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

-    Variations in monetary policy may not result in significant divergence

-    US non-farm payrolls probably rose by around 200,000 in July (13.30 BST)

-    China’s two manufacturing activity surveys less downbeat on employment

Key Market Themes

The US Fed, the Bank of England and the ECB sprang no great surprises this week and the outcomes of their meetings have had a limited impact on the markets. We still forecast the Fed to start scaling back its bond purchases in September, whereas we think the UK MPC and ECB will probably loosen policy further in time (see below). Against this backdrop, it is tempting to conclude that US Treasuries will continue to fare much worse than government bonds in Europe. But we doubt any additional underperformance will be really substantial.

Admittedly, the difference between the yields of 10-year US and German government bonds has already increased quite a lot in recent months, to around 100bp from roughly 40bp in early May. And the gap between the yields of 10-year US and UK government bonds has also grown, albeit by less. But history suggests that where the Fed leads, the markets often expect central banks to follow eventually, even when the near-term outlook for monetary policy differs.

For example, the 10-year German Bund yield rose sharply during the 1994 US Treasury sell-off that was sparked by Fed tightening, despite the fact that the Bundesbank continued to cut rates.

The upshot is that we do not expect Bunds or Gilts to be immune to the gradual upward pressure on Treasury yields that is likely to stem from a slow shift towards less accommodative US monetary policy. Although we expect Bunds and Gilts to outperform Treasuries – and even think the yield of 10-year Gilts may drop back a fair way in the second half of 2013 – we anticipate that their yields will rise quite substantially over the next two and half years as a whole.

With this in mind, we forecast 10-year Gilt and Bund yields to end 2015 at 3% and 2.25%, respectively. This equates to rises of around 60bp from current levels – less than our forecast of an increase of around 80bp in the 10-year Treasury yield over the same period, to 3.5%. (For more on the outlook for developed government bonds and other asset classes, see the latest quarterly edition of The Capital Markets Analyst, published on Thursday.) (Jessica Hinds)

What to watch for today: US

Our econometric model suggests that the pick-up in jobs growth in recent months was maintained in July. A rise in payroll employment (13.30 BST) of around 200,000 last month would be the fourth such gain in a row and would be consistent with the increase in the ADP employment survey in July. Payrolls may have been supported by automakers shutting down fewer plants than normal to prepare assembly lines for producing next year’s models. As the seasonal adjustment process “expects” auto employment to fall by more, this should generate a rise in payrolls after seasonal adjustment. More generally, other data suggest that jobs growth has neither improved markedly nor deteriorated drastically. If the size of the labour force rose by 150,000 last month, a 200,000 gain in employment would reduce the unemployment rate from 7.6% to 7.5%.

July’s personal spending and income figures (13.30 BST) will incorporate the recent GDP revisions and may therefore be different from the 0.5% m/m increases for each that we have been expecting. In general, we expect the spending figures to show that consumption lost less momentum in the second quarter than we previously thought. Meanwhile, income is likely to continue the recent string of decent gains, suggesting households are well placed to boost their spending more significantly in the third quarter. (Paul Dales)

The surge in the ISM manufacturing index (published on Thursday) to a two-year high of 55.4 in July, from 50.9, suggests that manufacturers continued to benefit from an improvement in domestic activity. This increase beat the consensus and our own forecast of a rise to 52.0. The improvement was broad based, with the production index surging to a nine-year high of 65.0, from 53.4, and the new orders index rising to 58.3, from 51.9. If it wasn’t for the small drop in the inventories index, the headline index would have risen further. The new export orders index also dropped back to 53.5 from 54.5. The headline index is now consistent with a further acceleration in annualised GDP growth to more than 2.5% in the third quarter. (Amna Asaf)

Continental Europe

The ECB warned on Thursday that market expectations of rate hikes next year currently seem unjustified. But otherwise, the Bank did nothing to clarify its commitment to an extended period of low rates and gave no indication that a rate cut was imminent.

President Draghi left the door open to future cuts in interest rates by stating again that rates would be kept at their “current levels or lower for an extended period” and that interest rates had not reached the “zero bound”. But the fact that the Governing Council apparently did not even discuss cutting interest rates today suggests that our previous forecast for a September rate cut is unlikely to be met. We now anticipate a reduction (in both the main refinancing and deposit rates) some time in Q4 as activity proves weaker than the Bank now expects and money and credit growth remain very weak.

Mr Draghi gave a bit more guidance about the future path of interest rates when he stated that current market expectations for rates to be raised towards the end of 2014 were “unwarranted”. But by stating that expectations were incorrect given the current outlook, he confirmed that, if the outlook changes, so might the ECB’s view on the right outlook for interest rates. He stopped short of providing more specific forward guidance, perhaps involving longer timeframes or making hikes conditional on specific economic thresholds (like a given unemployment rate).

In another attempt to improve transparency, President Draghi said that the Bank’s six-member Executive Board would present the Governing Council with a proposal to publish minutes of its monthly policy meetings this autumn. But while this seems like a sensible idea, we doubt that it will add very much colour to the current system of reading a press statement and immediately taking questions in an open press conference. (Jennifer McKeown)

Japan

No major data or events scheduled for today.

China

China’s two manufacturing PMIs diverged in July. The HSBC/Markit PMI dropped from June’s 48.2 to 47.7 last month, the same as the flash estimate. Most of the non-price components on this index worsened. By contrast, the official PMI rose from 50.1 to 50.3, even though not a single analyst surveyed by Bloomberg expected an increase. The breakdown points to a small but broad-based improvement in underlying conditions. Nonetheless, this rise did not come completely out of the blue. The official index gives a large weight to heavy industry where there has been evidence of a turnaround recently, including acceleration in sales of construction equipment and electricity consumption by heavy industry as well as a rebound of steel prices. Finally, the news from both surveys on employment, arguably the most important factor determining the policy stance, was less downbeat. (See our China Data Response published on Thursday for more.) (Qinwei Wang)

Other Asia-Pacific

Over the past couple of years, Indonesia’s economy has proved remarkably resilient despite the slowdown in export demand. However, data for exports and retail sales have softened in recent weeks. So although we expect GDP growth in the second quarter (03.00 BST) to have remained strong, the pace of expansion probably cooled slightly to 5.9% y/y. (Gareth Leather)

The July PMIs released on Thursday for Emerging Asia pointed to weakening conditions in the region’s manufacturing sectors. Both output and new orders were especially disappointing. We maintain our view that fragile global demand will cause Asia’s manufacturers to struggle at least until the end of the year. (Krystal Tan)

Key Data and Events

Mon 1st     00.50  Jpn  Monetary Base (End of Period, Jul)

            03.00  Idn  GDP (Q2)                              

            09.30  UK   CIPS/Markit Report on Construction (Jul)

            10.00  EZ   PPI (Jun)

            13.30  US   Change in Non-Farm Payrolls (Jul)

            13.30  US   Unemployment Rate (Jul)

            13.30  US   Average Hourly Earnings (Jul)

            13.30  US   Average Weekly Hours Worked (Jul)

            13.30  US   Personal Income (Jun)

            13.30  US   Personal Spending (Jun)

            13.30  US   PCE Deflator (Jun)

            15.00  US   Factory Orders (Jun)