Geopolitics will continue to weigh on sentiment this week

Macro Outlook

Has the Fed fired the starting gun for a stronger dollar? Well, in the very least, the market was taken by surprise as the members of an unexpectedly hawkish Federal Open Market Committee used dots to guide investors on expected rate hikes sooner than at its last meeting. The committee now expects rates at the end of 2015 to be at 1.0% , rather than 0.75%. Furthermore, Janet Yellen suggested in her press conference that the time between the end of the tapering programme and the beginning of rate tightening could be six months. That implies the first rate hike will be around June next year, whilst the Euro-Dollar short term interest rates suggest this could be even sooner. The one dissenting voice on the FOMC was Kocherlakota (a known dove on the committee) showed that not all are in agreement with the shift. However if the trend of data improvements for employment and housing are backed up this week by consumer confidence too, the dollar may well begin to claw back some lost ground. The “taper tantrum” is firmly behind the market now, with good news for the US economy being viewed as positive for both equities and the dollar.

Must watch out for: Japanese Consumer Price Index

Impact: Governor Kuroda of the Bank of Japan and his team will be watching the inflation data as closely as ever. The recent trends have been very positive and suggest that the BoJ is still on track to hit its 2.0% by the end of 2014. However, last month, inflation stalled at 1.3% and the expectation is for a third straight month of 1.3%. Recent BoJ communications have suggested they are comfortable with current monetary policy. However, an undershoot of 1.3% , if it does not prompt a change in policy it could prompt a change in language, which would be Yen negative.

Foreign Exchange

After spending much of the past month underperforming most major currencies (the Canadian loonie being a notably disappointing exception), the US dollar regained some ground last week. This move has significantly improved the relative performance of the Dollar Index. The only real exception has been the New Zealand dollar which has been buoyed by the recent rate hike. Another interesting development has been that despite being the strongest performing of the majors on a 12 month basis, Sterling has now deteriorated significantly and is now joint worst performing currency over a one month period (equal with the Canadian dollar). This is a time during which Cable has been put under increasing downside pressure and the Euro/Sterling has made sizeable gains. This week’s UK inflation data does not look especially helpful either, with a further decline to 1.7% from 1.9% forecast.

WATCH FOR: Sterling traders will be bracing for some volatility on Tuesday with the UK inflation data, whilst the Japanese yen will also be liable to some volatility with the Japanese CPI announced overnight on Wednesday evening. The yen is the classic safe haven currency and a flare up of tensions with Russia could see renewed strength. The US dollar bulls will be looking for some positive confidence and housing data.

Indices

There must be contrasting feelings on the desks of equity managers in the US and the UK. With Wall Street pushing back to all time highs, fund managers will be satisfied with resilience in the face of geopolitical tensions over Crimea and driven by the strength of robust IPOs and tech stocks. The index trades on around 18x forward earnings with an average yield of around 2.5%. UK fund managers must look on in envy as they have to invest in a FTSE 100 which trades on a mere 13x forward earnings and yields well over 4%. The FTSE 100 remains held back by its heavy weighting of resources sectors and banks. The FTSE 100 has underperformed the S&P by almost 7% in the past month and this shows little sign of reversing any time soon. With little corporate announcements to help drive the S&P clear into new high ground, this could be a slow week. It could therefore be an even tougher week for an underperforming FTSE 100.

WATCH FOR: Geopolitical events to continue to drive investor sentiment and subsequently equity indices. With little corporate news this week, the S&P investors will hope for Tuesday’s Consumer Confidence to improve as forecast and New Home Sales on Tuesday, Durable Goods on Wednesday and final reading of GDP on Thursday to help drive risk. DAX investors will certainly be looking at Tuesday’s German Ifo Business Climate, while FTSE 100 traders will also focus on Friday’s final GDP reading.

Commodities

The recent decline in gold was driven by an unwinding of the “insurance trade” as sanctions against Russia were viewed by the market as not as far reaching or punitive as had been feared. However, there is still the potential for the situation to flare up again, as we have seen over the past few weeks and this should help to underpin the price in the near term. Additionally, gold tends to be inversely correlated to the strength of the dollar which was boosted by an unexpectedly hawkish statement from the FOMC which suggested a shift in expectations of tightening monetary policy. Traders will be watching US data closely this week, such as the housing data and durable goods. Oil spiked higher on Friday as comments from US and EU leaders such as German Chancellor Merkel and Prime Minister Cameron left the door open to potential energy sanctions on Russia which could impact on supplies.

WATCH FOR: Geopolitics being the main driver behind commodity prices. Further sanctions which focus on Russia energy companies will impact directly on the oil price, whilst also this would also drive the insurance trade for gold. Any economic announcements that move the dollar could also impact on gold, so watch for US housing data (Tue and Thu) and durable goods orders (Wed).