability in same-maturity Treasuries (-0.1%).

Year to date, EMU bonds are down by 5.5%, representing – barring a late recovery – the worst annual performance since 1999, when 7-10 year Bunds plunged 9.6% as the newly-created ECB tightened policy at the tail-end of the technology boom.

A country-neutral QE operation – with purchases spread across national markets in proportion to GDP or population – would emphasise the monetary motivation and counter criticism of a backdoor fiscal bailout. A reasonable initial target would be buying of 5% of GDP over four months (i.e. equal to the current UK programme), implying a monthly rate of about €120 billion. For comparison, the ECB has purchased a cumulative €120 billion since its “securities markets programme” (SMP) was restarted in early August, equivalent to €35 billion per month.

Claims that such a policy would amount to inflationary money-printing should be met head on. The ECB is already conducting QE via its SMP and covered bond purchases – the SMP "sterilisation" operation involving auctioning one-week term deposits is entirely cosmetic since banks will regard such deposits as fungible with central bank reserves. More importantly, money-printing is necessary to head off deflation if the banking system is destroying deposits by accelerating deleveraging in response to sovereign bond losses and misguided regulatory pressure.

“Flash” PMIs for November released this morning confirm a Eurozone recession while suggesting that Chinese industrial momentum has slowed abruptly. The latter indication, however, is at odds with other recent evidence. The latest regional Fed manufacturing survey, meanwhile, echoes an improvement in optimism in other recent polls.

Asian equity markets were knocked back by release of the Markit Chinese manufacturing PMI data, showing a slump in new orders in November, reversing surprising strength in October. The Markit survey, however, sometimes diverges from the more reliable official PMI, November results for which will be released at the start of December – note the misleadingly-weak Markit new orders reading in mid 2010.

The suggestion from the Markit survey of an abrupt weakening of Chinese industrial activity sits uneasily with other recent evidence, including a firmer leading indicator and less negative company earnings revisions.



Chinese real money trends, meanwhile, were signalling economic weakness earlier in the year but have recently started to recover.


Bottom line: the Markit results are probably erratically weak but will add to pressure for policy easing.

The Eurozone flash PMI new business indicator recovered marginally in November but remains in recession territory. The small rise was due to services with the manufacturing new orders index falling further.


Recent US manufacturing surveys, by contrast, have indicated stable current order flows and rising optimism about prospects. With three of the five regional Fed polls so far released (New York, Philadelphia and yesterday's Richmond), an average of orders outlook indices has risen to its highest level since April.

ECB system support rose by a further €48 billion to a new record last week. The definition of system support here covers lending in weekly and long-term repos, other claims on banks, “other assets” – incorporating the emergency liquidity assistance operations of Greece and Ireland (at least) – and sovereign and covered bond purchases.

System support has increased by €426 billion since April, equivalent to 4.5% of GDP – see previous post for more discussion.

According to the Financial Times, the Office for Budget Responsibility (OBR) now expects the structural (i.e. cyclically-adjusted) current budget deficit to be eliminated in 2016-17 on announced policies – two years later than at the time of the Budget. This slippage, however, reflects a downward reassessment by the OBR of the UK economy’s supply-side capacity rather than worse-than-expected recent borrowing outturns.

Running the raw borrowing numbers through Datastream’s seasonal adjustment programme, the actual current deficit was an annualised £91 billion in the first seven months of 2011-12 – on track for the OBR’s previous full-year forecast of £90 billion. Overall public sector net borrowing was £124 billion versus a £122 billion full-year projection.

This year’s fiscal performance, in other words, has been surprisingly good against the background of weaker-than-expected economic growth.

The fiscal position, moreover, is better than implied by the targeted measures, which exclude income arising from the financial interventions of recent years – see previous post. In particular, the Bank of England is currently earning about £10 billion per annum on its QE operation (by paying Bank Rate on reserve money created to finance a higher-yielding gilt portfolio).

It is bizarre that the government is under pressure to implement additional fiscal tightening because OBR economists have changed their guess about supply capacity and despite respectable progress to date in reducing the deficit.

Equity earnings revisions ratios for November offer further evidence of a tentative recovery in global economic momentum, albeit one at significant risk from the escalating Eurozone crisis and premature US fiscal tightening – the failure to agree a longer-term deficit reduction plan has lowered the probability of payroll tax cuts and jobless benefits being extended beyond end-2011.

The revisions ratio expresses the net number of upgrades to company earnings forecasts as a proportion of the total number of analyst estimates. It correlates closely with business survey information – in particular, the new orders component of the manufacturing purchasing managers’ survey – but is available earlier and at higher frequency (i.e. weekly as well as monthly).

The world revisions ratio remained negative in November (i.e. more downgrades than upgrades) but rebounded from a depressed October reading, reaching its highest level since July. This confirms a small rise in the G7 PMI new orders index in October and suggests a further increase to above the break-even 50 level this month.

The regional breakdown shows, unsurprisingly, relative weakness in the Eurozone and strength in the US, where the revisions ratio turned positive for the first time since May – consistent with recent better-than-expected US economic data discussed in yesterday’s post. Even the Eurozone ratio recovered significantly, however, suggesting a less downbeat new orders reading in tomorrow’s “flash” PMI report for November.

Amid the gloom in markets, it is worth noting that recent US economic news has been mostly encouraging, consistent with earlier monetary strength. In particular, retail sales recorded another solid gain in October while Philadelphia manufacturers were much more upbeat about order prospects in early November. Both suggest a further gain in the key ISM manufacturing new orders index in November.



The issue, of course, is whether financial and economic weakness spreading from Europe will abort an incipient upswing in US momentum. Historically, the US ISM new orders index has led the corresponding Eurozone purchasing managers’ survey measure rather than vice versa. Is this changing or will the Eurozone “flash” PMI for November released this week show some recovery from a very weak October reading?


The euro weakened last week but many commentators have been surprised at its resilience in the face of escalating sovereign debt woes. September Eurozone balance of payments released today help to explain the puzzle: foreign portfolio investors, unsurprisingly, withdrew funds from the region in the latest three months but this outflow was more than offset by a repatriation of foreign assets by Eurozone residents. This may reflect Eurozone financial institutions being forced to liquidate foreign investments and convert the proceeds into euros because of the seizure of domestic funding markets.

David Smith wrote bearishly about the UK labour market in his Sunday Times column, highlighting a 305,000 drop in the labour force survey (LFS) measure of employees in the latest three months. This fall, however, is partly payback for a similarly odd-looking rise of 161,000 in the prior six months – the exaggerated fluctuations may reflect a sampling error. Vacancies are a smoother measure of labour market demand and lead the LFS measure – they have been moving sideways recently, consistent with stagnant conditions rather than major weakness.