Focus Shifts Away From The U.S.

From the Federal Reserve’s reluctance to raise interest rates in September, through the soft employment and retail sales report, and two Fed Governors arguing against a rate hike this year, the pendulum of expectations has swung hard. The implied yield of the Fed funds futures does not rise above 37.5 bp, ostensibly the middle of the target range following a rate hike, until July 2016.  Barring a contraction in the US economy or deflation in core measures of inflation, it is difficult to envision a shift out in expectations.

The US economic calendar in the week ahead features the latest readings on the housing market. News from this sector is unlikely to shift expectations. The dollar’s recovery last week began with news that weekly jobless claims matched the cyclical low while the smoothed four-week moving average fell to new post-crisis lows. Confirmation may be sought this week that it was no statistical fluke.  While US growth in Q3 may be soft (~1.0%-1.2%), the trend in weekly jobless claims is not consistent with a contracting economy.  

A Financial Times survey found none of the nearly 2/3 of economists it polled that anticipate a Fed hike this year expect it to be delivered this month.  The focus is on the mid-December meeting.  The next nonfarm payroll report in early November is the next key piece of news for such expectations. This means the focus will shift to Europe and Japan.

With the euro’s upside momentum stalling in front of  $1.15 last week, we suspect it will be difficult to rebuild it ahead of the ECB’s meeting this week.  At its September meeting, the ECB staff reduced growth and inflation forecasts.  This is how a shift in policy begins.  First, the economy does not perform as expected.  Next, a consensus has to be formed that a policy response is in order.  Then an agreement on that policy response is necessary. 

This week’s meeting is still too early in the process to expect an agreement.  However, some progress toward building that consensus is likely, and that is what investors will be keenly monitoring. There are three broad ways that the asset purchase program can be tweaked.