Fed to err on the side of caution

A man runs along the South Bank of the river Thames as snow falls on January 18, 2013 in London, England.
Oli Scarff | Getty Images
A man runs along the South Bank of the river Thames as snow falls on January 18, 2013 in London, England.

With the holiday season right around the corner (I was informed by a retail analyst that Christmas merchandise has been on the shelves since early August this year…a new record), markets are now focused on the direction for the final quarter of the year. The FOMC (Federal Open Market Committee) meeting taking place on Wednesday will be closely watched for any hints on how far off a tapering to its massive asset purchasing program is.

In the aftermath of a very weak, pre-government shutdown September jobs figure for the U.S., investors will also be looking for clues on the strength of the U.S. economy, and whether we can expect a pick-up before round two of the budget and debt ceiling debates early next year.

(Read more: Six dangerous myths about the debt ceiling)

Capital Economics pointed to the market sensitivity towards tapering, and the dovish stance of the next Federal Reserve chairman, Janet Yellen, as reasons why the Fed will err on the side of caution, and only put forth modest tapering measures. Capital Economics raised the possibility of asset purchases being cut to $75 billion, from $85 billion per month, but didn't see it happening before March.

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UK gilt yields outperform

In the U.K., preliminary data out on Friday showed the economy grew at its fastest pace in three years over the third quarter. U.K. GDP rose 0.8 percent on a quarterly basis, and 1.5 percent compared to the same period in 2012. Economists noted a broad-based improvement, but still questioned whether the pace of expansion could continue.

Interestingly, Capital Economics also argued that the strong GDP figures show the economic recovery was becoming more broad-based, and that it should be able to handle the upcoming hefty price hikes in energy. Capital Economics added that the inflation outlook had been helped by other commodity price movements, and that this indicated tough living standards should gradually get better next year.

(Read more: UK energy companies under pressure to explain price hikes)

However, Ashraf Laidi, chief global strategist at City Index, pointed out that the strong GDP figures came just three weeks after the IMF (International Monetary Fund) cut its growth forecast for the U.K. Laidi also highlighted that U.K. 10-year bond yields had outperformed counterparts in the U.S., Canada, Germany, China and Switzerland since late August, but that strong Gilt yields were nothing new, as this trend has been the case for most of the last 6 years.

Laidi importantly said that while the pound had been the best performing G-10 currency over the last three months, the Bank of England's attempts to talk down bond yields, given all the recent positive data, could result in a favorable move for sterling. On top of that, the Bank could decide to gently encourage sterling strength to counteract stubbornly high inflation, according to Laidi.

(Read more: Currency markets reach 'Europhoria' amid dollar dip)

Elsewhere on the U.K. economic agenda, watch for the U.K. GfK consumer confidence data, as it is expected to show a slight improvement and Friday will end the week with U.K. manufacturing PMI.