GBP/EUR 1.1857 (0.8434)
If we were to take our lead from risk markets, more specifically equities, it would appear markets do not expect the Fed to begin to taper tomorrow. There is no doubt that the recent sell off in equities was the result of some taper positioning but the lack of follow through in equity selling and in USD strength also supports this view. However, with thin liquidity and a relatively quiet pre-Christmas market tensions are likely to build into the release tomorrow evening, as the Fed decision has the ability to impact global markets, not just the US.
Stronger than expected data from both the Eurozone and US supported risk appetite yesterday. We mentioned in yesterday’s commentary that the Eurozone composite PMI was stronger than expected, lifted by stronger German manufacturing, whilst France continues to waiver and looks to be heading towards recession in Q4. Data from the US also lifted risk appetite as industrial production beat expectations posting growth of 1.1% versus .6% expected.
Again we cannot ignore the primary risk of the week and that is the FOMC who begin their two day policy meeting today. In our view there are three possible outcomes and all will require short term risk management. We spoke yesterday that any taper announced tomorrow will lift the USD into the year end, whilst no taper will likely see USD remain relatively neutral. Another concern to factor in is a change in the unemployment target for the US to begin raising rates.
The Fed are blue in the face pointing out that tapering is not tightening, simply slowing down the pace of loose monetary policy. Interest rates, if we are to believe their forward guidance, should not rise until unemployment hits (at least) 6.5%, should we see any change in this, possibly a shift to 6% then there is the risk of further USD weakness as the interest rate outlook for the USD shifts.
Away from the FOMC we have a host of economic releases from the UK, Eurozone and the US later in the day. UK inflation data is due in the form of CPI data with the year on year figure expected to remain unchanged at 2.2%, with a .2% rise expected in November. Looking at last month’s PMI data we would not be surprised to see an upside surprise in the CPI reading. Should this happen we are likely to see some short term GBP strength as higher inflation will put pressure on one of the BOE’s forward guidance caveats for tightening policy sooner than initially guided.
The Eurozone brings us the German ZEW economic sentiment survey, the ZEW Eurozone survey and also inflation data in the form of CPI. The German reading is expected to rise to the highest level in 3 months, especially following last month’s surprise interest rate cut. This may give the EUR a lift but given the rationale behind it follow through is likely to be lacking. The bigger concern for the EUR comes in CPI data, revised figures are expected to show November inflation held below 1%, with year on year Inflation at 1% (the ECB’s target is 2%). Whilst inflation remains subdued there is always a concern the ECB will remain dovish, and we will see continued calls for further policy easing from the ECB.