Outlook for January
1) US fiscal/monetary policy – key date – FOMC meeting January 30/31
Although this meeting is not followed by a press conference and no policy change is expected, it will be the first time the Fed is able to officially comment on the impact of the tax reform passed at the end of December. It also could be Yellen’s last meeting – though she may not attend if Powell is confirmed as Chair by the Senate in time. It seems likely that the passage of the reform will lead the Fed to take a more positive view of the economy going forward, as most expect the reform to boost GDP around 0.5% in 2018. The January meeting contains no updated projections or press conference – for that we will have to wait until March – but will release a statement which seems likely to be on the upbeat side given the reform and recent strong GDP data.
2) Equity market performance
US equities continued to perform well through December capping a very strong performance through the year, but with valuations stretched and the market anticipating higher interest rates through the year, the trend is looking potentially vulnerable to correction. However, foreign equities finished the year in more mixed fashion, with European markets in particular dropping back in the last couple of months, suggesting they provide better value. That being said, European equities rarely manage to rise when the US market is falling. Many FX markets will be affected by the general tone in risk appetite, so equity market performance at the start of the year will be important, particularly for the traditional safe havens.
There is nothing notable scheduled in Brexit negotiations, but the first shots across the bows in trade talks are likely to be heard. Initial positions are likely to be deliberately tough, and early indications from the EU suggest they see the likely trade deal with the UK as being similar to that for Canada and South Korea rather than the closer ties with Norway and Switzerland. In particular, the initial EU position is that financial services will get no special treatment, and that the hopes of the City of London that current arrangements will be largely unaffected will be disappointed. It is hard to know how the markets will take any statements, as most believe that at this stage everything is a negotiating position. But the progress so far suggests that the EU will not be backing down very far from their initial stance.
4) European politics
The announcement of the Italian election for March 4 and the Catalan regional election in December which returned a separatist majority have had little initial impact on markets, but the issue of populist and separatist politics in Europe is likely to be in the news in the early part of the year as a result. In the UK, a cabinet reshuffle in January looks likely, but shouldn’t significantly impact the political equilibrium.
5) NAFTA negotiations – late January in Montreal
These negotiations have been continuing for some months without any noticeable progress, and fears are rising that Trump is prepared to announce a withdrawal if progress is not made. The next round of talks is scheduled for late January in Montreal. In practice, it would seem that few see much advantage in withdrawal, so such a radical step seems unlikely, but concerns may intensify as meetings approach.
EUR/USD remains confined to the 1.15-1.21 range seen since late July, but continued to press the top end of this in December despite the passage of the US tax reform which, on the face of it, should have been supportive for the USD. While some of the EUR’s strength may be ascribed to the stronger than expected German CPI data released late in December, the USD’s weakness in the last week of the year is in line with a seasonal tendency, and we are inclined to ascribe the latest USD weakness to seasonality. This tends to unwind by the end of January, but often persists in the early part of the month, so the 1.2093 high from September may yet be broken in early 2018 trading. Nevertheless, the conditions do not yet seem right for sustained strength in EUR/USD with yield spreads broadly stable at attractive levels for the USD. Although EUR/USD gained through the second half of 2017 without the support of yield spreads, this could be viewed as a valuation correction in part due to unwinding of positions, and is less likely to be repeated with speculative positioning heavily long EUR and valuation at more sensible levels. Even so, the top end of the range looks, for the moment, more in danger than the downside, which is only likely to be threatened if Italian and Spanish politics move more into focus, or if Brexit negotiations turn extremely acrimonious.