The top three for the week ahead

Fundamental analysis comes to the fore this week as a jam-packed economic calendar and a Federal Reserve meeting, along with a Bank of England meeting, take centre stage. After a few weeks of watching what stocks will do next, due to the sharp selloff in US technology stocks, the stock market sell off could take a breather as the market assesses the state of the global economic recovery and we find out if more central bank stimulus is forthcoming. Below we take a look at the three most important events to watch. 

1, The Federal Reserve meeting

This takes place on Wednesday 16th September, and the market will be eager to hear more details about the Fed’s new average inflation targeting regime, after it was first unveiled at the Jackson Hole symposium last month. While some may argue that the Fed will keep things short and sweet at this meeting since it already made a big announcement last month, we believe that this meeting could be critical, as it will include the Fed’s latest economic projections. Expectations are that inflation will remain below the Fed’s prior 2% target for the entire forecasting period of three years. If this is the case then the Fed has two choices at this meeting– do nothing, which is akin to throwing in the towel and would no doubt spook financial markets, or it could announce a shift in the guidance that it gives for its asset purchase scheme. There is a small expectation that the Fed could announce that any future increase in its bond buying scheme will concentrate on bonds with longer-dated maturities, at the expense of bonds with shorter-dated maturities. This would have the effect of pushing down longer term yields, which would be good news for risky assets and could kick start a recovery for tech stocks, which have been under pressure for the past 2 weeks. Overall, this Fed meeting is worth watching, as we believe there is an underlying expectation that the Fed will promise more monetary stimulus. Thus, if Fed governor Powell does not give the market what it wants and instead calls for more fiscal stimulus from the US government, we could see a broad sell-off in risky assets. 

2, Euro vulnerability 

After the ECB failed to confirm whether or not more stimulus from the central bank was forthcoming at its meeting last week, the euro rallied. However, the rally was shallow. There is some residual concern in the FX market that the ECB will have to boost its asset purchase scheme or cut interest rates in an effort to boost inflation in the euro area. This week sees euro members release their inflation data for August, and it’s not looking pretty. The Eurozone is expected to see prices dip 0.4% last month, with core prices down 0.5%, the annual core rate of inflation is expected to come in at 1.2%, well below the ECB’s 2% target. This leaves the ECB in a conundrum, inflation is weak, which suggests that the euro area’s economic recovery from the pandemic is stalling, and a strong euro is making things worse as it is likely to weigh further on prices in the coming months. We believe that the ECB will avoid trying to talk down the euro in the coming days and weeks, which is usually a futile exercise, and instead it could be forced to take action as early as its next meeting in October. If the euro looks shaky this week, we believe that it will be down to the market pricing in the possibility of more ECB monetary support in the near future. However, a weaker euro could also come courtesy of a stronger dollar. EUR/USD is down a touch at the start of trading this week, however, euro bears may need to be patient. A dovish Fed combined with more weakness for the pound could be enough to support the euro this week, and a break above $1.1850 would be a short-term bullish development. However, due to the deflationary risks that are circling around the Eurozone’s economy, the threat to the euro is growing, and $1.1950 is likely to remain stiff resistance. 

3, What next for the pound?  

GBP has been one of the world’s most unloved currencies this month. It’s decline last week felt precipitous, as political concerns around the UK trying to re-write the terms of its departure from the European Union spooked the market. The FX market has never trusted the UK’s decision to leave the EU, hence why there has been no meaningful recovery in the pound since 2016. It definitely did not appreciate the UK government’s plans to rip up its agreement with the EU, which potentially has far-reaching consequences including damage to the Northern Ireland peace process, threatening the post Brexit UK/US trade deal and damaging the UK’s reputation as a country that upholds the rule of law. These are weighty concerns, hence why the market ditched sterling last week. After the UK’s justice minister tried to defend the UK government’s actions by saying rewriting the withdrawal agreement is a mere backstop, the pound attempted to rally to $1.28 late on Sunday, however this first attempt has failed, and GBP/USD is back at $1.2790 at the time of writing. Weak inflation data, dismal retail sales for August and a drop in average earnings data and a rise in the claimant count are all expected to be announced this week, hardly the stuff that GBP recoveries are made of. Thus, watch out for further GBP weakness, support lies at $1.26, the low from 20th July. If we get an extremely dovish Fed, then GBP/USD has a chance to recover, with $1.2855 the first line of resistance.