The following is an excerpt from a Capital Daily report by London-based research provider Capital Economics.

-    We expect the Fed to begin phasing out monetary stimulus in September

-    UK MPC and ECB rate decisions will probably pass without event (12.00 and 12.45 BST)

-    US economy grew faster than expected in the second quarter

 

Key Market Themes

As this edition of the Capital Daily was published, markets were still awaiting the outcome of the FOMC’s two-day meeting. We do not expect the Committee to have sprung any surprises, such as announcing an imminent scaling back of its asset purchases. However, we continue to think it will start this process at its next meeting in September.

 

Our expectation is that the Fed will tread very cautiously in phasing out its monetary stimulus and we see monthly purchases grinding to a halt only by the middle of next year. We also expect that interest rates will remain very low across all advanced economies, including the US, for an extended period.

 

This underpins our outlook for many asset classes. (See our forthcoming quarterly publication The Capital Markets Analyst.)

 

For example, we expect the gradual removal of policy accommodation by the Fed to put some upward pressure on government bond yields over the next couple of years. We forecast that the 10-year US Treasury yield to end this year close to current levels of around 2.6% and then drift up to 3.5% by the end of 2015. We suspect that the yields of UK Gilts and German Bunds are also likely to rise over our forecast horizon, albeit by less than those of US Treasuries.

 

We also expect the Fed’s stance to boost the dollar. We forecast the US currency to appreciate in particular against the yen (despite its already significant gains) since the Bank of Japan is likely to have to be even bolder in its monetary easing in order to achieve its inflation objective.

 

In terms of equities, we are sceptical that the US stock market can make further substantial gains this year simply because the Fed exercises extreme caution, given how far the market has already rallied. The stage of the profit cycle may also hamper gains. We forecast the S&P 500 to slip back to 1,625 by the end of this year before climbing steadily to 1,750 by the end of 2015. European equities appear more attractively valued but we doubt that they will fare better than US stocks given the relatively poor prospects for economic growth in Europe.

 

Finally, for most commodities, the accommodative stance of monetary conditions in the advanced economies should remain supportive. Even if the Fed halts its asset purchases completely by the middle of 2014, there will still be more stimulus in place then than there is now. This is one reason why there may still be upside for the price of gold. But subdued growth in the advanced economies and a slowdown in China should continue to weigh on the prices of industrial metals. (Jessica Hinds)

 

What to watch for today: US

Conditions appear to be improving in the manufacturing sector, although at a very slow pace. We have pencilled in a further rise in the ISM manufacturing index (15.00 BST) to 52.0 in July from 50.9 in May. The evidence from the regional surveys has been more upbeat. Both the Empire State and Philly Fed indices rose in July. The flash estimate of the national Markit PMI improved as well. The international survey evidence, however, has been more mixed, with activity indices in China weakening but those in the euro-zone strengthening. (Amna Asaf)

 

Real GDP growth accelerated from 1.1% annualised in the first quarter to 1.7% in the second, suggesting that the recovery is gaining momentum. Growth was supported by a 1.8% gain in consumption, down only slightly from a 2.3% gain in the first quarter. Turning to the comprehensive revisions to the historical data, the level of nominal GDP was revised up by 3.4%. That was largely due to the capitalisation of research and development, which is now included as fixed investment. In response to some upward revisions to the average level of GDP in 2012 and slower growth at the start of 2013, we are revising our forecast for GDP growth this year down to 1.5%, from 2.0%. We continue to expect growth of 2.5% in 2014 and 3.0% in 2015. (Paul Ashworth)

 

Continental Europe

With indicators of economic activity improving slightly, the ECB is unlikely to cut interest rates today (12.45 BST). Meanwhile, divisions within the Governing Council might prevent it from clarifying last month’s pledge to keep rates low for “an extended period”. This would leave the Bank lagging further behind others. We still see the ECB cutting rates before long and it might also offer more very long-term loans to banks to complement the recent loosening of its collateral criteria. But it is unlikely to rescue struggling peripheral economies by buying their bonds without very strong conditions attached. (Jennifer McKeown)

 

The latest news on unemployment and inflation in the euro-zone (published on Wednesday) was a little sobering after the recent run of stronger activity data. Unemployment fell by 24,000 in June, the first monthly drop since April 2011. And the unemployment rate was a touch below expectations at 12.1% (median & CE 12.2%). But this reflected a downward revision to previous months’ data and the unemployment rate is still at a record high. Meanwhile, although CPI inflation held steady at 1.6% in July as expected, the slight fall in the core rate from 1.2% to 1.1% highlighted the weakness of underlying price pressures in the region. (Jonathon Loynes)

 

 

Japan

The first drop in the manufacturing PMI (published on Wednesday) since late last year indicates that the recovery may now be entering a slower phase. The index dropped from 52.3 to 50.7 in July, weaker than our prediction of 51.9. Meanwhile labour cash earnings only rose 0.1% y/y in June, and thus did not accelerate as much as we had expected. The key reason was that bonus payments were only up 0.4% y/y. What’s more, wage growth remains insufficient to compensate for rising inflation as regular pay continues to fall. (Marcel Thieliant)

 

China

Today sees the release of China’s two manufacturing PMIs, which will give further clues to the state of the economy at the start of Q3. HSBC and Markit last week reported a further fall in their flash estimate of July’s PMI to 47.7, worse than most had expected. We have no particular reason to expect the final reading of HSBC/Markit PMI (09.45 BST) to be any different. That said, there have been other, more encouraging signs. For example, sales of construction equipment have been picking up recently, while steel prices have stopped falling. These might be signs that investment spending is recovering. If so, the official PMI (09.00 BST), which gives a high weight to large firms in heavy industry, may perform better than the HSBC/Markit measure. (Qinwei Wang)

 

Other Asia-Pacific

A host of Asian countries will release purchasing manager indices (PMIs) at the start of August. The PMIs in recent months have generally been disappointing, and suggest that Asia’s manufacturing sectors have continued to struggle. The June PMIs point to new orders remaining weak, which bodes poorly for the near-term performance of the region’s industrial sectors. As such, we expect the latest batch of PMIs to suggest growth remains quite sluggish. (Krystal Tan)

 

GDP data released on Wednesday (01.30 BST) showed that Taiwan’s economy remained lacklustre in the second quarter. Growth is likely to remain weak in the near term but, with the global economy set to record a slow, but steady recovery over the next couple of years, Taiwan’s prospects should pick up. (Gareth Leather)

 

Key Data and Events

Thu 1st     00.00  Kor  CPI (Jul)

            01.00  Kor  Exports (Jul)

            01.00  Kor  HSBC Manufacturing PMI (Jul)

            01.30  Tha  CPI (Jul)

            02.00  Chn  Official Manufacturing PMI (Jul)

            02.45  Chn  HSBC Manufacturing PMI (Jul)

            03.00  Twn  HSBC Manufacturing PMI (Jul)

            04.00  Idn  HSBC/Markit Manufacturing PMI (Jul)

            09.00  EZ   Manufacturing PMI (Jul Final)

            09.30  UK   CIPS/Markit Report on Manufacturing (Jul)

            12.00  Cze  Interest Rate Announcement (Aug)

            12.00  UK   BoE Interest Rate Announcement

            12.00  UK   BoE QE Announcement

            12.45  EZ   ECB Interest Rate Announcement

            13.30  US   Initial Jobless Claims (27th Jul)

            13.58  US   Markit Manufacturing PMI (Jul Final)

            15.00  US   ISM Manufacturing Index (Jul)

            15.00  US   Construction Spending (Jun)

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