It has been a busy week for US markets, filled with plenty of data and the outcome of the midterms on November 4th. The result of these was a Republican takeover of the Senate, and in all the expression of dissatisfaction or anger at Mr Obama’s performance. The S&P 500, which opened on Monday around the 2020 mark, slightly edged lower ahead of results, then took back its gains on Tuesday-Wednesday leading to a high of 2033 over the week, a fresh record pushed by October job reports on Thursday and Friday. The Dow Jones gained 19.46 points at 17,573.93 and the S&P closed at 2031.92.
Let’s look at the job reports: initial jobless claims were better than expectations coming in at 278k rather than the expected 285k. Nonfarm payrolls instead were lower than expected by 17k, but still the unemployment rate edged lower to 5.8 %. The result should be seen positively since the labour participation rate slightly increased by 1 percentage point to 62.8%, and the employment-population ratio increased to 59.2% in October. There was also a revision of + 31k of the number of net new jobs gained in the previous two months. In all, cautiously, these were positively seen by the markets considering that they indicated a continued slow improvement which should keep rates low most probably into Q3 2015. Up until wages rise at a strong pace though, we may not be so sure about full recovery just yet.
With regards to bond market this week, yields lowered due to job and wages reports just slightly south of their best day since October 15th. Measures undertaken by the BoJ and expectations of future policy easing from the ECB may have boosted demand for Treasuries. The benchmark 10-year Treasury was trading at 2.40 before the jobs data, then plunging at 2.30 after the reports.
The dollar index edged higher over the week but eased lower on Friday, in line with its performance towards the Euro.
This was another important week for the UK, providing us with relevant data from the industrial sector and also the house one. Let’s start with the Markit PMI coming in on Monday well above expectations, at 53.2 against a 51.2 consensus. Yet another sign of improving business and economic conditions in the British economy. Last week we mentioned the possibility that the house market may be in fact cooling down a little, something we already had predicted last May. This slowdown in the house market is once again verified by the PMI Construction reports which showed a slower growth than what expect (61.4 w.r.t. 63.5), so our forecasts seem correct. The demand for houses is slowing and, in turn, so is the supply. Just another piece of data so as to confirm the sceptics: Halifax House Prices on Thursday were lower than the 9.1 % consensus at 8.8 %. With regards to more macro news, this week we had the Bank of England’s Monetary Policy Committee voting (rather expectably) to keep base interest rate at 0.5%. Obviously, given the latest economic environment, there is no interest in hiking rates in the near future. Inflation is not picking up and the house market issues seem to have calmed down. The members of the MPC though have been split in the past few months, two of them voting for a 0.25% increase. The FTSE 100 over the week followed the S&P 500 trend, slightly lowering in the first half then pairing its gains in the end of the week. The GBP lost ground towards the Euro though volatility was high this week given the large amount of data.
This week’s European economic data were depressing once again. In particular, Italian Manifacturing PMI returned below 50 at 49.0 vs 50.6 expected, European Retail Sales dropped 1.3% in October and German Industrial Production and Factory Orders came out both below expectation at 1.3% vs 2.1% exp and 0.8% vs 2.2% exp respectively.
However, the main event was the ECB meeting on Thursday. The degree to which Draghi was dovish depends on the degree to which the much discussed 1 trillion Euro balance sheet expansion was official policy already. If you didn’t think it was official policy and were worried it was something Draghi had discussed in the open without full support of the committee then he should be seen as bullish. Draghi’s statement explicitly announced that the ECB has unanimously agreed to target the return of its balance sheet back to early 2012 levels.
As most people are aware, it will be near impossible to reach such a target without the purchases of Government bonds so the statement does bring Government QE a step closer. Many in the market were disappointed that more details were not discussed but yesterday was always unlikely to be the occasion. The good news is that we now have a firm policy that the ECB can be benchmarked and judged against which is important.
If there is a worry, it is perhaps to question whether such balance sheet expansion is anywhere near enough to be a fire breaker. With this in mind, a simple calculation suggests the balance sheet might increase €500bn ($621bn) in 2015 – ignoring complications with any LTRO repayments. How does this compare to the Fed and the BoJ in recent times and going forward. The Fed expanded its balance sheet by $1100bn in 2013 and $454bn in 2014 (now likely frozen for 2015). The BoJ expanded by $303bn in 2013, $456bn by YE 2014 and likely $696bn in 2015bn (at current exchange rates). For reference the Euro area economy is about 80% of the size of the US economy and the Japanese economy is about 30% of the size. So the BoJ will likely buy 10% more paper in 2015 even with an economy less than half the size. Also Europe will potentially only be expanding its balance sheet at just over half the rate the Fed did at its peak – albeit with a smaller economy. So this is not shock and awe but at least we have a firm commitment.
In terms of how this all translated into price action this week, the EUR/USD was heavily under pressure. It breached the 1.24 resistance after Draghi’s speech but then recovered on Friday ending the week at 1.246.
After last week’s Bank of Japan unexpected announcement of an expansion of the monetary base to fight deflation, Japanese stocks rallied: the 225-issue Nikkei Stock Average rose 2.7% Tuesday, following a 5% gain Friday. The yield on the benchmark 10-year government bond fell slightly to 0.446%, as the BoJ monthly purchases of Japanese government bonds under the new policy ( ¥12 trillion) will be roughly equivalent to the government’s monthly issuance of those bonds. On Wednesday, in a further statement governor Haruhiko Kuroda confirmed the BoJ would use any possible measure to reach the 2% inflation target.
On Friday the Nikkei closed at 16880, as many exporters forecast revenues and profit increases due to weaker Yen (115 against the dollar): Toyota, whose net profits rose by 23% to 4.7 billion in 2014 Q3, has already benefitted from the Japanese currency at seven year lows.
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