Daily Insight – Shaking off the shutdown

by: Nick Kounis , Peter de Bruin , Roy Teo

  • Gain in US ISM non-manufacturing index suggests economy weathered shutdown relatively well
  • EC sees slow recovery and low inflation in the eurozone
  • BoJ Governor confident on inflation, but may still need to step up stimulus

Gain in services activity suggests US economy weathered shutdown relatively well

The ISM non-manufacturing index unexpectedly rose from 54.4 in September to 55.4 in October. In contrast, the consensus forecast was for a small drop to 54. Looking at some of the details of the report, there was a solid rise in the employment index (from 52.7 to 56.2), which suggests there are some upside risks to our forecast of a 130K rise in payrolls for this Friday’s nonfarm payrolls report. That said, the more forward looking new orders index declined (from 59.6 to 56.8) though it remained at quite elevated levels. Overall, the rise in both the ISM manufacturing and non-manufacturing index suggests that the economy weathered the consequences of the government shutdown relatively well. Indeed, the composite index rose from 54.2 to 55.5 in October. Although the relationship between the composite index and GDP growth is not always constant, at its current level, the composite index is consistent with GDP growth of around 3%, which is slightly higher than our current forecast of 2.5%.

EC recovery continues, but at a slow pace

The European Commission published its Autumn forecast for the European economies yesterday. There were a number of key takeaways. First of all, the economic recovery is likely to continue in the coming years, but it is likely to do so only at a moderate pace. GDP growth for the eurozone as a whole is seen at 1.1% next year (down from 1.2% previously) and 1.7% in 2015. We are a little more optimistic for growth in 2014 (at 1.3%) reflecting that we expect a stronger acceleration in global growth. We have not published forecasts for 2015, but the EC’s projection seems reasonable. The slow economic recovery is going to leave unemployment elevated and a lot of economic slack that will weigh on inflation. Headline inflation is seen at 1.5% next year and 1.4% in 2015, which is below the ECB’s price stability goal. Nevertheless, we think that given inflation was at 0.7% in October and there are still disinflationary pressures in the pipeline, inflation is likely to be lower than the EC’s forecasts. This is likely to be reflected in the ECB’s new forecasts next month, which should trigger an interest rate cut. Finally, the Commission expects some countries (most notably France) to miss their deficit target in 2015 on an unchanged policy scenario, which emphasises that further fiscal consolidation will be necessary in that year. Indeed, we suspect that the pace of budget cuts could be once again be stepped up in 2015 following something of a break from austerity in many countries next year.

BoJ governor Kuroda confident on inflation target – we have doubts

In the currency markets, USD/JPY dipped temporarily after BoJ governor Kuroda expressed confidence that the central bank would hit its inflation target. Although growth is likely to decline in 2014 and 2015 following the scheduled sales tax hike, he asserted that growth would remain above its potential. However, we suspect that Mr Kuroda is too optimistic on the inflation outlook. In particular, much of the price pressure we have seen up until now relate to the past fall in the yen, which will prove temporary without a stepping up of monetary stimulus. We therefore expect the BoJ to announce an even larger QE programme next year, which together with a tapering by the Fed, should push USD/JPY higher to around 110 by the end of 2014. This will also be aided by an increase in outward currency investments by local investors. Indeed several Japanese life insurance companies have indicated that they will be looking to buy foreign currencies including the USD and EUR during periods of JPY strength. Furthermore they will be looking to reduce the currency hedges on foreign investments and even unwind existing foreign currency hedges should a weak JPY trend resume.


131106 Daily