15/12/2024 Market Analysis

Week Ahead: Fed Eyes December Rate Cut

Last week saw significant moves from major central banks. The Swiss National Bank and the Bank of Canada reduced rates by 50 basis points, while the European Central Bank implemented a smaller 25 basis-point cut. These actions signal that the global monetary easing cycle may extend into next year. The Reserve Bank of Australia remained on hold, with stronger-than-expected employment data dampening expectations of a rate cut in early 2025. Meanwhile, U.S. inflation data met expectations, with a second consecutive monthly rise in CPI and related indicators suggesting modest year-on-year improvement.

The Federal Reserve is expected to cut rates by 25 basis points at its upcoming December 18 meeting. However, there is a possibility of a "hawkish" cut, with signals of fewer rate reductions in 2024, acknowledgment of a stronger economy, and cautious commentary on inflation trends. Market speculation about a Bank of Japan rate hike has shifted toward January, while the Bank of England’s upcoming decision remains uncertain. Despite the UK economy contracting in October and prior months, a surprise rate cut on December 19 appears unlikely, though the central bank has hinted at significant easing in 2024.

The coming week is packed with central bank decisions and critical economic data releases. Beyond the Federal Reserve, interest rate announcements are expected from Japan and the UK. In the eurozone, surveys may reveal whether the region’s economic activity is stabilizing. Additionally, China will release a series of key data points as the year-end approaches. Central bank actions and data from major economies are set to shape the outlook heading into 2025.

United States of America

US Economy Stronger Than Expected

The Federal Reserve Chair recently admitted that the U.S. economy has been performing better than officials anticipated in September. Job growth rebounded after temporary disruptions, earlier data revisions improved, and average hourly earnings rose. Although the unemployment rate ticked up to 4.2%, it remains consistent with trends seen throughout the second half of this year. The Atlanta Fed's GDP tracker projects a 3.3% growth rate for Q4, reflecting the economy's resilience. Inflation also showed an upward trend, with the headline CPI rising for the second consecutive month.

Inflation Expectations Ahead of the FOMC Meeting

Economists now expect the Fed's preferred inflation gauge, the PCE deflator, to increase to 2.5% from 2.3%, following strong PPI data. While this remains below November 2023's 2.7%, the slight rise highlights ongoing inflationary pressures. Just ahead of the Federal Reserve's meeting, upcoming data is likely to show solid retail sales and a recovery in industrial production. This paves the way for a “hawkish” rate cut, where the Fed could signal fewer rate reductions next year due to economic strength and persistent price pressures.

Focus on the Fed’s Rate Decision and Projections

The Federal Reserve is set to announce its final policy decision for 2024 on Wednesday, with markets widely expecting a 25-basis-point rate cut. However, attention will shift to the updated Summary of Economic Projections (dot plot). In September, the Fed projected 100 basis points of rate cuts for 2025, but markets are now pricing in just 75 basis points. This raises the possibility that policymakers may signal fewer cuts than previously anticipated.

Dollar Index Trends and Outlook

Ahead of the FOMC meeting, the Dollar Index stabilized after retracing its losses since reaching a yearly high of 107.00 on November 22. A short-term decline toward 106.20 is possible, but the overall sentiment for the dollar remains positive. Analysts maintain a bullish outlook for next year, with targets around 109.00, aligning with key retracement levels from previous moves.

Key Economic Data in Focus

• PCE Inflation: The Fed’s preferred inflation measure will be released on Friday.
• Manufacturing Reports: Empire State Manufacturing Survey and flash PMIs on Monday.
• Retail Sales: Data for November is expected on Tuesday.
• GDP and Jobless Claims: Final Q3 GDP figures and weekly jobless claims come Thursday.
• Housing Data: Housing starts are due Wednesday, followed by existing home sales on Thursday.

Key Points:

• The Federal Reserve’s rate decision and economic projections
• Market expectations for rate cuts in 2025
• PCE inflation and retail sales data
• Dollar Index movement after the Fed meeting
• Broader U.S. economic indicators as the year comes to a close

Australia & New Zealand

Australian Economic Outlook and Central Bank Stance

The upcoming Australian economic data, including the flash December PMI, consumer inflation, and last month's private sector credit, are unlikely to significantly shift expectations for the Reserve Bank of Australia's (RBA) monetary policy. The RBA has emphasized that there is currently no urgency to cut interest rates, nor is there any ongoing discussion about hiking rates. Since the disappointing Q3 GDP report, which showed only 0.8% year-over-year growth, the weakest since the end of 2020, the futures market has raised the odds of a rate cut in April to nearly 90%. The swaps market is pricing in almost 75 basis points of cuts for 2025.

Australian Dollar Trends

The Australian dollar hit a new low for the year last week, reaching $0.6335 following the RBA's dovish stance. However, it bounced back the next day, rising to nearly $0.6430 on the back of a better-than-expected employment report. Despite this, a strong selling pressure brought it back down to $0.6350. A break below this level could lead to further losses, possibly toward $0.6300, and then the 2022 low near $0.6270.

Bond Market Expectations and Government Budget Update

Bond traders in Australia are anticipating the federal Labor government’s midyear budget update, though the exact timing is yet to be confirmed. Many economists expect the update before the end of the week. There is speculation that the government may use this opportunity to announce additional spending in anticipation of the federal election, due before May. Such a spending spree could shift expectations about the timing of RBA interest rate cuts, potentially pushing those expectations into the second half of next year.

New Zealand Economic Data and Interest Rate Expectations

In New Zealand, traders are closely monitoring the third-quarter economic growth figures, set to be released on Thursday. Given the weak economic performance, it would take a significant surprise rebound in growth to alter expectations for further interest rate cuts by the Reserve Bank of New Zealand.

Key Points:

• RBA unlikely to alter its policy stance in the short term.
• Australian dollar faces pressure with a potential downside below $0.6300.
• Bond traders await government budget update, potentially influencing rate cut expectations.
• New Zealand's economic growth figures expected to confirm rate cut outlook.

Canada

Bank of Canada Rate Cut and Employment Data

Despite the strongest three-month increase in full-time positions (~192k) since January 2023, the Bank of Canada (BOC) proceeded with its second consecutive half-point interest rate cut last week. This decision highlights the BOC’s cautious stance despite positive employment data. The upcoming November Consumer Price Index (CPI) report, due on December 17, is expected to show a moderation in price pressures. A flat month-over-month result would push the year-over-year inflation rate below 2%. Headline inflation had decreased from 2.9% in May to 1.6% in September before slightly recovering to 2.0% in October. In November 2023, Canada's CPI stood at 3.1%. The core inflation measures are also expected to show a slowdown, following their first increase since May.

Retail Sales and Foreign Investment Outlook

Retail sales figures for October are set to be released at the end of the week, with a median forecast of a 0.7% increase. Retail sales had declined by an average of 0.3% per month during the first half of 2024 but surged 0.6% per month in Q3. Additionally, Canada's foreign investment in stocks and bonds is on track for a record pace, with approximately C$142 billion flowing into the country during the first three quarters. The October figures may show that this strong foreign demand has been sustained.

US Dollar Performance Against the Canadian Dollar

The US dollar hit a new four-and-a-half-year high against the Canadian dollar after the BOC’s rate cut. The exchange rate approached CAD1.4250 ahead of the weekend. A move above CAD1.4265 would target CAD1.43, although the Covid-era high near CAD1.4670 still stands as a significant level. The yield differential between US and Canadian two-year bonds has practically disappeared, with the US now offering a premium of 120 basis points, the highest since 1997. Momentum indicators are trending higher, and the US dollar is testing around CAD1.4240. Initial support for the Canadian dollar may be near CAD1.4200.

Outlook for Canadian Inflation and Housing Data

Canadian inflation data for November, due for release Tuesday, will be closely watched by investors for clues about future interest rate moves. While the BOC has delivered two consecutive rate cuts, future rate reductions are expected to be more gradual. The BOC has stated that it will assess the need for further rate cuts on a case-by-case basis. Additionally, Canadian housing starts data will be released on Monday, offering more insights into the domestic economy.

Key Points:

• Bank of Canada cuts rates despite strong employment data.
• November CPI data expected to show inflation moderation.
• Retail sales are forecast to rise by 0.7% in October.
• Foreign investment in Canada remains strong, at a record pace.
• US dollar hits new highs against the Canadian dollar.
• Inflation and housing data will be key in shaping future rate expectations.

China

Beijing’s Economic Support Measures

Beijing’s efforts to stimulate economic activity are beginning to show some results, with November’s real sector data expected to reflect this trend. However, officials remain unsatisfied with the pace of recovery and continue to explore additional monetary support, including potential rate cuts and reductions in reserve requirements. Some analysts believe China might counter a potential increase in US tariffs with currency depreciation, although it appears Beijing still favors maintaining a relatively stable exchange rate. Rather than yielding to external pressures, Beijing has taken a firm stance by imposing export bans on critical minerals to the US, including a ban on third-party shipments to the country. This approach suggests that China may prefer strength and resoluteness in negotiations, rather than compromising.

Dollar and Offshore Yuan Performance

While the US dollar did not rise every day against the offshore yuan last week, it did increase against both the yuan and the yen for the second consecutive week. The dollar settled at its highest level since December 3 (~CNH7.2850) ahead of the weekend. The People’s Bank of China (PBOC) continues to set the dollar’s reference rate below prevailing rates, effectively limiting the yuan’s decline. China's 10-year Treasury bond offers a nearly 260 basis point discount compared to the US, the most significant difference in a decade. Despite a strong trade surplus, factors such as lackluster equity market performance (CSI 300 up less than 0.5% this year) and China’s lower interest rates are more influential in driving the yuan's value. The offshore yuan is also being used as an attractive funding currency by market participants.

Economic Activity Data and Stimulus Impact

China will release final key economic activity data for 2024 on Monday, with particular attention following the Central Economic Work Conference’s signals for bolder stimulus measures. Economists expect China's consumption, investment, and industrial output to have stabilized in November, which would indicate that Beijing's recent stimulus efforts have helped stabilize the economy. Retail sales are expected to have increased by 4.7% year-over-year, slightly down from October's 4.8% rise. Fixed-asset investment is projected to have grown by 3.4% in the January-November period, matching the first ten months of the year. Industrial production is anticipated to have risen 5.3%, the same as in October.

Housing Market and Investor Sentiment

The upcoming housing data and property investment reports will be closely watched for signs of improvement in China’s real estate sector. Investors are hoping for positive developments, such as rising home prices and increased demand from potential homebuyers. A boost in construction activity from developers could further improve sentiment. How major developers’ stock prices react to this data will provide insight into investor sentiment and shape optimism for the coming year.

Key Points:

• Beijing’s efforts to support the economy are beginning to show results, but more monetary support is expected.
• The US dollar rose against the yuan, aided by China’s low bond yields and weak equity market performance.
• November economic data is expected to show stabilization in key sectors, signaling the effectiveness of stimulus measures.
• China’s housing market remains under scrutiny, with expectations for positive signs in home prices and construction activity.
• Investors are closely watching how developer stocks react to the latest economic data.

Europe

Eurozone Economic Data and Outlook

On Monday, the flash estimate purchasing managers’ indices (PMIs) for France, Germany, and the eurozone will offer insights into the region's subdued economic outlook. This follows the European Central Bank's recent decision to lower its GDP and inflation forecasts while implementing another interest rate cut. These indicators are crucial in assessing the economic health of the eurozone and the potential for further policy adjustments.

Germany's Economic Data and Challenges

Germany's economic struggles will be closely monitored this week, with the release of the Ifo and ZEW indices on Tuesday. These reports will shed light on the economic sentiment in Europe’s largest economy. Additionally, Germany’s GfK consumer climate survey is set for release on Thursday, providing further context on consumer sentiment in the country. Despite these updates, Germany’s outlook remains weak, adding pressure to the eurozone's economic picture.

Eurozone Inflation and Confidence Surveys

On Wednesday, the eurozone will release its final inflation figures for November. These figures are expected to provide clarity on inflation trends and the ECB's ongoing policy decisions. Later in the week, Italy will publish its consumer and business confidence surveys on Friday, followed by the eurozone’s December consumer confidence survey. These reports will offer a snapshot of the region's sentiment and potential impacts on future economic growth. Additionally, producer price indices from Germany, France, and Italy will be released, providing further insight into inflationary pressures.

Eurozone Focus Shifts from Central Bank to Politics

With the ECB rate cut behind us, attention shifts away from the eurozone’s central bank to broader political developments. While the preliminary December PMI may cause some market fluctuations, it is unlikely to be the primary driver for exchange rates. The real focus this week will be on the US Federal Reserve's meeting. Meanwhile, European political drama continues, with Le Pen advocating for slower deficit reduction, which could strain relations with the European Commission. In France, President Macron’s appointment of a new prime minister could face challenges, particularly if there is no substantive change in the national budget. Additionally, Moody’s downgraded France’s sovereign rating to Aa3, aligning it with S&P and Fitch's AA- rating.

German Government Confidence Vote

On December 16, Germany faces a critical confidence vote in its government. The vote is expected to fail, potentially leading to new national elections in mid-February. This political instability adds to the uncertainty surrounding the eurozone's economic and political future, with implications for both domestic policies and international relations.

Euro Performance and Market Trends

The euro experienced lower highs and lower lows last week but managed to break a six-session losing streak ahead of the weekend. Cross-rate demand likely supported the euro against the US dollar. The euro’s recent low ($1.0455) was slightly above the 61.8% retracement of its bounce from this year’s lows ($1.0335). Despite an earlier recovery above $1.06, the euro has struggled to maintain a foothold above $1.05. While there may be some potential for upward movement before the Federal Reserve’s meeting, any gains are expected to be limited.

Key Points:

• Eurozone PMI data on Monday will offer insights into the region’s economic outlook.
• Germany's economic data and consumer sentiment reports highlight ongoing struggles.
• Eurozone inflation figures and confidence surveys will provide further context on the region's recovery.
• Focus is shifting away from ECB decisions to US Federal Reserve’s meeting and European political developments.
• The euro has been struggling to maintain strength above $1.05 but may see limited upside potential before the FOMC meeting.

Japan

Bank of Japan's Rate-Hike Decision

All attention is on the Bank of Japan (BOJ) as speculation mounts over whether the central bank will raise interest rates at its two-day monetary policy meeting ending on Thursday. Economists are divided on whether the BOJ will implement its final rate hike of the year in December or wait until the new year. Nomura economists expect a 25 basis point rate hike to 0.50%, but they also acknowledge the possibility of deferring this decision to January or beyond.

Rate-Hike Expectations and Economic Outlook

If the BOJ opts not to hike rates in December due to uncertainties or fiscal policy considerations, the likelihood of a rate increase in January increases. However, if the decision is based on concerns over insufficient economic fundamentals, a rate hike may be postponed beyond January, as no significant economic changes are anticipated during that time.

Consumer Price Data and Inflation Trends

On December 20, Japan’s consumer price data for November is expected to show a slight uptick in inflation due to the fading impact of government energy subsidies. Core consumer prices, excluding fresh food, are projected to rise by 2.6% compared to the previous year, slightly faster than October’s 2.3% increase. The Ministry of Finance will also auction 1 trillion yen worth of 20-year Japanese government bonds on Tuesday, which may see muted investor interest ahead of the BOJ’s rate decision.

Volatile Economic Growth in Japan

Japan’s economic growth has been volatile, with a 0.4% annualized growth in Q4 2023 followed by a contraction of 2.4% in Q1 2024. The economy rebounded by 2.2% in Q2 and expanded by nearly 1% in Q3. Barring unexpected events, Japan’s economy seems to be stabilizing at around 1% growth, a significant achievement given its shrinking population. The BOJ's meeting concludes on December 19, and while the US Federal Reserve is not expected to ease, there seems to be no strong reason for the BOJ to hold off on a rate hike.

CPI Trends and Policy Implications

Japan’s November CPI report, due the day after the BOJ’s meeting concludes, is expected to show a rise due to the timing of energy subsidies. Tokyo’s CPI has already increased to 2.6%, up from 1.8%, and core CPI has risen to 2.2%. The national CPI typically runs higher than Tokyo’s, suggesting inflationary pressures could persist. Despite this, Japan’s real policy rate remains deeply negative, which weakens the yen but limits sympathy for the currency’s decline.

US Dollar and Yen Exchange Rate Movements

The US dollar has been gaining against the yen, reaching JPY153.80 before the weekend. This marked a significant retracement of the earlier decline from November’s high of JPY156.75. The US 10-year yield has also risen, approaching 4.40%, its highest level since November 22. Momentum indicators suggest further upward movement, with technical resistance expected near JPY154.80-JPY155.00, and a trendline near JPY155.40 by the end of next week.

Key Points:

• The Bank of Japan’s rate decision is uncertain, with a potential hike in December or a delay until January.
• Inflation data for November will show a slight increase, driven by the end of energy subsidies.
• Japan’s economy is stabilizing at around 1% growth despite a shrinking population.
• CPI trends suggest continued inflationary pressure, though the real policy rate remains negative.
• The US dollar continues to gain against the yen, with technical resistance levels around JPY154.80-JPY155.00.

United Kingdom

Bank of England Rate Decision

The Bank of England (BOE) will announce its decision on Thursday, with widespread expectations that it will keep its policy rate at 4.75%. The central bank has adopted a cautious approach, gradually reducing rates every few months to avoid pushing inflation higher. Market predictions show an 85% chance that the BOE will hold rates steady this month, with February's meeting considered more likely for any rate cuts.

Inflation Data and Rate Outlook

Ahead of the BOE’s decision, November’s annual CPI inflation data is expected to show an increase, reinforcing the argument for keeping rates on hold. After falling below the BOE’s 2.0% target in September, CPI inflation rose to 2.3% in October. Economists at Investec predict a further increase to 2.6% in November, along with a rise in core inflation. If inflation follows this trend, it would likely argue against faster rate cuts.

Impact of Economic Data on BOE Policy

The BOE's policy remains highly data-dependent, with officials carefully analyzing economic data before making any decisions. Recent data showed the U.K. economy unexpectedly contracted for a second consecutive month in October, leading to questions about future rate cuts. Ahead of the December 19 meeting, BOE officials will receive updated reports on employment, CPI, and economic activity, but the likelihood of a policy change remains low. The bank rate is expected to remain at 4.75% by the end of the year, reflecting a 50 basis point reduction from last year.

Rate Cuts and Gilt Market Reaction

Governor Andrew Bailey has suggested the possibility of up to 100 basis points of rate cuts next year, and swaps markets have priced in around 80 basis points of cuts. The 10-year Gilt yield has recovered from the surge triggered by the government's budget announcement, but it remains significantly higher than the 10-year Bund yield, reflecting ongoing uncertainty. The yield has reached its highest levels since the Gilt crisis of September 2022, currently sitting at around 4.60%.

Sterling’s Movements Against Euro and Dollar

Sterling reached its highest level against the euro since April 2022 last week but reversed course after the disappointing October GDP data. The euro briefly dipped to GBP0.8225 before recovering, closing the week slightly above the 20-day moving average at around GBP0.8300. The next key resistance level is between GBP0.8350-60. Meanwhile, the pound also weakened against the dollar, with GBP/USD falling to around $1.2600 after the poor GDP data, finding support near $1.2565.

Key Points:

• The Bank of England is expected to keep rates at 4.75% this month, with a higher chance of cuts in February.
• November’s inflation data is likely to show a rise, supporting the case for no immediate rate cuts.
• Economic data, including GDP contraction, will influence future BOE policy decisions.
• Rate cuts of up to 100 basis points are anticipated for next year, with markets pricing in around 80 basis points.
• Sterling rose against the euro but fell against the dollar, with key technical levels to watch.