Politics Not Economics Push Markets Into Year End

It seems only fitting that politics, which have shaped the investment climate to such a large extent this year, dominates on this last day of 2012. To be sure though, activity is thin and it seems only those who must transact, are. The US dollar itself is mixed. It is slightly firmer against the euro, Swiss franc and yen, while softer against the dollar-bloc (which had lagged last week) and sterling. It is also mixed against emerging market currencies.

Equities are mixed, though on the back of a stronger China PMI (from HSBC), the Shanghai Composite tacked on 1.6%, extending its impressive recovery to 16.5% since the multi-year low was recorded on December 4th near 1949. European bourses that are open are mixed, though France's CAC is up almost 1%. Utilities and health care are leading the most, but all sectors are advancing. Meanwhile, bond markets are little changed, though US Treasuries are firm, with yields off 2-3 bp.

HSBC's measure of December's manufacturing PMI rose to 51.5 from the 50.9 preliminary reading. It is the highest since May 2011 and is the second consecutive month above 50. Of particular interest, the new orders component rose to 52.9, the highest in nearly two years. The official measure will be reported tomorrow and is expected to rise from 50.6 to 51.0.

The political theme, the US fiscal cliff stands out. The ostensible deadline is less than eighteen hours away. It is difficult to say that substantial differences remain, as the differences from the economic point of view seem quite modest (hubris of small differences). A rare Sunday session for the House and Senate (last time was 12 years ago) failed to reach an agreement and talks will resume just before midday (EDT), when it will already be the new year in parts of Asia.

Differences remain over the income tax threshold, expiring estate tax levels, tax rate on capital gains and dividends and efforts to limit the expansion of the AMT (alternative minimum tax). There also is a disagreement over whether to use a new inflation measure for Social Security, which would limit the increase in payments to recipients.

European political developments are also noteworthy. In Italy, Bersani is leading in the latest polls, but a center coalition, ostensibly led by Monti, may be pulling ahead of Berlusconi's PDL. In France, the constitutional council rejected the government's 75% marginal tax rate on the "rich". It seems like a technicality and one in which the government will revise accordingly; indeed it anticipates a revised form early in 2013.

In Germany, Merkel's erstwhile SPD challenger Steinbrueck seemed to undermine his candidacy by claiming the chancellor is underpaid. He found little support and much derision for this stance. In Greece, parliament is beginning an investigation of former Finance Minister Papaconstantinou over tampering with a list of tax evaders.

In Japan, where the markets are closed today, there is a sense that Finance Minister and former Prime Minister Aso is slowing the yen-bashing rhetoric. His comments seemed to focus on two-way risk and playing down the need for dramatic yen depreciation. The JPY90 level, which would still leave the yen over-valued according the OECD has been cited as the government's objective. Separately, reports suggest the new Japanese government may revise/replace the 1995 apology for its colonial rule and aggressiveness, which is likely to add to regional strains.

Lastly, we note that Bolivia is finishing the year with one more expropriation. Recall that earlier this year, President Morales took a tin and zinc mine from Glencore (GLEN.L)) and took over Red Electrica (RDEIF), a power grid operation. Over the weekend, he nationalized four business units, including two electricity distribution companies from Spain's Iberdrola (IBE.MC).