Stock market rallies to new record, dragging Sterling and emerging markets along with it

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30 January 2017

Written by
Enrique Díaz-Álvarez

Chief Risk Officer at Ebury. Committed to mitigating FX risk through tailored strategies, detailed market insight, and FXFC forecasting for Bloomberg.

An unusually quiet week in terms of significant policy decisions and economic news meant that FX markets focus was elsewhere.

I
n particular, they reacted to the generalised return of risk appetite in financial markets. Renewed hopes that Trump tax cuts will mean a windfall for US equities sent stock markets higher. In particular, the Dow Jones Index broke cleanly through the psychological barrier of 20,000. G10 crosses moved in tight ranges amid subdued trading, with the exception of Sterling that rallied yet again alongside emerging market currencies. This positive correlation between the Pound and riskier emerging market currencies is certainly one worth paying attention to.

The surprising outperformer of the week was without doubt the Mexican Peso, which rose in spite of the escalation of the political conflict between the Trump administration and Mexico. Markets appear to be thinking that the worst scenario in terms of Mexican-US trade disruption is already priced in by a currency that is still down 13% since the US election.

This week, the news calendar return with a vengeance. The Bank of Japan has its monetary policy meeting on Tuesday, then Wednesday the Federal Reserve meets, and the Bank of England follows suit Thursday. The all-important US monthly payroll report closes on Friday in what promises to be a very volatile week.

Major currencies in detail

GBP

The sharp Sterling rally since the lows of mid January has been driven by a combination of general undervaluation of the currency, excessively bearish sentiment, and a general improvement in risk appetites in financial markets.

The true test for this rally will come on Thursday, as the Bank of England holds its February meeting. This will temporarily steal the spotlight from Brexit headlines. We await that the expected path of inflation will be adjusted significantly upwards, and generally more hawkish rhetoric from the monetary policy committee. If the general tone in markets continues to be positive, we could very well see additional short term rallies in Sterling.

EUR

Fourth-quarter GDP is the sole major data point to come out this week. We expect the headline number to come out at 0.5% QoQ, outperforming expectations by 0.1% and providing yet another positive surprise out of the Eurozone. However, this is a lagging indicator with a limited ability to move markets.

Moves in the common currency this week will be far more dependent on events across the Atlantic, including the February FOMC meeting and the January US payrolls report out on Friday.

USD

Last week, the fourth quarter GDP growth report came out slightly below expectations at 1.9%, dragged down by a larger than expected trade deficit. Far more important than this lagging indicator will be the communications from this week’s FOMC meeting on Wednesday.

There will be no outright shift in policy, and no update of the critical “dots plot” as this is done only every other meeting. However, Federal Reserve officials have sounded noticeably hawkish of late. We expect to see an upgrade to both the inflation and labor market outlook in the Statement. It doesn’t appear as if this hawkishness has been fully priced in by the market, so we could potentially see a significant Dollar rally in the second half of the week.

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