Big Picture: Last week saw an aggressive sell-off of risky assets, which has been attributed to worries over global growth, concern about China’s financial stability and renewed economic and financial stress in Argentina. However, we think that most economic indicators published last week were consistent with our view that the global economy is strengthening. The soft Chinese PMI data may well have been impacted by the Chinese New Year. In addition, Argentina is clearly an entirely unique case and it would appear very odd to use Argentina as a reason for ‘contagion’ to other emerging economies.
Rates: We expect the Fed to decide to reduce its asset purchases to USD 65 billion at this week’s meeting. The broad balance of evidence suggests that the US economy has entered a new stronger phase, while recent weak payrolls and PMI data likely reflect bad weather. We expect tapering to continue at this pace in coming months. Looking forward, we see signs that the labour market has less spare capacity than previously thought, which could pressure the Fed to raise rates earlier than it is now signalling, though probably not before mid-2015.
FX: An abrupt deterioration in investor sentiment triggered by developments in emerging markets supported the Japanese yen and the Swiss franc and led to sharp declines in emerging market currencies. Given our view that the global economic recovery will remain on track and that emerging market fundamentals are generally much more healthy than in the 1990s, we think these moves will unwind going forward, though there are clearly well-known problems in a handful of specific economies.