The first is that France is a new sick man of Europe

Outlook

There is an ominous black cloud hanging over Europe, or maybe two of them. The first is that France is a new sick man of Europe, having reported manufacturing PMI at a 7-month low in Dec with output down to 45.3 from 48 and services down o 47.4 from 48 when 49 was forecast. But never mind—numbers under 50 mean contraction. The French slide into stagnation has been going on for some time and it remains a mystery why it’s not poisoning the euro, or at least giving it a stomach-ache. The other cloud is the upcoming bank capital adequacy review and stress tests. Are European banks in a zombie condition or not? We see fear-mongering stories. Some analysts go so far as to say Mr. Draghi will be sitting on his hands for many months until this picture gets clearer (one of those instances in which “bad” news is good for the currency).

As for the dollar’s presumed support from rising yields, we didn’t get it on Friday. The excuse is that tapering is already priced it in, but that’s ridiculous and seems to be an excuse for not having a clue. On Friday, the 10-year yield hit the high of the week at 2.89%, not quite to the Dec 6 highest high at 2.93% but certainly close enough, and the Friday close at 2.868% is not chopped liver, either. The real question seems to be why it’s not 3% and more, if tapering is a done deal sometime in the next month or two, if not this week. To say that the bond market accepts “lower for longer” doesn’t really cut the mustard—most comments are quite skeptical on that point, and not only because the bond gang likes to anticipate so far in advance. One big fat fly in the ointment is the presumed nomination of Stanley Fischer to become Fed Vice-Gov, when Fischer has doubted out loud whether forward guidance has any value at all.

Other items on the table this week include European banks repaying €22.65 billion in LTRO to the ECB ahead of the asset quality tests to begin in January. In the US, we get the Empire State manufacturing survey, forecast up to 4 from -2.2 in Nov. We also get Nov industrial production and capacity utilization for Nov, forecast up 0.6% after -0.1% in Oct. And this afternoon, Bernanke speaks at the 100-year anniversary of the Fed (“Centennial Commemoration”) but it goes without saying he won’t be letting any cats out of the bag. We also get the Treasury TICS report on long-term capital flows today and that might generate some headlines tomorrow—China was pretty mad at the US for the October shut-down.

Finally, Larry Summers has another muddled op-ed in the FT about “secular stagnation,” defending his ideas on that score but not once referencing the Rogoff and Reinhart data demonstrating that recessions after big burst bubbles are always longer-lasting than recessions from other causes, 8-10 years instead of 3-4. This is not to say stagnation is not the right diagnosis, just that Summers is not analyzing it correctly. (In one place he says the burst bubble raised risk aversion permanently and in another place he points out that ultra low rates favor risk appetite.) We do better when we read commentary from people who have actually traded something, anything. Academics may have a lot of things to contribute but commentary on market sentiment is not one of them.

It looks like rising yields are not going to support the dollar, after all, at least not today and not until we get a consensus scenario about tapering. This was always a likely outcome but it is still an uncomfortable idea. Better growth, more robust financial institutions, and rising rates, however glacial the rise, “should” be favoring the dollar. As we say in economics, bah.