End of Government shutdown drives broad risk rally; dollar falls broadly
21/Oct/2013 • Currency Updates•
Equities and Government bonds rallied strongly last week, buoyed by the resolution of the US budget impasse and the end of the US Federal Government shutdown. US equities rose to all-time highs, and global equities rose to their cycle highs. However, the news failed to help the dollar. The greenback fell following news that Chinese rating agency Dagong had downgraded the US sovereign rating. It is clear that markets have priced out almost completely the possibility that the Fed will start the taper at its December meeting. We think that this is a little hasty, as there are still two key employment reports to be released between now and the last FOMC meeting for 2013, starting with the September release that will come out Tuesday now that the shutdown is over. A couple of moderately strong reports could bring the Fed squarely back into play.
Last week brought a rather confusing employment report in the UK. While commentators focused on the large drop in claimant count unemployment, which fell by 41,700, as well as a net addition of 155,000 in the three months to August, the average unemployment rate in the three months of August was steady at 7.7%; the August print was actually an increase to 8.0%. Also, wage growth slowed further, to 1.1% yoy, while inflation last month was steady at 2.7% yoy, confirming the pattern of real wage cuts we have seen since the 2008-9 crisis. Currency markets seem to take a skeptical view of this report as well, as Sterling followed the general rally against the USD but failed to make headway against other European currencies, notably the Euro.
Eurozone economic indicators had a mixed week. Industrial production in August was confirmed to have partially rebounded from the dismal July numbers, increasing 1% mom. However, the overall July/August level is still 0.4% below the previous quarter production, and August rebound was almost entirely driven by the auto sector; given the lack of significant rebound in car registrations, this rises the risk of a relapse in the coming months. Also out last week was inflation, which dropped a significant 0.2% to 1.1% in September. This number is well below the ECB official target of “close to, but below 2%”, and the trend towards lower levels appears to be firmly established. A gap appears to be developing between market expectations of rate hikes and the ECB’s more dovish views, and this will make the next ECB meeting all the more interesting. Recent Euro appreciation can only increase the pressure on Draghi.
The 16-day US budget-and-debt charade came to an end Wednesday, as the Republican House leadership forced the agreement through with Democratic votes. Radical Republicans achieved nothing other than a precipitous collapse in Republican party polls. We are confident that there will not be a repeat of the shutdown when the current agreement on the debt ceiling expires early next year.
Attention now shifts to the macroeconomic fallout from the shutdown. Since macroeconomic releases themselves were affected or delayed by the events, it is not easy to get a firm read on this. Direct impact in the form of lost wages and Federal spending should be modest, in the order of 0.2% this quarter. Indirect losses caused by multiplier effects and lowered confidence are much harder to gauge, but we are optimistic that they will be low as well. The delayed September employment report, due out Tuesday, will provide key information on the state of the economy and labor market prior to the shutdown. We expect to have a firmer read on the underlying health of US growth by the end of next week, as other delayed reports filter out.