The EU’s leading negotiator whipsawed sterling yesterday. The net effect was to ease fears that the UK would leave the EU without the agreement Initial concerns that the negotiations had stalled sent sterling to nearly $1.3120
The willingness to discuss a two-year transition period spurred sterling’s recovery. After trading on both sides of Wednesdays, it closed on its highs was a bullish technical signal and there has been follow-through buying today. It is approaching a 50% retracement of the decline since late September. It is found near $1.3345, which also corresponds to the 20-day moving average. Next week, the UK reports CPI, retail sale, and September labor report. The market is pricing around a 75% chance of a rate hike next month and next week’s data will impact the expectations.
Today’s US data will likely determine if the dollar’s heavy tone this week is more corrective after a strong September or if this year’s downtrend is resuming. We suspect that both retail sales and CPI could surprise on the upside. Some of the strength we expect will reflect the headline reports, but the key to the markets’ reaction will be in the core rate. The median Bloomberg forecast is for a 0.2% rise in core CPI. That would match the August increase and be the best two month gain. The year-over-year rate is expected to move higher for the first time since January.
The headline retail sales likely rose sharply. It will be bolstered by the strong auto sales and higher gasoline prices. Excluding these two items and building materials, retail sales may rise 0.4%, which would fully offset the 0.2% decline seen in August. As we saw with autos, the storms are creating a demand shock for some goods, some of whom are in sectors where inventory levels were tight before the storms.
The December 2017 Fed funds futures is yield is unchanged from the end of last week at 1.265%. Our work suggests fair value, assuming a 25 bp hike in December is 1.295%. The December 2018 Fed funds contract’s implied yields are off 0.h5% for the week to 1.635%, which suggests that the market is just shy of discounting a single rate hike next year.
