Geo-politics is never far away; while the tensions have failed to really shake confidence for any great length of time, developments will be watched closely. This means shying away from Russian assets, despite a view that markets here offer good value. The US accusing Russia of planning to arm the separatist movement could keep risk assets contained, notably ahead of the weekend, plus the prospect of markets gapping lower if we do see events take a strong turn for the worse.
Earnings holding markets up
Earnings are coming in thick and fast from a number of geographies, with BSkyB, Anglo American and Danone due in European trade tonight. In the US 43% of S&P 500 companies have reported, recording 11.3% aggregate EPS growth and 5.2% revenue growth. Only financials (as expected) have seen a contraction in the top-line, and with those sorts of statistics the bulls will argue that a break of 2000 is deserved.
Still, next week looms large, and while corporate earnings have been the flavour this week, next week the US economy takes centre stage. The raft of macroeconomic announcements stemming from this one region could see a sharp pick-up in asset correlations, so regardless of what market or asset class you focus on there will be a central focus to which all assets will look to.
US Q2 GDP will be first on the docket on Wednesday, with economists expecting a sharp snapback in growth to +2.9% (from -2.9%). This could actually be the lesser of the tier-one releases in terms of market impact, although there’s no doubt that the weakness in the first quarter has suppressed bond yields and will be a reason why the Fed will have to cut its real GDP projections for 2014 from 2.1% to 2.3%, to something more in line with International Monetary Fund (IMF) forecasts of 1.7%.
On the same day, just five and half hours later we get the FOMC meeting, with the central bank taking its bond buying program down to a purchase rate of $25 billion a month. Little is expected from the narrative given Janet Yellen has been so active in communications of late. Still, traders will be keen to look at further detail around the Fed’s exit strategies and lifting short-term rates.
On Thursday we get the Q2 employee cost index (ECI), which, as raised in recent reports, is a key input into the Fed’s view on the quality of inflation. With the Fed seeing headline inflation as ‘noise’, wage growth is essential if it is to lose this stance; with the market expecting 0.5% growth in Q2, this is actually in-line with the highest levels since Q4 2011.
US average earnings in play
On Friday the headlines will be around the level of jobs created in the US non-farm payrolls report, with the consensus at 225,000 jobs (range 279,000 to 170,000). With the weekly jobless claims falling to the lowest level since February 2006, one feels a number between 200,000 and 230,000 seems very achievable. For me though, the most important thing to watch is the average hourly earnings, which at 2.2% would be a 20 basis point increase from the prior month. The Fed would like to see earnings move into a range of 3% to 4% before it is convinced that wage growth can cope with a rise in the Fed funds rate, but a number above 2.2% could get the USD bulls fairly excited.
The unemployment rate is expected to stay at 6.1%, which is within the Fed’s full-year forecast of 6% to 6.1%. In June 2013 the Fed was forecasting an unemployment rate of 7.3% and we actually saw unemployment at 6.7% by year, a 60 basis point (or 0.6%) miss. Could this year be similar? I am sceptical that we will see that degree of a miss, but there is certainly a chance it overshoots by around 20 basis points. It’s also worth looking at the U6 unemployment rate, which is the broadest measure of employment. At 12.1% this is still far too high and it’s from here the Fed sees slack in the labor market. A number below 12% would be positive for the USD, negative for bonds.
We also get the June core personal consumption expenditures (PCE), which at 1.5% is also already at the Fed’s year-end projections. The market expects an unchanged read at 1.5%, although the risks are we see a slight miss to 1.4%. A number above however really raises the possibility we see the Fed alter its summary of economic projections on at least three of its year-end forecasts, only a few months since it altered them in June.
Still, we go into the weekend with a number of major factors hanging over the market’s head in what could be a very revealing week for traders of all asset classes.