The Federal Open Market Committee (FOMC) raised rates as expected, and also slightly increased their estimates of future interest rates as they upped their forecasts for the economy. Looking at the “dot plot,” both the bottom and the top dots moved up for 2019 and 2020, while the median also for 2020. Nonetheless, the overall impression was dovish. GDP was revised up and unemployment was revised down to the 3% area. Nonetheless core inflation was not revised up, presumeably under the assumption that some fiscal stimulus would expand the supply side of the economy at the same time as demand was increasing. The overall impression was therefore dovish, particularly after Chair of the Board of Governors of the Federal Reserve System Janet Yellen reiterated that faster growth probably wouldn’t mean greater price pressures anytime soon. Bond yields fell with the yield curve steepening and the dollar declined as a result. We could see further dollar weakness as the market searches for a new reason to buy. The main risk to that forecast is simply year-end demand and position-closing, particularly with regards to USD/JPY.
AUD was the main gainer after Australia’s employment data far exceeded estimates. Employment rose 61.6k in November 2017 vs 19k expected (7.8k previous). The resulting shift in rate hike probabilities could keep AUD underpinned today.
Today is a busy day – three central bank meetings, the start of the EU summit, plus the preliminary Purchasing Managers' Indices, then overnight Japan’s tankan report.
The EU summit is widely expected to certify that talks between the EU and Britain have made “sufficient progress” that they can move onto the next stage of the negotiations: the nature of the trade relationship between the two after Brexit.
The other important point for GBP today is of course the Bank of England meeting. The market isn’t looking for a rate hike any time soon. Investors see only a 50% chance of a hike by June 2018, and some possibility that there won’t be any hike at all next year. If the Bank of England is really on hold for that long, there should be little market reaction to today’s meeting. The main point of interest will be what comments, if any, they make about the Brexit process. Governor of the Bank of England Mark Carney has said that a recalibration of monetary policy would be warranted once an agreement on transition was reached. I doubt however whether simply agreeing to start talks on that transition would qualify. This meeting may be neutral for GBP.
The European Central Bank meeting should also not result in any major surprises, now that they’ve made their announcement about when they’ll start tapering down their bond purchases. The main point of interest will be the latest macroeconomic forecasts, which will include the first forecasts for 2020. I’d expect European Central Bank (ECB) President Mario Draghi to get several questions about the divisions among ECB Board members about the tapering process and the forward guidance. One curious point: note from the graph that recently, the market has started to price in less possibility of a rate hike before the end of next year (the red line) and a small probability of a rate cut (the purple line).
The Swiss National Bank also meets, but they’re expected to be on hold until the European Central Bank starts to raise rates. The overnight index swaps estimate it’ll be about 5 years before we get even a 25 bps move from the Swiss National Bank.
As for the indicators, the Eurozone Purchasing Managers’ Indices (PMIs) are expected to be generally lower. This is not a catastrophe by any means, seeing as they are at the highest level in years (the EU-wide manufacturing PMI has only been higher once in the 20 years that it’s been calculated).Markit calculated that last month’s data was consistent with 0.8% qoq GDP growth in the Eurozone. Even if these figures lowered that to 0.7%, that would still be an acceleration from 0.6% qoq in Q3. In other words, I think a modest decline from these high levels would not be particularly negative for the euro, although of course it probably wouldn’t help much, either. This could be neutral to slightly EUR-negative.
UK retail sales are expected to be modestly higher than in the previous month. Markets are concerned about the health of the British consumer as prices rise faster than wages. A figure such as this, showing at least modest improvement in consumption, should reassure investors somewhat and could help to boost the pound, bearing in mind that Brexit developments and the Bank of England today are probably more important. My research shows that the figure best correlated with the market’s reaction is the month-on-month change in retail sales including gasoline. That seems to be the one the market watches most.
US retail sales for November 2017 are expected to rise more than they did in October 2017, when growth was depressed after the surge in September 2017. Gasoline prices were up but auto sales were down. The figure isn’t fantastic by any means but nor does it signal any weaking in the consumer demand. As such it could be neutral for the dollar.
In contrast to Europe, the US Markit PMIs are forecast to remain steady (manufacturing) or to increase (services). Here too they are at a relatively high level, although not as high as Europe. The closely watched Institute of Supply Managers’ manufacturing Purchasing Managers' Index is much higher than Markit’s. The data could be positive for the dollar.
Finally, overnight the Bank of Japan releases its short-term survey of economic conditions, aka the Tankan report. Household and corporate survey data have generally been improving, and the Tankan is likely to reflect the same trend. However, some of the data, such as industrial production, have been slowing, which suggests the possibility of a downward surprise. Generally speaking, large corporations tend to reduce their capital investment plans in the December Tankan, so it’s likely to see a drop in that indicator.
While much of the press reporting tends to concentrate on the large manufacturers, in fact I’ve found a much better correlation between the results for the non-manufacturers and the subsequent movement of USD/JPY. This is actually rather strange, because the manufacturers are the major exporters and therefore their health should have a stronger connection to the currency, but that’s the way it is.
This article comprises the personal view and opinion of the STO Investment Research Desk and at no time should be construed as Investment Advice.