Twelve Thoughts about the Week Ahead

1.  The Federal Reserve upgraded its assessment of the labor market in its statement at the end of last month.  It noted that the "under-utilization of labor resources was gradually diminishing".   There was nothing in the October jobs report that will challenge that assessment.  The Fed's new labor market conditions index will be released at the start of the week and the JOLTS report on Thursday. 

We expect the continued gradual improvement in the labor market will allow the Federal Reserve to hike rates around toward the middle of next year.  Yellen and Fischer have recently been emphasizing the Fed's desire to minimize the impact of changes in its monetary stance.  It will do so by being as transparent and forthright as possible.  It appears that process by which it announced and then implemented the exit from its asset purchase program serves as the model for the communication of its first hike.  Before the weekend, NY Fed President Dudley reaffirmed that barring a significant economic surprise, the Fed funds rate will likely increase next year.

2.  The continued improvement in the labor market should not be confused with a strengthening of the US economy.  Specifically, the recent construction spending and trade figures warn of a notable downward revision in Q3 US to possibly below 3%, and the data for Q4 appears to be tracking something closer to 2.5%.    This is probably closer to trend growth than the 3% handle that infatuates many. 

That said, the employment growth coupled with the decline in gasoline prices will likely boost discretionary spending.  As the recent consumer credit report confirms, household consumption is not relying on credit cards (revolving credit).  October retail sales, the main US economic report of the week, is likely to show a recovery after the unexpected weakness in September, especially in the measure that excludes, autos, gasoline and building materials.  University of Michigan consumer confidence is likely to have been lifted by the recovery in stock prices, the falling gasoline prices, and the gradually improving labor market. 

3.  Contrary to a widely cited Reuters report, the ECB came together and endorsed the expansion of its balance sheet toward the peak near three trillion euros.  It also unanimously endorsed adopting additional measures that will likely be needed given the downside risks, and instructed the staff to expedite their exploration of the options, within its charter, to expand its balance sheet.  These downside risks will be underscored by the ECB's Survey of Professional Forecasters, and will likely hint at what to expect from the next month's updated forecasts by the ECB's staff.

4.  The euro area zone reports Q3 GDP figures in the days ahead.  The area as a whole likely experienced meager growth of 0.1%.   Germany and France probably did not grow much faster, though a statistical fluke might have the latter grow a touch faster than the former.  Spain and Ireland have become the widely cited examples of success stories from the austerity/reform agenda.  Spain's economy may have grown by 0.4%-0.5%.  Italy, on the other hand, despite the reformist Renzi promising significant progress in his first hundred thousand days, has not really found a growth path and is expected to have contracted by another 0.3% in Q3.  An acceleration in euro zone October industrial output will fan hopes of somewhat stronger Q4 GDP. 

5.   The UK's labor market is also improving, and the unemployment rate (3-months annualized) is expected to dip below 6% when the latest report is published on November 12.    Similar to what we observed in the US, improvement in the UK labor market does not mean that growth is accelerating.  In fact, the UK economy has steadily lost momentum since the middle of the year.  The October composite PMI, reported last week, fell to 55.8, its lowest since May 2013. 

The downward pressure on wages may ease but will hardly be suggesting imminent wage-push inflation.  Arguably, the weak nominal wage growth and falling real wages are sapping aggregate demand.  BRC retail sales, due Monday, are expected to have declined again (~0.5%) in October.  They have fallen in three of the four months through September. 

6.  The same day as the UK's October employment data is released, the Bank of England issues its Quarterly Inflation Report (QIR).  Given the lack of an MPC statement at the end conclusion of its monthly meetings, as Federal Reserve does, or a press conference like the BOJ and ECB, the BOE's quarterly inflation report takes on added importance in the period in which officials rely on forward guidance.  The QIR is expected to be dovish, revising down the expected growth path,  and support the swing in market expectations of the first hike into late 2015. 

7.  Japan's current account position is always better in September than August.  This year is not likely to break the historical pattern.  While the decline in the yen is not boosting the volume of Japanese exports, it can be expected to boost the investment income (dividend and coupon payments) earned overseas.  The decline in the price of oil is also likely to be beneficial to Japan.  Since mid-June the price of Brent has fallen by about 30% while the yen has declined 11%. 

8. China's Xi will meet Japan's Abe at the APEC meeting.  This is the first time the two men will meet as leaders of their respective countries.    They have not met due to China's displeasure with Japanese policies in the South China Sea, where it nationalized disputed islands, and Abe's insistence on visiting a war shrine in Japan that antagonizes not only China but South Korea.  Abe seemed to be pushing harder for the meeting than Xi, and it is not clear what concessions were made.  Japan did indicate that it would relax the screening of Chinese tourists' visas.  Last year, Abe visited the Yasukuni Shrine last December.  Visiting it again this year would prevent building on the APEC meeting. 

9.  Xi will use the APEC meeting to showcase China's regional leadership while Obama will have to work hard to convince that he is not a lame duck.  Obama's Asia pivot looks hollow if his Trans-Pacific Partnership falters as it looks likely.   China will press for its alternative--Free Trade Area of Asia-Pacific.   Abe has agreed to explore joining it.  Xi also intends to reach Memorandum of Understanding to launch an Asian Infrastructure Bank (a regional "World Bank"). 

10.  China had shifted from an export-led economy to one driven by investment.  However, that investment was financed by debt, and that cycle is over.  China appears to be relying again on exports to underpin growth.  The October trade figures were released over the weekend.  China reported an October trade surplus of $45.4 bln, a 50% increase from September's $30.9 bln surplus.  Over the past 12-months, China has recorded a $316 bln surplus, a record.  Exports rose 11.6% from a year ago (Bloomberg consensus 10.6%).  Imports rose 4.6% (consensus 5%).   China releases other data in the week ahead, including inflation, industrial output, retail sales, and bank and total lending figures.  While lending is expected to have slowed, the other readings are expected to be little changed from September readings. 

Exports to Hong Kong rose 24% in October.  The gap between China's reported exports and Hong Kong's reported imports (in September the gap was the widest of the year) has fanned concern of a resumption in fictitious trade invoices to conceal capital flows.  After rising more than 10% in September, China's precious metal exports to Hong Kong rose just less than 5% in October.  This is still three times the pace of October 2013 pace.   

11.  China is not expected to object to Japan's aggressive monetary policy stance, which some say is a shot in the currency wars.  However, Korean officials are a different matter.  The won is at six-year highs against the Japanese yen, and finance officials are concerned about the impact on Korean industry, especially, autos, steel and electronics.  Against the dollar, the won has fallen for seven consecutive sessions to reach a 14-month low.  It is the second weakest currency in Asia, losing 4% of its value this year (vs. -8.1% decline in the yen).  Do not expect much official sympathy for Korea, where the OECD estimates the won is nearly 27% under-valued. 

Moreover, if Japanese exports are not increasing much in volume terms, how much can the weakening of the yen really hurt South Korea.  In the first ten months of 2014, South Korea recorded a trade surplus of $36.7 bln.  In the same period in 2013, its trade surplus was $35.6 bln, and in the same 2012 period, its trade surplus was $22.1 bln.  Exports in October 2014 were 2.5% higher year-over-year.  Imports were 3% lower.    The South Korean central bank meets on November 12.  A Bloomberg survey found nine of 10 economists expected it to keep its seven-day repo rate unchanged at 2.0%.  With CPI at 1.2%, the multi-year strength of the won against the yen, and pressure from the pressure from the US over its chronic intervention, the risk of a    rate cut seems larger than many investors may suspect.  

12.  The confrontation over Ukraine is heating up again.  Following, provocative elections in the east, Russia has sent reinforcements in the form of weapons, ammunition and personnel, according to the Organization of Security and Co-operation in Europe.   Since 2008, Russia has occupied a couple of regions in Georgia and continues to intimidate a number of small (and large) countries on its borders.  Investors should be prepared for an intensification of the conflict in the coming weeks, which will likely entail new sanctions. 

The combination of the sanctions and the drop in oil prices is delivering a significant blow to the Russian economy.  In late October, the central bank surprised many with a 150 bp rate hike to try to stem the capital outflows.  Last week, the central bank changed foreign exchange regime by reducing its intervention to one $350 mln a day operation, of course, it can still intervene whenever it wants.  This ad hoc intervention rather than it former rule-based operations is closer to a dirty float.  Previously it had predictably intervened with $350 mln every five-kopeck move below the approved floor.   Russian reserves have fallen by about $83 bln this year, though part of this decline likely reflects valuation adjustments, given the euro’s 9.4% against the dollar this year.