G3 Recap 11-23-10

Main Items:

  • North Korea shells a South Korean island, killing one South Korean marine and wounding several others; South Korea has scrambled fighter jets to the area and raised its military alert to the highest level.
  • US Q3 GDP Growth was revised up to 2.5% from 2.0% vs 2.4% expected. The upward revision was encouragingly driven by better consumer spending and business investment.
  • FOMC Minutes did not have much in the way of surprises. Some key points:
  • “several [members] noted that the recent rate of output growth, if continued, would more likely be associated with an increase than a decrease in the unemployment rate.”
  • “Most saw the risks to growth as broadly balanced, but many saw the risks as tilted to the downside.”
  • “Several participants saw a risk that a further increase in the size of the Federal Reserve’s asset portfolio, with an accompanying increase in the supply of excess reserves and in the monetary base, could cause an undesirably large increase in inflation.”
  • Notable changes in central tendency forecasts:
  1. GDP Growth 2011: 3.3% vs 3.85%. (Note that 2010 expectations is 2.45%, with growth potential at 2.5%-2.8%)
  2. Unemployment: 2011: 9.0% vs 8.5%. 2012: 7.95% vs 7.3%. 2013: 7.15%. NAIRU estimate is 5-6%.
  3. Core PCE: 2011: 1.25% vs 1.1%.

Canadian Core CPI jumped to 1.8% YoY vs 1.5% expected and previously

Brian Cowan, Irish prime minister, defied calls for a snap election, but said he would trigger a poll in the new year after passing an emergency Budget designed to stave off further financial turmoil.

At the 2nd EU-IMF review of Greece, the IMF suggested the possibility that Greece’s repayment period for IMF loans could be extended.


  • There are reports that Chinese banks have achieved their full lending quota for 2010 and that they will stop extending loan books to avoid exceeding limits.
  • EU PMI Composite improved to 55.4 in November vs 53.6 expected and 53.8 previously. Both manufacturing and Services were better than expected, with a big upside surprise in services. Both French and German measures came in better than expected.
  • German GfK Consumer Confidence improved to 5.5 in Dec vs 5.1 expected and 4.9 previously. This is the highest print in 3 years.
  • Italian Consumer Sentiment improved to 108.5 in Nov vs 107.4 expected and 107.7 previously.


  • The EU saga continues. Spanish CDS (orange below) hit all time highs today. This is the big one. The EU & ECB needs to halt this move, because if they don’t, they will be forced by the market to intervene. As I suggested yesterday, a halt will only buy a few more months for Spain to get its house in order. Since the PIGS are running a current account deficit, they need increasing foreign sponsorship of their sovereign debt just to keep prices stable. Since this is clearly not happening, the trend will continue until the ECB or other price insensitive buyer gets involved, or they start running budget surpluses.

    Some put butterflies or spreads in white Eurodollars are probably a reasonable bet here, since EU banks represent a large portion of the Libor polling pool. There is a pretty reasonable spike in white contracts over the next couple of months. EDH1 hasn’t sold off yet, and is pricing in a 3m Libor setting of ~40bps. We saw a high of 54bps last May, and Spain is a much bigger problem that may be bigger than the EFSF given that the other 3 PIGS members may have already tapped it by the time Spain needs it.

  • The increases in FOMC central tendency forecasts for unemployment relative to NAIRU is substantial and solidifies the idea the Fed expects to be on hold for at least the next 2 years. Furthermore, based on these statements, there is a good chance that the Fed will increase the size and duration of QE2 if GDP growth in 1H2012 is anywhere close to the 2.5% growth rate that has prevailed this year, even though the minutes suggest the latest policy move was not overwhelmingly popular. Finally, the worries of some members that the growth in excess reserves will cause inflation down the road should be scrutinized. The worries appear to be mostly due to uncertainty and an analysis framework based on a narrow monetary theory construct that is likely to lose credibility over time, as inflation remains low in the coming years despite increasing excess reserves.