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Investors ponder US inflation outlook - AM Briefing
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Investors ponder US inflation outlook

Early moves

Mixed start for European indices

Wall Street closes off highs

It’s been a mixed open for European equities so far this morning. This follows another positive close on Wall Street, even though the US majors pulled back sharply to end well below their intra-day highs.

Investors now have to decide how to play the last fortnight of an extraordinary year – one which has been topped and tailed by US rate hikes following a ten year period of relentless easing. It’s worth remembering what a grim start to 2016 we had with markets in melt-down. Many blamed the Fed’s rate hike. However, there was also an unexpected Chinese yuan devaluation, stress in the high-yield bond market followed on by the Bank of Japan shocking everyone by adopting negative interest rates.

This time it’s different, but perhaps no less dangerous. Certainly, investors are falling over themselves to load up on US equities and the dollar is trading at multi-year highs. But there are very real fears that Donald Trump’s promised fiscal stimulus is coming at just the wrong time as the US unemployment rate is at pre-crisis lows and inflation is picking up. The worry is that the Fed finds itself “behind the curve” and is forced to tighten more aggressively than is currently being priced in. At the same time, if the market gets the feeling that Trump won’t get his stimulus measures through Congress then there’s every reason for the post-election rally to unwind.

Stock Index Update

US indices pull back from intra-day highs

Investors ponder US inflation outlook

Global stock indices were steadier in early trade yesterday following a US-led sell-off on Wednesday night. Investors were busy reassessing their outlook for equities given the Fed’s more hawkish than expected outlook for monetary policy for next year and beyond. The Fed’s FOMC forecast 75 basis points worth of increases next year which was more than the 50 basis points it forecast back in September. But it wasn’t just this slight upward adjustment to the interest rate outlook which had such an effect. Investors were viewing this in the context of president-elect Donald Trump’s campaign promises. Trump’s commitments to cut taxes, boost infrastructure spending and slash regulation are all pro-growth, pro-inflation examples of fiscal stimulus which the Fed has previously asked for from policymakers. However, with unemployment at a seven year low of 4.6% and inflation picking up there are fears that unleashing these measures now could cause the US economy to overheat. If inflation expectations pick up sharply and bond yields rally in response then this could destabilise equity markets.

Commodities Update

WTI breaks below $52

Gold and silver slump on dollar rally

Crude oil fell sharply in early trade yesterday, following on a move which began at the beginning of the week. On Monday both WTI and Brent hit their highest levels since July 2015 as prices continued to benefit from promised output cuts from OPEC and non-OPEC producers. However, they suddenly turned lower as investors rushed to take profits on concerns that the world’s major producers would be unable or unwilling to follow through on their commitments. It also seemed likely that US shale oil drillers would quickly ramp up production to capitalise on higher prices. Crude lurched lower again as the latest US inventory data from the American Petroleum Institute (API) showed bigger-than-expected increase in crude inventories. Then OPEC released a report predicting that the oil market wouldn’t rebalance until the second half of 2017, some months later than the IEA’s report the previous day. Crude managed a brief rally after the US Department of Energy showed a bigger-than-expected inventory drawdown, but sold off after the Fed released its hawkish outlook for rate rises next year. WTI has now broken back below the key technical level of $52 per barrel. If it fails to recapture this level over the next few days then it could be set for a more significant pull-back.

Wednesday night’s Fed rate hike and overall “hawkishness” appear to be the final nails in the coffin for precious metals this year. While both have managed to rally a touch in early trade this morning, buyers are wary of stepping back in having had their fingers burnt repeatedly over the past six months. It seems strange now to think back to the summer when gold and silver were amongst the best performing assets in the first half of 2016. Yesterday gold broke below $1,130 to hit levels last seen in early February this year and it’s hard to see anything, other than a sudden collapse in the dollar, which can prevent it from falling further. It’s difficult to pinpoint any decent levels of support between current levels and the multi-year low of $1,050 hit this time last year.

Silver also appears to be breaking down too. The metal seemed to be building a decent floor of support just above $16 per ounce. Silver had held up better than gold following Trump’s surprise election victory (and proposed infrastructure spending proposals) due to its many industrial applications. But yesterday silver broke below $16 which suggests that, without a sharp recovery, a move to $14 can’t be ruled out.

Forex Update

Dollar soars as Fed indicates more rate hikes ahead

EURUSD plunges to near 14-year low

The dollar soared on Wednesday night following the US Federal Reserve’s monetary policy meeting. As has been covered earlier, investors were spooked by the FOMC’s “dot plot”. This pointed to more aggressive monetary tightening from the central bank than previously factored in to FX. The dollar continued to rally throughout yesterday’s session. This move saw the EURUSD crash to a near 14-year low of 1.0366 after it broke below support just under 1.0500 - the low from March 2015. The break of this level suggests that a retest of parity could finally be on the cards. It certainly appears that the US economy is diverging significantly from the Euro zone economy. This means that the US Federal Reserve is considering the implications of a pick-up in growth and inflation while the ECB struggles with a deflationary environment and a troubled banking system. Just last week the ECB extended its bond purchase programme, even though it also attempted to put the idea of tapering into investors’ heads. It’s also worth bearing in mind that the Bank of England cut rates at the end of the summer even though the UK has year-on-year GDP growth of 2.3%, well above the US’s 1.6%.

The dollar posted strong gains against all the majors. However, the dollar’s move against the Japanese yen over the past 5 weeks has been stunning. The greenback has rallied over 17% in the five weeks since the presidential election.

Upcoming events

Today’s significant economic data releases and events include the Euro zone’s Trade Balance and CPI. From the UK we have the Bank of England’s Quarterly Bulletin and CBI Industrial Orders Expectations. From the US we have Building Permits and Housing Starts.

Disclaimer:

Spread Co is an execution only service provider. The material on this page is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by Spread Co Ltd or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

 

Posted by David Morrison

Tagged: AM Bulletin

Category: AM Bulletin


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