Equity Research: Market Commentary 12.18.13

Equity Research: Market Commentary 12.18.13

Tuesday: With market participants viewing the Fed’s tapering decision as “a coin flip,” share prices generally declined. Bond yields were a bit lower. The dollar was mixed.

Could it be? After all these months, have the financial markets finally figured out that tapering isn’t tightening, that the Fed will have to scale back and eventually conclude its asset purchase program? Or perhaps the markets have a case of taper fatigue.

Amid decreasing headwinds, economic growth is widely expected to pick up over the course of 2014. Long-term interest rates should trend gradually higher, although we may see a fair amount of volatility around that trend.

The Consumer Price Index was little changed in November, held down partly by lower energy prices and a mild increase in food prices. Core inflation was a little higher than expected (+0.155% before rounding, not a big miss). Gasoline prices fell 1.6% (-3.3% before seasonal adjustment, -5.8% y/y). Food at home was flat (+0.6% y/y), while food away from home rose 0.3% (+2.1% y/y). Medical care commodities and services were both flat (+0.8% y/y and +2.6% y/y, respectively). Airline fares rose 2.6%, following a 3.6% rise in November (+4.2% y/y).

Real weekly earnings rose moderately in November, partly reflecting a rebound in hours following the government shutdown in October. Still, lower gasoline prices have helped.

The current account deficit, the widest measure of foreign trade, fell unexpectedly in the third quarter, while the second quarter figure was revised down. The current account hit a whopping 6.2% of GDP in 3Q06. Increased energy production has led to a steady down trend in oil imports in recent years, which should continue to keep the current account gap at reasonably low levels for the foreseeable future. That implies less downward pressure on the dollar.

Homebuilder sentiment snapped back in December, largely reflecting better current sales perceptions. Some of the strength may be pent-up demand related to the government shutdown, but the pickup suggests that the rise in mortgage rates hasn’t thwarted the housing recovery completely.

Today: Will they or won’t they? If not now, then the Fed will begin to wind down its asset purchase program soon in 2014.

Back in September, many Fed officials felt that the decision to taper was “a close call.” In hindsight, it was the right decision. The partial government shutdown clearly had a negative impact on the economy. However, the economy looks to be in much better shape now. Last week’s budget deal leaves a minor fiscal drag in 2014, but no threat of another government shutdown. Inflation has continued to trend low, which is a concern for a number of Fed officials, but most continue to expect that inflation will move back to the 2% target. The financial markets appear to be much better prepared for a taper. The challenge for the Fed will be how to communicate its intentions.

The Fed will also release revised projections of growth, unemployment, and inflation, which may provide some clues to the expected pace of tapering in 2014.

The government will release November construction data in the morning. September and October housing starts, delayed due to the government shutdown, should finally show up.

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