-     Which assets will prove resilient to Fed tapering?

-     Recovery in the UK manufacturing sector may have lost some momentum (09.30 GMT)

-     US manufacturing ISM probably dropped back slightly (14.00 GMT)

Key Market Themes

The Fed now looks as if it will start to scale back its asset purchases next spring, although the tone of the FOMC’s late-October statement released on Wednesday (see below) suggested that the process might even begin earlier. However, the bigger picture is that the US central bank is still set to become less accommodative over the next couple of years. We therefore expect government bond yields to drift higher, with the 10-year US Treasury yield rising to 3.5% by the end of 2015, from 2.5% currently.

This is likely to drag up the 10-year yields of Bunds and Gilts. But we continue to believe that they have the scope to outperform US Treasuries in the coming years (see Chart 1), as monetary policy remains looser for longer in Europe than in the US. The relative outlook for monetary policy should also boost the dollar.

Meanwhile, investors’ appetite for “risky” assets is likely to wane once the Fed begins to take away the punchbowl. In general, though, we do not expect the prices of risky assets to fall sharply given that monetary policy elsewhere is likely to remain highly accommodative. Moreover, the Fed itself is likely to tread very cautiously and not raise its funds rate until 2015. (For more on the outlook for different asset classes, see the latest quarterly edition of The Capital Markets Analyst, published on Thursday.) (Jessica Hinds)

What to watch for today: North America

October’s ISM manufacturing survey (14.00 GMT) will provide the first widely-watched insight into how the national economy coped with the three-week Federal government shutdown. We anticipate only a small drop back in the index to 54.0, although the early regional manufacturing surveys have varied significantly, so a surprise in either direction is possible. The Empire State manufacturing index slumped back to only 1.5 in October, from 6.3, although some of the key orders and employment indices strengthened. In contrast, the Philly Fed index fell only slightly to a still very strong 19.8, from 22.3. Then again, the Markit national manufacturing PMI slipped to 51.1 in October, from 52.8. The global evidence was also mixed, with the euro-zone PMI falling while the China PMI strengthened. (Amna Asaf)

Meanwhile, the policy statement from the Fed on Wednesday was remarkable for what it omitted rather than what it included. There was no explicit mention of the government shutdown or what impact it might have on the economy or the Fed’s monetary policy. It is possible that Fed officials want to downplay the recent three-week closure and the potential for another shutdown early next year because they still intend to begin tapering the asset purchases at the FOMC meeting in December. The other big omission in the statement was the dropping of the language used in mid-September that “the tightening of financial conditions...could slow the pace of improvement in the economy”. Obviously, Fed officials have been comforted by the drop back in long-term interest rates. If officials are trying to downplay the impact of the shutdown and are happier with the level of long-term interest rates, then perhaps a December taper is not quite as out of the question as we had previously thought. (Paul Ashworth)

In Canada, the stronger-than-expected 0.3% m/m increase in August GDP suggests that the economy grew by close to 2.5% annualised in the third quarter, stronger than our previous estimate of 2.0%. (Data published on Thursday.) But since much of this growth reflects a surge in energy output following earlier shutdowns, it is unlikely to convince the Bank of Canada that the recovery is on a firmer footing than it had previously assumed. (David Madani)

Continental Europe

No major data or events scheduled for today.

The latest euro-zone unemployment figures published on Thursday put a significant dent in hopes that the labour market may have reached a turning point. Unemployment rose by 60,000 in September and the 38,000 fall recorded in the preceding three months was revised to a 159,000 gain. As a result of this, the unemployment rate stood at a record high of 12.2% in September, unchanged from August’s upwardly-revised figure. (Ben May)

UK

October’s CIPS manufacturing survey (09.30 GMT) may show that the sector’s recovery has lost some momentum in response to sterling’s recent appreciation and the disruption caused by the US debt-ceiling crisis. That said, the orders-to-inventories ratio of the CIPS survey in September – which is a good bellwether of the output balance – indicated that the latter would hold steady, rather than weaken in October. Accordingly, we have pencilled in only a small fall in the PMI from 56.7 to a still-strong 55.5. (Samuel Tombs)

The slight fall in the composite GfK/NOP measure of consumer confidence (published on Thursday) from -10 in September to -11 in October ended a run of five consecutive months of rising confidence. But the measure remains high and should continue to buttress growth in household spending, in spite of the headwinds presented by falling real pay and the high level of household debt. Indeed, on the basis of past form, the GfK/NOP measure is still at a level consistent with annual growth of the official measure of retail sales volumes of about 2%. (Jack Allen)

Japan

At its late-October meeting on Thursday, the Bank of Japan left its policy settings unchanged and only marginally tweaked its economic forecasts. The largest revision was to GDP growth in the coming fiscal year, which was nudged up from 1.3% to 1.5%, reflecting the government’s recently-announced fiscal stimulus measures. Partly as a result of these measures, the BoJ took a sanguine view regarding the impact of the upcoming consumption tax hike. This suggests that near-term policy easing is unlikely. However, we still think that there is more work to do, as the 2% inflation target is unlikely to be reached over the coming two years.

Meanwhile, Japan’s manufacturing PMI data released on Thursday showed that manufacturing conditions have improved and they pointed to a further rebound in industrial production in the coming months. The headline number increased from 52.5 to 54.2, a three-year high. Data on labour cash earnings showed a growth of 0.1% y/y in September. This was largely driven by a strong rebound in (volatile) bonus payments, even though they only accounted for a small share of total earnings in each of the past two months. But regular earnings continued to fall. What’s more, due to the surge in inflation in past months, real earnings are falling sharply. (Marcel Thieliant)

China

Friday’s two manufacturing PMIs for October will be carefully scrutinised for signs as to whether Q3’s economic rebound may have continued into this quarter. The HSBC/Markit flash PMI released last week picked up to a seven-month high, beating the consensus. We have no particular reason to expect the final estimate (01.45 GMT) to be much different. That said, we are less confident this time given the large gap between the flash and final readings in September. Furthermore, the bulk of activity and spending data over the last few weeks, including our latest China Activity Proxy, suggests that the momentum had already started to fade at the end of last quarter. This was mainly because state sector activity, which was the major driver of the rebound, had been cooling. The impact of this should be more apparent in the official PMI (01.00 GMT), which is skewed towards large state-owned firms. We expect the official PMI to have stopped rising in October. (Qinwei Wang)

Other Asia-Pacific

A number of Asian countries will release October purchasing manager indices (PMIs) on Friday. The September PMIs pointed to improving manufacturing conditions, with headline numbers rising from the month before in every country except Singapore, where the reading was unchanged. Encouragingly, there was a broad-based rise in the new orders component, suggesting a more promising outlook for the months ahead. As such, we expect the latest batch of PMIs to show further improvement. While we think the worst is probably over for most of Asia’s manufacturers, conditions remain fairly weak and we expect the recovery to be a gradual one. (Krystal Tan)

GDP data for Taiwan released on Thursday showed growth slowed to 1.6% y/y in the third quarter, down from the 2.5% expansion recorded in Q2. A breakdown of the data showed a slowdown in export and private consumption growth. The only improvement came from investment, which recorded positive growth after shrinking by 2.8% in Q2. In seasonally-adjusted q/q terms, GDP grew by just 0.1%, compared with a 0.6% expansion in the second quarter. Looking ahead, we expect things to get better slowly, on the back of continued loose monetary policy and a steady improvement in global demand. (Gareth Leather) 

Key Data and Events

Thu 31st      23.00    Kor    CPI (Oct)

Fri 1st             -        Tha    CPI (Oct)

                   00.00    Kor    Exports (Oct)

                   00.00    Kor    Imports (Oct)

                   00.00    Kor    HSBC Manufacturing PMI (Oct)

                   01.00    Chn   ‘Official Manufacturing PMI’ (Oct)

                   01.45    Chn   HSBC Manufacturing PMI (Oct, Final)

                   02.00    Twn   HSBC Manufacturing PMI (Oct)         

                   03.00    Idn     HSBC Manufacturing PMI (Oct)

                   04.00    Idn     CPI (Oct)

                   05.00    Ind     HSBC Manufacturing PMI (Oct)

                   05.00    Jpn    Vehicle Sales (Oct)

                   09.30    UK     CIPS/Markit Report on Manufacturing (Oct)

                   11.00    Brz    Industrial Production (Sep)

                   12.58    US     Markit Manufacturing PMI (Oct, Final)

                   14.00    US     ISM Manufacturing Index (Oct)