It’s been a broadly positive week for markets in Europe, with the Stoxx 600 and Euro Stoxx 50 making fresh record highs, even if the FTSE 100 has drifted lower in the past couple of days, due to weakness in basic resources.
Last night’s US Federal Reserve decision went more or less as expected, with the central bank announcing an initial monthly reduction of $10bn in treasuries, and $5bn in mortgage-backed securities, starting this month. This was also tempered with a narrative that pointed to a rate rise remaining some way off, and an insistence that inflation was still very much transitory in nature, and while prices were expected to rise further, they would soon fall back without undermining the recovery. Fed chair Jerome Powell was fairly unequivocal in insisting that a rate rise remained some way off, which helped to push US stocks to new record highs, and the US dollar sharply lower.
This strong finish has seen Asia markets post a decent session and looks likely to translate into a positive European open this morning. That said, despite the weakness in the US dollar, there still remains a wider undercurrent that doubts the Fed will be able to hold the line of no imminent rate hike if the data continues to improve, which helps explain why the US 10-year yield rose to 1.6% and the 2-year yield also recovered its initial losses to finish higher on the day.
Over the last few weeks UK 2-year gilt yields have more than tripled from 0.2% at the beginning of September to over 0.7%, over concerns that inflation might not be as transitory as central bankers might have us believe. There was always a risk that central banks were being complacent that the various problems being experienced around the world in terms of surging energy prices and supply chain disruptions might become more persistent in terms of pushing up prices.
Before he left his post as chief economist at the Bank of England, Andy Haldane was already arguing that the central bank’s asset purchase programme might need to be scaled back, along with external MPC member Michael Saunders, who dissented again at the last meeting, although he was also joined in this by Dave Ramsden. Since then, the narrative has shifted sharply with Bank of England governor Andrew Bailey expressing concern about rising inflation expectations and that the central bank might have to act to counter an increase in pessimism about the inflation outlook. These concerns have been echoed by new chief economist Huw Pill, Haldane’s successor, in much more assertive terms.
This has prompted markets to price in the prospect of multiple possible interest-rate rises on the part of the Bank of England by the end of next year, amid talk that the central bank might be on the cusp of making a policy mistake. While Bailey’s comments set this particular hare running, markets appear to have run well ahead of it, which means that the Bank of England faces a difficult task in resetting the narrative with today’s decision. The argument goes that amid concerns about various supply chain disruptions and surging energy prices, the last thing the economy needs is a rate hike. That argument rather overlooks the fact that the market has already tightened policy in anticipation of a move by the central bank, and that for the bank to not act with a modest rate increase by the end of this year would damage what credibility it has left, given that it has cried wolf more often than not over the past few years, under Bailey’s predecessor, the 'unreliable boyfriend' Mark Carney.
It is true a rate rise now would be a sharp change in policy from the last meeting in September, but it wouldn’t be the end of the world either. A rate increase of 0.15% to 0.25% could be argued as being entirely consistent with the recovery in the UK economy seen since the emergency measures were implemented back in March 2020, and while any decision is unlikely to be unanimous, we know of only two who would be more than likely to vote against a rise in rates, Tenreyro and Mann, given their recent comments on policy. One thing is certain it will probably be a split decision and likely to be decided by the odd vote, but more than anything if the UK economy can’t withstand a 0.15% rise in base rate, then we are in a very sorry state indeed.
More than anything, having painted themselves into a corner, the markets could be very unforgiving if, having been led up the garden path by the Bank, it fails to deliver on its promises. More than anything it will be how the central bank manages the message when it comes to further rate rises that will be key, rather than raising rates today, or at next month’s meeting. A dovish hike, if there is such a thing, could be delivered within the confines of forward guidance. A failure to deliver today would be incredibly damaging to what’s left of the central bank's credibility, and could also cause the pound to plunge, and potentially exaggerate any inflationary impulse. In any case the central bank will still have to raise its outlook for inflation, while at the same time adjusting its growth forecasts as part of today’s inflation report.
US weekly jobless claims are set to come down further to 275,000, along with continuing claims which are set to fall below 2.2m, to 2.15m.
EUR/USD – if we are able to push through resistance at the 1.1620 area we could see a retest of the 50-day MA at the 1.1700 area. Support remains at the 1.1520 area and October lows. A break below 1.1500 targets the 1.1400 level.
GBP/USD – we’ve held above 1.3600 for two days in a row, however while below the 50-day MA at 1.3720, the risk remains for a move back towards the 1.3570 level, and possibly lower. We need to see a move back above 1.3730 to stabilise.
EUR/GBP – unable to push beyond the 0.8520 area, we’ve now slipped back with support back at the 0.8470/80 area. Above 0.8530 retargets the 0.8580 level. Below 0.8470 retargets the recent lows at 0.8400.
USD/JPY – little reaction yesterday with resistance at the November 2017 peaks at 114.75, a break of which opens the 116.00 area. The 113.20 area remains key support, followed by the 112.40 area.
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