Fed tapering is nearly upon us as the FOMC meet and announce to the world on Thursday

Week Commencing Monday 16th September 2013


This week in Brief



  • The UK has a moderately busy week ahead with CPI, the MPC Minutes and Retail Sales all stealing the limelight. We expect core inflation to drop 0.1% this quarter, bring the figure closer to MC’s golden 2% target. Retail Sales is likely to decline slightly, although given the recent UK push on the fundamentals I would not be surprised if we see a better than expected release this time.

  • European news is dominated with the German ZEW, which is expected to expand once again demonstrating that Europe’s number one economy is leading the recovery on the continent. Downside risks remain however we the Troika inspecting Portuguese austerity, so be mindful that any EUR gains may be temporary.  

  • In the US we have potentially the biggest decision of the year in the form of Fed QE tapering. Most analysts point to some easing in the amounts, with the market pricing in a $10 - $15 billion drop in AP. Any deviation from this is likely to cause significant volatility on all majors.


Market Themes & Current Events


This week it is the turn of Portugal, with representatives from the International Monetary Fund, the European Commission and the European Central Bank beginning their latest examination of Portugal's economic recovery. This is an important visit from the troika, and Portugal’s next bailout instalment in hinged on the country meeting the criteria set by the group at the start of the Eurozone crisis. It is widely believed that the country will pass the test and receive the next tranche. Despite the seemingly good news, there are fears that Portugal's economy remains volatile, as seen by the rising cost of borrowing in recent months. The yield on benchmark 10-year government bonds flew above the 7% barrier earlier this summer, considerably higher than the level at which other European countries have sought a bailout. With unemployment also amongst the highest in the Eurozone, there is still a long way to go in the periphery before markets can return to normal.


In more from the Iberian Peninsula, Spain's public debt reached a record high in June, according to the country’s central bank. The figure has risen to 942.8bn euros which equates to 92.2% of the entire countries GDP. This is nearly 15% higher than the same period last year and above the Spanish government's target limit of 91.4%, despite severe public spending cuts. This is likely to put considerable pressure on the Rajoy government, especially as unemployment is set to top 26% in the coming weeks. Even more damaging for the government is that the central bank believes public debt could top 100% of GDP in the next 3 years. Like its Iberian counterpart, Portugal, Spanish government bond yields have been soaring of late, especially as economic fundamentals continue to point towards some form of additional Eurozone support for the indebted nation.


Moving back to home soil and in more good news for the UK economy, the rate of unemployment in has dropped to 7.7% from 7.8% in the previous three months. This came as the number of people unemployed fell 24,000 in the third quarter to 2.487 million. Official figures also showed the number of people claiming unemployment benefits fell 32,600 to 1.402 million, its lowest level since February 2009. All this suggests that the jobs market is recovering in line with the broader economic recovery, and is another impressive indicator that the conservative led coalition can brag about at their party conferences. This, coupled with the exceptional PMI figures published in the first week of the month, are pushing analysts GDP estimates for the UK economy into uncharted ‘post-crisis’ territory, with some estimates now as high as 1.3% y/y. With this in mind and moving forward to the coming months, it may well be that the strong Sterling we have seen these past weeks is here to stay!


Sterling Outlook


We have a moderately busy week for the UK economy with the release of the CPI inflation figure, the MPC minutes and Retail Sales. We start the week with CPI, which has become ever more important with its inclusion within the forward guidance provided by Mark Carney. We expect a fall from 2.8% to 2.7%, which should be highly noteworthy given the requirement of inflation to drop below 2.5% in18-24 months under the new forward guidance regime. That being said, with the Syrian crisis still looming in oil markets, there is potential for the markets to be disappointed as higher petrol prices skew the release and keep the indicator flat.


Moving to Tuesday, the minutes and votes form the latest MPC meeting are expected to hold few surprises, as both QE and the headline bank rate were left unchanged. We expect all MPC members to have voted for the above and no dissenters to have risen in the ranks.


Finally we move to Thursday’s Retail Sales figures, which are expected to come in slightly slower than previous at 0.5% (against last month’s 1.1%). It is worth noting however that all the signs from the UK have been significantly better than forecast, and in our mind there is potential for the market consensus to be incorrect on this. Should we see anything around the 1% market expect further Sterling rallies, which should last until the end of the week. 


US Dollar Outlook


We have a massive week for the US, with the potential beginning of the Federal Reserve tapering its asset purchasing program on Wednesday. This question is likely to be answered when the FOMC reconvene for a 2 day meeting, ending with the usual FOMC press conference from Bernanke. Markets seem to have priced in a tapering event this week, so in many ways the more interesting outcome will be if the Fed decide to avert tapering and push back the decision until October. Another potential outcome would be the value of the taper, with the markets expected an amount of between $10 - $15 billion. Either way, Wednesday’s press conference will likely cause some of the more significant volatility in the FX markets we have seen this year, regardless of the decision.


Moving away from the FOMC meeting minutes, we have existing home sales, building permits and the Philly Fed manufacturing figures all due this week. However, given that market have been associating recent events with the likeliness of tapering, then those occurring after the press conference are likely to have less of an impact.


Starting with existing home sales, the indicator edged up in July to their highest level in over three years, reaching 5.39 million units, signifying higher mortgages are having a limited impact on the housing market. We expect a strong reading this month, however falling short of last month’s figure by posting 5.27 million units this time. We then shift our attention to the Philly Fed, where factory activity weakened in August after posting a multi-year high of 19.8 in July. We have seen new orders fall and a distinct lack of overseas demand, and with this in mind we expect the index to come in at 10.5 this month.


Euro Outlook


We have another quiet week for the Eurozone with only one event of note in the form of German and EZ ZEW economic sentiment figures. Along with the recent upward trend in the Eurozone, we are expecting to see strong figures out from both these releases. The German ZEW tends to take precedence over its European peer, and with markets forecasts pointing towards a rise from 42.0 to 45.3, we expect some of the recent Euro shorts to be reversed as a result. Should the German economy post this, it would be a six month high for the figure.


The EZ ZEW economic sentiment figure is somewhat ahead of its German rival, with markets expecting a proportionately larger rise, from 44.0 to 47.2. This would represent a notable boost for the bloc, and given the recent rate of growth in this figure along with a clear pickup in sentiment, I do not see why the Euro cannot reverse some of its recent losses. 

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