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3 Conditions Keeping Fed Tapering on Track

3 Conditions Keeping Fed Tapering on Track

Kathy Lien, Technical Strategist

Barring any swift changes in geopolitical factors, a sudden spike in US Treasury yields, or a miss from next week’s non-farm payrolls (NFP) report, Fed tapering is likely to happen in September.

With investors growing less anxious about Syria, US economic data surprising to the upside, and ten-year bond yields back at 2.75%, we believe that the Federal Reserve is still on track to reduce asset purchases in September.

According to the latest economic reports, the US economy expanded by 2.5% in the second quarter, up from an initial estimate of 1.7%. Stronger inventory investment, an upward revision to exports, and downward revision to imports offset a reduction in spending. This data confirms that the US economy gained momentum for the second straight quarter.

As long as next week’s non-farm payrolls (NFP) report grows by more than 150k, the recovery in the labor market should be satisfactory for the Fed, which has been looking to reduce stimulus for the past two months. Most policymakers have probably made their decision already as to when they want to taper, and the only question is by how much bond purchases will be reduced on a monthly basis.

Friday’s personal income and personal spending reports are not expected to affect anyone's decision, and the same is true of the Chicago PMI figures and revisions to August consumer confidence numbers. Even if the data surprises to the downside (and we think it will because manufacturing, retail sales, and hourly earnings have been weak), they need to disappoint in a major way for the central bank to reconsider its plans. The recent uptick in commodity prices should only harden the Fed's plans to taper.

Euro Loses Big; More Letdowns Ahead

Thursday’s worst-performing currency was the euro (EUR), and while part of its weakness can be blamed on stronger US data, German unemployment numbers also missed expectations, which could limit the optimism from the European Central Bank (ECB) when it meets next week.

See also: The Good, the Bad, and the Euro

Looking ahead, German retail sales are scheduled for release on Friday, and unfortunately, we believe that the data could put additional pressure on the euro.

According to the latest consumer confidence report, the outlook for September deteriorated. Labor market conditions have worsened, and a retail survey by Markit Economics found little change in spending on a month-to-month basis. The retail PMI index remains in expansionary territory, but the level of expansion did not change. This leads us to believe that consumer spending may not have rebounded as much as economists expected in the month of July.

By Kathy Lien of BK Asset Management

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.