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Fundamental Analysis 23.01.2018 - Market Outlook

A temporary funding bill was passed and the US government is funded through 8 February 2018. The agreement still requires negotiations and discussions on various topics, notably immigration, to take place. The Democrats agreed to fund at least part of Trump’s wall on the Mexican border. Yesterday the dollar was higher after the US government shut down. Today the dollar is lower after the government starts up again. 

GBP/USD was briefly above the 1.4000 level before coming down slightly on profit-taking at the round number. The trigger seems to have been a BBC interview with French President Emmanuel Macron over the weekend, when he hinted that the UK finance industry could be included in a trade deal if Prime Minister Theresa May made some concessions. This is an improvement from the standard trade agreement that the EU has so far insisted is the only one possible. The comment was particularly significant coming from Macron, since France has been one of the hard-line countries in these talks and hopes to benefit if financial services move to the continent. We’ve now heard softer talk from a number of EU leaders. 

JPY moved slightly higher after the Bank of Japan altered its language on inflation slightly. It said inflation expectations are unchanged, while previously it had said they were weakening. As the graph shows, this is true – in fact, the 10-year breakeven inflation rate has risen recently. However, the Bank also kept its inflation and economic forecasts unchanged, instead of raising them slightly as was expected. This suggests that there won’t be any change in policy for some time.

CHF was the worst-performing G10 currency. It could also be continued reaction to last week’s comments by Swiss National Bank President Thomas Jordan that the CHF is still “highly valued.” But CHF has been considered to be overvalued by some people on a Purchasing power parity (PPP) basis since the mid-1980s.

The good performance of NZD and the poor performance of AUD may be related. AUD weakened as iron ore futures in China fell some 4.4% and Australia’s benchmark 3-year yield fell 2 bps.

Today’s market

The annual World Economic Forum starts today in Davos, Switzerland. Also the The North American Free Trade Agreement (NAFTA) talks continued again. 

It will be a busy day for indicators today.

Britain starts the day off with the public sector borrowing. The figure excludes the borrowing for the banks that the country nationalized during the Global Financial Crisis. Borrowing is quite seasonal, because taxes are seasonal too, and so the figure itself is of little value – what’s important is how it affects the trend. If it comes in as expected, then the 12-month moving average would fall further, continuing the downward trend in borrowing –GBP-favorable. 

Next comes Germany’s ZEW survey. The subsequent movement of EUR/USD is more closely correlated with the current situation index than with the expectations index, except:  it’s backwards! EUR/USD tends to fall (i.e., EUR weakens) when the indicator beats market expectations. 

In any event, the expectations index shows the proper relationship, but much weaker correlation. That’s the one I’d expect to have more of an impact, because investors move on expectations; the current situation is already in the price. 

The CBI trends survey isn’t a big market-mover, but can affect the pound when people are intently focused on trying to figure out what is going on with the UK economy.

Federal Reserve Bank of Richmond manufacturing survey is not one of the major Federal surveys. The currency market reaction is pretty tenuous. In theory a small decline such as the market is expecting could weaken the dollar a bit, but given everything else that’s going on, I don’t think it’s going to have a big impact on the currency.

The US Senate holds a confirmation hearing to consider the nomination of Marvin Goodfriend as a Governor of the Federal Reserve Board. Goodfriend is a well-respected economist who worked at the Federal Reserve Bank of Richmond for over 20 years before becoming a professor. There’s no question that he’ll be confirmed. The question is what he’ll say about current monetary policy.

Goodfriend has been a big critic of the Federal Reserve's actions. He argued that quantitative easing was courting higher inflation and that the Federal Reserve should just stick to controlling inflation. The fact that inflation has consistently been below the Federal's target during the Quantitative Easing (QE) period and afterwards does not seem to have affected his views one bit.

He has also come out in favor of using a monetary policy rule, such as the Taylor rule, “to improve the discipline” of monetary policy. Such a rule nowadays would imply a fed funds rate of 4.1%, far above not only what the rate currently is, but even what the most hawkish member of the Federal Open Market Committee (FOMC) currently estimates for the long-term equilibrium rate (3.50%).

Note that Goodfriend is not the only new hawkish voter on the Federal Open Market Committee Federal Reserve Bank of Minneapolis President Neel Kashkari and Chicago Federal Reserve President Charles Evans, who both dissented from the rate hike in December 2018, are no longer voting members. They’ll be replaced from this meeting by San Francisco Federal Reserve President John Williams and Cleveland Federal Reserve President Loretta Mester, who are both known for their defense of higher rates.

Furthermore, even after Goodfriend is confirmed, three openings on the Board of Governors will remain (after the current Chair, Janet Yellen, departs). If Goodfriend is an indication of the direction that President Donald Trump is going to push the FOMC, then rates are likely to rise at a faster pace than the market is discounting and the dollar could recover faster. 

Finally, overnight Japan announces its trade figures for December 2018.

The Fundamental Analysis is provided by Marshall Gittler an external service provider of an independent analytical company. Any views and opinions expressed are explicitly those of the writer. Any information contained in the article, is believed to be reliable, and has not been verified by STO and is not guaranteed to be accurate. References to specific products, are for illustrative purposes only and are not a form of solicitation, recommendation or investment advice. Past performance is not a guarantee of future performance.
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