US Stalls While China And Europe Strengthen‏

Once again US politicians struck a last-minute deal and once again fears were running high as the deadline got nearer. However, markets kept their cool and were buying the rumour of a deal more than trading on fear of a breach of the deadline. So where do we go from here? Below an overview of how we see the situation and what we expect from US in the coming quarters.

Some damage to US activity has been done even though the disaster scenario was avoided. The government shutdown is expected to subtract 0.2-0.4 percentage points from Q4 growth and the indirect effect of weaker sentiment among households and businesses will weigh on activity. It adds to this year’s double whammy of a) the sharp fiscal tightening and b) the significant rise in bond yields that has already eaten into Q3 growth, which is now tracking only 1.5-2%. We saw further evidence of the effect on housing this week with a decline in the NAHB housing index, which fell from 57 to 55, the second monthly decline. It looks increasingly likely that growth will be stuck in the 1.5-2% range also in Q4. This would leave H2 clearly weaker than expected and as the debt ceiling deal is only a case of kicking the can down the road, it does not give the much needed lift to uncertainty. This may keep businesses hesitant to invest and hire.

In terms of key data we expect ISM manufacturing to correct a bit lower in coming months. The ISM new orders index fell in September and ISM non-manufacturing took a nosedive. Hard data have also failed to show the strength of ISM manufacturing and given the government shutdown the risk of a move lower is quite high. Consumer confidence is also likely to decline due to widespread frustration with Washington.

While the headwinds have dragged out we expect growth in the US economy to gather pace in 2014. Firstly, the drag from fiscal policy will peter out, which will significantly lift growth. Secondly, the sharp negative impulse from the rise in bond yields will also fade as bond markets take a breather. Thirdly, the housing market is still in a structural recovery phase – even if it is halted temporarily by the ‘bond yield shock’ this year. Wealth effects from rising house prices will underpin consumer confidence and there is still substantial pent-up demand in housing, as both sales and activity are still running at very low levels from a historical perspective.

Fed tapering is now likely pushed into next year and our baseline scenario is now the 29 January meeting. Uncertainty is clearly high, though, as the short-term economic outlook is foggy. The Fed likely needs to see the recovery on a stronger footing before it will start to taper. Hence hard data on private consumption, capex and job growth should improve in order for the Fed to move. However, since the September decision was a borderline one we may not need a very big improvement in hard data. The tapering probability distribution in our view: 15% at December meeting, 40% at January meeting, 30% at March meeting and 15% later.

To Read the Entire Report Please Click on the pdf File Below.