The big move in markets this morning has been the oil price which has surged 5% following an agreement by non-OPEC oil producers to help curb output. With UK inflation at 2 year highs and trending higher, it will be interesting to see if the recent rally in oil prices elicits any comments in the minutes that will be released following the MPC’s meeting this week. No change in UK rates is expected but with the economy stabilising after the referendum vote and cost push inflationary pressures building, this is a subject that may well gain in importance over the coming months.
This week, we have a FOMC meeting in the US and the market has close to a 100% probability of a rate hike built in. With Trump advocating supply side stimulation for an economy that is already growing relatively strongly, the markets have taken a view that the Fed will need to continue to tighten in 2017 as inflationary pressures build. Consequently, yields on the benchmark 10 year US treasuries have broken through the 2.5% level for the first time since October 2014, and 5 year US swap rates are at 1.9%- up from 1.25% when the presidential election took place. Supply side stimulus and trend inflation are generally positive for equity markets and, so it is the case in the US where the Dow rallied another 2.5% in the tail end of the week to close at 19,756- another all-time high.
Sterling has had a pretty good run over the past few weeks and briefly broke through 1.20 last week. It has already traded above Friday’s high of 1.1945. The post referendum high is 1.2266 and sterling looks capable of testing that level again. Normally, liquidity disappears from FX markets over the past couple of weeks of the year and range-trading dominates and in that scenario, it would be difficult to see a break of 1.2266 before January. However, the ongoing travails in the Italian banking sector could be the catalyst for a break. There is some speculation that Unicredit will come to the market looking to strengthen its capital base with a rights issue for €13b before the year end and Monte Dei Paschi is also looking to recapitalise before the end of the year after the ECB rejected its request to delay until mid-January its requirement to raise up to €5m in new capital. A state bail-out of the bank will force losses on retail junior bond holders and would be politically sensitive in Italy at a time when the pro-Europe government is already reeling from its own referendum defeat.