Fed minutes and flash PMIs in focus

Fed minutes Outlook: A rebound in oil prices, and a weaker US dollar helped markets in Europe reverse their Monday losses and close at three-month highs in an otherwise lacklustre session.

US markets followed that pattern helped by some better-than-expected earnings numbers, and an expectation that any future Fed rate rises would be tempered by falling inflationary pressures, a trend that appears to be being amplified by the fact that rising covid cases in China will act as a brake on demand.

As we look ahead to today’s price action and a holiday shortened US trading week, the main focus is set to be on today’s Fed minutes, as well as the latest November flash PMIs.

A lot of water has flowed underneath the bridge since the Federal Reserve hiked rates as expected a few weeks ago by 75bps.

The initial reaction to the statement leant into a narrative that the central bank was aware that lags in monetary policy might require a slower pace of hikes going forward.

The markets liked the sound of this until we got to the press conference and the Q&A with Powell got under way.

He knocked back hard the idea that this in anyway meant the Fed was leaning into a dovish pivot, acknowledging that while a slowdown in the size of rate rises was likely, it didn’t alter the fact that rates would probably still need to go much higher than the 4.5% terminal rate markets had priced in, to get inflation back to target of 2% over time.

In the wake of that press conference yields shot higher, however the recent CPI number has sent yields sharply lower, and below the levels they were in the leadup to the recent Fed meeting.

Recent commentary from some Fed members has leant into the idea that rate hikes from hereon in are likely to be of a lesser magnitude, with this week’s publication of the Fed minutes likely to shed some light into how many FOMC members are becoming concerned about policy lags and the impacts of such lags on the US economy, although Bullard’s recent comments about a terminal rate of over 5% suggest there is some scope for divergence on this.

With Fed chair Powell keen to impress on the market that he wants to limit the scale of advances in the equity market, it will be interesting to see how many other Fed officials share that view, and whether it is reflected in the minutes.

The most recent French and German PMIs were a bit of a mixed bag with France’s services activity retaining a degree of resilience in October at 51.7.

One doesn’t have to look too far to understand why with the French governments subsidy of energy prices sheltering French consumers form the worst effects of high energy prices. Services activity in Germany has been much more subdued and has been in contraction for the last 4 months. Manufacturing has been trickier with businesses not protected in the same way, nonetheless French manufacturing has proved to be more resilient than German manufacturing.

Nonetheless both countries manufacturing sector has been in contraction for a couple of months now and November isn’t expected to be any different, with France set to slip to 47, and Germany to 45.

In the UK, October saw manufacturing PMI slide to its lowest level since May 2020, at 46.2, and has been in contraction territory for the last 3 months.

November is unlikely to see much in the way of an improvement given that the Chancellor of the Exchequer was seen to be mulling tax rises on business, as well as ordinary taxpayers, with a decline to 45.8.

The services sector has been in slightly better shape, but even here the sector slipped into contraction territory in October at 48.8, as higher energy prices constrained spending.

Business confidence has shown a sharp fall, with evidence that hiring has slowed sharply, while input costs have continued to rise. The biggest falls have been in hotels, restaurants and leisure as consumers cut back spending.

The only silver lining was in employment which continued to grow; however, the rise was the smallest since March 2021.

One of the biggest factors around stubborn prices was the weakness of the pound so the recent gains in sterling will be particularly welcome, however that isn’t likely to prevent further weakness today with a slide to 48.

This means, its highly likely that the uncertain outlook will lead to a second quarter of negative GDP, with the only uncertainty being as to how much of a Q4 contraction we see.

We’re also going to see US weekly jobless claims a day early due to the Thanksgiving Day holiday due tomorrow, which is expected to remain steady near 225k.

University of Michigan inflation expectations could see some volatility in the US dollar and rates if 1- and 5-year inflation expectations deviate markedly from the consensus expectations. Any softening in these numbers will feed into the narrative of a slowdown in the pace of US rate rises. Currently one year is at 3% and 5-10 year is at 5.1%.

EUR/USD – While below 1.0400 and the 200-day SMA area, risks a return to the 1.0180 area. A close above 1.0430 is needed to push up towards the 1.0600 area. A break of support at the 1.0180 area retargets parity. 

Fed Minutes Quotes

“Watch for three things:

The discussion that bolsters Powell’s guidance that the terminal rate estimates are likely to be revised higher in December’s ‘dot plot’ compared to September and the range of opinions around the issue using the Fed’s frequency of citations language (one, a couple, a few, some, several, many, most, all etc).”

“Also watch for the frequency of opinions around timing the downshifting in the pace of rate hikes after Powell said “that timing is coming and it may come as soon as the next meeting or the one after it.” Markets are priced for a downshift to 50bps in December and could be vulnerable to any indications that the FOMC is still considering a larger move.”

“Finally, expect further rejection of pausing the tightening stance given Powell’s guidance that is “very premature.”

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