Markets look to Fed next week for guidance after ECB ends QE programme

Following my update on Monday, the ECB yesterday ended their QE programme, and as I suspected; in the process duly delivered a rather downbeat outlook and set of forecasts for next year. The impact of that hasn’t really showed up much in terms of the EUR yet. I think the main reasons for that might be due to the calendar and more likely due to the proximity of the FOMC policy decision next week on 19th.

Before I look at that in a little more detail a brief word about the pound and developments this side of the pond so far this week. Teresa May survived what many consider to be an ill timed challenge to her leadership from within her own party. Now some have been highly critical of those that delivered this challenge, but in the event it only wasted one more day and after all what difference did that make given the 2 ½ year tedium we have already had to endure?

The reasons for this coming to a head in the first place were simply down to May’s intransigence and failure to listen to anyone questioning her policy agenda. Perhaps rather ironic therefore that she is continuing to be met with similar intransigence over the channel.

What this has done is to narrow the potential outcomes on Brexit and certainly shortened the odds of a perceived ‘no deal’ and perhaps even potentially of no Brexit at all. The increased prospect of the latter is probably the main reason why the pound has rebounded back above 1.26 versus the dollar over the past 48 hours. Earlier in the week I did note that a breakdown through a key support area at 1.2660 could open a path to significantly lower levels.

Well, we did see that immediately play out at the start of the week as the price fell by around 2 cents to as low as 1.2475. So, it has rebounded as the week draws to a close, but it’s not yet out of the woods by any stretch. Having said that a close tonight above 1.2660 could open a path for a move back towards 1.30 again, but even if that does take place there will still be sellers looking for opportunity up there I think. I have made my views perfectly clear on where I think the price is ultimately headed in previous commentary, so I won’t repeat them again here. Meantime, we shall just have to see what, if anything the politics deliver ahead of the weekend.

Turning back to the main theme today and what the Federal reserve will or won’t deliver next Wednesday evening. The consensus is that the US central bank will raise rates by 25bp and that is surely still the most likely outcome. However, and as with the ECB yesterday, it's how they actually deliver that, and what exactly they indicate about future policy, that is more important for the markets now.

Of course, if by some chance the Fed doesn’t raise rates next week then the dollar is going to get immediately savaged. I think that’s a racing certainty given the current elevated position of the currency.

Notwithstanding that, and any short term relapse, the problem for the Fed is that they do need to get rates as high as possible and probably a little above neutral so that they can later react effectively to any downturn when it comes. All the signs now are that the end of the current economic cycle is getting ever closer.

The perversity of current monetary policy path is that; if continued it might actually expedite the end of that cycle. Leaving that irony aside, I have already noted in previous articles some of the potential outcome permutations for next week so I won’t repeat those again here.

What I can say with a fairly high degree of confidence is that I think the dollar is going to remain strong for the rest of this year and not necessarily due to anything that the Fed does or doesn’t do, assuming they don’t do anything of course.  The main reason for that rests with another central bank right now and how they are going to move forward. The ECB has made it perfectly clear yesterday that they think Europe is going to slow down next year and certainly given all the evidence I have seen I am not going to question that outlook.

Whilst the price action in the EURUSD has been tedious for the past few months, its failure to rebound back above 1.15 over that period speaks volumes I think and so all the time this continues, ahead of the year end, I think the chances of a further relapse, nearer to the 1.10 mark look very live to me.

Key economic releases due today

14/12-  1.30pm US November advanced retail sales