Fed Eyes Tapering, ECB Eyes More Easing

Central banks are on diverging paths these days. In the US the strong payroll report put Fed tapering back on the agenda. Average job growth in the past three months is now 201k, which is broadly where the Fed wants to see it to start tapering. At the hearing in relation to her nomination for Fed chairman, Janet Yellen noted that the labour market has seen meaningful progress but that the Fed wants to see growth strong enough to sustain gains in the labour market. She said there is no set timing for tapering but the Fed will evaluate the data meeting by meeting. We look for Fed tapering to start in January as we expect more signs over the next two months that US growth is on a firmer footing.The negative effects of the fiscal tightening, the government shutdown and the sharp bond yield rise will fade gradually. Consensus is currently for tapering to start in March.

Despite technically overbought markets and Fed tapering back in the equation, risk markets have continued to perform. Stocks in both Europe and US have gained further ground after pausing a bit last week. Deflation worries as well as disappointing growth numbers out of Europe were also shaken off by the markets.

Yet again, risk appetite is proving very resilient. The belief in global recovery and low rates for a long time continue to push investors out on the risk curve underpinning risk assets. In the euro area the ECB rate cut and rising talk of QE may give some support. We believe risk assets will continue to perform going into 2014 but following this year’s strong performance and the decline in risk premiums, we are getting more cautious and expect returns to be lower next year.

While developed risk markets keep rallying, Emerging Markets took another hit from the renewed focus on Fed tapering. Equity, bond and currency markets saw significant losses over the past week, although not quite as bad as seen over the summer or this autumn. We believe EM market volatility will be with us in the short term as Fed tapering gets closer. However, more details about Chinese reforms should underpin EM markets and next year a moderate EM growth recovery as well as lower inflation pressures will add support.

The ECB is expected to launch a new LTRO, but to refrain from QE. The talk about QE from the ECB was fuelled by comments from ECB member and chief economist, Peter Praet, who several times mentioned asset purchases as a tool ECB could implement if needed to fulfil its target of inflation just below 2%.

The speculation about QE is likely to linger as long as inflation stays low, which could very well be the case for some time. While we do not expect euro inflation to fall much further from here – and see the risk of deflation as very limited – we do look for it to stay below 1% for a long time (see also Strategy: Deflation is not always a bad thing, 8 November).

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