Market Review – Fundamental Perspective 21 September 2017

Market moves yesterday were largely motivated by the FOMC statement which was slightly more hawkish than what the market had expected. The USD rallied and 2y US Treasury yields surged in response.
The price action most likely was driven by the surprising shift in the Fed’s “dot plot.” 13 of 17 FOMC participants now believe one or more rate hikes this year is appropriate.
Fed funds futures markets are now pricing in more than a 60% probability of a December hike. In line with this, we continue to expect the incoming data, including upcoming prints on inflation, to lead to a third rate increase this year at the December meeting.
The FOMC also announced the beginning of balance sheet normalization next month which was in line with expectations as it had been well signposted to the market.
Barclays Research expects “the actual amount of runoff to be less than implied by the cap sizes…” and for the balance sheet to “…to normalize at about $3trn in approximately three years…”.
UK retail sales surprised to the upside yesterday, coming in at 1%m/m (vs. consensus 0.2%m/m) This was primarily driven by strength in non-food and online retailing.
This beat saw GBPUSD trade up above 1.3600 briefly, before the market looked to fade the move ahead of the FOMC.
We believe that the details of the retail sales, combined with the information in the latest BoE agents’ summary, support our view of a BoE hike in November. However, the subdued longer-term outlook for households, due to negative real wage growth, may limit the potential for further hikes.
Focus now turns to Theresa May’s Brexit speech in Florence, expected tomorrow afternoon. The Speech will clearly set the tone for the next move in GBP in the short term ahead of a quiet week of data, next week in the UK.

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