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Fed’s ambivalence prompts US market decline

As expected the Federal Reserve kept monetary policy unchanged at its latest meeting, but there was never any expectation that this wouldn’t be the case. Investors were much more interested to see what policymakers thought about the outlook for inflation and the economy.

Unsurprisingly there was a tweak to the language around inflation, which was changed to reflect the much firmer headline numbers seen earlier this week, with “run below” changed to “moved close to 2%”, while the reference to “monitoring inflation developments” was removed completely, as was the reference to the economic outlook strengthening in recent months.

Initial market reaction saw the US dollar slip back sharply, on the basis that markets had expected a much more hawkish tilt given recent inflation readings. This was always likely to be optimistic, given the previous reluctance to pre-commit. There was nothing in yesterday’s statement to undermine the prospect that rates won’t rise next month, as Fed officials remained non-committal as to whether we could get 3 or 4 rate rises this year.

The Fed’s outlook on the economy while positive wasn’t exactly effusive, if anything it was strangely ambivalent. The removal of the reference to the strengthening of the economic outlook, while innocuous, may well suggest some latent concerns about a possible softening heading towards the end of the year. This may reflect some concern about a slowdown or be merely an attempt to inject a little bit of optionality into the market. This is never a bad thing, as it keeps the bank from backing itself into a corner, something the Bank of England would do well to learn.

It was possibly this ambivalence on the economy, against an expectation of rising rates that would appear to have prompted the sell-off and subsequent negative close for US markets yesterday.

The rise in the US dollar while appearing to hold back US markets appears to be having the opposite effect on European markets with the German DAX enjoying a strong session yesterday, breaking back above its 200-day MA and closing at a three-month high, as the euro slid lower. The FTSE100 likewise also closed at three-month highs.

With US inflation, as well as wages, starting to show signs of picking up attention turns back to Europe and today’s flash EU CPI number for April which is expected to remain at 1.3%, however in a blow to ECB hopes of seeing a pick-up in core prices, these are expected to dip back below 1% to 0.9%. A weak number here will only reinforce the recent weakness in the euro, which is likely to be welcomed by the central bank as in the longer term it will help bolster inflation expectations.

The pound continued to remain under pressure yesterday despite a strong rebound in construction PMI activity in April. Back in March economic activity slipped into contraction territory at 47, with the cold weather acting as a drag, while the Carillion fall-out also continued to weigh on the sector. Yesterday’s rebound to 52.5 was therefore welcome, helped by a rebound in residential construction.

Today’s services PMI number, it is hoped, will also show a similar rebound given a similarly weak reading for March of 51.7. It is expected that we could see a rebound to 53.5, after the weather-related slowdowns of the previous month.

Any rebound while welcome is unlikely to change expectations about next week’s Bank of England meeting where we’ve seen the prospect of a rate rise diminish sharply in the last few days.

Asia markets took their cues from yesterday’s weak US session but also with one eye on the upcoming trade talks between the US and China which are set to get underway over the next day or so in Beijing, and this weakness looks set to manifest itself into a weaker European open later this morning.

EURUSD – continues to fall with the next support coming in at the 1.1930 level as we head towards the 1.1800 level. We need to get back above the 200-day MA at 1.2015 to stabilise and open up the prospect of a return back towards 1.2150.

GBPUSD – this week’s fall below the 1.3700 level now opens up a move towards the 200-day MA at 1.3520. We need a move back above the 1.3720 area to stabilise and target a return towards the 1.4020 area. 

EURGBP – still finding it difficult to move beyond the 0.8830 level. A move through here would target the 200-day MA at 0.8880. While below the 100-day MA we could drift back towards the 0.8750 and last week’s lows at 0.8680.

USDJPY – continues to push higher with the next resistance up at the 200-day MA at 110.25, with trend line resistance at 110.50 behind that. Support remains back at the 108.70 area. A move beyond 110.50 opens up the 112.00 area.

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