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The week started with mixed feelings. Investors broadly ignored the Federal Reserve (Fed) members’ latest warnings that the interest rate cuts won’t come as soon and as fast as priced in by the financial markets. Equity bulls look determined to keep the Xmas magic alive. Big banks like Goldman Sachs also add fuel on fire, citing that the dovish Fed is good for stocks. We all agree. Dovish Fed is good for stock valuations, yet, how long the Fed could remain dovish if the economy heats up? It depends…

Yesterday’s trading was marked by geopolitical tensions and news. The week started with the news that the world’s leading shipping companies decided to halt transit through the Suez Canal due to attacks by Iran-backed Houthis on commercial ships. The latter increases the risk premium of using the short-cut of Suez Canal and encourages ships to go around Africa instead. An extended period of disruption in global trade ways should not only sustain energy prices, but also put a renewed pressure on global supply chains and shipping prices. The latter is a threat to inflation.

As of today, upside risks to inflation persist and build up, and this will inevitably dawn on investors sooner rather than later. A stronger case is being built for a sizeable downside correction in both stock and bond markets into next year.

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The Federal Reserve’s (Fed) rate cut talk is getting chaotic and frankly, hard to follow. After the Fed signaled a possible end to its monetary policy tightening campaign and the European policymakers refused to adhere, some Fed members including John Williams and Raphael Bostic pushed back the Fed cut expectations.

But anyway, investors could give the Fed doves the benefit of the doubt until Friday’s PCE data. The PCE, the Fed’s favourite gauge of inflation, is expected to show a further decline in both headline and core inflation.

Elsewhere, the Bank of Japan (BoJ) will announce the year’s final policy verdict on Tuesday. The BoJ Governor Ueda’s comments, two weeks ago, that the BoJ’s policy would be hard to maintain from the year end had triggered expectations that the BoJ will finally say goodbye to negative rates. There is nothing more than a slim probability for the BoJ to exit negative rates this week, but investors are eager to hear further details about how and when the BoJ will leave the negative rate territory. Concrete details regarding the BoJ’s policy plans and/or changes in BoJ’s inflation outlook could cause swift moves in yen markets, which became very volatile since Ueda hinted that something is cooking in his kitchen.

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The European Central Bank (ECB) and the Bank of England (BoE) refused to join the Federal Reserve (Fed)-thrown pivot party. Both Christine Lagarde and Andrew Bailey declined to discuss cutting interest rates judging a policy loosening too early as the inflation threat looms. BoE’s Bailey pointed at the possibility of another rate hike, as three MPC members favoured hiking rates, while the ECB announced to accelerate EXIT from the PEPP stimulus, and the Norges Bank popped up with a surprise rate hike.

As a result, the rally in global stock and bond markets slowed. The euro and sterling rallied.

Note that the contrast between the resilient US economy adopting a dovish stance and faltering European economies holding on to a hawkish position gives the impression that something is amiss. Therefore, this week certainly threw the foundation of a stronger euro and sterling against the US dollar but the medium-term potential could be limited.

Elsewhere, the People’s Bank of China (PBoC) announced the largest to date liquidity injection to date, the latter could barely boost appetite in Chinese stocks but the industrial metals could be a good play in the context of increased Chinese stimulus.

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The Federal Reserve (Fed) wraps up the year with a resounding finale. The Fed is not bothered to see the US yields fall in preparation for a rate cut. On the contrary, they endorsed the idea of a policy pivot thanks to an encouraging fall in inflation and sounded way more dovish than everybody expected at their announcement yesterday – which clearly exposed that the policy pivot is coming.

The US sovereigns rallied, the Dow Jones hit a record, the US dollar tanked.

Now today, it’s the European Central Bank (ECB) and the Bank of England’s (BoE) turn to give their final policy verdict for this year. Both Mme Lagarde and Mr. Bailey are certainly annoyed to see the Fed go so soft yesterday, as Christine Lagarde had said herself that no reduction in rates should be expected in the next few quarters. It will be interesting to see if ECB and BoE officials feel comfortable about giving up their tough stance.

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US headline inflation fell to 3.1% on a yearly basis as expected, but headline inflation was slightly higher-than-expected on a monthly basis. And that small uptick has raised suspicions that the Federal Reserve's (Fed) final stretch in combating inflation may be more challenging than anticipated.

The latter triggered a mini selloff in the 2-year bond right after the data, yet the selloff didn’t last long. The US 2-year yield is about where it was yesterday morning.

With the latest inflation report behind us with minimal fanfare, the Fed officials will lightheartedly keep interest rates steady this month. Economic forecasts and the dot plot will play a crucial role in providing insight into the perspectives of Federal Reserve officials regarding expectations for rate cuts.

We will probably face a satisfied, calm but cautious Powell, who will say that the Fed has done a great job fighting inflation, but that the rates will remain restrictive as long as needed. One dovish tweak could be deleting ‘additional policy firming’ from the post-meeting communication.

In the best-case scenario, the doves will make a mountain out of the smallest dovish details that could justify a further fall in yields. In a more down-to-earth scenario, Powell will contain market optimism and rectify the rate cut bets. If so, we should see correction and consolidation in bond and stock valuations during the final weeks of the year.

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The week started on an optimistic note ahead of today’s US inflation update, tomorrow’s FOMC decision and Thursday’s European Central Bank (ECB) and Bank of England (BoE) decisions. The US 2-year yield advanced to 4.77% and the 10-year yield tested the 4.30% resistance, but both are down this morning, as bond investors lie in ambush before the US inflation update that will hit the headlines in a couple of hours from now.

Headline CPI in the US is expected to have steadied on a monthly basis thanks to subdued energy prices and the yearly figure may have eased from 3.2% to 3.1% in November. Core inflation is seen steady at 4%. A softer-than-expected set of inflation figures could further boost the Fed doves and appetite in US bonds, but gains will likely remain limited before tomorrow’s Fed decision and economic forecasts.

Elsewhere, US crude is gently recovering toward the $72pb level on threats that OPEC would extend and deepen cuts in case the selloff continued, but growing shale production in the US prevents the bulls from getting charmed by OPEC support.

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Friday’s jobs report from the US was strong. The stronger-than-expected jobs data sent the US 2-year yield to near 4.75%, and the 10-year yield recovered to 4.28%, but the stock traders gave a cheerful reaction to the news that the US jobs market is softening, not collapsing. The latest data suggests that the Fed is one step closer to realizing its Goldilocks scenario: it could win the inflation battle without pushing the economy into recession. Is it too good to be true? This week’s inflation update and the Fed decision will tell.

The economic calendar for the week is heavy. The US will announce its latest CPI update on Tuesday and the Fed will announce its latest policy verdict on Wednesday, then the Swiss National Bank (SNB), the European Central Bank (ECB) and the Bank of England (BoE) will give their last verdict for this year on Thursday. All four major central banks are expected to keep their interest rates steady at the current levels, but we will closely scrutinize how they address the rate cut expectations that have been ahead of their skis since the end of October. Chances are that the accompanying statements will attempt to cool down the doves.

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Yesterday was finally the day that most FX traders have been waiting for since at least a year: the day where the Bank of Japan (BoJ) gave a hint that it will finally exit its negative interest rate policy. Precisely, the BoJ Governor said, after his meeting with the Japanese PM - that handling of monetary policy would get tougher from the end of the year. Fundamentally, it is not too early for the BoJ to start hiking its policy rate. But it would be a sudden move – that’s for sure!

In any case, it is more likely than not that the fortunes of the Japanese yen turned for good this week. In the short run, consolidation is the immediate answer to yesterday’s kneejerk rally – which took the USDJPY immediately into the oversold market conditions as the move was also amplified with many traders covering their short positions. But from here, USDJPY traders will be looking to sell the tops rather than to buy to dips.

Elsewhere, the US bonds were little changed yesterday – for once – as traders sat on their hands ahead of this week’s much-awaited US jobs data, while technology stocks were on fire yesterday.

Today, all eyes are on the US jobs data!

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US crude plummeted 4% yesterday and sank below the $70pb mark and Brent slipped below $75pb.

Falling energy prices help soften global inflation expectations and keep the central bank doves in charge of the market, along with sufficiently soft economic data that points at the end of the global monetary policy campaign.

The US and European yields continue to fall, the S&P500 and Nasdaq both fell yesterday, while their European peers extended gains regardless of the overbought conditions. The Stoxx 600 closed yesterday’s session above the 470 level and screams: correction!

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