Busy Economic Week Offers Confusion
Equity markets pushed to new highs in the latest week, with the Dow Jones Industrial Average climbing 0.9% and the S&P 500 rising 0.5%. On the surface, much of the data released last week was bullish, but weakness in underlying components left market participants optimistic that central bankers would continue asset purchases.
On an aggregate basis, economic data last week was positive, but there is a slowing trend across the globe. The Citigroup Economic Surprise Index decelerated from 50 to 0 in the past several months, signaling that economic data and expectations are in line with one another. A similar trend is evident in Europe, but emerging markets data sets are failing to outperform expectations.
The nonfarm payroll report for October proved to be one of the many interesting, and puzzling, reports of the week. Total payrolls expanded by 204,000 jobs, but the unemployment rate ticked up 0.1% to 7.3%.
On the confusing side, the labor force shrunk by 720,000, but there is some debate as to whether that number is skewed by the government shutdown and its impact on contractors. Regardless, the civilian employment-population ratio fell to 58.3%, the lowest since the early 1980’s.
Civilian Employment-Population Ratio:
Source: Federal Reserve Bank of St. Louis
Participation continues to be an ongoing struggle for labor markets. Most major age groups are experiencing declines in labor force participation, with the odd exception of older age groups. This is due in large part to sub-par savings rates and the financial crisis, which left potential retirees with lighter pockets.
Source: Washington Post
Consumers received some good news in the form of personal income for September, which was up 0.5%, matching similar gains from August. Spending was not quite as robust, showing gains of 0.2%, lagging the 0.3% increase posted in August.
At the same time, consumer credit increased by $13.7 billion in September. Non-revolving credit was the main culprit, up $15.8 billion, led by federal government loans, consumer loans, and student loans. Revolving credit remained negative, a further sign that consumers are not comfortable with credit card expenditures in the current environment.
Somewhat surprisingly, third quarter GDP posted a 2.8% gain, beating expectations of 2.0%. Despite a strong headline figure, equity markets sold off sharply after realizing that underlying components were less than stellar. Personal consumption expenditures added 1 percentage point to growth, while residential investment added another 0.4 percentage points. Less sustainable was the 0.8 percentage point contribution from inventories. It is likely that inventories will return that growth next quarter and act as a detractor.
Currency Markets Show Signs of Reversal
A mixture of surprising economic data and changing central bank policy led to sharp moves in currency markets last week. This came after several gyrations in FX markets earlier this year. Looking forward, volatility is likely to remain, but many signs point towards a strengthening U.S. dollar.
Most notable of the FX pairs was the euro, which sold off sharply against the dollar on Thursday after a surprise rate cut from 0.5% to 0.25%. ECB officials were forced to act after a recent inflation report showed annual inflation of 0.7% across the Eurozone. Deflation was not an immediate concern in 2012, but prices are trending quickly lower across the Euro bloc, with some countries dipping into deflationary territory year-over-year.
The euro moved down again on Friday after the U.S. labor report. Since a recent peak of $1.38 to the dollar in late October, the euro has traded off on concern that the situation in Europe will require “lower for longer” rates relative to the U.S. The latest reading shows the Euro at $1.34 against the dollar.
Also reversing course was the Australian dollar (AUD). The AUD was hit hard over the summer months due to slowing growth in China and fears about the impact it might have on the Australian economy. Those fears subsided during the fall, and an accommodative central bank in Australia allowed the currency to rally. Unfortunately, economic data in Australia is soft, and monetary conditions in China are gradually tightening. Coupled with the stronger U.S. labor report, the AUD was pushed down quickly.
Across 2013, the most interesting currency, and best trading opportunity, has been the Japanese yen. Popularly dubbed “Abenomics” has been successful at depreciating the yen and moving speculators into the stock market.
Enthusiasm for Japanese equities is apparent in the Wisdom Tree Japan Hedged Equity Fund (ticker: DXJ), which saw its assets skyrocket since the end of 2012.
Source: Research Puzzle
Despite a flat lining of the yen relative to the dollar since the start of summer, a number of analysts believe the yen could dip again into 2014, while also seeing the Nikkei move higher. The biggest catalyst is appetite for Japan’s central bank to expand its balance sheet further. According to Barclays research, the Federal Reserve’s balance sheet is expected to peak around 30% of GDP, whereas Japan could near 60% of GDP by the end of 2014.
Source: Barclay’s Capital
The latest week could be a small preview into currency market trends for the quarters ahead. St. Louis Fed President James Bullard recently said that tapering in the U.S. could begin as soon as December. If his prognostication proves accurate, it would represent another bullish sign for the USD against most major currencies.
The Week Ahead
It will be an interesting week given the expected testimony of Federal Reserve Chairwoman nominee Janet Yellen in front of the Senate Banking Committee Thursday. She is not likely to offer detailed insight to her thinking on monetary policy, but her testimony should provide certain clues about what the future of monetary policy in the U.S. will hold.
Bond markets are scheduled for closure Monday, but stock exchanges will be open for business. Releases to watch include small business optimism, industrial production, and the Chicago Fed national activity index. Small businesses are feeling the effect of the government shutdown, along with the recent implementation of the Affordable Care Act, which could weigh on October optimism.
Central banks to keep an eye on this week include those in South Korea and Indonesia.
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