So much as expected the Federal Reserve didn’t disappoint this week with their second interest rate increase in 10 years, exactly one year after the last, so much of this issue is going to focus on the US. As mentioned in previous articles it was pretty much a gimme and the actual increase itself was very much priced into the market already. However, it was the subsequent hawkish FOMC statement that everybody was watching and which gave the USD the extra momentum to push higher against other currencies. The forward guidance, which includes the “dot plot” indicated a possible three interest rate rises next year, more than the originally predicted 2. The “dot plot” is essence view from each FOMC members to when interest rate rises will happen. Each member, voting or otherwise gets an opportunity to predict and this then forms the “dot plot” and is considered the main form of forward guidance. In addition to changes in the dot plot Fed Pres Yellen also made remarks around her not favouring running a high inflation economy suggesting that they are even more prepared to increase rates faster should the economic picture change.
There are some interesting things to consider for next year though. Firstly, the make-up of the voting members of the FOMC is decidedly more dovish in attitudes. In addition to this we should cast our minds back to this time last year when we faced the same scenario as we have now, a significant monetary policy divergence between the US and the rest of the world. We know that most global economies have been significantly accommodative over the last several years which is pumped huge amounts of dollar debt into the global economy, with a tightening monetary policy and increasing interest rates this debt becomes significantly harder to service. This caused some of the global economic turmoil at the beginning of this year, and most central banks set off on a policy of weakening the US dollar, which subsequently meant the Fed pulling back on its interest rate proposals. With a strengthening dollar, partly due to monetary policy divergence, but also because of fiscal stimulus under the new Trump administration, this is only going to put added pressure into the system.
We also have the issue relating to the new Trump presidency and what that means to the global economy next year. We’ve already seen evidence of isolationism from the President-elect threatening to withdraw from trade deals and focus on bringing businesses back to the US. This could lead to a reduction in global trade across the world which would further add complications to the overall global picture. If the US stops buying abroad then this reduces the amount of US currency in the economy which further heats up the issue around cost of borrowing, particularly for emerging markets. On the converse, should the fiscal policy and stimulation promised by the new government not thicker then we potentially face a scenario where the dollar is significantly overpriced, which again could chaos in the financial markets.
So personally, the message but 2017 from me is that we are likely to see USD strength certainly in the short term while the market fully accepts the changes to monetary policy, but you’re aware of overall sentiment going into the New Year.
Of course, the interest rate was not the only event on the calendar for the USD last week, we saw core retail sales and retail sales underperform slightly with CPI and core CPI coming in on expectations. There are no two ways about it though, monetary policy, and more important convergence in monetary policy, is the ultimate driver at present.
it was a light week for the ECB this week with the only significant releases being various Flash Services and Manufacturing PMI readings. The Euro is still very much on a bearish footing despite perceived tapering of QE announced last week, albeit tapering for longer. There are still significant headwinds for the single currency with the political upheaval likely to take front and centre stage next year with elections in various countries.
The UK week started positively with inflation edging up slightly at 1.2% and ended the week solidly with a relatively neutral position from the Bank of England and no further changes to monetary policy. It’s hard to know what is in store for the UK with so many uncertainties around Brexit in terms of start date, duration and nature, with rumours of multiple stages and anywhere up to 10 years to complete. The key thing will be early in the New Year when we hear the verdict from the Supreme Court about whether the Prime Minister can instigate article 50 without a parliamentary vote.
Looking ahead to next year
There are no two ways about it is going to be an interesting year, some could argue it can’t possibly be more interesting than this, but many of the consequences of this year won’t be felt until next. The isolationism from Trump, the UK finally leaving, already starting to leave the EU, China struggling to maintain economic control while fighting a property boom and the inevitable tensions between the US, China and Russia. Even today I was reading that it is by no means a certainty that Donald Trump will become president as there are currently 30 of the 37 electoral college members needed currently saying they will refuse to support the voters decision. We see a US president installing cabinet members in government departments that they are diametrically opposed to as well as using Twitter as his primary method of political communication across the globe. It’s going to make for interesting times.
Written by Andi Thornton of tradetheforex.market
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