Fed minutes offer few clues as to next rate move

Equity markets have got off to a solid start this year with the FTSE100 making new all-time highs this week, helped by a continuation of the trends seen at the end of last year, namely that of firmer commodity prices, improving economic data, and rising inflationary pressures.

This week has seen manufacturing and services data broadly improve across the board in China, Japan, Europe, the US and the UK, but more importantly we’ve also seen rising inflationary pressures manifest itself in the data as well. This has helped banking stocks maintain their end of year resilience helped by another sell-off in bond markets this week, as rising inflation expectations start to get priced back into higher yields.

Last nights Fed minutes reinforced US policymaker expectations that we could well see multiple rate rises this year after last month’s rate rise, though officials remained cautious given the lack of clarity on the type of fiscal expansion that might be forthcoming in the coming months.

In contrast to last year when there was widespread talk of multiple rate rises in a deflationary environment this week’s data would appear to suggest that while pricing pressures are on the up Fed officials seem a lot less certain about the glide path of future projected rate rises.

This may well explain why the US dollar has sold off sharply from this week’s new 14 year peaks, with the Yuan in particular surging, against a backdrop of concerns about the impact of a stronger currency, and a lack of clarity on the new US administrations upcoming fiscal plans.

The surge in the Yuan may well have been exacerbated by reports that Chinese authorities are placing curbs on capital outflows, along with a failure to crack the 7.00 level, prompting a bout of profit taking.

Even so it is quite clear that unlike last year the rebound in commodity prices will exert upward pressure on inflationary pressures as we head into 2017. This will be particularly true of oil prices in the months ahead given that a just over year ago we saw crude prices put in multi-year lows at $26, and this deflationary effect will drop out of the numbers in the next month or so.

This has already started to manifest itself in headline CPI numbers already in the last few months with this week’s German and EU CPI numbers jumping sharply in December to multi year highs.

US markets meanwhile still seem intent on trying to make fresh attempts at new record highs with the Dow once again falling short of the 20k level. Another failure here may well prompt a bit of a sell-off in the short term, while a weaker US dollar could well see European markets drift off as well after this week’s new highs.

The UK remains in focus today with the latest December services PMI numbers set to bring the curtain down on a better than expected Q4 for the UK’s economy. We’ve already seen fairly robust manufacturing and construction numbers this week and a decent number in the services sector will raise expectations for a strong end to a year that six months ago had a lot of people marking down their economic forecasts aggressively.

Having seen a strong November number of 55.2, expectations are for a slight slowdown in December, but nothing too disastrous with 54.8 being the consensus view, reinforcing an expectation that we could well see a Q4 expansion close to Q3’s 0.6%.

While it is acknowledged that this level of expansion is unlikely to last, driven as it is by the services sector there has been evidence in recent months that manufacturing and construction could well pick up some of the slack, despite the pressure of rising prices.

In the US ahead of tomorrow’s December employment report we get the latest ADP employment report which is expected to show a drop from November’s 216k number to about 175k, while the latest ISM services sector is expected to show a slight slowdown to 56.8, from 57.2 in November.

EURUSD – having made a new multi-year low at 1.0340 the risk of a rebound appears to be increasing. The lack of follow-through could see a move back towards the 1.0520 area and even 1.0700. While below 1.0700 the prospect of a move towards parity remains.

GBPUSD – despite breaking below 1.2300 we’ve managed to rebound from 1.2199 and remain vulnerable to a short squeeze towards 1.2500. The big support remains back at 1.2080 as we continue to range trade between 1.2100 and 1.2500.

EURGBP – despite a squeeze back to 0.8670 at the end of last year the bias remains for a move lower through the 200 day MA at 0.8350 to target a move towards the 0.8230 area. A move through 0.8580 argues for a return to 0.8700.

USDJPY – currently has resistance at 118.65, potential double top with support at 115.80. A break below 115.80 could well target a move towards 113.00. While above the 115.60 level the objective remains for a move higher towards the 120.00 level.

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