BoE Decision to Rock Sterling

Thursday November 2: Five things the markets are talking about

In the U.K the Bank of England (BoE) is expected to hike interest rates for the first time in more than a decade (+0.25 bps to +0.5% at 08:00 am EDT) on the back of inflation running well ahead of the central banks +2% target. Nevertheless, there is a large degree of uncertainty on the vote split. The median consensus is 6-3 in favor of a rate rise, but it could even be larger.

In the MPC’s updated economic projections, the consensus believes that the BoE’s inflation forecasts are likely to continue to show an overshoot of the +2% target at the 2- and 3-year forecast horizon, leaving the door ajar for additional tightening in the coming months.

However, given the market’s uncertainty around the U.K’s political and economic outlook, it would not be a surprise to hear Governor Carney at the press conference (08:30 am ETD) to continue to stress that additional interest rate rises will be highly data dependent, with any increases likely to be ‘limited’ and ‘gradual.’ Not matter what, expect sterling (£1.3260).

Finally, watch out for Carney’s Brexit assumptions. A change in the BoE’s language on how Brexit is expected to pan out would have an implication on market expectations of future rate rises. To date, the BoE has expected a “smooth adjustment.”

Uneventful Fed dislodges U.S dollar and Treasury yields momentarily

Yesterday’s Federal Open Market Committee (FOMC) did not stray too far from what capital markets had been expecting – no rate hike, and the committee reiterating their view that U.S economic growth is “solid” and are considering raising rates once more by year’s end.

President Trump is due to announce the next Fed Chair at 03:00 pm ETD. His pick is expected to be Jerome Powell, who is a current Fed Governor, and would represent continuity in monetary policy.

Aside from central banks, investors remain focused on the progress toward U.S tax reform, corporate earnings and tomorrow’s U.S and Canadian job numbers.

1. Stocks see green

In Japan, the Nikkei share average extended its strong rally to trade atop a new 21-year peak overnight, ahead of a long weekend, supported by robust earnings prospects. The Nikkei ended up +0.5%, its best close since late June 1996. For the week, the index rallied +2.4%, its eighth straight weekly gain and longest winning streak since PM Abe’s Abenomics reforms started five-years ago. The broader Topix gained +0.4%.

Down-under, Australia’s S&P/ASX 200 Index dipped -0.1% and South Korea’s Kospi index lost -0.4%.

In Hong Kong, stocks slipped, mirroring some market nervousness as investors waited for key policy events in the U.K and the U.S. Both the Hang Seng index and the China Enterprises Index fell -0.3% respectively.

Note: Investors are also weighing up the impact of a possible policy change that could change the share structure of “H-shares,” or mainland companies listed in Hong Kong.

In China, Shanghai stocks weakened on Thursday, dragged lower by industry and material shares, as investors worried about a possible economic slowdown and tighter liquidity before year-end. The blue-chip CSI300 index was unchanged, while the Shanghai Composite Index closed down -0.4%.

In Europe, regional indices are trading relatively flat, consolidating gains ahead of another busy session of earnings and the impending BoE rate decision.

U.S stocks are set to open in the ‘red’ (-0.1%).

Indices: Stoxx600 flat at 396.6, FTSE +0.1% at 7494, DAX -0.2% at 13445, CAC-40 flat at 5511, IBEX-35 flat at 10505, FTSE MIB +0.5% at 23110, SMI flat at 9265, S&P 500 Futures -0.1%

2. Oil steady on OPEC led supply cuts, tight U.S. market, and gold higher

Oil prices are trading steady as supply cuts by OPEC and non-OPEC members have tightened the market despite higher production in the U.S.

Brent crude is down -20c at +$60.29 a barrel. Yesterday, Brent reached its highest intraday level in two-years and it is up +36% from its June low. U.S light crude (WTI) is -20c lower at +$54.10 and almost +30% above its July low.

Earlier this morning, the Saudi Energy Minister Khalid al-Falih said supply and demand balances were tightening and oil inventories falling, while compliance with the OPEC-led pact to curb supplies had been “excellent”.

Note: Overall, oil markets have been slightly undersupplied this year, resulting in inventory drawdowns and the OPEC pact to withhold supplies runs to March 2018, but there is growing consensus to extend the deal to cover all of next year.

Ahead of the U.S open, gold has rallied to a one-week high overnight amid a weaker dollar and on increased demand from Chinese retail investors and as the market waits for the announcement of a new chair of the U.S Federal Reserve. Spot gold is up +0.3% at +$1,278.10 per ounce, after earlier rising to +$1,281.43.

3. Sovereign yields little changed

U.S Treasuries stalled Wednesday after the Fed held interest rates steady as expected. The yield on the benchmark U.S 10-year note settled at +2.378%.

Fed officials expect “that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate,” the FOMC statement said.

Note: At their September policy meeting, Fed officials suggested they expect three-rate increases in 2018, two in 2019 and one in 2020 – a path that is deemed rather ‘hawkish’ given the lag in inflation.

For the new Fed head, it does not matter for the interest rate cycle who replaces Janet Yellen. Today’s front-runner, Jerome Powell is seen as a tad more hawkish than Yellen, but still on the dovish side, and John Taylor, who is on the hawkish side.

Elsewhere, German 10-year Bund yields are little changed at +0.38%, while U.K 10-year Gilts have backed up +1 bps to +1.35% ahead of the BoE decision.

4. Will Sterling buck the trend?

The BoE are expected to raise interest rates by +25 bps, but it is also likely they will hint at two further rate increases in the next two or three years, so that sterling (£1.3240) can strengthen enough to bring inflation back to +2%.

A rate increase is nearly all priced in, but sterling can still rise if the BoE follows through with its hints that it will raise rates.

However, if they don’t hike, the pound is expected to come under considerable pressure. The pull back could be temporary, as investors will shift their focus on prospects of Brexit talk progress.

A ‘no’ rate rise would see EUR/GBP rise modestly and GBP/USD would probably test back towards stronger support atop of £1.3070 area. But further out, positioning for a Brexit deal and sufficient progress at the EU Council in December could open the door for the EUR/GBP to return to a €0.84-0.86 trading range and GBP/USD could rise towards £1.3500 handle.

The USD is a tad softer in quiet trading, but off its worst levels, while EUR/USD is off its best levels ahead of the U.S open with the pair up +0.1% at €1.1635.

5. U.K construction activity edges higher, but outlook bleak

U.K data this morning suggests that the construction sector looks troubled.

Markit’s purchasing managers’ index on construction rose to 50.8 in October, from 48.1 in September. The print does signifying expansion in the sector, but only just.

Digging deeper, growth in house building partly offset lower civil engineering and commercial activity. But the sector’s outlook is bleak, with the balance of firms expecting business activity to increase over the next 12 months at its weakest in five-years.

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