Back from the festive season break, traders pushed stock market indices to new highs for the rally, logging a full house of five up-days for the S&P 500 Index and pushing the CBOE Volatility (VIX) Index - also referred to as the "fear gauge" of the US stock markets - down to levels last seen pre-Lehman in 2008.

Pundits shrugged off Friday's unexpected decline in non-farm payrolls, as well as mixed economic data earlier in the week, focusing instead on the Federal Open Market Committee's (FOMC) communiqué for its December 15-16 meeting which maintained its "extended period" stance for easy monetary policy, i.e. more "juice" for risky assets.

Asha Bangalore (Northern Trust) said: "The details and tone of the December employment report indicate that labor market conditions remain bothersome. A meaningful pace of hiring is unlikely in the next few months given the structural unemployment in the economy, the shortened workweek, and the large number of part-time workers. In other words, the December employment report reinforces expectations of the FOMC on hold in the near term. The Fed is unlikely to undertake a reduction of monetary accommodation until the unemployment rate has peaked."

Source: Walt Handelsman

The past week's performance of the major asset classes is summarized by the chart below - a set of numbers that indicates renewed investor appetite for risky assets. Silver (+9.5%), "the poor man's gold", and platinum (+7.0%) were the stars of the week, playing catch-up on historically cheap ratios relative to gold bullion. The yellow metal (+3.7%) also resumed its uptrend with a so-called "upward price dynamic" on Monday. Bonds performed poorly as Pimco and BlackRock, among others, cut holdings of US and UK debt as the two nations' borrowings hit record levels.

Source: StockCharts.com

A summary of the movements of major global stock markets for the past week and various other measurement periods is given in the table below.

The MSCI World Index (+2.5%) and the MSCI Emerging Markets Index (+2.7%) experienced a strong first week of 2010. Only three emerging markets - the Shanghai Composite Index (-2.5%), the Russian Trading System Index (-0.4%) and the Venezuela Caracas General Index (-1.2%) - bucked the broader uptrend.

Notwithstanding solid gains since the March lows, only the Chile Stock Market General Index, one of the week's strongest performers, has been able to reclaim its 2007 pre-crisis peak - now trading 6.5% higher. Mexico and Brazil could be the next countries to eliminate the bear market losses.

As far as the US indices are concerned, Wall Street managed to hit 15-month highs on Friday. This means that the S&P 500 Index and the Dow Jones Industrial Index have now retraced 55% and 54% respectively of their crisis losses. After the thin festive season period, volume on the NYSE came close to the one-year average.

Nine of the ten economic sectors (as measured by the SPDR exchange-traded funds [ETFs]) closed higher for the week, with the cyclical sectors in general outperforming the defensive sectors. Materials (+5.9%), Energy (+5.8%), Financials (+5.7%) and Industrials (+5.3%) all returned handsome gains, whereas Utilities (-1.0%) was the only sector in the red.

Top performers among stock markets this week were Latvia (+13.2%), Peru (+12.3%), Luxembourg (+6.1%), Greece (+6.0%) and Cyprus (+5.4%). At the bottom end of the performance rankings, countries included Slovakia (-14.1%), Bermuda (-2.5%), China (-2.5%), Nepal (-2.2%) and Venezuela (-1.2%).

The declines in the Shanghai Composite Index came in the wake of investors' concerns about a flood of initial public stock offerings (IPOs) and the authorities' actions to slow down lending. Of all the major indices, the Shanghai Composite is the only one trading marginally below its 50-day moving average. Also, as shown by the declining green line in the bottom portion of the chart below, Chinese stocks have since July been underperforming the S&P 500 Index - a reversal of roles since China turned the bear market corner five months before most other markets in November 2008. Interestingly, Marc Faber told CNBC (via MoneyNews): "My feeling is that the US will outperform emerging economies in the first six months of 2010."

Source: StockCharts.com

Of the 96 stock markets I keep on my radar screen, 79% recorded gains, 15% showed losses and 6% remained unchanged. The performance map below tells the past week's rather bullish story.

Emerginvest world markets heat map

Source: Emerginvest (Click here to access a complete list of global stock market movements.)

John Nyaradi (Wall Street Sector Selector) reports that, as far as ETFs are concerned, the winners for the week included SPDR S&P Metals & Mining (XME) (+13.8%), Claymore/Delta Global Shipping (SEA) (+12.3%) and Market Vectors Coal (KOL) (+11.4%).

At the bottom end of the performance rankings, ETFs included ProShares Short Oil and Gas (DDG) (-4.6%), HOLDRS Merrill Lynch Telecom (TTH) (-3.1%) and Vanguard Extended Duration Treasury (EDV) (-2.9%).

Referring to the issue of financial reforms, the quote du jour this week comes from Nobel economist Joseph Stiglitz. He recently warned (via MarketWatch): "Unless Wall Street's incentive system is drastically reformed, 'the financial sector will only try to circumvent whatever new regulations we put in place. We will simply have a short respite before the next crisis.' Warning: nothing's changed, it's worse: Lobbyists run Obama, Congress and the Fed."

To this, former IMF chief economist Simon Johnson added (according to MarketWatch): "Yes, 'we're running out of time ... to prevent a true depression'. The 'financial industry has effectively captured our government' and is 'blocking essential reform', and unless we break Wall Street's 'stranglehold' we will be unable prevent the Great Depression 2."

On a related note, The Wall Street Journal reports that the Financial Crisis Inquiry Commission, formed by Congress in 2009 to investigate the causes of the economic turmoil, will have public hearings on Wednesday and Thursday in Washington with top Wall Street bankers.

Next, a quick textual analysis of my week's reading. This is a way of visualizing word frequencies at a glance. The usual economic terms ("economy", Fed", "rate", etc.) feature prominently, but "bonds" and "silver" also mustered some attention. Will we perhaps look back at these assets a year from now and see one of the worst and one of the top performers respectively for 2010? A long silver, short Treasuries trade makes perfect sense to me.

Back to the stock markets: The major moving-average levels for the benchmark US indices, the BRIC countries and South Africa (where I am based in Cape Town) are given in the table below. With the exception of the Shanghai Composite Index (discussed above), the indices in the table are all trading above their 50-day moving averages, with all the indices also comfortably above their respective key 200-day moving averages.

As far as the S&P 500 Index is concerned, the next upside target will be at the upper end of its upwardly sloping price channel at 1,250. A break below the lower level of the channel at 1,085 (and the December low of 1,092) could signal a deeper pullback.

"Anecdotally investors remain very skeptical of the continued advance which suggests the 'wall of worry' is still in place," said Kevin Lane of Fusion IQ.

Source: Fusion IQ, January 7, 2010.

Casting his eye on 2010, David Fuller (Fullermoney) said: "Stock market action continues to confirm a bull market in every respect. Downside risk is probably limited to periodic mean reversions towards the rising 200-day moving averages.

"The main danger signs to look for will be an eventual, persistent tightening of monetary policy and an inverted yield curve. When this next happens, and both tend to be lead indicators, I will focus on introducing trailing stops for all equity positions, actual or mental, and ideally use strength to reduce equity exposure. Currently, I maintain that we are still in the second psychological perception stage of the bull market, characterized by the 'wall of worry'. With any luck, we can look forward to the third and climactic stage of a bull market cycle, in which investors become euphoric.

"The time to start thinking about closing long portfolios in anticipation of the next bear market, I suggest, will be when the yield curve (US 10-year yields over 2-year yields) next inverts by moving below zero. However, the lead was so early last time (early 2006) that some of us became complacent about it."

Source: Fullermoney

While on the topic of long-term charts, when considering S&P 500 monthly data, three momentum-type oscillators (RSI, MACD and ROC) all still signal a bullish trend. (As an aside, the long-term picture for US government bonds is in bearish mode as highlighted in a post a few days ago.)

Source: StockCharts.com

"Where breadth goes, the market usually follows," goes an old market saw. Analyzing market internals, the number of NYSE stocks trading above their respective 50-day moving averages has increased to 86% from 30% in October (see chart below). "The fact that breadth has caught up with the new highs in the overall market is a good thing for the health of the bull market. If it gets up near 90%, however, there won't be much more room for upside in the short term," remarked Bespoke. For a primary uptrend to be in place, the bulk of the index constituents also need to trade above their 200-day averages. The number at the moment is 89% - somewhat down from its September peak of 93%, but nevertheless firmly in bullish terrain.

Source: StockCharts.com

Not everybody shares Fuller's optimism. Having pinpointed the bottom in March, GMO's Jeremy Grantham now warns that our irrational nightmare will repeat. "A year ago we came dangerously close to the Great Depression 2. Unfortunately, we've learned nothing ... condemning ourselves to another serious financial crisis in the not-too-distant future," he is quoted by MarketWatch. "We had our bear-market rally. Next, historical cycles plus our irrational behavior guarantees another, bigger global meltdown. We learned nothing."

It goes without saying that the strong rally since March is bound to be followed by a correction at some stage. But rather than pre-empting (and more often than not getting it wrong as a result of short-term noise), I will be guided by the longer-term charts and the yield curve to identify a major top. Meanwhile, I am watching valuations carefully, and specifically how the Q4 earnings reports stack up. Although I am treading with caution after the 74% rally in the mature markets and 109% in emerging markets, I am not ignoring good old stock-picking, and specifically those companies with strong balance sheets that will be growing their dividends over time with a reasonable degree of certainty.

For more discussion on the economy and financial markets, see my recent posts "Byron Wien's ten surprises for 2010", "Bob Doll's crystal ball into 2010 and the next decade", "Bill Gross: Let's get 'Fisical'", "Chart du Jour: Subpar recoveries follow financial recessions", "Chart du Jour: No signs of imminent rate hike" and "Is there a decennial pattern in equity returns?" (And do make a point of listening to Donald Coxe's webcast of January 8, which can be accessed from the sidebar of the Investment Postcards site.)

Twitter and Facebook
I regularly post short comments (maximum 140 characters) on topical economic and market issues, web links and graphs on Twitter. For those readers not doing so already, you can follow my "tweets" by clicking here. You may also consider joining me as a friend on Facebook.

Economy
The Recession Status Map below, courtesy of Dismal Scientist Economy.com, aggregates growth statistics from around the world and allows one to see at a glance which economies are in recession, at risk, recovering or expanding. Click on the map to link to the interactive version.

Source: Dismal Scientist

"Business sentiment around the globe remains about where it has been since last summer - consistent with a tentative global economic recovery. Businesses are most upbeat when responding to broad questions about current conditions and expectations through the middle of this year. However, they remain cautious when responding to specific questions about sales, pricing, inventories and hiring," according to the results of the latest Survey of Business Confidence of the World by Moody's Economy.com. Importantly, the survey results suggest that the global recovery is holding its own, but provide no indication that the recovery is gaining significant traction.

Source: Moody's Economy.com

Released on Monday, purchasing managers' surveys for December exceeded expectations from China to Europe and the US, reported the Financial Times. "Across the world, the combined scores of national purchasing managers' indices, compiled by JP Morgan, rose to 55 in December, the highest since April 2006, with the index for new orders at a 5½ year high."

The global economic rebound is likely to be even stronger than many have anticipated and developed markets have the potential to outperform emerging markets, Jim O'Neill, head of global economic research at Goldman Sachs, told CNBC. "I think what we've seen since the turn of the year ... is actually really strong," he said.

Goldman Sachs analysts estimate that the world economic growth will be 4.4% this year and 4.5% in 2011.

A snapshot of the week's US economic reports is provided below. (Click on the dates to see Northern Trust's assessment of the various data releases.)

Friday, January 8, 2010
• December employment report - hiring freeze yet to thaw

Thursday, January 7, 2010
• Total continuing jobless claims post new high

Wednesday, January 6, 2010
• Minutes of December FOMC meeting - vulnerable aspects of economic recovery and inflation dynamics dominated deliberations
• ISM non-manufacturing survey shows improvement

Tuesday, January 5, 2010
• Auto sales advanced in December, but declined in Q4
• Decline of Pending Home Sales Index partly due to original expiration date of homebuyer tax credit program
• Factory inventories advance; noteworthy revision of shipments of non-defense capital goods

Monday, January 4, 2010
• Factory sector survey sends a strong positive signal
• Construction outlays dip in November, but Q4 residential construction spending could be noteworthy

The minutes of the FOMC's December 15-16 meeting also point to few changes in monetary policy over the next few months. There was a consensus that near-term growth would be only slightly above the economy's potential, but the minutes show a growing divide between FOMC members less worried about inflation, and thus arguing for more aggressive monetary policy steps, and those more worried about inflation.

As shown below, there is a significant and positive correlation (0.73) between the composite ISM purchasing managers' index and the year-to-year change in US real GDP. According to Asha Bangalore, the noteworthy gains in the ISM survey over the past few months "suggest that an impressive headline reading of GDP for the fourth quarter should not be surprising".

Source: Northern Trust - Daily Global Commentary, January 4, 2010.

Week's economic reports

Click here for the week's economy in pictures, courtesy of Jake of EconomPic Data.

Click here for a summary of Wells Fargo Securities' weekly economic and financial commentary.

The European Central Bank (ECB) will make an interest rate announcement on Thursday (January 14). US economic data reports for the week include the following:

Tuesday, January 12
• Trade balance

Wednesday, January 13
• Fed Beige Book
• Treasury budget

Thursday, January 14
• Jobless claims
• Retail sales
• Import and export prices
• Business inventories

Friday, January 15
• CPI
• Empire manufacturing
• Capacity utilization
• Industrial production
• Michigan sentiment

Markets
The performance chart for various financial markets usually obtained from the Wall Street Journal Online is unfortunately not available this week.

Final words
Bertrand Russell, English logician and philosopher (1872-1970) said: "What a man believes upon grossly insufficient evidence is an index into his desires - desires of which he himself is often unconscious. If a man is offered a fact which goes against his instincts, he will scrutinize it closely, and unless the evidence is overwhelming, he will refuse to believe it. If, on the other hand, he is offered something which affords a reason for acting in accordance to his instincts, he will accept it even on the slightest evidence. The origin of myths is explained in this way." (Hat tip: David Fuller.)

Let's hope the news items and quotes from market commentators included in the "Words from the Wise" review will prevent the readers of Investment Postcards from falling into this trap, allowing them to build considerable wealth with their investment portfolios.

That's the way it looks from Cape Town (whose balmy weather I will leave behind on Thursday for the snowy environs of Switzerland).

Source: Chuck Asay

David Fuller (Fullermoney): Themes for 2010
"Our favourite investment themes throughout 2009 were Asian-led emerging markets, South American-led resources markets and information technology. We were bullish of commodities, favouring precious metals, industrial resources and the agricultural sector subject to weather-related shortages.

"How will these Fullermoney themes perform in 2010?

"I receive at least as many bearish or cautionary stock market reports as bullish forecasts. I am inclined to regard these as contrary indicators, suggesting that we are still in the lengthy 'wall of worry' portion of this bull market. Crucially, monetary policy remains extremely accommodative as we approach 2010, although no one knows for how long these stimulative measures will persist, not even the central bankers. I will take my cues on monetary policy from the central banks, not the pundits.

"I am content to ride the stock market uptrends, with some provisos. For instance, most share indices have spent the last few months in a corrective phase. Having seen some partial mean reversion towards the rising 200-day moving averages, it is important that stock market indices sustain upwards breaks where sideways trading ranges are currently evident.

"Conversely, downward breaks from trading ranges would signal at least a further correction. I will give the upside the benefit of the doubt, at least while leading indices maintain their progressions of higher reaction lows. You do not need to watch them all, although I do, but I suggest monitoring the technical consistency where you have investments, and also China and the US, given their powerful leash effects.

"Incidentally, while China and India currently show additional upside scope following lengthy consolidations, Brazil may need some further ranging mean reversion towards its MA before another meaningful advance can be sustained.

"As for precious metals, they have underperformed since gold's steepening advance was checked by a large downward dynamic on December 4. The US Dollar Index's rally also provided a headwind, although this did not trouble many other commodities which were less overstretched on the upside than gold. Interestingly, platinum has subsequently rebounded and appears capable of extending its upward trend before long. Gold and silver appear oversold and have lost downward momentum recently, although they have yet to show reassuring upward dynamics. [PduP: This happened on Monday, January 4.] Seasonal conditions will remain favourable for precious metals through at least 1Q 2010.

"Among industrial metals, copper is the most influential and it is extending its ranging upward trend."

Source: David Fuller, Fullermoney, December 31, 2009.

CNBC: Jim O'Neill - recovery will be stronger than forecast
"The global economic rebound is likely to be even stronger than many have anticipated and developed markets have the potential to outperform emerging markets, Jim O'Neill, head of global economic research at Goldman Sachs, told CNBC Tuesday [January 5] ."

Source: CNBC, January 5, 2010.

Financial Times: Rise in factory orders spurs markets
"Manufacturers around the world are at their most optimistic for almost four years after booking a sharp rise in new orders in December as Asia's recovery spread to the US and Europe.

"Surveys of purchasing managers from China to Europe and the US in the final month of 2009 released on Monday [January 4] exceeded expectations, sending stock markets higher in advanced economies.

"Across the world, the combined scores of national purchasing managers' indices, compiled by JP Morgan, rose to 55 in December, the highest since April 2006, with the index for new orders at a 5½ year high.

"Manufacturers' intentions on employment rose above 50 for the first time since March 2008, signalling that the brutal shake-out of factory jobs over the past two years is coming to an end.

"David Hensley of JP Morgan said: 'If a rebound in the manufacturing labour market can be maintained, this should aid with sustaining the broader recovery.'

"The surveys have long been good predictors of manufacturing output, the most volatile part of the economy.

"Although there were a few pockets of gloom, notably Australia and Spain, the strength of Asia's recovery was underlined by sharply better sentiment in China and India, and steady improvements in South Korea and Taiwan. Brighter prospects were also recorded in the US, UK and the eurozone. The US Institute of Supply Management manufacturing report stood at 55.9 in December, its highest since April 2006."

Source: Chris Giles, Financial Times, January 4, 2010.

CNBC: John Taylor on the real crisis culprit
"Insight on whether monetary policy is not the problem, with John Taylor, Stanford University economics professor."

Source: CNBC, January 7, 2010.

Reuters: Rate hikes not best way to burst bubbles - Bernanke
"Federal Reserve Chairman Ben Bernanke said on Sunday that vigorous financial regulation would have been the best way to restrain the housing bubble that helped cause the deep recession, but said policy makers can no longer rule out monetary policy to curb the buildup of risk.

"In a speech defending the Fed's rock-bottom interest rates in the early 2000s, a policy many say fueled a runaway housing boom that triggered a devastating crisis when it went bust, Bernanke said regulatory and supervisory actions, rather than rate hikes, would have been more effective ways to check the run-up in house prices.

"Bernanke and the Fed face sharp criticism over actions leading up to the crisis. Bernanke's renomination as Fed chairman faces an unusual degree of opposition, and the Fed's responsibilities stand to be curtailed if congressional proposals become law.

"Bernanke said, however, in a speech to the American Economic Association, that policy makers can no longer eliminate rate increases from their arsenal to prevent future crises.

"'If adequate reforms are not made, or if they are made but prove insufficient to prevent dangerous buildups of financial risks, we must remain open to using monetary policy as a supplemental tool for addressing those risks,' he said.

"Bernanke conceded that efforts by the Fed and other regulators beginning in 2005 came too late or were insufficient to slow the housing bubble.

"'The lesson I take from this experience is not that financial regulations are ineffective for controlling emerging risks, but that their execution must be better and smarter,' he said.

"The US Senate is poised to begin debate over financial rules reforms that would peel away the Fed's authority for regulating large financial firms. The US central bank would be charged instead with focusing on monetary policy.

"Bernanke and other Fed officials have argued that such a change would hurt the Fed and oversight of the system in general by removing a crucial monitor from the pulse of the financial system.

"Analyzing the Fed's decisions to keep rates low for an extended period in the early 2000s, the Fed chairman argued that those policies were a response to the worry about a possible deflationary spiral that hobbled the Japanese economy through much of the previous decade.

"Bernanke pointed to adjustable-rate mortgages and overconfidence that house prices would continue to rise as the main culprits behind the catastrophic housing bubble."

Source: Mark Felsenthal, Reuters, January 3, 2010.

Time: Pimco's Bill Gross sees 2010 as year of reckoning
"Pimco managing director Bill Gross not only oversees the world's biggest bond fund, his views often sway markets. In a late December interview with TIME's John Curran, Gross pointed to the second half of 2010 as a period when investors large and small will reckon with a new reality of poor economic growth and a Federal Reserve that is hard pressed to offer much help.

TIME: Where do you see the economy going over the next 6 to 12 months?
Bill Gross: The economy should be relatively strong in the first half of 2010 then weaken in the second half. That's not to say we'll return to recession but we'll see weakness as opposed to a continuation of what will probably be a decent first half.

What will make the first half of 2010 so good?
The first half will be dominated by government stimulus and by inventory accumulation or a lack of [inventory] liquidation among businesses. I expect nothing from consumer [spending] and nothing really from housing or really any of the standard cyclical leading sectors. It's hard to put a number on GDP growth rates, but let's say 4% in the first half and then 2% in the second half, which would basically call for some additional help.

You're talking about a second shot of federal stimulus?
Yes, something else is probably needed if the [government's] thrust is really reducing unemployment below double digits and re-normalizing the economy.

What does this say about the Federal Reserve's hopes to start pulling its added liquidity out of the markets, either by raising short-term rates or just getting out of buying bonds, which has been keeping long rates low?

I think the Fed's statements suggest that they really want to exit in some fashion from the buying program. The first step in that direction, logically, would be to stop buying and our sense is that they're at least going to try that. But based on our forecasts for the second half of the year they may have to re-initiate it, and that will be difficult to do once they stop because it then becomes a political hot potato.

All that said, I think they'll stop buying mortgage agency securities, and the trillion-and-a-half dollar check that's been written over the past 9 to 12 months basically disappears. It's significant from the standpoint of interest rates and interest rate spreads in certain sectors. And I would even go so far as to say it might be a mistake.

Because they might have to restart the buying program later?
Yes, I think the Fed wonders about this as well. But you have to understand that the Fed's probably under political pressure - such as the hearings for new regulation of the Fed, the growing public unease about the supersized Fed balance sheet, etc. The Fed's expanded balance sheet is not something that I consider to be a problem, but I think the market does - and so the Fed will probably be working in the direction of pulling some of the liquidity out of the marketplace. They won't sell - it's a near impossibility to unload what they've purchased over past 12 months. But they'll at least stop buying.

Won't that put upward pressure on interest rates?
I think it will. I mean the mortgage market would be your first place to look in terms of something that's overvalued that would become normalized. Nobody knows what the Fed's buying is worth - we think about half a percentage point on rates, but we don't know."

Click here for the full article.

Source: John Curran, Time, January 5, 2010

Bloomberg: Krugman sees 30-40% chance of US recession in 2010
"Nobel Prize-winning economist Paul Krugman talks with Bloomberg's Steve Matthews about likelihood the US economy will slide into a recession during the second half of the year as fiscal and monetary stimulus fade. Krugman, an economics professor at Princeton University, also said the Federal Reserve's plan to end purchases of $1.25 trillion of mortgage-backed securities and about $175 billion of federal agency debt in March could spur an increase in mortgage rates and lead to declines in home sales and prices."

Source: Bloomberg, January 4, 2010.

MoneyNews: Rosenberg - economy is in post-bubble collapse
"David Rosenberg, chief economist for Gluskin Sheff & Associates, takes issue with the consensus view that a sustained economic recovery has begun.

"'We are in a post-credit bubble credit collapse that is ongoing,' he writes on The Big Picture.

"And that doesn't bode well for financial markets, though the recent rally might continue for a while, Rosenberg says.

"'Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways.'

"Economists err in calling this downturn 'The Great Recession', Rosenberg writes.

"'This is truly a gentle way of saying 'Depression."

"So first we must acknowledge that we indeed experienced a depression.

"'Then ... we can draw a conclusion that a sustainable recovery will not get under way until the ratio of household credit to personal disposable income reverts to the mean - and goes to an excess in the opposite direction,' Rosenberg says.

"'I know it sounds harsh, but we shall endure - believe it. Transition is rarely without pain.'"

Source: Dan Weil, MoneyNews, January 5, 2010.

Bloomberg: Stiglitz says Wall Street "talking up" recovery
"Nobel laureate Joseph Stiglitz said investors are 'talking up' signs of a global economic recovery in a bid to boost equities.

"'Wall Street is talking up the recovery because it would like to sell stocks,' Stiglitz told reporters at a conference in Paris today [Thursday, January 7].

"The MSCI World Index of stocks has surged 73% since its low of last March even while the economies of advanced nations grow below their potential rates following the worst recession since the Great Depression.

"Stocks are rallying because interest rates are low and companies have been cutting costs by reducing payrolls, factors that suggest economies remain weak, said Stiglitz, a professor at Columbia University in New York.

"'Whenever rates are low, stock markets are often high,' he said. By contrast, economists are 'almost universally pessimistic'.

"Speaking at the conference, Stiglitz said US regulators haven't done enough to address the risks posed by large banks, derivatives and executive compensation.

"He recommended a tax be introduced on financial speculation as a way of generating revenue and forcing investors to focus on the longer-term."

Source: Isabelle Mas and Simon Kennedy, Bloomberg, January 7, 2010.

Asha Bangalore (Northern Trust): Minutes of December FOMC meeting
"The FOMC left the federal funds rate unchanged at the close of the December FOMC meeting. There is little doubt about the Fed staying on hold in the first-half of 2010. There are different points of view about when the Fed will start reducing the monetary accommodation in place. It is too early to find hints in the minutes about when the Fed is likely to implement a change of course in its monetary policy stance. The minutes of the December deliberations show varying points of view among the members of the FOMC on different aspects about the economy and monetary policy.

"Most members agreed that incoming economic data was consistent with forecast of growth and inflation envisioned in the November meeting. Employment conditions were seen to improve only gradually in 2010, in line with previous recoveries following a financial crisis. There appeared to be a broad consensus about the weakness in underlying labor market conditions. In addition to the high unemployment rate, members noted that the significant decline in production hours and the drop in the employment-population ratio as raising concern about the labor market.

"In the residential real estate sector, although home prices were showing signs of stability and sales and construction had moved up from their cycle lows, the improvements were seen as tentative. The expiration of the home buyer tax credit program in April 2010, likelihood of additional foreclosures leading to lower home prices, and the possibility of pressure in mortgage markets as the Fed winds down the mortgage securities purchase program were seen as factors that could create unfavorable conditions in the housing sector once again.

"There were three opinions pertaining to inflation. The significant slack in labor and product markets and contained inflation expectations were seen as factors helping to keep inflation subdued in the near term. Most members agreed about the forces keeping inflation under control but seemed to differ about the relative role that each would play. Inflation expectations have moved up in recent weeks and are holding at levels below the mark seen prior to the onset of the crisis in August 2007.

"There were mixed views about the monetary accommodation necessary in the future, which is evident in the following excerpt:

'A few members noted that resource slack was expected to diminish only slowly and observed that it might become desirable at some point in the future to provide more policy stimulus by expanding the planned scale of the Committee's large-scale asset purchases and continuing them beyond the first quarter, especially if the outlook for economic growth were to weaken or if mortgage market functioning were to deteriorate. One member thought that the improvement in financial market conditions and the economic outlook suggested that the quantity of planned asset purchases could be scaled back, and that it might become appropriate to begin reducing the Federal Reserve's holdings of longer-term assets if the recovery gains strength over time.'

"All in all, 2010 will be a year of challenges for Fed and other policymakers."

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, January 6, 2010.

Reuters: US Fed's Duke sees low rates for "extended period"
"The US Federal Reserve sees a moderate economic recovery continuing in 2010, but needs to keep interest rates 'exceptionally low' for an 'extended period' to foster job growth, a Fed policymaker said on Monday.

"Fed Governor Elizabeth Duke told an economic forum that slack in the economy was likely to remain above historical norms for some time, helping to keep inflation subdued.

"'In the current environment, the FOMC continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period,' Duke said, referring to the US central bank's policy-setting Federal Open Market Committee.

"'Such policy accommodation is warranted to provide support for a return over time to more desirable levels of real activity and unemployment in the context of price stability.'

"Fed watchers have focused on any changes in that language for clues to the timing of a possible tightening of monetary policy as the economy recovers. The FOMC maintained the 'extended period' stance in its last statement on December 15.

"In remarks to the Economic Forecast Forum in Raleigh, North Carolina, Duke said recent data on production and spending suggested that economic activity continued to increase at a 'solid rate' during the final months of 2009 after real GDP turned positive in the third quarter.

"'I expect to see a continued moderate recovery in economic activity in 2010, supported by a further healing in financial markets and accommodative monetary policy,' Duke said.

"But echoing comments by Fed Vice Chairman Donald Kohn in Atlanta on Sunday [January 3], Duke said constraints on lending would slow recovery."

Source: David Lawder, Reuters, January 5, 2010.

Bloomberg: Hoenig says Fed should eventually lift main rate to 3.5%- 4.5%
"Federal Reserve Bank of Kansas City President Thomas Hoenig said the central bank should move 'sooner rather than later' to reduce stimulus, with a goal of eventually boosting the benchmark interest rate to 'probably between 3.5 and 4.5 percent'.

"'The process of returning policy to a more balanced weighing of short-run and longer-run economic and financial goals should occur sooner rather than later,' Hoenig, who votes on monetary policy decisions this year, said today in a speech in Kansas City.

"'Maintaining excessively low interest rates for a lengthy period runs the risk of creating new kinds of asset misallocations, more volatile and higher long-run inflation, and more unemployment - not today, perhaps, but in the medium- and longer-run.'

"Policy makers are considering how to exit from unprecedented stimulus and emergency credit programs amid signs the US economy is rebounding. They pledged at the end of their December 15-16 meeting to complete $1.25 trillion in purchases of mortgage securities and $175 billion of agency debt by the end of March, while holding the benchmark interest rate in a range of zero to 0.25 percent for an 'extended period'.

"'The Federal Reserve must curtail its emergency credit and financial market support programs, raise the federal funds rate target from zero back to a more normal level, probably between 3.5 and 4.5 percent, and restore its balance sheet to pre-crisis size and configuration,' Hoenig said in remarks prepared for a speech to the Central Exchange, a group that promotes leadership development opportunities for women.

"Hoenig said he disagrees with economists who forecast the economy may falter and predicted growth will exceed 3 percent this year.

"'Fiscal and monetary stimulus will continue to provide major support to the economy,' he said. 'Much of the fiscal stimulus package announced last year will have its impact in 2010, and it might well be more substantial than initially projected due to delays in implementing spending programs.'"

Source: Steve Matthews, Bloomberg, January 7, 2010.

Asha Bangalore: ISM non-manufacturing survey results show improvement
"The ISM non-manufacturing survey results showed an improvement in the service sector, with the composite index climbing to 50.1 in December from 48.6 in the prior month. The index measuring new orders slipped 3 points to 52.1 in December but the level denotes an expansion in activity."

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, January 6, 2010.

Continue to Part II