Daily Market Brief 12 October 2017

Rate Hopes Outweigh Brexit, for Now

October 12th: Highlights

  • First talk of planning for “no deal” Brexit
  • Rate hike still market’s base case
  • U.S. inflation data key to FOMC decision

Budget to plan for “all possibilities”

U.K. Finance Minister Philip Hammond addressed Parliament yesterday to provide advance guidance on his Autumn Budget which will be delivered next month. On Brexit he said it was too early to start to plan for the “nightmare scenario” of a no-deal Brexit and funding for that couldn’t or wouldn’t be provided until the last minute.

Hammond’s boss, Prime Minister Theresa, commented later that funding would be available for whatever the final deal involves. The pound remained close to its recent lows since, as far as Brexit is concerned, most of the bad news is in the market and traders await significant developments, good or bad, before adjusting their positions. The pound has developed a certain immunity to speculation about what the final deal will look like. Given the complete lack of progress since talks began, no matter what David Davis or Theresa May say in public, whatever the departure looks like it is the effect on the economy and monetary policy that concerns traders and investors.

David Davis and Michel Barnier will today sum up the current state of negotiations as the fifth-round ends. There has been remarkably little given away as the talks have continued but a breakthrough is extremely unlikely.

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Rate hike expectations still base case scenario

There is almost an air of “if they don’t do it now, they may not get another chance” around the chances of the MPC raising rates at next month’s meeting. Next week’s inflation and employment reports will be crucial in the decision as will the Quarterly Inflation Report. In similar fashion to the U.S. employment report, the headline unemployed figure will be largely ignored as traders look for signs of wage inflation which will probably “seal the deal”.

Inflation is the key to the decision. If headline inflation breaches 3%, a peak which was anticipated in next month’s report a hike is likely. However even if prices don’t breach that “line in the sand” signs of a higher rate of growth in wages will also be a trigger for MPC members.

There is no “normal” any more since Central Bankers acted so unconventionally to deal with the effects of the financial crisis. Even so, hiking rates at such a precarious time both politically and economically will only be able to be judged in the fullness of time and with the benefit of hindsight. The motive for any rate hike is lost on the market but whether it happens or not, Sterling could be fragile in the aftermath.

U.S. Rate Hike also hinge on inflation data

Forget, jobs, trade or any of the other traditional drivers of monetary policy, in the new post-crisis world, it is inflation that drives central bank policy. Whether it is the BoJ, ECB, BoE or Fed, there is close to alarm that the flooding of their economies with cash hasn’t led to (apart from the U.K) runaway inflation. It will doubtless be the subject of any number of future theses but for now, the desire to withdraw stimulus and normalize rates is strong.

However, the question is why? The financial crisis heralded a new era for the global economy. Globalization had led to the domino effect of the crisis spawning global banks considered too big to fail.

Growth is returning albeit slowly and following yesterday’s release of the minutes of the latest FOMC meeting, the lack of inflation concerns some members leading to doubts about a hike in December.

Therefore, today and tomorrow’s reports on producer prices (today) and consumer prices (tomorrow) are vital to the discussion. Lael Brainard, a well-known dove on the FOMC, will speak later today. She will most likely reiterate her concerns over inflation and this could lead to a softening of the expectations for December’s FOMC

Have a great day!

About Alan Hill

Alan has been involved in the FX market for more than 25 years and brings a wealth of experience to his content. His knowledge has been gained while trading through some of the most volatile periods of recent history. His commentary relies on an understanding of past events and how they will affect future market performance.”