The Week Ahead

The Week Ahead: The Fed in focus

It may be the last full week of trading before 2025, however, there is a bumper week of data and news to digest that could impact market performance before year end. Central bank decisions, year-end economic data and European political developments are all worth watching.

In the UK, stories over the weekend focused on the ever-shrinking LSE, as companies delist, and IPOs remain thin on the ground. Another company listed on the London Stock Exchange bit the dust on Monday, with the takeover of Royal Mail by EP Group confirmed. The £3.6bn takeover has been approved by the UK government. Although the UK government will maintain a golden share, and EP Group has agreed to a Universal Service Obligation to ensure service levels continue, this move is still likely to cause concern about UK companyies low valuations and takeovers of key British industries.

It is not all doom and gloom for the LS however, TV production company Canal + is expected to list in London this week. Because its HQ is not in the UK, it will not be included in the FTSE indices, however, it is still expected to have a valuation of EUR 6-8bn.

European political risks grow

The European bond market is in focus after France’s credit rating was unexpectedly cut by Moody’s late on Friday. Its credit rating was lowered to Aa3 from Aa2, Moody’s justified the move by saying that the country’s public finances will be substantially weakened in the coming years. Moody’s is also not convinced that the next government will reduce the French budget deficit in the near term. The move by Moody’s brings it in line with Fitch and S&P, but it highlights the focus on French budget deficits and the risks they pose to bond market stability. French bond yields are a touch higher on Monday, but are generally stable. This comes after bonds sold off in Europe and in the US last week. The French 10-year bond yield rose 16bps last week, the UK yield rose by 18bps, and the 10-year Treasury yield also rose by 18bps. If we see continued upward pressure on yields, then bond market risk could be front and centre after the New Year.

German government likely to collapse

Germany is also on the radar this week, and Chancellor Olaf Scholz will face a no confidence vote at the start of this week. This is part of the continued fallout from the sacking of the FDP finance minister Christian Lindner in November. The result of the vote should be known by 4pm local time on Monday. Scholz is expected to lose this vote after the Far-Right ADP party said that it would vote in favour of the motion and the Greens said that they would abstain from voting. If Scholz does lose, then the German President will be asked to dissolve government and set an election date, which will likely be confirmed for February. The political turmoil has not disrupted the German bund market or the Dax, which reached a fresh record high on 13^th December. However, with France and Germany essentially rudderless at an important time for the economy and the global geopolitical situation, this is not a positive development for Europe, and it is weighing on the euro. EUR/USD fell a further 0.5% last week, and it is hard to see this pair stage a meaningful recovery with a huge amount of political and fiscal risk on the horizon, at the same time as the ECB is expected to cut rates.

Bitcoin makes fresh highs as Super Micro Computer set to join the tech super star index

Elsewhere, Bitcoin has surged to a fresh record high above $105,000 and is up nearly $2,500 on Monday. Bitcoin had its best week since 2021, at the same time as global stock markets slowed down last week. A combination of factors continue to push the crypto currency higher, including Donald Trump’s support for crypto, and the inclusion of Micro Strategy Computer, the software company that is also a leveraged bet on bitcoin, on the Nasdaq 100 Index. Micro Strategy is raising billions of dollars to plow into bitcoin, its inclusion in the Nasdaq 100 will help the company to borrow even more money, this leaves the company vulnerable to bitcoin’s every move.

The surge in bitcoin is also down to hopes that crypto can go mainstream, however, the pace of gains have been slowing recently, after moving extremely quickly since Trump’s resounding victory in the November 5^th US election. Inflows into crypto ETFs have surged recently. Bitcoin is attracting the bulk of the ETF flows, with $12.2bn of inflows since the election, ETFs in Ether have seen $2.8bn of flows. Hope and FOMO is driving Bitcoin to record highs, and unless we see Donald Trump change his tune on Bitcoin, it is hard to see crypto lose steam in the short term, although it is an extremely volatile asset class.

Below we look at the other major macro developments that could drive markets this week.

1, The Federal Reserve rate decision

The market has priced in a 97% chance of a rate cut by the Fed when they meet on Wednesday. This would be the third consecutive rate cut for the US, at the same time as the labour market remains solid and the US economy is expected to grow at a 3.3% annualized rate in Q4, according to the Atlanta Fed’s GDPNow model. However, is the slowdown in US stock market gains in recent days, and the rise in Treasury yields a sign that the market thinks the Fed could pause after that? There is only a 17% chance of a cut in January. The Fed may have started its rate cutting cycle with a bang and a 50bp rate cut, but the gear is changing as we move into 2025. The Fed will also release their latest quarterly economic projections and their Dot Plot this week, and it could show that the pace of reductions will slow in the coming years. There are currently just over two rate cuts priced in for 2025.

The other development at this week’s Fed meeting is that the Fed may not all vote in unison, with some hawks voting against cutting rates again. This could be a sign that winning the hawks over will be a tougher job for Powell next year compared to this year.

There is another elephant in the room at this week’s Fed meeting: how to accurately forecast economic activity and inflation rates, when the President elect’s policies are expected to have a huge economic impact and could trigger more inflation. For example, the risk of deportations and tariffs could trigger wage growth and domestic inflation in the US. The Fed is also reported to be concerned about euphoric conditions in the stock market and the exceptional rise in Bitcoin, which could spur excessive consumption. One way to blunt the stock market gains would be to signal fewer rate cuts next year, although that may not impact the Magnificent 7 tech stocks, and instead weigh on the cyclical sectors of the US stock market. This may hinder the broadening out of the US stock market rally and increase concentration risk. If the Fed’s Dot Plot does suggest fewer rate cuts, this is also supportive of the dollar.

2, The Bank of Japan and the BOE

Other central banks to watch this week include the Bank of Japan and the BOE. The BOJ is expected to remain on hold this week, with a narrow margin of economists expecting them to delay hiking or normalizing interest rates until next year. There is a 52% chance of a rate hike from the BOJ in January, however, this is not suggestive of a high level of confidence that a rate hike will take place next month. There are approx. 35bps of cuts priced in by October next year, however, the BOJ will need to sound hawkish for the yen to stage a recovery rally. USD/JPY rose 1.59% last week, and the yen was the second weakest performer on the G10 FX space.

In the UK, there is virtually no expectation of a rate cut from the BOE this week, with the market instead pricing in a 76% chance of a cut in February. The BOE have been vocal about their plans for gradual rate cuts, however the weak run of confidence data and economic data means that the commentary from the BOE will be worth watching on Thursday. While we doubt the BOE will cut rates, they could signal a faster pace of cuts next year. There are currently 3 cuts expected, however, we think that the BOE could cut at a faster pace due to the deterioration in the economic data. If the BOE does sound concerned about the growth outlook at this week’s meeting, then it could have a big impact on financial markets even if they don’t cut rates on Thursday. There is also a chance that the market starts pricing in a 50bp cut for February, after arch hawk Catherine Mann said in a recent speech that super-sized rate cuts could have a bigger impact on the economy rather than a gradual approach to rate cuts. The deteriorating growth picture is weighing on the pound, and GBP/USD declined by 1% last week. GBP/USD is stable this morning at $1.2635, for now, however a dovish BOE could send this pair down to $1.40.

This is the final week ahead of the year from XTB, we will be back on 6^th January with our weekly outlook.