Fed-fueled

Data this week, on net, was pretty much a positive for the UK and the British Pound. Employment data came in above line on Tuesday, Retail Sales beat expectations by a wide margin on Thursday and even monthly CPI, the boogeyman around the topic of rate hikes out of the UK, came in better than what analysts were looking for. But none of that mattered: The Sterling got crushed against both the US Dollar and Japanese Yen after each Central Bank started what looks to be the long and arduous road of removing ‘emergency-like’ accommodation from the global economy. GBP is currently off by over 320 pips against both USD and JPY, and if anything, this should highlight which drivers should take precedence in this ZIRP-fueled, ‘normalizing’ global economy. These themes are likely going to continue for a while, somewhat of a return of the ‘risk on/off,’ trades from years past, as the Federal Reserve is looking at a whopping four rate hikes in the calendar year of 2016. This is quite a distance away from the two rate hikes that the street is looking for, so expect volatility around risk trends to continue.

The good news for Sterling-traders going into next week is that data is light and the holiday on Friday will likely bring a much-needed sense of calm after the ‘historic’ rate hike on Wednesday. And perhaps more to the point, there’s possibility of a reversal in GBP-prices as the positive data this week was pretty much overrun by the driving themes of USD and JPY strength. The big data point out of the UK is the Final revision for 3Q GDP on Wednesday. But because this is a final print, it’s not likely to be ground-breaking; and perhaps more importantly, this could be that small impetus that traders need to bid GBP.

It’s the technical perspectives that make this so utterly interesting GBP/USD has found support just below a vaulted psychological level at 1.5000, and GBP/JPY is a short distance away from its own ‘big level’ support barrier at 180.00. These could both present attractive risk-reward setups on the reversal.

However, those larger overall risk trends will likely be significantly more important than any simple technical inflections; and those risk themes appear to be on the verge of bursting through the seams. With a holiday week for a world full of risk, this may not be the time to press. So we’re taking a neutral stance due to fundamental risk despite the attractiveness of the technical setup.

Despite the 2015 Fed liftoff, USD/JPY stands at risk of facing range-bound prices in the week ahead as the final U.S. 3Q Gross Domestic Product (GDP) report is anticipated to show a downward revision in the growth rate, while the Bank of Japan (BoJ) largely endorses a wait-and-see approach for 2016. The updated projections from the Federal Reserve suggests that the central bank will continue to normalize monetary policy in the year ahead as Chair Janet Yellen remains confident in achieving the 2% inflation target, and the 2016 committee may highlight a hawkish outlook for monetary policy especially as the U.S. economy approaches ‘full-employment.’ However, as the final GDP print is expected to show the U.S. economy expanding an annualized 1.9% during the three-months through September, a marked downward revision in the growth rate accompanied by a subdued reading for the core Personal Consumption Expenditure (PCE), the Fed’s preferred gauge for inflation, may drag on interest rate expectations should the data prints undermine the central bank’s scope to implement higher borrowing-costs in the first-half of 2016.

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In the wake of the holiday’s season, investors have been unwinding positions, closing their books as year-end approaches and liquidity diminishes. As the Fed missed all other interest rates hike opportunities during the year, they have chosen December, the most illiquid month of the year to start the lift off.

In a historical meeting, the Fed ended the era of zero interest rates by tightening monetary policy by 25 bps, increasing the Fed funds target range to 0.25% to 0.50% and the discount rate to 1.0%, with a unanimous vote.

Although the event didn’t generate large volatility for the major five currencies, it happened to be a major episode for emerging market and commodity currencies as we continue to witness lately. For now, commodities and emerging markets continue to hemorrhage as their future will be determined by how the disagreement between the market and the Fed about the pace and extent of hikes gets resolved.

According to the Fed, labor market slack had diminished ‘appreciably’ and the Fed is ‘reasonably confident’ inflation will rise to 2% in the medium term. The FOMC maintained that future adjustments will be ‘gradual’ although notably the dot-plot was little changed, suggesting four quarter point hikes next year, while the median long run funds rate is still seen at 3.5%. The announcement was perceived to be less dovish than the markets anticipated sending the US dollar up across the board.

Equity markets also rallied on the news, in part as Yellen made it clear the Fed would proceed slowly with further tightening. However, the reaction on the foreign exchange side was different.

After largely outperforming its peers on Wednesday and Thursday, the USD has reversed part of its gains by the end of the week with the Euro rebounding from the 1.08 level. Thursday’s few macro releases didn’t do much to move the currency. The German IFO survey was as uninspiring as the latest ZEW or Eurozone PMI. The currency ended the week near the low at 1.0870.

In the UK, the Sterling Pound is ending the year on the back foot, as the currency is at risk of slipping to its lowest level since April. Sterling hardly received any relief from the release of relatively strong UK retail sales data on Thursday. UK consumers have been the pillar of the strong UK recovery. But for the pound to reverse recent weakness, the data would need to be accompanied by more visible inflation pressures through 2016, for the moment nonexistent.

The Yen had its own part of drama