Yesterday’s sell off in stocks appears to have been precipitated by a similar sell off in bond markets as investors weighed up the prospect that we could well see a modest easing off of the accelerator in terms of loose monetary policy by the Bank of England, US Federal Reserve and the European Central Bank over the course of the next few months.
There has also been a great deal of speculation about the identity of the next chair of the US Federal Reserve, and while it is important, it doesn’t change the fact that we’ll probably still see a rate hike by year end, as well as the prospect of at least another two rate rises next year. Some have suggested that Stanford economist John Taylor appears to be a frontrunner despite his being viewed as a hawkish choice.
This seems rather counterintuitive given that President Trump would appear to have a preference for a weaker US dollar, and most of what we know about John Taylor would point to the opposite. We will hopefully know more in the next couple of weeks but despite the credentials of all the candidates they will still only have one vote on the FOMC.
Despite yesterday’s sell off, markets in Europe look set to open higher this morning with one eye on developments in Catalonia where the next stages in Spain’s constitutional crisis look set to play out between now and the weekend. Splits appear to be opening up on both sides of the divide with respect to next steps in the Catalan crisis with some on the Catalan side calling for a clear declaration of independence while some in the Spanish parliament are unhappy with Prime Minister Rajoy’s increasingly hard line, the Basques being a case in point.
The pound saw a reversal of fortune and a nice rebound yesterday after the weakness of Tuesday as a better than expected Q3 GDP number of 0.4% put aside concerns that the Bank of England might get cold feet at next week’s rate meeting about pushing bank rate back to 0.5%, and back to where it had been before last year’s August rate cut.
We do still have a week to go until next week’s meeting with more economic data due out between now and then, but a weak number yesterday would have made it much harder to justify pulling the trigger on a move next week.
As it stands markets are now pricing in an 89% probability that we’ll see a rate rise next week and given markets have more or less priced it in, any decision to delay would not only be difficult to justify given recent signalling, but would probably also be received badly by the markets.
It’s set to be all eyes on Frankfurt today and the latest press European Central Bank press conference of ECB President Mario Draghi.
No changes are expected to be made to monetary policy at this meeting, however there has been persistent speculation as to what measures the ECB governing council might look to take with respect to the amount and duration of their €60bn asset purchase program which most people expect to be pared back at the end of this year.
For several meetings now President Draghi has tantalised the markets about what steps the ECB might take, given the looming scarcity of assets to buy at a time when, despite the strong recovery being seen across Europe, inflationary pressures continue to remain suppressed, and well below the ECB’s 2% target.
Some progress has been made with CPI now at 1.5% compared to 0.4% a year ago, but it still remains below its 2% peak earlier this year. Core prices have also struggled, though here they are also above where they were a year ago, but only marginally so at 1.1% from 0.8%.
So far this year the euro has risen 12% against the US dollar, a not ideal scenario for a central bank that wants to keep a floor under inflation, and this is clearly a concern for ECB policymakers who appear split between those more hawkish members who want to cut asset purchases sharply as they no longer consider them necessary, and those who worry that a too sharp a withdrawal of stimulus could be premature at a time when political instability appears to be making a bit of a comeback in Europe.
The big question therefore comes round to this, how much to cut by and how quickly with a number of options being touted. Cut to €40bn a month with an end date of September 2018, or a much sharper reduction to say €20bn or €30bn a month with a longer duration, or variations thereof.
Whatever options the governing council chooses the concern is that the euro could end up punching higher through the recent highs at 1.2000 and head towards 1.2500, and in the process risking exerting more downward pressure on inflation.
EURUSD – currently range trading between resistance at the 1.1870 level and support above the recent lows at the 1.1670 area. A move below 1.1720 has the potential to open up these lows.
GBPUSD – managed to rebound from support near the 1.3100 area and above last week’s low at 1.3090. We also have longer term support from the March lows just below that so the potential for a return towards the 1.3340 area remains. We need a move back the 1.3340 area to retarget the 1.3420 area.
EURGBP – having failed to push up close to the 0.9000 area the euro has slipped back but has found support at the above the 0.8870 level. While above the 0.8870 level we remain susceptible to a move back towards the 50 day MA, and the 0.9000 level. Below 0.8870 targets 0.8820.
USDJPY – continues to edge towards the range highs from May and July at 114.40, with a break targeting 115.60. Below the 113.40 area retargets the 112.40 level.
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