While European markets had a disappointing session yesterday, US equity markets endured a rollercoaster session before closing more or less flat on the day, disturbed by the uncertainty created by those Trump junior emails while looking towards today’s testimony by Fed chief Janet Yellen to US lawmakers on Capitol Hill.

Speculation has continued to grow as to the timing of when the Federal Reserve could start to pare down its balance sheet and whether this process would happen alongside the prospect of further rate rises. Such a move would in all probability be a little on the risky side, tightening policy from two different directions, and will be a process the Fed will need to be able to communicate effectively in the coming months.

Judging from Fed Fund futures pricing, markets already appear to be pricing the prospect that further additional rate rises are likely to be the least preferred option, and that the main focus is likely to be on looking at preparing the ground for reducing the size of the balance sheet gradually.

Permanent Fed governor Lael Brainard, usually one of the more dovish members of the FOMC certainly hinted that she was thinking along those lines in comments made yesterday, in which she expressed concern about weak inflation but was comfortable about pressing ahead “soon” with plans to shrink the Fed’s balance sheet. Any clues that Fed chief Janet Yellen gives today regarding this course of action would certainly raise the prospect of a move as soon as September, as long as the data supports it, and given the strength of the recent jobs data this would probably an easier sell than further rate rises.

Before that though we have the prospect of further UK data after the disappointment of last week's poor economic data. The pound took a tumble after both Bank of England chief economist Andrew Haldane and deputy governor Ben Broadbent failed to make any direct mention of monetary policy in comments they made yesterday. This was a little bit of a disappointment to traders in general who had expected something a little more substantive, given that central bankers generally haven’t been shy about commenting on monetary policy in the past.

Today’s wages data is likely to be closely scrutinised for evidence of a pickup in wage growth, having seen a few months of weak and below inflation increases. Last month we saw weekly earnings for April rise 1.7% excluding bonuses, well below the 2.9% CPI numbers, which are due out next week.

It is expected that this number will rise to 1.9%, and that over the next few months the gap with inflation will then start to close again, particularly if unemployment continues to remain at 42-year lows of 4.6%. This number is expected to stay unchanged, while the employment rate is expected to stay at or near its record levels of 74.8%.

On the subject of monetary policy the Bank of Canada is expected to increase its headline rate by 25 basis points to 0.75%, shadowing last month’s US Fed move. The big concern here is the lack of inflation, particularly since the Canadian dollar is very susceptible to moves in the oil price, and the big question will not be around whether or not the Bank of Canada hikes, but what their forward guidance will be with respect to future moves.

Certainly the economy in Canada is not doing too badly so a reversal of one of the 2015 rate cuts needn’t be viewed as a cause for alarm, rather a reflection of an economy that is not as weak as it was and is now stronger than when rates were cut previously. Maybe the Bank of England should take note.

Forex snapshot

EUR/USD – remains on course for a test of the 2016 highs at 1.1617 while above the 1.1300 area, after moving through the 1.1450 area yesterday. Only a move below 1.1280 opens the possibility of a move back to the 1.1100 June lows.

GBP/USD – remains under pressure while below the 1.3040 level and while we do so the prospect of a move back to the 1.2750 area remains, with support also at the 1.2820 area.

EUR/GBP – pushed through the 0.8865/70 area and has moved up to the 0.8920 area which is the 61.8% fib level of the 0.9300/0.8300 down move. A close through here opens up the 0.9000 level with support now back at the 0.8860 level.

USD/JPY – has pulled back from the 114.40/50 area, though we do also have resistance behind that at the 115.20 level and March highs. Looking overbought so could struggle here with a drift back to the 112.40 level a possibility.


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