Where is GBP going to go? With the BoE inflation report yesterday showing 2013 inflation well below target, the door appears to be wide open to further QE. But GBP has been relatively strong of late, caught between haven flows from Europe on the one hand and a declining economy and hence the growing chance of further QE on the other. As a result, GBP is not my preferred risk-on or risk-off currency, and I can’t see a reason to trade it on any other basis at present.

Fitch upset the markets yesterday by saying that, while US banks had “manageable” exposure to the PIIGS, “contagion” affecting the European core would mean their ratings would probably be cut. There is some useful information here — that US banks are not very exposed to the PIIGS directly — but the point about “contagion,” which was apparently not defined in the report, could have been made by my granny.

I have read some further discussion today about the situation in China. Citi has said that residential construction accounted for 6% of Chinese GDP last year — i.e. not that much. On 10th November I said: “Residential investment is a leading indicator in the US because it indicates financial weakness among households, and US recessions are usually caused by a fall in household spending, which has knock-on effects in other sectors of the economy. Should China be expected to have the same kind of business cycle? In that country, investment spending, to a large extent government-funded, is the driver of growth; strong investment spending means that people are employed and have money to spend, and hence consumer spending is also strong. In other words, the direction of causation in China probably runs from investment to consumption and not the other way around. A fall in residential investment may therefore not mean very much for the Chinese economy.” Confirmation that residential construction is a small part of China’s economy seems to support that view. 

A Barclays analyst has separately estimated that a 10-30% fall in house prices would trim 0.5-1% from Chinese GDP, and said that the Chinese government will probably loosen restrictions on the residential property market is house prices fall 20%. The latter point is important: Chinese house prices may have fallen a little, and that may have a bit of an effect on GDP, but that is presumably exactly what the authorities wanted in the first place — and hence it would be strange if they start loosening policy in response to a little drop in prices. I do expect the Chinese to stimulate like billyo if their economy weakens significantly, but I do not expect them to do very much yet. Incidentally, a possible objection to the passage I quote above is to be found in anecdotal reports that local governments are stopping land sales in response to weakness in the housing market. Since land sales are an important source of funds for local governments and local governments are a major source of investment spending, there could be a knock-on effect from weaker housing to the broader economy via this route. China’s economy is opaque so there is not much to analyse here, but this is a point I will bear in mind.

The Philadelphia Fed’s quarterly survey of professional forecasters is out, and it doesn’t show a lot of change — a slight upgrading of 2011 growth from 1.7% to 1.8% and a slight downgrading for the coming two years, 2.6% down to 2.4% in 2012 and 2.9% down to 2.7% in 2012. The most notable change is in the probability of recession in the present quarter, which has fallen from 20.9% to 11.8%. The chance of recession in the individual quarters of 2012 has also fallen, from about 19.5% in each quarter to about 17%. All this presumably reflects the surprisingly good data flow from late August onwards. From a trading point of view, the interesting thing is that the 2012 GDP forecasts fell because of a slight increase in the downside skew to the forecast distribution, I suspect because of the Eurozone crisis. As Europe’s crisis drags on and Europe enters a serious recession I expect the US to suffer from the fallout and thus for both forecasters and the market to continue to upgrade their assessment of downside risks to US growth. Thus US equities ought to fall as Europe deteriorates.

The Brent-WTI spread is continuing to close, sadly by WTI rising (as I am short Brent). It seems that ConocoPhillips is to sell its share of the Seaway pipeline to Enbridge, which together with the other existing owner will reverse the flow. This will allow a rising amount of oil (150k b/d by Q2 2012 and 400k b/d by Q1 2013, according to the owners) to be pumped out of Cushing to the coast, which should close the spread between the general oil markets and WTI. 

The Greek non-default has got people thinking about how useful CDS contracts will be in the future, if technical default can be avoided so easily. I think that they will remain useful. First, because creditors are not going to suddenly start agreeing to voluntary haircuts on corporate debt, so corporate CDS will remain useful; second, because if any large EU country — Italy, say — looks like having to default, it would be such a disaster for the banks that they would be unlikely to agree a voluntary haircut, so if there was a default it would probably be of the usual kind (an excellent point from Naked Capitalism); and third, because smart-alec schemes to avoid technical default are a feature of the peculiar circumstances of the European Union, and there is no reason to think that other countries could pull off the same trick.


US CPI -0.1% MOM d.e., 3.5% YOY. Core 0.1% MOM a.e., 2.1% YOY.
Cap Util 77.8% b.e. Oct.
IP 0.7% b.e. Oct.
UK Nationwide consumer confidence fell, d.e., to a level below its 2009 trough.
UK retail sales 0.6% b.e. Oct.

Next 24 Hours:

Building permits, initial claims, housing starts, Philly Fed, German PPI