GEMFOREX - weekly analysis

We are about to enter a crucial week for the FX and international asset markets. The US November CPI number and the FOMC meeting on Wednesday are the two major event risks. As investors consider how high the Fed will raise rates and how long it will keep them there, both will be important pieces of the puzzle.

Uncertainty reigns before the announcements, which contrasts with what investors have experienced for most of the year. Despite the most recent macroeconomic data allowing for a further 75 bps rise, the US Federal Reserve has indicated it would reduce the pace of tightening and is projected to deliver a 50-bps rate hike. On the other hand, European officials made hints about a probable 75 bps increase, although a more moderate 50 bps increase seems more plausible.

According to current market predictions, rates will rise by half a point this month and then again in the early part of the next year, when they will reach 4.85%. After that, the Fed is anticipated to remain silent for a while before lowering interest rates before the end of the year. Their actions stoked rumors that the Fed might act similarly, which Jerome Powell, the chairman of the Fed, later refuted. Speaking last week at the Hutchins Center, Powell said that gradual tightening may start as early as December of this year, but he also cautioned that until significant signs of progress on inflation appear, monetary policy is likely to remain restrictive for some time.

Economic indicators support this story. Even while consumption and the labor market are currently doing well according to official US data, disaster is on the horizon, according to forward-looking indications. Since inflation is still high, the Fed must continue its current course for the time being, but by the middle of next year, growth issues are expected to arise.

Data-wise, the United States has shown some promising indicators. In November, the ISM Services PMI increased to 56.5 against a predicted decline of 54.4. The Goods and Services Trade Balance showed a deficit of $78.2 billion in October, above market forecasts, while factory orders increased by 1%. Finally, November saw a decrease in wholesale inflation as the Producer Price Index (PPI) increased at an expected annual rate of 7.4%. The core value dropped from 6.7% to 6.2%, just above the 6% predicted.

There is a feeling that the tightening cycle is going to end in Canada. A quarter-point rate increase for this Wednesday has already been fully priced into the markets; it is anticipated to be repeated next month until the Bank of Canada permanently exits the market.

The BoC is being cautious due to the idea of policy delays because the full effect of the rate rises that have already been implemented has not yet been felt. The authorities fear that, if they proceed, they may trigger a financial “accident” given the beginnings of a property bubble and the excessively elevated levels of private debt.

In Europe, Ursula von der Leyen, president of the European Commission, suggested the ninth set of sanctions on Russia after deciding with the G-7 partners to impose a price cap on Russian oil earlier this month at $60 per barrel. Additionally, bottlenecks between the Black Sea and the Mediterranean have been brought on by new Turkish insurance regulations governing oil tankers arriving from Russia. The last week saw a slight decline in crude oil prices, which relieved some pressure on European energy prices. Moscow has however predicted that it is putting together a response to the most recent sanctions, and prices may rebound, escalating inflationary pressure in the Euro Area.

The Euro Area provided conflicting signals. The November PMIs were revised downward by S&P Global, pointing to a worse decline in the economy. Retail sales decreased by 2.7% YoY and 1.8% MoM in October. Positively, the Gross Domestic Product Q3 estimate shows that GDP increased by 0.3% in the three months leading up to September, which is more than the 0.2% anticipated.

On the other side of the world, most of the Australian economy is still operating at full capacity, which will lead to another rate increase when the Reserve Bank closes its meeting early on Tuesday. Since the RBA's last meeting, the economy has improved. The labor market is still incredibly tight, and the unemployment rate has returned to a 50-year low. In the meantime, last quarter saw a surge in wage growth, which is typically an indication that inflationary forces are solidifying.

Financial markets have also been impacted by fears of a worldwide recession. The majority of the main market indices ended the week in the red, with only modest losses, but nevertheless displaying investors' uncertainty about what will happen next. The announcements made by central banks next week might provide some clarity, but they are unlikely to allay recession-related anxieties.

During this week, along with statements from central banks, we will expect the German Harmonized Index of Consumer Prices (HICP), which is projected to increase by 11.3% YoY in November, and the US Consumer Price Index for the same month, which is projected to increase by 7.7% YoY, will both be released in the upcoming week. Later, the US will present November retail sales data, while the EU will present November inflation data.

Forecasts for the Gross Domestic Product (GDP) growth shown in the dot plot will also catch the attention of investors. The US dollar could be harmed by a large lower revision to the 2023 growth prediction, while a figure close to the September projection could have the opposite impact. If some policymakers predict a recession for next year, the US Dollar sell-off is expected to gain momentum as market investors wonder whether the Fed can afford to continue its tightening path.

The US economic calendar will include statistics on retail sales on Thursday before S&P Global releases its preliminary December Manufacturing and Services PMI readings on Friday. However, given that investors are awaiting the Fed's statement on policy, it is unlikely that these statistics would cause a significant market reaction.

It is also important to keep in mind that the Bank of England and the European Central Bank will also be releasing policy decisions on Thursday. A dovish stance from the ECB or the BOE might underline the policy divergence and pave the way for fresh US Dollar strength even if the Fed leads the US Dollar to decline.