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What signal will the Federal Reserve send?

Ahead of next week, here are the big questions we are asking at FT Markets

What signal will the Federal Reserve send?

The last US central bank meeting of the year will unfold on Wednesday with all eyes on officials’ latest assessment of the economy and the press conference of Fed chief Janet Yellen. Plenty has changed since their previous gathering just before the US election.

Dollar strength and record-breaking US share markets have been accompanied by higher Treasury yields, which are pricing in a quarter percentage-point increase in the Federal funds rate. Assuming the Fed delivers the first nudge higher in official borrowing costs for a year, the focus will be on the trajectory of tightening for 2017 and 2018. There is some risk that hawkish members of the Federal Open Market Committee lift their forecasts for where they expect rates to head.

Until now the FOMC had forecast two rate increases during 2017, but that was before Donald Trump’s election victory and the prospect of substantial fiscal stimulus next year.

“The biggest hawkish risk is that the number of FOMC participants that expect three or more hikes in 2017 increases from the seven dots at the September meeting,’’ says Steven Englander, global head of currency strategy at Citi. “The market could probably swallow eight or nine but if it goes above 10, it would probably be viewed as a warning shot about the possibility of a steeper pace next year.’’

Will US equities maintain their bullish momentum?

Mr Trump may have sold his stock holdings earlier this year, but plenty are buying and have sent Wall Street further into record territory. Since the US election the S&P 500 has gained more than $900bn in market value, with financials accounting for 40 per cent of that shift, according to S&P Global’s Howard Silverblatt. The big question is how long the record run in shares — with the four main US equity benchmarks setting all-time peaks last week — can continue?

The upcoming Fed meeting suggests a degree of circumspection may soon benefit even the most ardent of bulls. Indeed, there has been a modest rise in equity volatility in recent days — a sign perhaps of some investors buying cheap insurance against the risk of a pullback in the market.

The surge in equities and the value of corporate bonds is only raising the bar for the incoming administration to deliver a fiscal shot for the economy in 2017 that translates into annualised growth north of 4 per cent.

At some juncture, the political realities in Washington are likely to dawn — namely, that policy proposals take time to pass through Congress. Alongside this, there is considerable uncertainty as to how much the economy can be boosted by a combination of infrastructure spending, lower taxes and less red tape. Investors are also carefully watching whether Mr Trump’s harsh campaign rhetoric over immigration and trade translates into policies that end up hurting the US economy and the very sunny forecasts across Wall Street.

France losing its haven status within the eurozone

Politics overshadows the eurozone, and that is certainly the message from France’s sovereign bond market. Many investors are worried about the country’s presidential election in the spring. Although centre-right candidate François Fillon remains the favourite to be the next president, the possibility of a victory for far-right Eurosceptic Marine Le Pen is exerting pressure on prices for French government bonds.

In turn, the gap between 10-year French and German yields — a barometer of stress — has doubled between the end of September and early December. And, as the European Central Bank continues buying billions of euros of bonds each month, the money it pumps into the eurozone is becoming concentrated in just four countries: Germany, the Netherlands, Luxembourg and Finland. No sign of France on that list.

What are the pound’s prospects ahead of the Bank of England meeting?

Fluctuations in sterling will be governed less by what Mark Carney, governor Bank of England, says on Thursday, and more by the tone of the Federal Reserve’s commentary the day before. There is also a slew of UK economic data next week, including inflation, job numbers, wages growth and retail sales.

The commentary around sterling and the trading of it has shifted from glass-half-empty to glass-half-full. Brexit politics are likely to go into abeyance up until the Supreme Court ruling on the government’s Article 50 case, which is expected in the new year. Meanwhile, UK data has (mostly) been positive, and ongoing political risk in Europe leaves the euro on the defensive against the pound.

But conviction is still lacking when it comes to investor sentiment towards the UK — hardly surprising given Brexit uncertainties. Poor manufacturing data last week sent the pound into decline, and most analysts expect the formal triggering of Article 50 to result in a sharp fall. There is a window for a further sterling bounce, but it looks narrow.

Additional reporting by Elaine Moore

Via FT