Markets are responding to a stream of key political developments in recent days. Theresa May trying to kick start the painfully slow Brexit negotiations, key elections in German and New Zealand and also the ongoing geopolitical tensions of the Korean Peninsula. Financial markets are trying to figure out the impact of all of this politics and the Federal Reserve monetary policy, whilst traders will also be looking ahead to key US inflation data this week. We look at the outlook for forex, equities and commodities.
The Federal Reserve is the first major central bank to begin unwinding its balance sheet. In October the Fed will stop reinvesting $10bn of Treasuries and Mortgage Backed Securities per month. That will then increase by $10bn every quarter until it will unwind by $50bn per month. No detail has been given on the eventual size of the balance sheet that the Fed wants to end up with. Quantitative Tightening should help to raise yields and subsequently help to support the dollar in the long term. The fact that it is such as gradual unwind should help to soften the negative impact on equities, whilst the normalising of monetary policy in the long term is certainly a preferred prospect. From the UK point of view, expectations of tighter monetary policy in “the coming months” has been ramped up too in the past week, helping to pull sterling higher. However Brexit remains a hot topic for traders. Theresa May’s speech in Florence seemed to be conciliatory, but somewhat short on detail. Nothing on Norther Ireland and no number put on the potential divorce bill. She only said that the UK would pay its budgetary commitments from “during the period of our membership”. This appears fair, but the EU is yet to give any concessions and unless this issue over money is resolved the negotiations will painfully drag and the real issue, trade, will suffer. Sterling traders seemed unimpressed with May’s speech and even less so with a Moody’s rating downgrade, however the Bank of England is still key.