Fed will raise sooner
The collapse of risk appetite continued today with selling across the board. Global equity indices, crude, USD and bond yields are all weaker. The Shanghai composite fell 5.22% and the Nikkei declined 3.89%. There is indiscriminate selling, rather than a traditional risk-off trade. Perhaps the clearest signal of a risk aversion trade is the decline of USD/JPY, which had recently reconnected with interest-rate differentials but now decoupled.
Expectations of higher US inflation is the likely cause. This, plus strong growth, will push the Fed interest rate path higher. The Fed Fund rate remains under-priced compared to “dots.” Repricing of the US yield curves has equity investors concerned that dot yields and stocks historically don’t move in tandem. Not helping is US President Trump’s statement blaming the Fed for the sell-off. “The Fed is making a mistake,” Trump told media, after the markets posted their biggest pullback in more than seven months. “I think the Fed has fallen on its head.” Markets are clear that an independent central bank is critical to overall market stability.
Brexit deal within reach?
A recent statement from EU chief negotiator Michel Barnier says an agreement could be reached by next Wednesday: this pushed the British pound higher. According to Barnier, 85% of the divorce is already agreed. Nevertheless, optimism might be short-lived as further uncertainty is coming. Prime Minister Theresa May is expected to submit the Brexit deal to Parliament in December – and the vote could go against her, as several of her own colleagues are willing to vote against the deal. The key remaining issue is that of border checks and free frontiers between the UK and Ireland, keeping EU and UK negotiators in intense day and night talks. The deadline of 18 October, when the future EU–UK trade deal must be submitted to all remaining 27 EU members, is nearing.
The cable continues to gain ground this week (+0.53% week-to-date), approaching the 1.3245 USD range. The 3-months 25 delta risk-reversal jumped by 4.40% since the beginning of the week, signalling further optimism.
