FX market outlook

• US stocks extend plunge as investors remain jittery of a Fed policy error, US government shutdown, and US-China tensions
• Yen outperforms as uncertainty deepens, while dollar continues to bleed
• BoE remains on hold, points to intensifying Brexit uncertainties

S&P 500 closes at September 2017 lows

There was no reprieve for US stock markets, which extended their losses as the dust following the latest Fed meeting settled. The benchmark S&P 500 (-1.58%) closed at its lowest level since September 2017, with investors continuing to rotate out of equities amid growing whispers that the Fed may be setting itself up for a policy mistake by raising rates further. The risk of a partial US government shutdown later today likely added to the risk aversion, as did a re-escalation in geopolitical tensions. The US Justice Department accused China of coordinating a decade-long hacking campaign to steal intellectual property from firms, reigniting concerns that the trade talks may fail to bear fruit.

Meanwhile, it’s worth bearing in mind that market sell-offs so close to the end of the year can sometimes “feed on themselves”, as large funds attempt to protect their year-to-date profitability in the midst of the carnage by liquidating prior long positions. Similarly, thin liquidity conditions can also exacerbate any sell-off. In this respect, note that today is “quadruple witching day”, which implies that stock volatility may be higher than usual and that large price swings can occur without much in the way of news.

Yen shines bright as uncertainty deepens, dollar falters

The biggest beneficiary of the market’s unrest was – of course – the defensive Japanese yen, which touched a three-month high against the underperforming US dollar. The greenback remains on the back foot as investors’ anxieties are manifesting into lower US bond yields, which lessens the currency’s carry appeal.

Separately, although the Fed may still hike a little faster than what is baked into markets, it’s becoming increasingly clear that it’s approaching “terminal” rates at a time when other major central banks will be gearing up to start their own tightening cycles. The implication is that the monetary policy divergence theme may have largely run its course, and that some investors may be trying to front-run the “policy convergence” that may well dominate next year, by limiting their exposure to the US currency.

Today, the US will be on the receiving end of the core PCE price index for November, the Fed’s preferred inflation measure. Personal income and spending figures for the same month as well as durable goods orders data are also due. Given the Fed’s increasing data dependence, these may prove crucial in determining the dollar’s performance heading into year-end.

BoE stands pat, highlights intensifying Brexit fears

As widely anticipated, the Bank of England (BoE) kept its policy unchanged yesterday via a unanimous vote, shifting to a slightly more cautious tone. Policymakers noted that Brexit uncertainties had “intensified considerably” since November, and also said that growth and inflation may be a touch weaker than previously anticipated. All in all, there was nothing particularly surprising from the BoE and hence, the reaction in the pound was limited.

The Bank is likely to remain sidelined until there is some greater clarity in the political arena. As for the pound, although Brexit updates are unlikely during the holidays since the UK Parliament is now in recess, note that if there are news, any reaction in sterling may be even larger than usual amid thin liquidity conditions.

US and Canadian data on the agenda today

As highlighted above, there is a raft of key data due for release in the US. In Canada, GDP and retail sales figures for October will hit the markets. Note though that the loonie’s overarching driver may be any moves in oil prices, which remain in the doldrums.

In the UK, the second estimate of GDP for Q3 is due out, though considering that Q4 is now almost over, it may be viewed as somewhat outdated.