To taper or not to taper ... that is the question!

Week Commencing Monday 7th October 2013


This week in Brief


In the UK, Manufacturing Production should stem the recently poor showing from Manufacturing PMI and indicate the sector remains in strong growth. Thursday’s BoE meeting is expected to see no change in Monetary Policy in line with Mark Carney’s Forward Guidance policy.


In the US focus continues to surround the debt ceiling and federal shutdown. The longer this situation continues the greater effect on US growth prospects as well as the US Dollar. Despite this we also have the FOMC Meeting Minutes, Unemployment Claims and most importantly the Preliminary UoM Consumer Sentiment report on Friday.


In Europe we have a raft of German economic data expected to be released during the first half of the week, whilst Mario Draghi is expected to speak on both Wednesday and Thursday. Mario Draghi’s speech is by far the more important with emphasis likely to be on the ECB’s potential use of LTRO’s in the coming months.


Market Themes & Current Events


We start this week’s news with the UK Service Sector, which according to last week’s PMI activity survey is growing at its fastest pace since 1997. The Markit/CIPS PMI services index said the rise was mainly due to growth in the financial services sector, boosted by a strong increase in lending within the real estate markets. The survey has risen hopes that the economy should see stronger than expected growth in the third quarter, continuing to push the UK further into expansion. The strong reading for the UK services sector follows similarly strong surveys of the manufacturing and construction sectors published earlier this week. Whilst these other PMI releases are important, the continued “over 60’s” growth of the service sector, which is by far the largest contributor to UK GDP, is fantastic news for the country. Is this too soon to say the UK is back in business?


Moving from incredibly positive UK news to some worrying US news, there is still no resolution in sight for the federal shutdown. It comes as Treasury Secretary Jacob J. Lew said Congress needs to pass a debt-ceiling increase by 17 October or the US will be “dangerously low” on cash and risk defaulting on its payments. Lew is projecting that the US will exhaust its “extraordinary measures” to stay under the USD 16.7 trillion federal debt limit no later than 17 October. At that time, the US will have about USD 30 billion in cash, which will be short of expenditures that can reach as high as USD 60 billion in subsequent days. It is thought that a one-week shutdown could shave as much as 0.1% from economic growth, so the longer this situation develops; the more damaged the US economic recovery becomes.


Moving to Spain and the number of registered jobless in Spain has risen for the first time in seven months as the tourist sector laid off workers after the summer season. Unemployment in September rose by 0.5% to 4.7 million, with the service sector leading the charge by shedding 52,000 jobs. Despite this setback, and the fact that Spain has been in recession for most of the past four years, the government is forecasting that the economy will grow this year. Spain’s return to growth is relatively assured; as can be seen in fixed income markets with the gradual decline of yield on Spanish government debt, however economic recovery in the Eurozone as a whole is far from certain.  This continues to remain the biggest drag on Spanish growth prospects, and could very well push the country back into recession once again. Mr Rajoy it seems must watch his step!


Not even Germany, the powerhouse of the European Union, could escape a surprise rise in unemployment last week. The number of people out of work in Germany unexpectedly rose by a seasonally adjusted 25,000 in September to just under three million. This surprising news came as analysts has projected a fall of 5,000 after the rise of 9,000 in August. The rise in German joblessness pushed the unemployment rate within the country from 6.8% to 6.9%. This however was not enough to stem the decline in joblessness in Europe as a whole, which posted a drop in August to 12.0%.


Sterling Outlook


We have a moderately quiet week in the UK, with the only two events of note come in the form of the manufacturing production figure and the monetary policy decision from the Bank of England. The MPC will decide on Thursday whether the current monetary policy will be altered from the 0.50% interest rate and GBP 375bn asset purchase facility. Given the forward guidance provided by Mark Carney, there is no expectation for any change in either direction. That said, should the accompanying statement provide anything out of the ordinary, this event has the possibility impact Sterling denominated markets.


The second event of note is the manufacturing production figure which is released on Wednesday. Given the disappointing manufacturing PMI figure last Tuesday, markets will be looking for this figure to indicate that the industry is still recovering. Currently, market expectations point towards a marginal rise from 0.2% to 0.3%, which would continue to indicate strong growth in the sector. From a volatility perspective, we should only get a notable market response should the figure come in well above or below estimates and therefore anything around this level is unlikely bring an response.


US Dollar Outlook


Last week should have been the best opportunity for markets to gauge how likely we are to see a October taper from the Federal Reserve, given the release of some critical jobs data. However, the failure of congress to reach a reasonable compromise over the budget has meant that we are currently without a spending bill. This means that the employees at the Department of Labour must take compulsory leave, meaning that until there is a resolution to this issue we will not receive any government calculated economic releases. In essence, the continued inability of congress to come to a decision, the less likely we are to get any taper in October. Despite the shutdown, the FOMC Meeting Minutes, Unemployment Claims and UoM are both still due to be released and are therefore the de-facto indicators to watch.


The lack of any Department of Labour jobs data last week means that the focus upon the weekly unemployment claims figure will intensify as investors look for hints as to the tapering decision at the FOMC meeting later this month. The expectation is that for any taper to be possible, we would have to see a significant betterment of employment levels, however the expectation is that we will only see a reduction by 1,000 from 308k to 307k. We would speculate that this would be insufficient to taper, especially without the headline figures being released. If anything, this release should bolster to non-taper camp, so expect markets to react accordingly.


On Wednesday, the FOMC minutes are set to be released and with it we expect to see some rationale as to why the committee decided to not taper in September. We will be specifically looking at the tone of the minutes and for further guidance as to what the conditions are for a taper. Given the significant impact of the current shutdown, I believe the sentiment is likely to swing further against a taper rather than towards it.


Finally, the University of Michigan consumer sentiment figure is due to be released on Friday. This is the preliminary release and is therefore deemed the most important by international markets. Given the lack of data out recently owing to the shutdown, we will likely see a greater importance placed on this indicator, and therefore we could see some increased volatility. The market expects a marginal fall to 77.2 from 77.5. However, given the increased worries regarding the debt ceiling and budget throughout September, I believe this could fall further than that.


Euro Outlook


Much like the UK, we have a quiet week in the Eurozone with only a raft of German data, along with two speeches from ECB president Mario Draghi dominating. We start with the release of the German trade balance, factory orders and industrial production figures during the first half of the week, and should act as a barometer of how the Eurozone and German economy is progressing. The expectation is that we will see a noteworthy improvement on all fronts, where the trade balance moves further into surplus and both industrial production and factory orders move back into positive territory. Despite this, these figures are unlikely to have a substantial impact individually unless we get a significant deviation from market expectations.


Finally on Wednesday and Thursday we will hear from ECB president Mario Draghi, where markets will be looking for further comments following his appearance at the ECB press conference last week. Much of the current emphasis and speculation is currently geared towards the possible use of LTRO’s by the ECB, which was not ruled out last week. Any further comments to further elaborate upon that standpoint would likely move markets and thus look out for any discussion of the topic.

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