Daily Market Report - 21/12/2015

Sterling hovered near an eight-month low against the dollar on Friday and was heading for its worst week since August on a trade-weighted basis, on bets the Bank of England is in no rush to follow the U.S. Federal Reserve with an interest rate rise. In a widely anticipated move, the Fed raised its benchmark interest rate on Wednesday by 25 basis points and signaled that it would raise rates 4 more times next year, sending the dollar higher against all major currencies. Though the Bank is expected to be the second major central bank to raise rates since the financial crisis, investors do not expect a move until late 2016, or even in 2017. Data this week showing inflation at zero and slowing wage growth will keep pressure off the Bank. BoE Deputy Governor Minouche Shafik said on Monday there was less of a need for the Bank to act at the moment than the Fed.
The U.S. Federal Reserve will raise interest rates again in the next three months, according to two-thirds of economists polled by Reuters, although many say rates won't rise as quickly next year as policymakers have suggested. The Fed hiked rates for the first time in nearly a decade last Wednesday (Dec 16), confident the U.S. economy can stand higher borrowing costs after years of stimulus and near-zero rates, although Janet Yellen, who chairs the rate-setting Federal Open Market Committee, made clear future increases would be "gradual". Considering the muted outlook for inflation and oil prices, a strong dollar hurting U.S. manufacturers, and the continued fragile state of the global economy, the Fed may have to be cautious with future rate hikes. Nonetheless, 77 of 120 economists in a snap poll conducted a couple of days after the meeting, said rates will next move higher by March. And all others but two said it would happen in the second quarter.

Defining "gradual" and determining how the FOMC will implement a "gradual" rate increase will become key to how the markets trade going forward. Many of the investment banks feel that the actual pace of interest rate increases will likely be slower than that implied by the FOMC 'dot plot'. But there are downside risks to the outlook, namely low oil prices, a strong US Dollar and the slowdown in China. Fed policymakers - whose views are visually plotted and published by the Fed as dots - currently estimate rates at 1.25-1.50 percent by the end of 2016, 100 basis points higher than the current rate. The median forecast among economists polled by Reuters, however, is that the fed funds target rate would be 1.00-1.25 percent by then.
The U.S. dollar tumbled against the yen on Friday after the Bank of Japan tweaked its monthly asset-purchase programme in a way that suggested the central bank may not ease policy as much as expected. The BoJ set up a programme to buy exchange-traded funds, extend the maturity of bonds it owns to around 12 years and increase purchases of risky assets. The adjustment hurt the dollar against the yen, since traders viewed it as an indication that the BoJ may be less likely to ease monetary policy further. The dollar has gained against the yen this year on the view that the Federal Reserve's tilt toward higher rates and the BoJ's path of more potential stimulus would support the greenback since it would drive more investment flows into higher-yielding U.S. assets.
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