SCOREBOARD: Merkozy boost

Risk on again by the looks of it, although we aren't talking record-breaking magnitudes. Clearly the market likes some of the rhetoric coming out of Europe. The latest last night was that German Chancellor Angela Merkel and French President Sarkozy said they had reached a "comprehensive agreement” to tighten the fiscal rules of EU membership, by applying automatic penalties for nations that violate deficit rules. They also intend to write debt limits into constitutions – details will be outlined in a letter to the EU president on Wednesday. Merkel also happily restated that private sector losses on sovereign debt would be limited to Greece – with Sarkozy adding "that in Europe we pay back our debts”. Good to hear. Italian bonds responded immediately, to that and also news on Sunday that the new prime minister, Mario Monti, got approval for his €20 billion austerity plan. So the 2-year yield dropped a full 100bps to 5.56 per cent while the 10-year was down 73bps to 5.95 per cent. Spanish and French yields were also down – Spanish yields sharply so – while spreads to bunds narrowed aggressively.

In the equity space, European stocks ended the session up 1.2 per cent on the CaC, 0.4 per cent on the Dax and 0.3 per cent on the FTSE, while euro is actually weaker. It was pushing higher for much of the session and hit a high of 1.3486. However, the currency sold off fairly sharply early this morning after news surfaced that S&P is likely to put Germany, France and pretty much the entire eurozone on credit watch negative. So 80 pips dropped off after that and as I write, euro is at 1.3397, or little changed from yesterday at 1630 AEDT. We saw similar moves for the Australian dollar and at the high, it touched 1.0305 (about a big figure higher than at 1630 AEDT) before following euro lower around the time of S&P's news. Currently the Aussie dollar is at 1.0261, up about 60 pips from yesterday afternoon. Otherwise sterling is just under 50 pips higher at 1.5645 while Japanese yen sits at 77.8.

Wall Street had a pretty solid session and that's despite some disappointing headlines on the data. The data wasn't worrisome or anything, maybe that's the point, but the non-manufacturing ISM index was weaker-than-expected at 52 (versus a forecast 53.9) in November from 52.9. This is the weakest result since January 2010. Then factory orders fell 0.4 per cent in October. Offsetting some of these headlines, the production and new orders components of the services ISM actually rose (although employment fell) and readjusting this survey on a similar basis to the ISM survey actually shows the non-manufacturing index increased. Similarly, the drop in factor orders was all in very volatile components – transport and defence – and excluding these, orders rose.

In any case, the S&P closed up 1.03 per cent (1257.11) although it was up 1.8 per cent at the high, only losing those gains following the news on the credit watch speculation. Financials, basic materials and tech stocks led the charge, while healthcare and consumer goods lagged. The Dow then closed 0.67 per cent, or 80.91 points, stronger (12100.33), the Nasdaq was 1.08 per cent higher (2655.33) while at 0715 AEDT the SPI had gained a modest 0.2 per cent (4328).

Most commodities were bouncing in and out of positive territory for much for the session, and the biggest move was on gold, which lost about $23 to sit at $1721. Crude looks to be down smalls so far both on WTI (-0.03 per cent to $100.9) and Brent (-0.3 per cent to $109). Otherwise, copper is off 0.6 per cent.

As for US Treasuries, they traded within a comparatively narrow range (1-7bps) and moves are small so far – major notes are little changed. So the 2-year yield is at 0.26 per cent, the 5-year at 0.93 per cent, while the 10-year is off just over 1bps to 2.05 per cent. Aussie futures traded on a 5-tick range on the 3s (down a tick to 96.74) and a 7-tick range on the 10s (down a tick and a it to 95.98).
That's pretty much it.

Looking at the day ahead we get the Reserve Bank decision on interest rates at 1430 AEDT, with economists largely split as to whether they'll cut or hold – and I think that is probably a good reflection of the discussion that will occur on the board. As I mentioned yesterday, the issue is whether the board will react to tightening financial conditions around the world, or save their ammo and hold off, given the generally more upbeat US and Australian economic data and the fact that banks seem unlikely to pass on, in full, any rate cut (judging from their rhetoric). Improved sentiment over Europe might also persuade them to hold at this meeting.

Prior to that decision we get the balance of payments figures and the public expenditure numbers at 1130 AEDT – both important feeds into the third-quarter GDP. Yesterday's number generally showed strong profit growth and robust sales, even in sectors like manufacturing. This should act to lift GDP above my expectations, although investors look set to make a serious detraction to growth. Strong demand and a drop in inventories seems to suggest this was an unanticipated drawdown in inventories and isn't necessarily a dangerous signal or anything.

Tonight, watch out for any eurozone GDP revisions, German factory orders and of course the BoC rate decision (no change expected).

Adam Carr is senior economist at ICAP Australia. See Business Spectator's glossary for definitions of technical terms used in SCOREBOARD articles.

Follow @AdamCarrEcon on Twitter.