5, 4, 3, 2, 1... Blast off!
Week Commencing Monday 14th December 2015
Overriding Market Themes
We start this week with the IMF, who has said that the recent growth, employment progress and deficit reduction in the UK economy has been strong. Christine Lagarde did however say that a potential “Brexit” and high household debt continue to pose the greatest risks to the recovery. She began by reaffirming that growth has outstripped other major economies, the unemployment rate has fallen, employment is at a high, the fiscal deficit has been reduced, and financial sector resilience has increased. They confirmed that steady growth looks likely to continue over the next few years, and inflation should gradually return to its 2 percent target.
Moving to more important news, this week spells the beginning of Fed week! With the solid November US employment report, coupled with the Federal Reserve signalling a move at the October FOMC, the markets are largely priced for a lift-off from the zero bound at this week’s FOMC meeting. We expect a 25 basis point rate hike this week, followed by three or possibly four hikes next year, bringing the target range for fed funds to 1.0-1.5 percent by end of next year. In terms of the economics, wages finally appear to be growing once again! In September, when the Federal Reserve first toyed with raising rates, average hourly pay had just grown by 2 percent y/y over the prior three months. Now that has risen to 2.8 percent, and by one measure even grew by a full 4 percent in the third quarter of the year.
That said, the Federal Reserve’s preferred inflation measure stands at just 0.2 percent, well below its 2 percent target. Cheap oil remains the main culprit; however core inflation, which excludes volatile energy and food prices, is only at 1.3 percent. The economics are less than ideal, and as discussed in the forecasting section of this report, could open up some volatility on either side. One thing is clear, this week is going to be a big one! Strap yourself in, it’s going to be a bumpy ride!
GBP This Week
We expect UK headline CPI inflation on Tuesday to be flat on a monthly basis, while core CPI inflation should continue to rise at a modest 1.1 percent year on year. Moving to Wednesday we then shirt our focus to the labour report, with unemployment likely to remain unchanged at 5.3 percent. Average weekly earnings growth should moderate slightly on a quarterly basis, potentially going down to 2.5 percent. Finally, November’s retail sales on Thursday should see a reversal in last month’s decline. The market expects to see a 0.6 percent print in the hard-line figure, and a 0.6 percent increase in the figure excluding fuels.
We remain bearish on GBP/USD, especially as we draw closer to the all-important FOMC statement this week. Sterling continues to hold firm above 1.50 for now, however with significant resistance expected near 1.52 we expect to see some significant downside this week. GBP/EUR should be the mirror opposite, with Sterling being caught in the cross-fire between EUR/USD. Expect to see Sterling regain some of its previous levels.
USD This Week
Finally, we have a rate decision pending!
The expected path of hiking is what the market will concentrate on, given that the market has already priced in a 25 basis point hike at this stage. Although we believe that the greenback will perform well after Wednesday’s announcement, we believe that more medium to long term strength could be muted depending on the response and/or conditions the FOMC have on further hikes.
Either way, we do have other US releases however given this is possibly one of the most important economic events of the year we suggest building your strategy around this event as it will set direction for the remainder of the month.
EUR This Week
The euro-area flash PMI on Wednesday is our first port of call, with consensus likely to remain unchanged at 54.2 in December. We should also see some improvement in German confidence, especially as a weaker Euro continues to fuel their booming export market. Next on the agenda is German IFO business climate index on Thursday, which is expected to remain unchanged at 109. Finally, France may not enjoy the same fate however, with French PMI’s expected to continue to edge down, mainly on weaker services sector following the terror attacks.
EUR/USD should continue to trade with the bears, with 1.07 on the cards should the Federal Reserve confirm the rate hike as expected.