Outlook for December
1) US fiscal/monetary policy – key date – FOMC meeting December 13/14
The market is fully priced for the December 13/14 FOMC meeting to produce another 25bp rate hike following the comments from chairman-elect Powell indicating that the case was “coming together” for another move in December. In fact, the hike was very nearly fully priced before those comments, so their impact was minimal, and there should be little impact on the USD from the hike itself assuming it is delivered. Any impact is likely to come from any indications the Fed provides in their statement or Yellen in her press conference about the likely future path of policy. There were some concerns expressed in the November minutes about the low rates of inflation and if these concerns are restated after the December meeting, the USD may weaken even though the funds rate target is likely to be raised.
There will also be some focus on fiscal policy, with the Trump/Republican tax reform likely to be approved by the Senate and moved to the House for approval in December. However, there now seems to be a general consensus that even if the tax reform is passed, impact on growth is unlikely to be very significant, with most of the benefits accruing to the wealthy and consequently unlikely to have a big impact on consumer spending.
2) Brexit negotiations – key date – EU summit December 14/15
The Press reported at the end of November that the UK had effectively reached agreement with the EU over the details of the “divorce bill” that the UK would have to pay, and that this would be formalized at the summit on December 14/15. This, along with agreement on the rights of EU citizens in the UK and the details on the Irish border, are the issues that the EU have said need to be resolved before substantive talks on post-Brexit trade relations can begin. The deal on the divorce bill is reported to involve the UK paying the EU around a net £50bn over the next 40 years, and is generally seen as a UK climb-down as this is close to the EU’s original demands. However, the pound rose on the news as some progress, however costly, was seen as better than no progress. Nevertheless, there is nothing official yet, and the EU has set a deadline of Monday December 4th for clear progress to be made if the EU is to agree to start trade talks at the December 14/15 summit. The problem of the Irish border is still seen as very difficult to resolve, as no-one wants a “hard” border, but some customs checks seem necessary if the UK is to be outside the customs union. Nevertheless, there are reports that a workable solution is near to being agreed. The problem for May’s government is that even if progress is being made on these negotiations and they get the green light at the EU Summit, any deal is dependent on a UK parliament vote in 2019. Winning this will require unity in the Tory Party, many of whom are none too happy about the shape of the deal as rumored, in particular the payment to the EU, and will certainly want a very attractive trade deal if they are to vote it through. May also needs the support of the DUP (the Northern Irish Democratic Unionist Party) who the government rely on for a majority and who will be very sensitive to the details of the deal on the Irish border.
OPEC has reportedly agreed to extend production cuts until the end of 2018 – a little more than the nine month extension the Saudis had been proposing. Oil prices have rallied slightly on the news, and remain near the highs of the year. Experience teaches that OPEC announcements often aren’t mirrored by action, but if the oil price holds up the recent weakness of the CAD may fade, and the MXN should also benefit.
Historically, December has tended to be a month of USD weakness, often followed by USD strength in January. However, it should be underlined that this is a tendency and very far from being a hard and fast rule and with speculative positioning in the futures market now generally short USD (except against the JPY) it seems less likely that here will be significant USD weakness this December.
EUR/USD has been in a 1.15-1.21 range for the second half of 2017, and while it is now testing the top end of that range, it seems unlikely that the range will easily break with yield spreads still very much in the USD’s favor. The T-note/bund spread continued to hover around 200bps, and with the Fed set to raise rates in December and the ECB continuing with QE until at least September 2018, it is hard to see a substantial narrowing of this spread in the short run, even if the market starts to reduce expectations of Fed tightening going forward because of concerns about the lack of a rise in US inflation. Typically, it would require a significant narrowing of yield spreads for the EUR/USD rally to extend far from here, especially since speculative positioning remains substantially long EUR according to the data from the CME. Nevertheless, the seasonal tendency towards a weak USD in December and the potential for a little disappointment around the FOMC meeting suggests a mild upside bias for EUR/USD in December, especially if optimism about Brexit negotiations continues to develop. But a major upside break seems unlikely at this stage.
Five-Year EUR/USD Movement: