A tricky week for world's markets is underway

A tricky week for world's markets is underway

Casting our eye across the data this morning we might have expected a generally positive reaction as far as risk is concerned. The positive tone of the European data continued, with the final manufacturing PMIs in Germany and France pushing up a bit and the PMIs elsewhere (such as in Italy) also coming in above expectations. In the UK, mortgage approvals were up and house prices rose modestly in January. In the US, the ISM made a somewhat bigger gain than the market was looking for and Fed Chairman Bernanke expressed the view that the rise in US inflation will be "temporary and relatively modest" (more on his remarks below). Instead of a positive reaction to all this we find that stocks are under pressure, with many European bourses down by around 1% and US indices losing more than this with an hour or so to go before the close. The source of the weakness seems to be renewed concerns about Middle East turmoil, with a related surge in the price of crude of more than 2%. Gold has jumped more than 1%. The catalyst for the jump in oil appears to be news of protests in Iran and further protests elsewhere.

Before we get to the US data and Bernanke's testimony, we should note yesterday's Chinese PMI data. Both the official' and HSBC manufacturing PMIs fell in January. At the same time the price components rose. Weconclude that the overall message is that growth is slowing but inflationary pressures are yet to abate. We see this as posing a dilemma for policy makers as further tightening would risk slowing sequential GDP growth (i.e. qoq) below 8% but premature policy easing would exacerbate inflationary pressure. As such the policy outlook is becoming more uncertain.

From the perspective of global growth, the slowdown in China is happening at the right' time when the US outlook is looking better. The ISM rose to 61.4 in February, matching its previous high in may 2004. The improvement showed breadth, with new orders rising to its highest level since Jan-04 and order backlogs also rising. The employment component rose to 64.5 (up from 61.7), its highest level since Jan-73. Wecontinue to look for +250k from non-farm payrolls on Friday. Prices paid made a new cyclical high of 82.0, on broad based gains in such components as aluminum, chemicals, copper, freight rates, fuel oil, textiles, plastics, rubber, primary metals, paper, machinery and electronic products. We see the strength in prices away from just energy as testament to the inflation pressures building in the early stages of processing.

The Fed Chainman is clearly less concerned, however. He felt that these price pressures would be checked by "stability in unit labor costs." This view and the fact that he thinks that "until we see a sustained period of stronger job creation, we cannot consider the recovery to be truly established" suggest he is still a long way from thinking about a policy shift.

The day ahead will be dominated by the evolution of events in the Middle East, the US data and Bernanke's second round of testimony and what is shaping up as a strong Australian GDP report.

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