Traders look to Federal Reserve for clarity on cutting back on monetary stimulus

TORONTO - Stock markets will likely start the trading week in a holding pattern and stay there until Wednesday when investors find out if the U.S. Federal Reserve ends months of speculation and decides to start winding up its asset purchases.

"We believe the conditions are more than ripe," said Doug Porter, chief economist at BMO Capital Markets.

Many traders aren't happy to see an end to the US$85 billion a month of asset purchases as they have kept long-term rates low and supported a strong advance on many markets this year, including the Dow industrials which has surged a good 20 per cent.

That hasn't been the case in Toronto where the TSX is heavily weighted in favour of the resource sector.

There has been a great deal of uncertainty surrounding tapering, particularly since September when the Fed surprised markets by saying the time wasn't right to starting winding up the program.

Analysts believe the prospect of a government shutdown over budget wrangling, along with difficulties in extending the debt ceiling, helped persuade the Fed to postpone tapering in September. The 16-day shutdown in October crimped economic growth and hurt consumer confidence.

But just this past week a bipartisan committee struck a budget bill.

That came on top of a slew of strong economic data the previous week, capped by a strong employment report for November.

"Between the solid employment report and the apparent preliminary budget deal, I would say those two events alone have pushed up the odds," said Porter.

"Frankly, ever since the September meeting, I think analysts have been a bit at sea as to exactly when the Fed plans on tapering and exactly what kind of schedule they’re looking at. But based on that fog, we would give a 50-50 odds that they will actually begin to taper as early as (this) week."

Porter said inflation is the strongest economic reason he can think of for the Fed holding off until early 2014 when incoming Fed chair Janet Yellen gets settled in the job.

And that’s because inflation at around one per cent is likely uncomfortably low for the Fed.

"But the counterpoint to that is the Fed cares about where inflation will be, not where it has been, and if they really believe that inflation will slowly pick up again, then I think that falls away as a reason not to taper as well," he said.

Markets will also be anxious to see what kind of time frame the Fed will attach to wrapping up this third round of quantitative easing.

Porter thinks it will be more than six months "because undoubtedly something will crop up over the next year, whether it’s a couple of months of disappointing employment or some kind of fiscal issue."

"But we think they would be done by about October."

Both Toronto and New York markets gave up ground this week amid the Fed speculation, with the TSX down 1.17 per cent for the week and the Dow industrials falling 1.65 per cent. The TSX is up 5.56 per cent for the year to date and the Dow has surged 20.2 per cent.

Elsewhere on the economic front, there are a trio of major Canadian reports coming out this week, including manufacturing shipments for October.

Economists expect a weak report, with shipments down 0.2 per cent on the month and Porter said it will reflect the fact that Canadian manufacturing has been a disappointment this year and particularly employment in the segment.

"And manufacturing output was also down," he said.

"It looks as if (manufacturing) is ending the year on a slightly better note but we’ve had all kinds of high-profile factory closings so I’m not sure the outlook for ’14 is a whole lot stronger."

On Friday, Statistics Canada releases the November reading on inflation and October retail sales.

Economists believe the consumer price index rose 0.1 per cent month to month, adding up to an annualized rate of just one per cent amid falling energy prices.

Economists also believe retail sales declined in October, with sales excluding vehicles down by 0.2 per cent.

But CIBC World Markets says auto sales may have been strong, "based on industry-wide indicators pointing to a robust month for dealers in October. That could see overall retail sales rise by 0.3 per cent."