We identify six key issues for investors in the holiday-shortened week ahead.
1. The recent string of US economic data showed not only an upward revision in Q3 GDP to 5%, but also strong consumption data, rising confidence and continued improvement in the labor market (weekly initial jobless claims). This has reinforced market expectations for the Fed's take-off next year. Both the December 2015 Fed funds and Eurodollar futures contracts imply the highest rates in two months. At the same time, it is important to recognize that after growing above trend in Q2 and Q3, the US economy should be expected to return to toward trend, even though holiday sales appear strong. This anchor of the divergence theme remains solid.
2. The divergence theme is not just based on favorable developments in the US, but more accommodative polices in Europe and Japan. Expectations that the ECB will expand the assets it is purchasing to include sovereign bonds are widespread, and have helped push many European bond yields to record lows (10-year benchmarks). The money supply and lending report is arguably more important than the final manufacturing PMI (January 2, flash 50.6). It is slowly improving, and this is important for the second phase of the TLTRO program which is linked to new non-mortgage lending.
3. Complimenting the unorthodox Bank of Japan monetary policy, the Abe cabinet approved a JPY3.5 trillion supplemental budget over the weekend. It estimates this spending will boost GDP by 0.7 percentage points. It has been under preparation for a couple of months, but follows on the heels of disappointing and unexpected declines in industrial production and retail sales. Despite the BOJ expanding its balance sheet by 1.4% of GDP a month and the decline in the yen, inflation pressures continue to subside. The supplemental budget will be financed by tax revenue anticipated by the stronger growth and unspent funds. About half of it will be used to public works. Of the remaining half, a third will be used to revitalize regional economies and two-thirds on programs to help households (e.g. shopping vouchers and subsidized heating fuel for low income households) and small businesses (low interest rate loans for businesses hurt by rising input costs, i.e., weak yen).
