Markets Show Signs of Caution Ahead of the Fed

LCG Research team London Capital Group

Wall Street showed signs of life for the first time in three days. The three main indices closed in positive territory, albeit close to the lows of the day. Asian markets put in a mixed performance with traders single-mindedly focused on the Fed. Not even news of a meeting between the US and China in January stirred much of a reaction.

All eyes are on the Federal Reserve, which is due to give its monetary policy announcement at 2 pm E.T. The market is pricing in a 72.3% probability of the Fed hiking today. This would be the fourth-rate hike for 2018. However, the real concern for the market is what comes next. With growing fears over the health of the global economy, the markets simply don't think the US economy can handle higher rates.

Traders will be watching for dovish signs, such as the dropping of the phrase "further gradual rate rises" from the statement and a softening of the dot plot from three hikes to at most two. In short, if the Fed must hike today, and they will struggle to justify not hiking on current US economic strength; then it will need to be a dovish hike to prevent the US equity markets dumping once more. The dollar has traded lower across the week in anticipation of a dovish hike.

Oil stabilises after 5% sell-off

The vast sell-off in oil in the previous session will also weigh in on the Fed's outlook. Oil plummeted over 5% on Wednesday. Falling oil prices are a deflationary pressure. When the decline in the price of oil is 40% in just 3 months, the deflationary pressure will be significant.

Oil was modestly higher in early trade on Wednesday, up 0.5% and hovering around $56.50. Persistent concerns of oversupply and the slowing global economy hitting demand have weighed heavily on sentiment. The price of oil is showing signs of stabilising, but we are not expecting any serious flip towards bullish sentiment.

UK CPI to drag the pound lower?

The pound was stronger versus the weaker dollar but weaker versus the euro. In-between Brexit headlines pound traders will look towards UK inflation data. CPI is expected to tick lower in November to 2.3%, down from 2.4%. Core inflation is expected to dip to 1.8% down from 1.9%. Softer inflation would be welcome news for the squeezed UK consumer. However, the BoE will be in no rush to consider hiking rates if inflation is falling. This could drag the pound lower.

Author

LCG Research team

London Capital Group

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