Will the Feast of Risk Events Bring Some Festive Cheer?

Markets Set to Enter Holiday Mood With a Bang?

Could there be a busier week to round off the year in financial markets? Crack open the mince pies and mulled wine, and settle in to five top tier G10 central banks who will grace us with their interest rate decisions and guidance for the months ahead. Economic data also comes thick and fast with US and UK inflation numbers likely to be high impact, while other releases like US retail sales, Australia employment and Eurozone PMIs will be a gauge for how the world’s economies are faring in the final quarter of another tumultuous year.

How High Will the Fed Raise Its “terminal” Rate?

The marquee event among the many highlights should be the final FOMC meeting of 2022. A smaller 50bps rate hike looks nailed on after four consecutive 75bp moves. Fed Chair Powell said in a speech only last week that the time to slow the pace of increases may come as soon as this week. He was also concerned about the prospects of overtightening policy while expressing some optimism about bringing inflation back down to target and the prospects for a soft landing. But Powell emphasised that the length of time monetary policy will be kept at restrictive territory is far more important than the near-term incremental pace of hikes.

This means there will be much focus on the Fed’s dot plots that show officials’ forecasts about interest rates, inflation, unemployment and growth in the months and years to come. Expectations are that rate projections will rise substantially from the previous September forecasts of a 4.6% terminal rate and show a Fed that is prepared to keep policy tighter for longer. Futures markets think that will be about 5% or a touch higher in May next year, before the central bank is forced to cut rates by at least 0.5 percentage points by the end of the year.

Market Reaction

Investors have latched on to the rosier aspects of recent Fedspeak and bid up stock markets and sold the dollar in anticipation of lower rates in the latter part of next year. The benchmark S&P 500 stock index is up 10% from its October lows though still 17% down on the year. The greenback has sold off over 6% this quarter, and lost some 10% versus sterling and over 5% against the yen and euro from its recent peak levels.

The US inflation data is also expected to liven up festive markets with hopes of falling price pressures and a second benign set of numbers further igniting a rally in risk. This would also most likely see more downside in the dollar, with December typically being a soft month for the world’s premier reserve currency. Fresh cycle lows look reachable if Powell and the inflation data confirm a Fed pivot. Markets will rejoice and may kick off the Santa rally in earnest.

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Written on 12/12/2022 by Lukman Otunuga, Senior Research Analyst at FXTM