Market analysis, October 2013
On the one hand, signs of improving economic activity have offset the greatest growth concerns, while international central banks have promised to maintain their present extremely relaxed monetary policies for the time being. On the other, political risks in both the US and Europe threaten the recovery. In Sweden, the Riksbank continues to issue warnings about rising household debt, but responsibility for rectifying the situation lies elsewhere.
The US Federal Reserve managed, for once, to surprise markets in September by postponing tapering awhile longer, preferring instead to maintain its current large scale monthly bond purchases at USD 85bn. Mainly, it wants evidence the recovery is more firmly established, particularly in the labor market, and is obviously concerned about the possible tightening effects of rising yields in recent months. Officials are probably also worried about the effects of political wrangling over the budget and debt ceiling. Raising the limit on how much money the country can borrow to continue financing its operations is a recurrent theme in Washington, but it is invariably resolved at the last minute. However, this year both sides appear particularly intractable. Moreover, the current budget battle also takes place at an especially sensitive point, with the recovery still fragile and fiscal policy already very restrictive at almost 2% of GDP. Protracted negotiations and a prolonged government shutdown could hurt growth this fall, endangering the economy and jeopardizing our expectation that the Fed will begin to taper bond purchases in December.
In the Euro-zone, a cautious recovery began in Q2 this year, with GDP increasing for the first time since Q3 2011. Further signs of a continued gradual improvement in regional sentiment suggest the upturn is likely to be sustained. Nevertheless, the economy will remain dependent on supportive record low interest rates for some time, with September inflation of 1.1% way below the ECB’s own target and credit volumes continuing to decrease. The central bank has reiterated its promise of record low (or lower) rates for an extended period. Surplus liquidity will steadily decrease as ECB bank loans are repaid, potentially driving short-term market rates higher. In that event, we would expect the ECB to announce yet another policy rate cut and/or conduct an additional very long-term refinancing operation. Meanwhile, Italy’s latest government crisis and threats of new elections, as well as current fragile support for both the Greek and Portuguese coalition governments illustrate the growing political challenges facing the Euro-zone.
In Sweden, GDP was surprisingly weak during H1 2013. However, improving sentiment indicators suggest growth will recover this fall. Labor market developments have been stronger than expected, while households can look forward to tax cuts in next year’s budget, raising hopes of a consumer driven recovery in 2014. In addition, exports should gradually increase, supported by rising global demand. Once again, the Riksbank left rates unchanged in September but still signaled an initial hike in September/October 2014. While signs that house prices and household lending are accelerating have raised concerns that such debt is expanding too rapidly, the FSA is now mainly responsible for such problems. Instead, we expect new measures, including pressure on banks to compel households to increase amortization, to increase opportunities for the Riksbank to focus more on inflation. Consequently, the central bank may defer starting to hike rates until December next year.