Rough week for equities as markets ready for FOMC meeting
16/Dec/2013 • Currency Updates•
Financial markets had a rough time last week. Positive macroeconomic data in the US are bringing the prospect of policy normalisation in the US closer, and investors reacted by selling off bonds and equities sharply. FX markets, however, are taking a calmer view of things and most G10 currencies traded in narrow ranges throughout the week. We are in the process of revising our forecasts, and will release our new targets for G10 currencies early this week. We continue to think that policy normalisation will come earlier in the US than any other major economic area, and therefore maintain a very bullish view of the US dollar.
A light week in terms of macroeconomic or policy news out of the UK. The November Markit/KPMG/REC Report on Jobs continued to signal a tightening job market. All readings in the survey are consistent with acceleration in wage growth from current tepid readings. With domestic demand data so far consistent with GDP growth above 3% in the fourth quarter, it is becoming increasingly likely that the UK will be the second major economic area to begin the exit process from extreme monetary easing, after the US. We are therefore revising our short-term forecasts for sterling higher against most other G10 currencies.
Signs of stalling euro growth in the fourth quarter continue to build. Industrial production in October surprised to the downside, declining 1.1% in October to start the quarter 3.6% below the average third-quarter level. We now think that the eurozone economy may well fail to post any growth at all. Coming after the miserly numbers posted in the third quarter, and the longest recession in its history in the six quarter before that, this has to be a very worrisome outcome for the ECB. The PMI business confidence surveys out next week are therefore even more important than usual. We keep intact our call for further cuts in the ECB rate to negative levels, unless those surveys clearly pick up or the inflation rate moves up significantly towards the ECB 2% target.
November retail sales and inventory reports both came out stronger than the market expected. The retail report is particularly important, as it paints a picture of strengthening consumer demand. Retail sales through November are consistent with real consumer demand well north of 3%. This in turn supports or view of overall GDP growth in the 2-2.5% range, which we believe to be a good estimate of the long-run growth potential of the US economy. Job creation in the order of 200,000 per month and GDP growth in the 2-2.5% range are, in our view, sufficient to justify the beginning of the taper by the Federal Reserve. The only question is whether it will happen next week or in late January. We continue to think the Fed will be reluctant to embark on a tightening course so close to the holidays, but think that next week’s FOMC statement will contain strong hints that the taper will start in the next meeting, at the end of January.