December is likely to be a crucial month for financial markets, setting market direction for the rest of this year and early 2016, as there is an unusually high occurrence of significant meetings taking place during the month:
December 3rd :European Central Bank.
December 4th :Organisation of Petroleum Exporting Countries (OPEC).
December 10th:Bank of England Monetary Policy Committee.
December 16th :US Federal Open Markets Committee (FOMC).
Clearly the first two of the four meetings have now taken place.
European Central Bank Meeting
The markets had high hopes that ECB Chairman Mario Draghi would come the rescue of the European economy and so providing further impetus to financial markets. As ever, it is better to travel than arrive! The weight of expectation was simply too much. The 0.10pc cut to the deposit rate (bank deposits at the ECB), when 0.15pc was already discounted, combined with the modest tweak to the ECB’s bond-buying programme – a six month extension to March 2017 with a marginal increase in eligible assets to take in regional government debt – was baked in to even the most cautious observers’ base-case scenarios, with many going much further.
Monthly ECB bond purchases were expected, in some quarters, to rise from EUR 60 BN to EUR 75 BN. When Dragi sat down, all but the most conservative predictions were disappointed.
By announcing details of his policy easing he perversely ensured a tightening of monetary conditions with the euro appreciating by 3pc, the biggest one-day move since 2009 with the market wrong-footed. Bond yields rose by up to 0.25 pc and equity markets also selling off in response.
Organisation of Petroleum Exporting Countries Meeting
Oil prices fell to their lowest in nearly seven years after OPEC failed to agree in its policy meeting on Friday to lower production in an attempt to stem prices that have dropped more than 60 percent since June 2014. For the first time in decades, oil ministers dropped any reference to the group’s output ceiling, highlighting disagreement among members about how to accommodate Iranian barrels once Western sanctions are lifted.
Bank of England Monetary Policy Committee Meeting
This meeting is perhaps the least significant of the four. It is widely believed that a rise in US interest rates brings an increase in the UK as, in the past, interest rates in the two countries have tended to follow similar paths. This time things are different. True, the UK economy is similar to America’s in both structure and stage in the business cycle. But the UK is ‘piggy in the middle’ between the US and continental Europe, the UK’s largest export market. Although the eurozone has strengthened this year, it remains weak. Indeed the ECB is loosening monetary policy, as discussed, just as the US ‘Fed’ is about to tighten.
The pound has been rising against the euro, and inflation is close to zero, so neither justify an interest rate boost right now. It is only the booming UK property market that would warrant a rate increase to prevent this boom becoming a ‘bubble’. The second half of 2016 is best guess for the first of a few gentle UK rate rises, well after the US.
US Federal Open Markets Committee Meeting
US Fed (Federal Reserve) policymakers are widely expected to raise US interest rates this month for the first time since 2006.Whereas this move is fully priced into asset prices, tighter US policy and a subsequent stronger dollar could highlight financial vulnerabilities among borrowers: The amount of dollar-denominated debt rose to USD 9.8 trillion in the second quarter of 2015, with dollar credit to borrowers in emerging markets doubling since 2009 to more than USD 3 trillion. A likely December increase in the US ‘Fed Funds’ rate likely represents just the beginning of the US rate tightening cycle with 3 or 4 further rises expected in 2016. Will such emerging market borrowers be able to service such USD repayments which have become significantly more expense to service as their currencies have weakened significantly versus the USD as part of the 2015 commodity price rout? Commodities have fallen about 25% so far this year with emerging market countries being both big commodity producers and exporters. Their currencies and economies have weakened significantly throughout the year. 2016 will be an interesting indeed!
Equities
S&P 500: 2100
Nasdaq: 5100
FTSE 100: 6250
Bonds – 10 Year Government Yields
US 2.20%
EU 0.60%
GB 1.80%
Foreign Exchange
EUR/USD 1.0850 (1 euro buys 1.0850 dollars)
GBP/USD 1.5100 (1 pound buys 1.5100 dollars)
Commodities
OIL: Brent: 42.00 (dollars per barrel)
GOLD: 1075 (dollars per ounce)
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Paul McCormick
