Data during the week added to evidence that the recovery lost some pace in the third quarter. Indeed, the 3.7% rise in durable goods orders was mostly driven by volatile transportation orders, and outside transportation, orders actually fell for the third consecutive month, casting some doubt on the strength of the manufacturing upswing. Meanwhile, the investment part of the report was also weak, with both capital goods orders (-1.1%) and shipments falling (-0.2%). The latter brought our Q3 GDP tracking estimate to a paltry 1.8% qoq saar, down from the 2.5% growth seen in Q2. But perhaps more importantly, the slight deceleration in GDP growth also seems to have taken some wind out of the sails of the labour market recovery. Indeed, nonfarm payrolls rose by just 148K in September (was 198K) bringing average monthly job gains to just 143K in Q3 down from 182K in Q2. Granted, the unemployment rate managed to drop a tenth to 7.2%, but this reflected that a very weak inflow in the labour force was more than offset by a modest gain in employment.
Meanwhile, data during the week that gave us more information about the fourth quarter, so far, seems to suggest that the government shutdown weighed on the recovery. Indeed, although we would like to await the results of the October’s ISM report for a more definite picture, Markit’s preliminary PMI fell to 51.1 in October, down from 52.8 the month before, bringing manufacturing activity to the lowest level in a year. The drop was partly caused by a fall in the more forward looking new orders sub-index. This suggests that while we expect November’s figures to bounce back a bit, as activity will no longer be hindered by the fiscal impasse, any rebound will be modest. What is more, the final estimate of the University of Michigan fell to 73.2, down from October’s preliminary reading of 75.2, keeping confidence on a downward trend. All this raises some questions about the sustainability of the upswing. Still, a steep drop in the pace of fiscal consolidation, together with strongly improved fundamentals should help the recovery to gain pace before long.
September’s weaker-than-expected nonfarm payrolls report has prompted us to shift our expectations of the Fed’s first tapering to the March meeting. The recent trends in initial jobless claims suggests that October’s official labour market report will be negatively affected by the government shutdown, and although we expect to see some some payback for this in November’s labour figures, this, at best would give FOMC members one decent labour market report during their December meeting. We think that this will not be enough to prompt them to start scaling back their QE programmes. This also means that this week’s Fed meeting will most likely be met with less interest by investors than usually is the case. Indeed, we do not expect that FOMC members will make any changes to their policy. Meanwhile, although the statement is likely to make some reference about the recent string of soft data on the back of the government shutdown, we do think that members continued to think that economic activity expanded at a ‘moderate pace’.
It was a good week for Treasuries with yields dropping. In the beginning of the week yields moved sideways, but this changed on Tuesday, when September’s nonfarm payrolls report came in weaker-than-expected. This generally prompted market participants to postpone their expectations of when the Fed will start to reduce its QE programmes, and hence led to a drop in yields. Indeed, we also pushed forward our expectation of the first tapering and now see this happening in March instead of December, as also explained in the previous box. This also has implications to our interest rate expectations. We now see 10-Y yields at the end of this year at 2.75% instead of 3.0% previously. We still think that the recovery will strengthen next year and expect the Fed to hike in the first quarter of 2015. As such, we continue to expect yields to rise by the same amount next year (though by extension, we have slightly reduced our 2014 end of year forecast to 3.75% from 4.0%).