France on the cusp of contraction once again as Mario Draghi wonders whether his rate cut was well timed!

Week Commencing Monday 11th November 2013


This week in Brief



  • In the UK we have a busy week with CPI, the Labour report, Mark Carney speaking and Retail Sales. We expect a relatively decent week for Sterling with all this in mind, perhaps with the exception of Retail Sales which usually drops before the big seasonal shop in December.

  • We have a considerably quieter week in the US ahead with Unemployment Claims and Fed Designate Yellen testifying before the senate. Expect the latter to produce the majority of volatility with taping questions likely to be raised.

  • In Europe we have a swath of GDP releases from a number of key European players, including France and Germany. Expect all GDP numbers to be down in the quarter and potentially to see France re-enter negative growth.  


Market Themes & Current Events


We start with UK Industrial Production, which increased more than expected in September on the back of some strong numbers in manufacturing, mining, quarrying and water management. Industrial output increased by 0.9% between August and September, above economists' predictions of a 0.5% rise in the indicator. Output in September was 2.2% higher compared with the same period a year ago, marking the strongest annual growth since January 2011. Despite services often being known as the jewel of the UK economy, the industrial sector continues to make up approximately a sixth of the whole UK economy. September’s growth came however after a dismal performance in August where industrial production fell unexpectedly. It seems that despite the country’s strong performance, we are certainly not out of the woods yet.


Moving across the Atlantic, The US economy added a better-than-expected 204,000 jobs in October, while Jobless claims decreased by 9,000 to 336,000 in the week from 345,000 the prior period, the Labour Department reported today in Washington. The news shocked the markets somewhat, with the majority of traders expecting to see some impact from the recent federal shutdown be reflected in the employment figures. Companies therefore may be feeling more confident, especially as vehicle sales and housing maintain gains and manufacturing shows signs of accelerating. These figures added to a relatively positive week for the US economy where on Thursday it was announced that the US economy grew at a better-than-expected annual pace of 2.8% in the third quarter. Investors therefore are watching as closely as ever to evaluate the health of the US economy, with signs of growing strength likely to raise expectations that the US Federal Reserve will begin to scale back its QE program.


Moving to France, Standard and Poor's (S&P) has cut France's credit rating to AA from AA+. The nation’s long-term long term foreign and local currency grade was lowered one step to AA from AA+. France lost the top rating at S&P back in January 2012 and has been on negative watch ever since, the new grade however, the third highest, is stable, according to the rating company. Despite the downgrade, French GDP will expand 0.2% this year and 0.9% next year, before increasing 1.7% in 2015, the European Commission said earlier this week. Ever capitalising on the positives, The French Prime Minister, Jean-Marc Ayrault, said France's ratings remained among the best in the world and that the agency did not take into account all the reforms made by the government. Obviously investors remain confident in Frances abilities to repay its national debt, as Credit-default swaps on France rose less than one basis point today to 53 basis points after dropping as low as 49 basis points yesterday, the lowest since April 2010. Let us hope however that we are not staring at the next major economy that will require a friendly bailout of their friendly neighbour hey!


Finally and sticking with the European theme, The European Central Bank (ECB) has cut its benchmark interest rate to a record low of 0.25%, down from 0.5% in a move that came as a surprise to many analysts, including us. ECB president Mario Draghi said the decision to cut rates reflected an outlook of low inflation and economic weakness in the Eurozone. This does however leave The central bank with just one more quarter-point cut left before reaching zero, increasing the likelihood of unconventional tools such as quantitative easing or a negative deposit rate if prices slow further or the economic recovery stalls. Euro-area inflation is less than half the ECB’s target and unemployment is at the highest level since the currency bloc was formed in 1999. With Mario constantly ruling out a Fed-style QE program, he may be short of the tools required to get the blocs economy back up in order. Better you than me Mr Draghi!!


Sterling Outlook


We have an extremely busy week for the UK which is due to kick off on Tuesday with the release of CPI y/y. The CPI measure of inflation is set to dominate the week’s proceedings, especially with its association to forward guidance set out by Mark Carney at the Bank of England. The condition of forward guidance outlined that interest rates would remain at their historic lows until the unemployment rate reached 7.0% or lower. However, there also was a stipulation stating that this is only valid as long as 18-24 month expectations of CPI remain at or below 2.5%. With market expectations pointing towards a fall in the figure to 2.5% from 2.7% in September. Should this be the case, we would be moving into a time where interest rates are unlikely to be raised in response to high inflation. With this in mind, should we see the CPI figure come in at or below 2.5%, it should be viewed as positive event and push out further expectations of loose monetary policies for the near future.


Moving to Wednesday we have a swath of jobs reports for the UK economy. The core two figures to watch for are the unemployment rate and the claimant count, both of which are due out in the morning session. The unemployment rate is undoubtly the highlight of the two, especially with its close ties to MC’s forward guidance, given that the 7% threshold is the level whereby the discussion over whether interest rates should be increased undertaken. Given this fact, analysts will be watching this figure for any further reductions; however market experts believe that it will remain stable at 7.7%. The claimant count should however continue to see further falls, especially as the last 13 out of 15 releases showing an improving employment condition. We believe that the current market expectation of -30.2k is also relatively pessimistic, and see room for a considerably large reduction to be posted.


Also on Wednesday, the Bank of England are due to release their latest quarterly inflation report. Expectations are running high with the report, with many speculating that the BoE is likely to be positive about the course of the UK economy. Important points of note would be a betterment of their current growth forecasts for the UK economy and a revision to their expected short term unemployment rate. Currently their expectations point towards the economy reaching the 7.0% threshold in early 2016, however if this changes expect some significant volatility moving forward.


Finally we await the retail sales figure, which is due out on Thursday. Markets point towards a fall in the month on month growth rate from 0.6% to 0.2%. That said, the expected figure remains firmly in growth territory so we do not expect any massive downward swings in Sterling pairs on the back of this release, especially as we approach the holiday season and the associated boost in sales for December.


US Dollar Outlook


We have a more gentle week for the US with Unemployment Claims coming out alongside the new Fed chairwoman Janet Yellen testifying before the Senate Banking Committee. Starting with Unemployment Claims, we expect the indicator to continue its downward path with a reduction of 5k expected to take the figure to 331k. We doubt that this will provide the FOMC with a sufficiently strong reduction in unemployment to consider tapering before the new year, and therefore we would need to see a strong miss in order to bring forward our estimation that the Fed will taper in Q1 2014.


Moving to Janet Yellen, this is her first testimony in front of the senate’s banking committee and as such will be heavily scrutinised. It will give her the opportunity to outline how monetary policy under her leadership is likely to take place and also provide insight of when she thinks tapering should occur. Given that tapering could occur when she takes the helm, expect some volatility when this point is raised.   


Euro Outlook


There are a number of releases of notes from the Eurozone this week, with the highlight being the preliminary GDP releases from Germany, France, Italy and Eurozone as a whole. We are expecting all releases to point towards a clear bias of lowered growth in the third quarter. German GDP is the most hotly expected with forecasts pointing towards a fall from 0.7% to 0.3%, while French GDP is expected to drop from a healthy 0.5% to 0.1% in Q3. The Eurozone is expected to drop as a whole by a more modest 0.1% to 0.2% q/q. It will be interesting to see whether the French figure comes in above the 0% mark, as considerable downside risk remains for the economy (especially in light of its recent downgrade).


Finally we are expecting the latest CPI figure from the Eurozone, which although has dropped in importance after the ECB lower interest rates, remains a key indicator within the bloc. The figure is expected to come in at the 0.7% level, however if it comes in higher it may well make Draghi appear somewhat impulsive and perhaps misguided in dropping base rate. 

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