Big Picture: US economic data was generally on the strong side, with nonfarm payrolls beating expectations in October, as well as seeing upward revisions to previous months . A large majority of commentators are now arguing that ‘good news is bad news’. In that line of thinking, good news on the economy is bad news for risky asset prices as it makes early tapering of asset purchases by the Fed more likely and we have seen over the summer what the effects will be. We think the ‘good news is bad news’ argument will prove to be wrong.
Interest rates: The ECB cut the refi rate a month earlier than we expected and left the door open for further action. We expect it to strengthen its forward guidance, while the chances of a further cut in rates has increased. Against this background, we think that rate expectations could fall further. On the other hand, continued evidence of a global economic recovery and Fed tapering expectations are likely to largely offset the impact on euro 10Y rates, though we see more significant downside for 5Y rates. We stick to our view that the Fed will taper in March, though the chances of a December move have increased.
FX: The ECB’s surprise rate cut resulted in an aggressive sell-off of the euro across the board as financial markets adjusted their view on the outlook for interest rates in the future downwards. The risks to our year-end forecast for EUR/USD of 1.35 are tilted to the downside and have clearly increased over recent days. This reflects that the differences between the likely paths of monetary policy on either side of the Atlantic have become more stark given the ECB’s rate cut and the strong US economic data. We largely expect this move to play out in 2014, hence we are forecasting a EUR/USD of 1.20 by the end of that year.