Fed: no other money untill recession. Or a further decline of the equity market...

The minutes of the 20 September monetary policy meeting - in which the Operation Twist was decided - indicated the FOMC members had different views on the best profile for the monetary policy. While 3 members out of 10 opposed the decision to implement the Operation Twist, two members preferred a stronger policy action, increasing speculation that the Fed may decide a QE3 in one of the next monetary policy meeting (the next one is on November 1-2).

Conclusion: in our view the minutes of the Fed did not give any indication of a further easing of monetary policy at the tail end of the year. The Fomc may decide to implement a QE3 program only in the case the economic outlook would deteriorate strongly and the possibilities of recession further increase. However, the better than expected data released since early October (ISM manufacturing – ISM non-manufacturing – employment report) indicated that the economic outlook in the short term may be better than expected (many economist revised upward their Q3’s GDP estimates after these data were released). For these reasons we do not see a QE3 plan in the short term.

UK unemployment rate and Euro zone industrial production

The UK unemployment rate rose to the highest in 17 years in August (from 7.9% to 8.1%) with the number of unemployed increased to 2.57 million, the most since 1994. In the Euro zone the industrial production rose by 1.2% m/m (after +1.1% m/m in July) and 5.3% y/y in August. The data benefited from the the increase of industrial production in Italy (4.3% m/m) and France (+0.6% m/m) that offset the decline in Germany (-1% m/m).                         

Conclusion: the increase of the unemployment rate is a clear sign of the weakenig of the UK economy and strenghtned the view of the BoE that the UK economy needed an easing of monetary policy as soon as in October despite the high level of inflation. Following the aneamic rate of growth in Q2 (0.1% q/q), the UK economy may fall short of economists expectations also in Q3 (the NIESR today predicted a 0.5% q/q growth in Q3).

The Euro zone industrial production data indicated that the Euro zone outlook in the short term may be better than expected. However, with the main business confidence indices in a downward trend, we expect the rebound over the summer to be temporary and the financial crisis over the summer to weigh on the data starting from September.

Q3's earning season starts in the USA

With the release of Alcoa’s (AA) Q3 results on Tuesday 11, the Q3’s earning session will have its traditional kick off:. After being caught by economic news and the debt crisis in the eurozone, the investors’ attention is likely to return in the next few weeks on corporate profits. continue on seekingalpha

The week ahead: focus on the Euro zone

On Sunday Chancellor Merkel and President Sarkozy said they will announce a comprehensive package of measures to stabilise the euro zone, including the recapitalisation of European banks if they need it, ahead of the November 3/4 G20 meeting. They did not provide any detail on the plan and promised to give them by the end of October. The main issues coming from the press conference are: 1) not giving any detail on the plan, Merkel and Sarkozy did not eliminate concerns that that the two governments had yet managed to resolve their differences on which entity will in charge to recapitalize the banks; 2) getting the other 15 member states to agree can prove challenging. The next key date is the 23 October EU Council when further elements to address the situation in Greece, the bank recapitalisation and the enhanced efficiency of stabilisation tools (EFSF) will be discussed.

The Slovakian Parliament will vote on Tuesday 11th on the approval of the EFSF. The latest headlines over the weekend suggest the governing coalition has still not found a compromise and will meet on Monday again. With Slovakia being the last country to vote for the approval of the EFSF, the plan is very likely to have a positive vote.

On Tuesday 11 the Italian Government will sell EUR7bn of 1 year BOT and EUR2.5bn of 3 months BOT. On Thursday 13 the Italian Government will 5/7/10/14 year BTP. In the latest long term government bond auction on September 29, Italy solo bonds due in 2022 to yield 5.86%, up from the 5.22% it paid Aug. With long term yields declined in early October, yields in the Thursday’s auction are likely to be lower than in September. The main issue is the level of the demand after Italy raised less than targeted in September: we do not expect a strong improvement in the demand as concerns on the Italian economic outlook remain elevated due to high public debt.

The Euro zone industrial production may decline by 0.7% m/m (after +1% m/m) in August after German industrial production declined by 1% m/m. The data would increase the possibilities that the Euro zone economy may fall in recession as soon as in Q4.

In the USA the focus over the week will be on the consumer spending outlook. Retail sales are likely to rebound by 0.4 m/m (0.0% m/m in August) and by 0.2 % m/m (+0.1% m/m in August) in September. The data would be in line with a 0.4% q/q increase of real consumer spending in Q3 ’11. The University of Michigan consumer confidence index may increase from 59.4 in September to 60 in October, remaining well below long-term average (90) and indicating a poor outlook for the consumer spending in Q4 ’11.

The minutes of the Fed 20 September monetary policy meeting are not likely to give any indication of a further easing of monetary policy in the next meetings.

PMI services below 50 in the Euro zone: risk of recession increasing

The PMI services indices released today all around the Euro zone came in worse than expected in September, signalling that the worsening of the economic outlook may be even stronger than projected. The Euro zone PMI fell from 51.5 to 48.8 - with a downward revision from the flash estimate of 49.1 - the lowest level since August '09. The index set below 50 - anticipating a contraction for the sector - both in Italy and in Germany while remained above 50 in France. The decline of the index below 50 in Germany is a sign that consumer spending may further weaken going forward, dampening the expectations that an improvement of German internal demand may sustain the economic activity and limiting the negative consequences on exports of the peripheral countries crisis. The Euro zone PMI services increased the chances that the Euro zone economy may fall into recession in Q4 '11.

USA: CPI higher than expected in August, Industrial production rose unexpectedly

Negative data came out today in the USA, with the expection of industrial production: 

1) Initial jobless claims rose in the week to September 10th from 417k (revised from) to 428k versus markets expectations at 411k. the 4 week moving average rose by 4k to 419.5k. The data signalled that labour market is likely to remain very week in September after the non-farm payrolls was unchanged in August;

2) The CPI rose more than expected in August: +0.4% m/m versus expectations at +0.2% m/m and the year-over-year change at 3.8% y/y vs +3.6% y/y in July. Moreover the CPI core rose by 0.2% m/m and +2% y/y (+1.8% y/y) in July - the highest since November 2008;

3) The Empire manufacturing index fell from -7.8 to -8.8, indicating a deteriorating of the manufacturing sector perspectives at year-end;          

4) industrial production rose by 0.2% m/m in August versus market expectations at 0.1% m/m. The most positive news is that manufacturing production climbed by 0.5% m/m, led by 2.6% m/m increase in auto production. 

Today's data increase the uncertainty on what the Fed would decide at the end of the next week monetary policy meeting. Indeed while the data on economic activity signalled a weakening of the economic outlook, inflationary pressures remains to high to see a strong easing of monetary policy, as we indicated yesterday in the article "Can The CPI Influence Monetary Policy Decisions?". While the possibility of an easing of monetary policy over the next week are at 50-50, we think that the impact on economic activity will be very low as long term interest are already at historically low level.

Can The CPI Influence Monetary Policy Decisions?

The major central banks are widely expected to further ease monetary policy in the next few months amid the weakening of global economic growth: The Fed may implement a QE3 program, continue on seekingalpha...