All eyes on Mr. Bernanke – Fed update, ECB worried about euro?

Eurozone recovery ongoing, slight deterioration of US economic outlook

Market expectations for the Fed have drastically shifted once again. The US economic outlook has deteriorated somewhat. The data was again disappointing (but not catastrophic): the unemployment rate declined to 7.2% and job creation was 150K in September. The government shutdown means that many economic releases have been postponed, making any assessment more difficult. The economic impact of the shutdown itself might be limited: missed payments such as wages of some government employees will be made retroactively (even without working hours) and states will be reimbursed for the temporary takeover of the financing of national monuments (e.g. the Statue of Liberty, financed by the state of New York and reopened on October 13). Sentiment might remain dampened by the ongoing uncertainty though.

At next week’s meeting, much data will not be available to the Fed (retail sales, CPI last minute, but not GDP). Hence, we do not expect the central bank to make a strong statement but rather to emphasize risks (the inclusion of downside risks to the economy is not to be ruled out). In our view, the Fed ‘could’ slow down purchases from December onwards, but only if the economic data shows significant improvement across the board from now on (the likelihood of this is below 50%). After that, the next meeting with a press conference is only in March, making this possibly the most likely, but by no means certain, timing. Market expectations seem to have been postponed until that meeting.

This is particularly relevant for the dollar: the EURUSD has increased to 1.38 on the back of expectations for central bank’s balance sheets. The ECB’s balance sheet has continued to shrink and excess liquidity is now below EUR 200bn. Even though it is unclear when a Euribor increase would follow, we remain confident that the ECB would, if necessary, provide further long-term liquidity, thus counteracting excessive euro liquidity reduction. Beyond that, in light of already low inflation projections, a strong euro might add to the need for ECB action. In spring, when the EURUSD had reached levels close to the current ones, Mr. Draghi’s announcement that a cut of the deposit facility below zero was not to be ruled out brought the exchange rate close to 1.30 again; this might now be repeated. Overall, as long as a slowdown of Fed purchases is expected next year only, and the ECB refrains from action, the dollar could continue to weaken (we have again adapted our forecast). The situation should revert when there are clear signals for a forthcoming slowdown of Fed purchases or the ECB steps in, but this might only be in 2014.

Industry polls: Germany improves again; France stable

This week, Flash Manufacturing PMI data for October was released for major countries. In France, the survey value for October dropped slightly to 49.4 (after 49.8). Given the fact that recent French poll data has been a bit too pessimistic, a stabilization of French industry seems to be realistic, based on current data. In Germany, the survey values for October have risen further to 51.5 (after 51.1) and point to the ongoing positive momentum of German industry. In China, the October data improved as well and clocked in at 50.9 (after 50.2). Based on this encouraging data set, it seems as if the recovery of Chinese growth continues. In light of the importance of Asia for German exports, the Chinese data is an encouraging signal for the German export industry. The development furthermore confirms our expectation that German growth rates will remain above the levels we expect to see for example in France. By early November, final PMI data will deliver further insights.

Manufacturing survey data for the entire Eurozone for October improved slightly (51.3 after 51.1). The values indicate a slight acceleration of production growth; order intake posted modest gains, according to survey data. The Eurozone composite index value – a measure that is taking the service sector into consideration as well, where recent poll data unfortunately hasn’t been very pleasant - cooled off a bit (51.5 after 52.5), but still indicates that growth is set to continue. From our perspective, the main takeaway is that current PMI data points towards a continuation of the recovery across all regions.