USD — Markets await key US data
The focus in the United States will be on the ISM services survey on Monday ahead of the latest producer price (PPI) report on Friday. The Fed’s decision to raise interest rates and for how long will be crucial pieces of the puzzle as investors assess how high to raise them.As of now, the market is predicting a half-point rate increase this month, followed by another half-point increase early next year that pushes rates as high as 4.85%. It is also expected that the Fed will remain on hold for several months, before cutting rates a notch towards the end of the year.
Statistical evidence supports this claim. Despite solid official US data and a healthy labor market and consumption, forward-looking indicators warn of trouble ahead. Therefore, the Fed must keep going for now, especially since inflation is still running high, but growth problems will likely arise by mid-year.
The outlook for other major economies is even worse, so it’s too early to call for a dollar reversal just yet, but the rally is likely nearing its end. Having a softer Fed profile is normally not enough to turn the tide in the dollar, it is also necessary for there to be an improvement in the economic outlook in the rest of the world to attract capital from outside the US, which does not seem to be the case right now.
AUD — RBA lowers the gears
Australian economic growth continues to be strong, setting the stage for another rate hike when the Reserve Bank concludes its meeting on Tuesday. It is currently estimated that 75% of market participants expect a quarter-point hike, while 25% expect no change at all. The economy has developed favorably since the RBA last met. With the unemployment rate at a half-century low, the labor market remains extremely tight. As wages grew last quarter, inflationary forces were becoming more prominent.
Nevertheless, investors say the tightening cycle may be coming to a halt this month. There are a number of reasons for this, including the unexpected cooling in inflation in October, which led many economists to believe the worst has passed. The RBA should slow down since house prices are also declining and external risks are intensifying as the Chinese economy slows.
The RBA could raise rates but softly open the door to a pause next year, buying some time to monitor the effects of its previous actions and how a changing global economy will affect the RBA’s position. This might initially lead to a positive reaction in the FX markets, but the reaction could quickly reverse once the terminal rate becomes lower.
Overall, despite the recent relief rally, Australia’s outlook is gloomy. Although Australia is unlikely to experience a recession in the next year, it might still suffer collateral damage from reduced trade flows and commodity demand. A risk-sensitive currency like the Australian dollar is tough to be optimistic about as China slows and stock market valuations look unrealistic.
On Wednesday, Australia will release its third-quarter GDP figures. Earlier that day, China’s trade stats for November and inflation stats for Friday will hit the markets, both of which could have a significant impact on the Aussie.
Source: Weekly Market Outlook: Focus on RBA, BOC Meets, and US PPI