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Few Surprises from the FOMC

No surprises overnight as the FOMC did little more than confirm what we already knew; the economy is robust, but inflation is missing in action.

And while the FOMC was on everyone's radar, to be frank, other than tax reform uncertainty inspired position covering and sporadic bouts of profit taking the FX markets remain stuck in the muck, but that's about to change.

There's a lot of factors in play on Thursday with the BoE meeting and the House Republican tax announcement, and for all intensive purposes, the cat appears to be out of the bag as Jerome Powell is reported to be the next Fed Chair to smiles and congratulations by all those concerned.

The tax reform release will no doubt send traders into information overload as the complexities of this deal will probably challenge even the most astute Chartered Accountant.

On the economic front, investors largely overlooked a fresh cluster of data despite the ADP Employment report showing a forecast-beating increase of 235,000 jobs (which was well above the forecast for a 200,000 rise). The dollar did get a small bump. but with bigger fish to fry, few were in the mood to push the greenback higher. But if anything can be gleaned from overnight price action is that a combination of robust data and a cheery Fed has resulted in a modest gain in US equity markets and a small bounce in USD sentiment.

The British Pound

The BoE is likely hike interest rates but will probably struggle to promote any market expectations to reprice more hikes in for 2018 given uncertainty about Brexit. Regardless , the market remains tentatively bullish on GBP on the rate differential curve while betting on a cleaner Brexit divorce proceeding heading into year-end.

The Euro

Activity on the EURUSD was remarkably tame again.The anticipated USD follow through demand after the dovish ECB taper has failed to materialise, and with few surprises from the FOMC conviction, one way or the other trade remains hugely muted. I suspect traders will continue to respect the current ranges.

The Japanese Yen

The markets remain guardedly optimistic that the tax reforms will be in place by Christmas while traders discount the possibility of phasing in of tax changes on the assumption that something is better than nothing, In addition, the markets are hanging their hat on the fact that with no change in Abe's cabinet it supports pro-economic growth policies to remain intact. Without sounding like a broken record, the long USDJPY trade continues to look favourable.

The Australian Dollar

Trade balance later today is expected to come out lower but for the most part, the Aussie should remain parked in Neutral until Fridays retail sales but with traders eyeing next weeks RBA and the real possibility of stronger worded dovish guidance, the AUD remains in a state of heightened vulnerability.

Information received since the Federal Open Market Committee met in September indicates that the labor market has continued to strengthen and that economic activity has been rising at a solid rate despite hurricane-related disruptions. Although the hurricanes caused a drop in payroll employment in September, the unemployment rate declined further. Household spending has been expanding at a moderate rate, and growth in business fixed investment has picked up in recent quarters. Gasoline prices rose in the aftermath of the hurricanes, boosting overall inflation in September; however, inflation for items other than food and energy remained soft. On a 12-month basis, both inflation measures have declined this year and are running below 2 percent. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Hurricane-related disruptions and rebuilding will continue to affect economic activity, employment, and inflation in the near term, but past experience suggests that the storms are unlikely to materially alter the course of the national economy over the medium term. Consequently, the Committee continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace, and labor market conditions will strengthen somewhat further. Inflation on a 12-month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee's 2 percent objective over the medium term. Near-term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely.

In view of realized and expected labor market conditions and inflation, the Committee decided to maintain the target range for the federal funds rate at 1 to 1-1/4 percent. The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.

The balance sheet normalization program initiated in October 2017 is proceeding.

Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Charles L. Evans; Patrick Harker; Robert S. Kaplan; Neel Kashkari; Jerome H. Powell; and Randal K. Quarles.

BoE Has Prepared Markets For a Rate Hike, Will it Deliver?

On Thursday, the Bank of England is widely expected to do something that a large group of people will never have experienced, raise interest rates.

For the first time in a decade and the first since the global financial crisis, policy makers will discuss the merits of a rate hike in a bid to prevent inflation moving too far above target. Or at least, that's what we're being told despite the acknowledgement that higher inflation is almost entirely down to the one-off currency depreciation that occurred since the Brexit referendum last year.

Inflation reached 3% in September, far above the central bank's 2% target and at the top of the range that the government deems acceptable before Governor Carney must write a letter to the Chancellor explaining why the central bank is failing to achieve its mandated target.

Interestingly, this is also around the level that the central bank expects inflation to peak at which begs the question why they've waited so long to raise interest rates. Also, why do they now deem it to be the right time to do so before we have a chance to find out how far it will fall again once the initial impact of the currency move falls out of the calculation?

If Inflation is Above Target, Why is a Rate Hike So Controversial?

As is to be expected in post-Brexit Britain, the decision on whether or not to raise interest rates is far from straightforward. This is clearly evident when listening to one of Carney's press conferences or appearances before the Treasury Select Committee, as well as in the rhetoric from his colleagues on the Monetary Policy Committee.

Not only does the inflation data and outlook not necessarily warrant a rate increase but the uncertain economic outlook muddies the water even further, which explains the divide on the committee.

It's quite clear that the economy has slowed since the vote last year, with the country falling from the top of the G7 growth table to the bottom in the first half of the year. Employment may have remained strong for now but with real wage growth having turned negative and spending slowed, it's clear that the economy is stalling which begs the question, is it really the correct time to raise interest rates?

The argument for the hawks on the MPC is that the economy hasn't slowed as much as was feared in the months after the referendum - partly due to the actions it took - and so a reversal of the rate cut in August 2016 makes sense.

While this hasn't been acknowledged by policy makers, there may also be a case that the BoE took a risk when cutting interest rates last year, taking base rate below the level that for the seven years previous was deemed to be the lower bound. Perhaps this is no longer seen as being a risk worth taking.

If this is the case then the BoE may refrain from committing to, or even hinting at, further rate hikes in the foreseeable future, which you would expect if this was in fact the beginning of a tightening cycle. Instead it may opt for the ECB approach of data dependent decision making. In other words, the less we know the better.

How Will Markets React to a Rate Hike?

Despite the divisions that we've seen within the MPC and the fact that the decision appears far from straightforward, investors are almost entirely convinced that the BoE will raise interest rates tomorrow. In fact, according to Reuters, a rate hike is almost 90% priced in. That would suggest to me that a rate hike alone won't be enough to lift the pound or UK yields too much. A change of heart on the other hand could deal a big blow to both, not to mention the central banks credibility.

How the pound trades - and the FTSE for that matter, don't forget the inverse correlation that the two share - in the aftermath of the decision will likely depend on the minutes, economic projections and press conference that accompanies the decision.

GBP Currency Index vs FTSE 100

Source - Thomson Reuters Eikon

Any indication that more rate hikes are planned for next year could trigger a sharp rally in the pound as I'm not convinced this is currently priced in, while anything else may weigh on the currency once the initial volatility - of which I expect a lot - has passed.

Super Thursday may for once live up to its name and I'm sure markets will be very sensitive to what policy makers have to say about the path of interest rates going forward, whatever the decision. Given the range of outcomes that we could see tomorrow, UK markets could get extremely volatile and the upside and downside potential should not be underestimated.

A hawkish rate hike from the BoE could see GBPUSD blow through 1.33 and see 1.36 being tested once again while no rate hike could see 1.30 severely tested, the success of which may depend on whether the increase is slightly delayed or postponed. In the case of the latter, I wouldn't be surprised to see 1.28 tested in the not-too distant future.

Gold has posted gains in the Wednesday session. In North American trade, the spot price for an ounce of gold is $1277.20, up 0.47% on the day. On the release front, ADP Nonfarm Payrolls surged to 235 thousand, crushing the estimate of 202 thousand. On the manufacturing front, ISM Manufacturing PMI slowed to 58.7, missing the forecast of 59.5 points. Today's highlight is the FOMC rate statement, with no change expected in the benchmark interest rate. On Thursday, and the US will publish unemployment claims.

Will the Federal Reserve rate statement move gold prices? The Fed is widely expected to maintain the benchmark rate at 1.25%, but the statement could provide clues about future rate policy. The markets have priced in a December rate at 98.5%, which would mark a third rate for 2017. What can we expect in 2018? That depends to a large degree on the new chair of the Fed. Janet Yellen will wind up her 3-year term in February, and she is not expected to be reappointed by President Trump. The front runner is economist Jerome Powell, who is a proponent of much higher rates – his "Taylor Rule", which calls for higher rates when inflation is high or the labor market is at full capacity. Trump is expected to make his choice on Thursday, ahead of his trip to Asia.

The US consumer remains optimistic about the economy, and that confidence has translated into stronger spending. CB Consumer Confidence jumped to 125.9 points, and last week's UoM Consumer Sentiment climbed to an all-time high of 100.7 points. Personal spending gained 1.0% in September, its sharpest gain since April 2016. The strong reading comes on the heels of Friday's UoM Consumer Sentiment Report, which hit an all-time record in September. Consumer spending is a key driver of the economy, accounting for two-thirds of economic growth.

The Bank of England is expected to raise rates for the first time in a decade on Thursday. Bank policymakers are in a quandary with regard to rate policy. Inflation is running well above the Bank's target of 2 percent, which has eroded consumer spending. As well, a labor market that is close to capacity is a reason in favor of raising rates. However, economic growth has slowed and there are fears that Brexit will take a toll on the British economy. The deadlock in the Brexit negotiations has done nothing to calm these concerns, as investors and the business community are becoming increasingly frustrated with the government's lack of a coherent policy regarding Brexit. At the end of the day, a quarter-point rate hike should not have a huge effect on the economy, but the psychological significance of the move could boost the pound against other assets, including gold.

The British pound has posted slight losses in the Wednesday session. In North American trade, GBP/USD is trading at 1.3266, down 0.20% on the day. On the release front, British Manufacturing PMI improved to 56.3, above the estimate of 55.8 points. In the US, ADP Nonfarm Payrolls surged to 235 thousand, crushing the estimate of 202 thousand. On the manufacturing front, ISM Manufacturing PMI slowed to 58.7, missing the forecast of 59.5 points. Today's highlight is the FOMC rate statement, with no change expected in the benchmark interest rate. On Thursday, the Bank of England is expected to raise interest rates to 0.50%. The UK releases Construction PMI and the US will publish unemployment claims.

Central banks are in focus this week, beginning with the Federal Reserve later on Wednesday. The Fed is widely expected to maintain the benchmark rate at 1.25%, but the rate statement could provide clues about future rate policy. The markets have priced in a December rate at 98.5%, which would mark a third rate for 2017. With a December rate hike a given, barring a meltdown in the US, what can we expect in 2018? That depends to a large degree on the new chair of the Fed. Janet Yellen will wind up her 3-year term in February, and she is not expected to be reappointed by President Trump. The front runner is Jerome Powell, who would likely follow Yellen's current policy of gradual, incremental rates. Another candidate is economist James Taylor, who is a proponent of much higher rates – his "Taylor Rule", which calls for higher rates when inflation is high or the labor market is at full capacity. Trump is expected to make his choice on Thursday, ahead of his trip to Asia.

The BoE will take center stage on Thursday, but unlike the Fed, the BoE is expected to raise rates at its policy meeting. A rate hike of 25 basis points would raise rates to 0.50%, and would mark the Bank's first rate increase since 2007. Investors have stayed on the sidelines on Wednesday, and shrugged off a strong Manufacturing PMI, which could have been a catalyst for purchasing pounds. Bank policymakers are in a quandary with regard to rate policy. Inflation is running well above the Bank's target of 2 percent, which has eroded consumer spending. As well, a labor market that is close to capacity is a reason in favor of raising rates. However, economic growth has slowed and there are fears that Brexit will take a toll on the British economy. The deadlock in the Brexit negotiations has done nothing to calm these concerns, as investors and the business community are becoming increasingly frustrated with the government's lack of a coherent policy regarding Brexit. At the end of the day, a quarter-point rate hike should not have a huge effect on the economy, but the psychological significance of the move could boost the pound against the US dollar.

The Federal Reserve is also in focus this week, with the release a rate statement on Wednesday. The Fed is not expected to raise rates, so analysts will be combing through the rate statement, looking for clues about future rate moves. The markets have priced in a December rate hike at whopping 96 percent, and the markets are focusing on what the Fed has planned for 2018. This will depend, of course, on the new head of the Fed, who will take over from Janet Yellen in February. The two front-runners, John Taylor and Jerome Powell, have very different stances on monetary policy, which has created some suspense ahead of President Trump's nomination. Trump is expected to choose the new head before departing for Asia at the end of the week. Powell is expected to continue Yellen's incremental approach to raising rates, while Taylor is a proponent of much higher rates, as underscored in his "Taylor Rule", which calls for higher rates when inflation is high or the labor market is at full capacity.

The prevailing risk-on mood ahead of key risk events in the next few days lifted the US dollar and weakened the yen in European trading on Wednesday. Upbeat economic data also boosted the greenback along with the British pound. The aussie and kiwi were other notable gainers, while the euro joined the yen in being the day's worst performers.

Manufacturing PMI out of the UK was the main data release in Europe. The index rose from an upwardly revised 56.0 in September to 56.3 in October, beating expectations of a fall to 55.8. The solid data reinforced expectations that the Bank of England will raise rates on Thursday, especially as, apart from stronger manufacturing growth, the IHS Markit report showed input and output prices also accelerated in October.

The pound extended its gains, climbing to a near three-week high of $1.3319 before settling around $1.3290 in late European trading. It was also up sharply against the euro, rising to a 4½-month high of 0.8730 pounds per euro. Reports that the European Union is ready to intensify the Brexit talks with the UK had lifted the pound earlier in the day, but the British currency remains vulnerable to downside moves if the Bank of England decides against raising rates when it concludes its two-day monetary policy meeting tomorrow or delivers a dovish hike.

Prior to the BoE's decision tomorrow the Fed will announce the outcome of its policy meeting at 18:00 GMT. The Fed is expected to keep rates unchanged despite growing signs that the US economy is gaining momentum, as it waits for inflation to recover from a soft patch. However, the FOMC statement will likely signal a December rate hike, although the event has been overshadowed by the highly anticipated choice of the next Fed chair. President Trump is due to reveal tomorrow his nominee to replace Janet Yellen when her term expires in December.

Another major dollar event tomorrow is the unveiling of the tax bill by House Republicans, while the ongoing investigation into Russian collusion with the Trump election campaign team poses a threat to the current risk-on sentiment following the first charges being filed this week against three of Trump's former aides.

In the meantime though, the dollar advanced higher on the back of more positive indicators out of the US. The ADP report on private-sector employment showed 235k jobs were added last month as US employers hired more workers after the disruption from the hurricanes in September. This compares with a downwardly revised figure of 110k in the prior month and forecasts of 200k. The strong number comes ahead of Friday's official nonfarm payrolls report.

The greenback hit a session high of 114.27 against the yen after the data but fell back towards the 114 level after the ISM manufacturing PMI missed expectations. The ISM's manufacturing gauge had hit a 13-year high of 60.8 in September but slipped to 58.7 in October, coming in below forecasts of 59.5. In contrast, the Markit manufacturing PMI improved during the month, rising from 53.1 to 54.6 in October's final reading.

In other currencies, the euro struggled for direction, falling against most of its major peers. The single currency was last trading at 1.1633 versus the dollar and at 132.65 versus the yen.

The Australian and New Zealand dollars held their ground against the resurgent greenback, with the aussie extending its gains to $0.7691, but the kiwi eased slightly from its earlier highs to around $0.6900. The Canadian dollar was flat, finding some support from surging oil prices after yesterday's surprise drop in Canadian GDP during August further dented expectations of additional rate hikes by the Bank of Canada in the near term. Dollar/loonie last stood at C$1.2877, not far from last week's 3½-month high of C$1.2916.

Crude oil prices enjoyed another day of gains, reaching fresh highs, boosted by strong compliance by OPEC members in October to the output deal. WTI crude hit a 10-month high of $55.22 a barrel, while Brent crude scaled a more than two-year high of $61.70 per barrel. There was little reaction to the latest US inventories data.

The EIA's weekly report showed a bigger-than-expected drawdown of 2.435 million barrels of crude stocks. Gasoline stocks also fell by more than forecast but distillate stocks dropped by less than expected.

Gold prices rebounded sharply today to briefly top the $1280 level amid some investor caution ahead of tomorrow's announcement on the new Fed chair. The precious metal was last trading 0.5% up on the day at $1277 an ounce. Other metals also performed well, with copper jumping 1.1% to $3.1265 a ton on hopes of higher Chinese demand, and nickel prices soared to a two-year high to break above $13,000 a ton, driven by rising demand for lithium batteries used in electric cars (of which nickel is a key component).

Manufacturing activity moderated slightly in October with the ISM index shedding 2.1 points off its September high. The underlying details are encouraging and signal continued strength in the factory sector.

Despite Modest Retreat in Headline, Production Remains Strong

The ISM manufacturing index retreated ever so slightly in October, losing 2.1 points to post a still solid figure of 58.7. The composite index is coming off a cycle high of 60.8 and continues to signal firmness in the manufacturing sector. As effects from the recent hurricanes fade from the data, we can get a more accurate read of how the manufacturing sector is performing.

While the majority of the index's subcomponents experienced a negative monthly change, the details are still encouraging. The production subcomponent lost 1.2 points but remains above 60.0, and has done so for 5 consecutive months. Likewise, the new orders component lost 1.2 points but posted a 63.4 reading, suggesting that future orders will remain strong in the coming months (top graph). This marks the 14th consecutive month of new orders growth.

Despite the 0.5 point decline in the employment subcomponent, hiring in the manufacturing sector continues to exhibit strength (middle graph). Of the 18 manufacturing industries, 15 reported employment growth in October. Friday's employment report will provide us with more detailed figures of the actual number of hires. We look for the factory sector to add to payroll growth in Friday's employment report.

Law of Supply Chain Disruptions

A line item that has perhaps not yet escaped the hurricanes' power is the supplier delivery component. Last month, supplier deliveries jumped 7.3 points to 64.4, reflecting storm disruptions from the Gulf area that caused delivery times to lengthen (bottom graph). The 3.0 point decline in October represents a partial normalization of the delivery supply chains. However, the 61.4 reading still remains elevated above its 6-month average of 55.1. We expect this component to continue to moderate in the coming months as businesses are able to return to their normal delivery schedules.

The inventory index came in at 48.0, a 4.5 point decline from September and is firmly below its 6-month average. The contraction partially reflects the supply chain disruptions, which has made it difficult for companies to deliver materials on their scheduled times. Customer inventories registered 43.5 in October, representing a 1.5 percentage point increase from September, indicating that customers' inventory levels are still considered too low.

Another area where hurricane effects were still lingering was in prices. Although the prices paid index fell to 68.5 in October, the index is still at elevated levels. Prices for raw materials have now increased for 20 consecutive months.

Construction spending rose 0.3 percent in September but outlays for August were revised lower and now show a gain of just 0.1 percent, compared to the initially reported 0.5 percent rise.

Longer-Run Trends Show Only a Slight Hint of Improvement

Overall construction spending rose slightly more than expected in September but the larger gain was largely due to a downward revision to the prior month's data. The monthly data are extremely volatile and the initially reported figures are often revised substantially. Moreover, deviations due to sampling error are typically much larger than the reported monthly change in the series.

The September data were likely impacted by the hurricanes, which disrupted building activity in Texas, Florida and some other parts of the South during August and September. Hurricane damages may have boosted public construction spending. Total public construction outlays rose 2.6 percent in September, with spending for power projects jumping 11.0 percent and outlays for conservation and development surging 12.6 percent. That latter category includes outlays for dams, levees and jetties. Spending for highway and street projects rose 1.1 percent during the month and spending for transportation projects rose 5.0 percent. Public spending for all of these categories remains down year-to-year, however, which is a testament to the sustained drag that government spending cuts have placed on overall construction spending and the economy.

Within public construction spending, outlays for state and local government projects rose 2.5 percent, while outlays for federal projects increased 3.4 percent. That marks the first increase for federal government construction spending since May and is only the second increase in the past six months. We like to utilize a 12-month change of a 12-month moving average for both series, which smooths out much of the monthly volatility. On this basis, state and local government spending is the weak spot, with outlays down 3.5 percent year-to-year. Federal government outlays are essentially flat on this basis.

Overall construction spending in the private sector fell 0.4 percent in September, with spending on nonresidential projects falling 0.8 percent and spending for residential construction unchanged. Oddly enough, spending for both single-family and multi-family construction rose modestly in September, climbing 0.2 percent and 0.6 percent, respectively. Spending on home improvements tumbled 0.6 percent, however. We expect to see that drop reversed in coming months, as homes are repaired following the recent hurricanes.

Private nonresidential construction has seen persistent weakness with reduced spending for manufacturing projects accounting for much of the recent slide. Within manufacturing, most of the drop has been in construction of new petrochemical facilities, which had surged around the middle of the decade but have pulled back considerably in recent years.

USD/CHF - 1.0009

Most recent candlesticks pattern : N/A

Trend                                    : Up

Tenkan-Sen level                  : 1.0004

Kijun-Sen level                    : 0.9994

Ichimoku cloud top                 : 0.9987

Ichimoku cloud bottom              : 0.9970

Original strategy :

Buy at 0.9980, Target: 1.0080, Stop: 0.9945

Position : -

Target :  -

Stop : -

New strategy  :

Buy at 0.9980, Target: 1.0080, Stop: 0.9945

Position : -

Target :  -

Stop : -

As the greenback has continued moving higher after breaking indicated level at 1.0000, suggesting the pullback from 1.0038 has ended at 0.9938 and a retest of this level would be seen, break there would confirm recent upmove from 0.9421 low has resumed and may extend further gain to 1.0050-55, then towards 1.0075-80 but price should falter below 1.0100 resistance.

In view of this, we are looking to buy dollar again on pullback as 0.9975-80 should limit downside, bring another rise later. Below 0.9960 would prolong consolidation and risk weakness towards support at 0.9938, however, reckon downside would be limited to 0.9920-23 (38.2% Fibonacci retracement of 0.9737-1.0038) and 0.9885-90 (50% Fibonacci retracement) should remain intact. 

GBP/USD - 1.3268

Most recent candlesticks pattern   : N/A

Trend                                 : Near term up

Tenkan-Sen level                 : 1.3286

Kijun-Sen level                    : 1.3280

Ichimoku cloud top              : 1.3219

Ichimoku cloud bottom        : 1.3167

New strategy  :

Stand aside

Position : -

Target :  -

Stop : -

As cable surged and broke above indicated previous resistance at 1.3279-87 earlier today, suggesting early erratic rise from 1.3027 low is still in progress and near term upside risk remains for this move to bring retracement of early decline towards resistance at 1.3338, however, as broad outlook remains consolidative, reckon upside would be limited and price should falter below 1.3380-90, bring retreat later.

In view of this, would not chase this rise here and would be prudent to stand aside for now. below 1.3245-50 would bring pullback to 1.3215-20 but only break of minor support at 1.3196 would signal top is formed, bring further fall to 1.3170.