With the ECB having disappointed investors with the QE extension package (but no mention of any expansion) announced on the 6th December, investors now turn to tomorrow’s Federal Reserve (Fed) meeting where interest rates are strongly expected to be raised, albeit gradually, for the first time in a decade. How the markets react will be the focal point, with the main focus being the tone of Janet Yellen’s message.

With the US economy growing at a rate of over 2%, the economic fundamentals have been far from stellar ahead of the highly anticipated Fed interest rate hike. With the services sector making up about 85% of the US economy, the latest Services Purchasing Manager’s Index (PMI) yoy fell -5.73 percentage points. This signals a significant slowdown. Unemployment claims were also on the increase, with last Thursday’s data coming in at 16,000 claims above expectations. However, this data was of little concern to markets, as investors remain adamant on the Fed raising rates.

Meanwhile, core retail sales and the Producer Price Index (PPI) both came in above expectations last Friday, indicating a continued recovery in the US. Consumer sentiment on the other hand, albeit higher than the previous data, came in below expectations.

The latest Consumer Price Index (CPI) figures are due later today, and it is the last data to surface before the Federal Open Market Committee (FOMC) statement tomorrow at 8:00pm (CET). Current expectations estimate CPI to come in lower than previous data as a result of the lower oil prices seen over the past month. Core CPI however is expected to remain unchanged.

Does the above data point toward a slowdown in the US recovery?

Investors are having mixed beliefs as to whether the time is right to raise interest rates. With economists estimating a 74-90% chance that the Fed will hike tomorrow, investors are trying to predict a market reaction. With weaker global growth highlighted by a stagnant Eurozone and slowdown in Asia, the US finds itself in a position where increasing rates may negatively affect its economic recovery.

Some investors are of the opinion that a rate hike is premature and would ultimately push an improving but slowing US economy back into recession, which would inevitably force the Fed to revert into Quantitative Easing measures.

Other investors believe that a rate hike is now overdue, and that rates should have been raised earlier, which consequently may have helped prevent the burst of the Chinese bubble earlier this year, highly impacted by the abundance of cash in global markets.

Caution will set the tone for tomorrow’s meeting. With Fed expectations more than seemingly priced into markets, the Dollar is still expected to strengthen further vs its peers and most notably the Euro. We may not see a EUR/USD parity scenario as of yet as any rate rise by the Fed should be a dovish one.

Should CPI figures come in above expectations today, then the green light would be given to Yellen and her crew. The rate lift-off, however, may be limited to progressing in 1st gear for the time being, at least until the next few rounds of economic data, where the Fed will be hoping for improved figures, most notably out of the labour market.

This article was issued by Mathieu Ganado, Junior Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt .The information, views and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.  

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