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Monthly Review: September

In the US, the positive surprises in manufacturing continue, creating expectations for acceleration in growth and corporate profitability in 2014. On the other hand, the observed deterioration of the new orders to inventories ratio might presage the end of the recent series of positive surprises in the sector.

Abating geopolitical concerns and the absence of any tapering of bond market purchases are further positive surprises as the deflation of the geopolitical premium puts pressure on the oil price and the environment of excess liquidity is maintained.

The Fed’s positive surprise can be explained either by concerns about the side-effects of its exit policies or by (the Fed’s) expectations for future strong negative fiscal shocks.

In the Eurozone, after the German elections, we could be entering a period where intense discussions on the nature and extent of European integration are more likely. In this context a rise of fluctuations in European markets is increasing in probability. The timing of such a change of climate remains elusive. The economic data in Japan continue to improve but the Fed’s excess liquidity surprise and the recent hike in the sales tax, pose significant risks. In China cyclical data have also improved, but the shadow banking system seems to remain in an expansion mode.

A large number of positives are likely discounted in the US equity markets, which remain relatively expensive while entering a period of neutral (from positive) technical indications. Emerging market equities remain relatively cheap and are likely to enter a period of over-performance. The combination of excess Fed liquidity and the debt-ceiling concerns are particularly negative for the dollar. At this stage, as things on the European front remain quiet, the EURUSD maintains an upward trend. We are raising our 12-month target to 1.30. The price of gold is unable to benefit from the current environment as investors reduce strategic positions. The price of oil remains too high while the geopolitical premium is correcting. US government bonds appear expensive, while the long-term technical picture remains negative. However in the US fiscal concerns have a deflationary impact strengthening its bond markets. We expect any such trend to be short-lived. In Germany, government bonds have a neutral picture (with a negative bias) both in terms of valuations and relative to market dynamics. The trend in European periphery spreads remains downward, but already many positives could be discounted.

The EURUSD economic fundamentals have improved, but risks of peripheral spreads widening and the general uncertainty surrounding the issue of closer European integration remain. Geopolitical concerns have made the oil price unreasonably high, but the technical picture remains positive. The overall outlook for gold remains negative. In bond markets, longer durations in the U.S. are considered cheap compared to shorter ones, while the overall picture is negative for American and neutral for German bonds.