The main market moving event this week was Wednesday’s US Federal Reserve monetary policy statement. As was widely expected the Fed announced that it would increase its benchmark lending rate by 0.25%. However, markets were caught off guard by indications that the rate-setting committee is forecasting 3 additional rate hikes in 2017, up from previous guidance of 2 rate hikes. The upward revision in the Fed’s “dot plot” was driven by President-elect Trump’s stated policy objectives. The business-friendly spending and taxation changes Trump has advocated are the kind of fiscal stimulus that central bankers the world over have been eager for. Fresh fiscal stimulus allows the Fed to look at tightening up its ultra-accommodative monetary policy without derailing the economy. That in effect means the Fed can hand the reigns of the American economy back to elected officials after being its caretaker since the global financial crisis.
The greenback has found itself propelled higher by the Fed and on a trade-weighted basis is trading at 14-year highs. Notable gains have been made at the expense of sterling, the Japanese yen and euro. In fact, this week’s Fed activity has reinforced bank forecasts that EURUSD will touch parity this year. As it stands, three rate hikes by the end of 2017 are about 30% priced into markets. This suggests that the big dollar has quite a bit of scope to rally further against all currencies in the New Year should it continue to look like the Fed will tighten policy as predicted. It’s worth noting that in light of the rate hike this week, the United States now has the third highest benchmark interest rate of all developed western nations, trailing only Australia and New Zealand. The implication being that USD could benefit from higher investor demand for yield in a safe destination.
According to data published this week, the British economy appears to be chugging along rather well, despite the uncertainty associated with June’s referendum result. The labour market in the UK remains tight, with wage growth edging up to its highest level in over a year and the unemployment rate at its lowest level since December 2005. Additionally, it was revealed that in November inflation pushed up to its highest level in 2-years.
Sterling found itself temporarily lifted by the results, but the Bank of England was quick to pour cold water on Sterling’s gains this week. At its scheduled monetary policy update, the BoE observed that sterling’s recovery of 6% since October’s flash crash softens the inflation outlook. Analysts took the remark to mean that the BoE now feels it has more latitude to keep policy accommodative through Article-50-related uncertainty. Ironically, this caused the pound to sell off. Beyond the reference to inflation, little else of note occurred; the benchmark interest rate and QE program were left unchanged. The BoE has shifted from exceptionally dovish to a more neutral stance recently, abandoning explicit guidance that additional policy loosening could lie ahead. However. linking currency performance to inflation looks to have put sterling bulls on notice, and as the week draws to a close GPBUSD has slipped to near 1-month lows.
Looking to next week, the data calendar is rather light, with little in the way economic events that might stimulate rate volatility. However, next week marks the beginning of the holiday period which tends to be characterized by thin liquidity and elevated rate volatility. In fact, for both of the last 2-years GBPUSD and GBPEUR had rages of about 5% respectively in the period from mid-December to early-January. If history is any guide, and in consideration of current post-Brexit volatility in GBP, it could be an interesting next few weeks, regardless of what the data calendar has in store. A market order might be a way to take advantage of expected conditions given the prospect of large rate swings in the weeks ahead. Please contact your Cambridge representative if you’d like to know more.
This will be the last UK Weekly Commentary of 2016. It has been a pleasure being your bridge to currency markets this year. From the entire Cambridge Global Payments team, best wishes during the holiday season and we look forward to working with you in 2017.
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