EUR/USD

During the holiday period, market sentiment fluctuated greatly, as evidenced by unusually large price swings in equity and fixed-income markets. There appears to be widespread concern among market participants about growth prospects in the three major economic areas, the United States, China and Europe. The unsolved trade dispute between the US and China, the government shutdown in the US and the uncertainties about Brexit only add to investors’ concerns. In this environment, major equity indices troughed between Christmas and New Year and have recovered by about 5-10% since then. Bond yields tumbled as investors trimmed their rate-hike expectations for the Fed and the European Central Bank.

Jerome Powell, chairman of U.S. Federal Reserve, said on Friday that the Fed "will be patient" while it weighs future interest rate hikes.

Powell said the Fed noticed the concerns about downside risks, which include slowing global growth, ongoing trade negotiations, and general policy uncertainty coming out of Washington.

Heading into 2019 with these conflicting signals, Powell stressed that the Fed was "going to be taking that downside risk into account." "There is no preset path for policy," he said, "and particularly with muted inflation readings that we've seen coming in, we will be patient as we watch to see how the economy evolves."

Powell said that the Fed would be prepared to adjust their normalization plans, after a three-year long campaign to shrink the portfolio that the Fed purchased after the Great Recession took place. "If we ever came to the conclusion that any aspect of our normalization plans was somehow interfering with our achievement of our statutory goals, we wouldn't hesitate to change it, and that would include the balance sheet, certainly," Powell said.

Last month, Fed policymakers already lowered the forecast of the rate hikes in 2019 to two times, while their previous estimate was three. However, Powell voiced more flexibility in the future path of Fed's monetary policy. Powell said the Fed "will be prepared to adjust policy quickly and flexibly" in order to maintain the expansion, support the labor market and keep inflation near 2%. "We're always prepared to shift the stance of policy and to shift it significantly, if necessary," Powell added.

The USD reaction to Friday’s robust December labor-market report was muted. While the strong US numbers sent a reassuring message about the health of the US economy and stronger labor market data clearly argue for further policy normalization/tightening, the more fragile financial markets demand at least a pause – and Fed Chair Jerome Powell’s that the Fed would “listen carefully” to the market, fulfilled investors’ hopes for a “Powell put”.

Scope grows for eventual EUR/USD gains to the 1.1516 Fibo, a 50% retrace of the 1.1815 to 1.1216 (September to November) drop. On Thursday EUR/USD failed to register a daily close under the 1.1323 Fibo, a 61.8% of the 1.1216 to 1.1497 (November to January) recovery. The market continues to trade back within the daily cloud (1.1354-1.1516), further reinforcing the upside. We remain long for 1.1570.

Bearish sentiment dominates the US and German stock exchange and the data released today can do little to change the negative picture. The US annualized GDP was released, amounting to 3.4%, 0.1 pp. below market expectations. Growth structure was similar to the previous estimate, albeit with slightly lower contribution of private consumption and slightly better investment. The reading does not change much in the trading perspective. The economy seems to be slowing down  as growth in Q3 was 0.8 pp. lower than in previous quarter, when the economy probably peaked during the current cycle. Slightly disappointing was also the November reading on durable goods orders, which grew 0.8% m/m vs. median forecast at 1.6%. Despite disappointment, both readings were however quite good, showing that the real economic sentiment may be not as bad as suggested by sliding stock indices.

Therefore, it is justified to expect the S&P 500 to stop at current level, where investors are supposed to await new information. After this consolidation, it seems probable that the current downward trend will be continued until the index reaches 2400 pts. At the moment, this support seems to be good starting point to start upward correction, that would drive the index towards 2500 pts or even 2550 pts., depending on incoming information. Looking at German DAX Index, similar scenario is possible, with 10250-10500 pts being the area where the index could turn north. 

As for the gold price, both technical situation and fundamentals, given by the fear of economic slowdown, allow to expect reaching USD 1280. Extending this movement in short term is however unlikely, especially if stocks pared losses over the nearest few sessions.

The Federal Reserve has raised the fed funds target rate by another 25bp to a range of 2.25%-2.50%. The Committee, however, sounded more cautious about the outlook and pledged to “monitor global economic and financial developments”. The FOMC members’ median interest rate projections now only show two hikes for 2019 (down from three), while the estimate for the longer run natural rate was lowered to 2.75 from 3.00%.

Despite tighter financial conditions and growing political pressure, the Federal Reserve today delivered a unanimous 25bp rate hike. With this move, the Fed has lifted its target rate four times this year, for a total of 100bp. That is the largest annual increase in short-term rates since 2006. Strong economic growth, a falling jobless rate and inflation rates close to the 2% target allowed the Fed to gradually normalize its policy stance. It is important to remember, however, that even after those rate hikes, the target rate remains below most estimates for the equilibrium rate. In other words, the policy stance has remained accommodative.

The post-meeting statement contained only a few changes. But those that were made send the clear message that the FOMC’s confidence in the medium-term outlook has been rattled. First, it is now the Committees “judgment” rather than its “expectation” that “some further gradual increases in the target range for the federal funds rate will be consistent with” meeting the dual mandate. Second, it is now the Committee’s judgment that risks to the outlook are “roughly balanced”. Moreover, the statement qualified the balanced-risk assessment by adding that the Committee will “monitor global economic and financial developments and assess their implications for the economic outlook.”

At the very least, these wording shifts represent a weakening in the Fed’s forward guidance in favor of a more data-dependent approach. This is how it should be, in particular as rates have gotten closer to the neutral level, while at the same times headwinds are mounting.

The macroeconomic forecasts have not been changed by a lot, with the 0.2pp downward revision to 2019 GDP growth (from 2.5% to 2.3%) being the single-largest adjustments. The changes that were made, however, all point in the same direction: GDP growth a tad lower, the jobless rate a tad higher, and inflation a tad lower. This mirrors the declining confidence in the outlook amid growing uncertainties and mounting headwinds. In line with this – and consistent with Chair Powell’s recent comments made to the Economic Club of New York –, the FOMC members have lowered their interest rate projections. The median projections (the “dots”) now show only two hikes for 2019 (down from three), followed by one more hike in 2020. The resulting fed funds target rate for yearend 2019, 2020, and 2021 is thus 2.9%, 3.1% and 3.1%, respectively. At the same time, the estimate for the longer-run natural rate has been lowered to 2.8% from 3.0%. This implies that the Committee’s baseline scenario still looks to bring the fed funds target rate into a mildly restrictive are by the end of next year.

With the downward revision to the 2019 dot, Fed officials now project the same amount of rate hikes for next year as we do.

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