- EM fears undermine market sentiment, though we see too big positives
- US data out this week is likely to show that the economy has continued to grow above its potential rate
- Against this background, the Fed should continue to gradually wind down its QE programmes
EM fears hit investor risk appetite
Last week ended with a significant deterioration in market sentiment. This was triggered by turmoil in specific emerging markets, which led to worries in the EM universe more widely and eventually undermined investor risk appetite globally. We have seen an escalation of the political unrest in Ukraine, internal challenges in Turkey and the devaluation of the Argentine peso, while this happened against the background of weaker Chinese economic data. Emerging market currencies have been aggressively sold off. The South African rand dropped to levels not seen since 2002 and the Turkish lira fell to an all-time low despite the currency interventions by the Central Bank of the Republic of Turkey (CBRT) on Thursday. The CBRT reserves are insufficient to continue aggressive FX intervention. The market is aware of this and wants the CBRT to hike official rates. The devaluation of the Argentine peso resulted in a deterioration in sentiment for Latin American currencies. Concerns in the market about contagion of emerging markets is rising. As investors pulled out of emerging markets, US Treasury bonds and German Bunds were in demand, resulting in higher prices and lower yields. The US dollar, the Japanese yen and the Swiss franc were also bought especially versus emerging market currencies. Gold prices received some support as well, while equities moved lower in a typical risk off move. We see too big positives that should support investor sentiment in the end. First, the outlook for global demand and hence trade is positive. Second, EM fundamentals look much more solid than in the 1990s.
On the agenda: US Q4 GDP growth to have been strong…
This week will be an important one for the US, with data likely to show that the economy continued to do well in the fourth quarter of last year. One reason why the recovery seems to be getting on a stronger and more sustainable trajectory is that households are shrugging off the effects of the rise in the payroll tax and the income tax rates that we saw in the beginning of 2013. Indeed, we estimate that consumption grew by 4.0% qoq saar in Q4, double the rate seen in Q3, and the strongest performance since 2010Q4. Furthermore, businesses have rediscovered their appetite to invest. Capital goods shipment data – the best gauge for investment in equipment – surged in November, leaving investment on track to grow by around 8% in Q4. Meanwhile, judging from monthly data, both residential investment and net exports are likely to have made another healthy contribution to growth as well. Bringing everything together, Q4 GDP growth should come in at 3.5%, after growing by 4.1% in Q3 of last year. This would mark the second quarter of above trend growth (estimated to be around 2.5%), and clearly underlines that the economy has embarked on a stronger growth trajectory.
…while Fed set to trim asset purchases by another $10bn
Although the Q4 GDP figures will only be released after the FOMC concludes its two day meeting on Wednesday, we think that incoming data has been convincing enough to prompt the Fed to trim its QE programmes by another $10bn to $65bn (made up of $30bn of mortgage backed securities and $35bn of Treasuries), in particular as December’s dire nonfarm payrolls report seems to have been caused by adverse winter weather. Given our scenario for the labour market and inflation, we expect the Fed to continue to reduce its asset purchases by $10bn at subsequent meetings, and to completely wind down its programmes with a final $15bn cutback at its October meeting. This still leaves in place a considerable amount of stimulus though. Indeed, under the scheme, the Fed is on track to purchase $450bn of longer-term assets this year, only $150bn short of the $600bn assets bought under QE-2. Although we think that the Fed will ultimately move to hike rates earlier than it is currently signalling, we still think the first increase will not be before the middle of 2015. All this points to a rather favourable environment of easy policy and accelerating economic growth.