- Strong US economic data trigger market focus on Fed tapering of asset purchases…
- …but sentiment rescued by rumours that a US budget deal is close
- Central banks remain in focus, with the ECB the headline act…
- … we expect a strong signal that policy will remain accommodative for prolonged period
Jump in ADP employment bodes well for official report
Private sector employment as measured by the ADP rose by 215K in November following a 184K increase in October (revised up from 130K). The outcome was stronger than the consensus forecast of 171K. The ADP numbers bode well for the non-farm payrolls report that will be published on Friday. Indeed, we expect a robust rise in private sector payrolls of 200K, which is above the consensus forecast of 181K and would be the third monthly rise of 200K or more during the past four months. Other data was mixed. The ISM non-manufacturing index surprisingly fell in November (to 53.9 from 55.4). We think this is probably a blip given the strengthening fundamentals behind domestic demand. For instance, the housing market looks to be re-accelerating following the summer dip, when the jump in Treasury yields sapped momentum. Indeed, new home sales surged by 25.4% in October, the most since May 1980. Finally, the trade balance narrowed on strong exports. On balance, we remain comfortable with the view that the US economy is set to accelerate significantly in the coming quarters.
Taper wobble gives way to budget optimism
The strong ADP report seemed to put a tapering of asset purchases into focus and led to a market wobble. Treasury yields climbed, equities dipped and the dollar eventually strengthened. However, market sentiment was to some extent rescued by reports (from congressional aides) that a budget deal was close, leading to a rebound in equities. The reports on the budget alluded to a deal to set funding in fiscal 2014 and 2015, while at the same time reducing the drag from the sequesters. This would take the risk of a government shutdown off the table, but there is no news on whether there has been progress on the debt ceiling.
We see tapering in March – process likely to be calmer
Our base scenario is that the Fed will taper in March. Even though the jobs numbers look like they will be strong enough to bring a December taper into consideration, broader evidence on the labour market and economy is probably not yet convincing enough for the FOMC to feel confident. In any case, we do not expect tapering to lead to risk aversion. Our sense is that investors have adjusted following the dry run earlier this year, while the past experience of QE announcements is that the market action is front loaded, as the expectation effect tends to be more important than the actual flows.
On the agenda: ECB headline act as central banks meet
Today the ECB, BoE and Norges Bank are expected to leave their key policy rates unchanged. Most of the market attention will be on the ECB. The recent rebound in eurozone inflation has made big bold action – in the shape of negative rates or QE – by the ECB even less likely at this meeting. Especially given the resistance in some corners of the Governing Council. Nevertheless, inflation is still uncomfortably low, so the central bank will certainly leave the door to such actions in the future open in case downside risks intensify. In addition, we expect dovish ECB commentary on the outlook and low inflation forecasts from the institution’s economists to signal to markets that rates will remain low for a prolonged period. This should push down short rate expectations and undermine the euro. Meanwhile, there is chance that some additional policies that have been under consideration come to the fore at this meeting. One is a scheme to encourage commercial banks to lend more to SMEs. The other possibility is a plan to start publishing minutes of the Governing Council meetings. However, there is a lot of uncertainty about precisely where the ECB is on these issues.