By Craig Erlam
Equity markets are paring gains ahead of the Federal Reserve announcement on Wednesday, perhaps a little caution ahead of the final decision of the year.
The announcement, forecasts, and commentary will set the scene for next year, in particular the first quarter which is still fraught with uncertainty over just how far the central bank will go.
Policymakers have been clear this year that regaining control of inflation comes first, no matter the economic consequences. Of course, the two are linked and throughout that time, the central bank has maintained that a soft landing is possible and if recent inflation data is to be trusted, it may well be achieved.
Tuesday’s CPI data was very welcomed by investors, confirming once more that inflation is heading in the right direction, finally, and at a pace – much like the ascent this year – that’s exceeding expectations. The rate hikes are working and given they work with a lag, the numbers in the new year should be more promising again.
There will be an economic cost, though, and the stubbornness of higher wage growth could pose a risk to the Fed returning inflation to target. But the last couple of CPI reports will help settle the nerves at the Fed and attention next year may now shift more to not overtightening, creating deflation risks, and even supporting the economy.
To what extent the central bank is willing to admit or acknowledge that, will determine how markets respond later Wednesday. As will the forecasts, which could heavily hint at what the policy response will be early in the new year.
While markets are still pricing in another 50 basis points of hikes in the new year, following an anticipated 50, that could be further scaled back if the forecasts allow for it.
UK inflation cause for optimism
The Bank of England arguably has a greater challenge ahead, with the UK economy suffering higher and potentially more stubborn inflation, as well as a deeper recession next year. That’s some storm for the central bank to navigate.
It’s a lose-lose situation but Wednesday’s inflation data will offer a glimmer of hope that its hikes are working, base effects are favourable and the path back to 2% may be less turbulent than it currently appears.
Or perhaps this time of year is just rubbing off on me.
Huge uncertainty for oil
There remains uncertainty over the outlook for crude demand and supply which is leading to plenty of volatility in oil markets. The price rebounded in recent days after WTI fell close to $70, the level at which the White House has previously indicated it will start refilling the SPR following a year of repeatedly drawing it down.
With China finally navigating away from zero-Covid, which alone brings huge uncertainty for next year, the global economy slowing, Russia continuing its war in Ukraine, and OPEC+ seeking to maintain balance, I don’t expect volatility to subside in any significant way soon.
Gold eyes Santa rally
Gold is paring its post-CPI gains ahead of the US interest rate decision. It finally broke $1,810 but failed to hold on and eventually ended the day back around that level.
A dovish Fed on Wednesday could seal the deal and deliver a Santa rally for the yellow metal in the final weeks of the year.
Craig Erlam is Senior Market Analyst, UK & EMEA at OANDA
Opinions are the author’s, not necessarily that of OANDA Global Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. Losses can exceed investments.
