Market Outlook What to expect next week

City Index Market Outlook  

• Main themes

• Look Ahead: Indices

• Look Ahead: Stocks UK

• Look Ahead: Commodities

• FX Technical Outlook

1. Main Themes:

US: Clinton’s Presidency not necessarily a boon for US markets

The final Presidential debate is over, and with less than three weeks to go before the election on November 8^th, it appears that Hillary Clinton may have done enough to win the Presidency with only 10 Electoral College votes (at the time of writing) left to win. It appears that she is pulling ahead in the race to attract support from the major swing states, especially Florida, and this could put Hillary Clinton back in the White House, but this time not as First Lady.

US assets have had a fairly muted reaction to the shift in the polls in favour of Clinton. The dollar pullback in recent days and the retreat in 10-year Treasury yields from the key 1.8% level suggests that the markets could stay range-bound in the run up to the election. Likewise, US stocks have also traded sideways in recent days. We believe that two things could limit the dollar rally, and potentially the US equity market rally in the aftermath of a Clinton victory. Firstly, the Fed may only hike rates once in the coming months, most likely at the December meeting, and could then leave rates on hold for 2017, which is what the market is currently pricing in. Unless Yellen and co. hint that rates will rise at a faster pace, then it could be tricky for the buck to extend its recent rally. Secondly, if Clinton’s Presidency heralds a lurch to the left in a bid to win the support of the Bernie Sanders supporters then we could see equity markets in the US start to wobble.

Overall, the outcome of this Presidential race is looking increasingly sewn up for Clinton, however the impact on the markets remains unclear. This could keep US assets range-bound between now and the election on November 8th.

Europe and the UK: Relative values as BOE and ECB may diverge (UK)

The pound’s Brexit-inspired decline came to a halt last week, as the downward pressure on sterling abated giving the UK currency a chance to recover against all of its G10 counterparts bar the New Zealand dollar. While this “recovery” has been mild, it has broken the seemingly never-ending downtrend in GBP since the Tory Party conference at the start of this month. The reason for the pound recovery is two-fold: firstly, the government rhetoric around Brexit has softened of late, Theresa May is expected to call for a smooth Brexit when she meets her European counterparts at her first EU summit. Secondly, rising UK price pressures make it less likely that the Bank of England will cut interest rates this year. Market expectations for a rate cut by year end have plunged from nearly 30% one month ago to a mere 11% today. As the BOE backs away from rate hikes, we see this acting as a floor for GBP.

We believe that GBPUSD may still hit 1.20 between now and the end of the year as there remains a lot of political risk for the pound, however this is likely to be a key level of support and we don’t think that the pound will fall much further from here. We think that from now until Q1 (before we Trigger Article 50), GBPUSD could trade in a range between 1.20-1.25. A lot of the negative news is already priced in for GBP, so we don’t think it has that much further to fall. We are more bullish on the pound’s prospects vs. the euro, and we could see back to 0.85 in EURGBP by year end, especially if the ECB announces that it will expand its asset purchase programme after it expires in March 2017.

In contrast to the BOE, the ECB is expected to boost its QE programme when it expires in March 2017. We expect an announcement to be made at its December meeting, with the ECB potentially lengthening its QE programme until autumn next year. The ECB’s asset purchases have boosted its balance sheet to a whopping EUR 3.4 trillion, however, it appears to be having the desired effect:  the latest ECB Bank Lending survey showed an increase in both corporate and domestic lending in recent months. Lending rates are rising because of low interest rates, thus, if the ECB wants to see lending growth continue to expand, which we believe that it does, they may have no choice but to increase the longevity of its asset purchase programme. This is mostly euro negative, in our view, especially vs. the GBP. If the BOE remains on hold while the ECB continues to expand its balance sheet, then the single currency could come under broad-based pressure in the coming weeks.

Asia: China unlikely to intervene in the renminbi (SG and AU)

Two things are worth noting as we look towards a new week. Firstly, China’s currency remains close to a 6-year low versus the USD, with USDCNY above 6.74. This suggests that the Chinese authorities have not intervened to prop up its currency since coming back from the public holiday. We think that the Chinese authorities may be reluctant to step back in to prop up the CNY at this stage for a couple of reasons: firstly, the PBOC’s balance sheet has contracted by 10% in 2 years as the PBOC has used FX reserves to buy the renminbi and increase its value at various stages. A 10% decline in the size of a balance sheet the size of China’s is a serious chunk of change. The PBOC may not want to see its balance sheet decline too much more, lest it tightens monetary conditions too much and chokes off economic growth. Secondly, the US government has been on hold during election season, so China has not come under international pressure to boost the value of its currency. We may not see the US, who have labelled China as a currency manipulator in the past, pile the pressure back on Beijing to boost the value of its currency until next year, once the new President is sworn in. Thus, the PBOC could save its arsenal of CNY-supporting measures for the future, and we may see further CNY weakness in the coming weeks, particularly if the dollar rally is extended.

Looking ahead to next week’s BOJ meeting, a BOJ member said last week that pushing back its forecast for when the economy will meet the BOJ’s 2% inflation target is not a way to ease monetary policy further. The BOJ seems to be prepping the market for a neutral statement at its meeting that concludes Nov 1^st, and we do not expect the BOJ to announce any increase in its stimulus programme before year end. With Brexit and US Presidential risk taking a back seat after hogging the limelight for so long, we think that fundamentals could come back into focus in the coming weeks. Thus, any signs that the BOJ could remain on hold and will not ease policy further could boost the yen against the euro, where we think policy will be eased further, and potentially against the USD, as we believe the Fed could tone down any hawkish sentiments after it potentially hikes rates in December. Relative value could the new buzzword in the global FX market.

2. Look Ahead: Indices

Markets in Europe and the States have been in a more obvious ‘wait-and-see’ mode than their Asia-Pacific peers over the last week as the main risk event of the year—the US elections—loom ever closer. Both the UK’s FTSE 100 and the North American benchmarks, the Dow Jones Industrial Average and the S&P 500, have made tight round trips over the last seven sessions that left them less than a percentage point away from closes in the middle of the week before.

The influence of the weakening yen on Japan’s export-dependent Nikkei 225 shares may account for Japan’s benchmark easily outperforming its major international peers with a rise of almost 2.5 percentage points. Whilst Japan Inc. would be just as vulnerable to Donald Trump winning the US Presidency, the waning currency impetus between the US-Europe axis provided no further reason to chance deeper investment, with the outcome of the 8th November poll not guaranteed.

At the time of writing however, with the final presidential debate out of the way, and Democratic nominee Hillary Clinton widely perceived to have held on to both her dominance of the political argument and her poll lead, stock markets might show signs of becoming more sanguine, though even a Clinton presidency would hold clear challenges to equity markets and beyond. The repeated intention of the Washington veteran to double down on tax rises and ‘Obamacare’ whilst turning a more critical eye to the healthcare and drugs industries will certainly contain any bullish relief in the medium term.

On that basis, it makes sense not to expect strong outright rallies by US shares into the election and even after it, before the political landscape becomes clearer.

From a technical perspective we are more inclined to find nearer-term reasons for optimism across the pond than in UK shares. Our S&P 500 chart shows a bullish Fibonacci-based pattern completed last week, suggesting a cautious target as high as the previous kick-back point (C). Note this would still be below the index’s recent new all-time high (A)

Purist chartists would argue that the pattern doesn’t conform to the conventional Gartley pattern, or even that it is not one of the recognised patterns named after an animal, such as a ‘bat’, or ‘butterfly’. However the most important point to make is that the pattern has close and consistent symmetry. Furthermore, price action following completion of the pattern at point ‘D’ coheres with the view that confirmation of support (‘D’) combined with tried and trusted price reversals at Fibonacci intervals (B, C and D) provided confidence for the market to recoup.

As for the FTSE 100 (represented in our chart by the (UK 100 CFD) it continues to be challenged by the same rising trend line that has capped prices for more than a week. The clearest signal that the index is ready for another attempt to mark a new all-time closing record, would be a clean and sustained break to the upside of the line.

S&P 500 chart 

Source: City Index

FTSE 100 chart

Source: City Index

3. Look Ahead: Stocks

Barclays may see the firmest tailwind from sterling’s fall

Investors in UK banks are looking back with envy and some optimism at US lenders’ earning season which saw the largest all beat The Street’s forecasts.

For Barclays, Lloyds Banking Group and Royal Bank of Scotland however, it’s been a trickier quarter, as the PPI saga, continuing legal settlements and the collapse of the pound continue to cloud the outlook for Britain’s Big 3.

Even so, the least UK-dependent, Barclays, stands the best chance of delivering a strong quarter, when it releases earnings on Thursday. We believe that the weakness of the pound since Britain’s Brexit vote in the summer will have boosted Barclays overseas earnings. Additionally, from our point of view, expectations for one-off enhancements to its third-quarter performance are being underestimated.

Barclays own consensus forecast, compiled from estimates by external banks and brokerages calls for a profit before tax of £1.295bn, though the bank’s own estimate of “other net income” for Q3 at £535m is well above the £446m forecasted by analysts on average.

Either way the market is very likely to react with as much enthusiasm as it did to the bank’s better-than-expected second-quarter results, which were of course driven by robust growth in its internationally facing commercial and investment operations, which RBS and Lloyds have retreated from substantially since the end of the last decade.

Barclays’ third quarter revenues are expected to slip 21% to £4.77bn according to an average forecast compiled by Thomson Reuters, whilst pre-tax profit is seen 22% higher at £933m.

As usual, there will be a barrage of one-off factors to consider which will both aid and hinder the bottom line. The biggest risk to Barclays Q3 results, albeit a remote one is that, the bank may book a penalty for substantial redress of one of the outstanding misconduct litigations it is undergoing, particularly at the US Department of Justice.

4. Look Ahead: Commodities

Crude oil prices remain on course to push further higher due to rising expectations of a tighter oil market as US oil inventories decline and production elsewhere either falls or freezes, while demand grows steadily. At least that is the hope for the OPEC, chief among them Saudi Arabia. The country’s energy minister, Khalid Al-Falih, has claimed this week that demand from China is not slowing down and that oil prices could stabilise further “if members act collectively” – in other words, collude to restrict supply. And by ‘members’ he presumably also means some non-OPEC countries like Russia. Comments such as these clearly suggests the OPEC and probably Russia will now have to cut their production in due course, for if they don’t then the consequences could be severe as not only will they lose further credibility but prices may then remain low for a lot longer than would otherwise have been the case. With regards to Chinese demand, Mr Falih is arguably correct. Refining rates in the nation rose last month as 43.8 million tonnes or 10.7 million barrels per day of crude oil was processed, up 2.4% from a year ago, while oil imports rose to a new record high of 8 million bpd. There’s also evidence of declining oil production in China where output fell nearly 10 per cent to near its lowest in six years.

Meanwhile in the US, crude inventories have been mainly falling since the month of May with the exception of a handful of occasions. Several sharp and unexpected oil inventory reductions have been reported in recent weeks by both the American Petroleum Institute (API), an industry group, and officially from the US Department of Energy (DOE). Although that trend was halted in the week ending October 7 with a large build of 4.9 million barrels in US oil stocks, inventories at the storage hubs in Cushing fell sharply, as too did stocks of distillates. In fact, that large crude inventory build was reversed entirely last week. According to the DOE, oil stocks in the US fell by a good 5.2 million barrels in the week ending October 14. What’s more, Cushing crude stocks again saw a sharp reduction and distillate inventories decreased by 1.2 million barrels. The inventory reduction in the US also points to a tighter oil marker, which is good news for prices if it can be sustained. From a technical perspective, WTI now needs to decisively clear its technically-important prior swing high of around $51.65 in order to encourage fresh buying momentum, potentially towards the levels shown on the chart. However the bullish technical outlook would become invalid in the short-term if support at $49.10 gives way on a daily closing basis.

WTI crude chart

Source: eSignal and City Index.

5. FX Technical Outlook:

USD/JPY

The USD/JPY’s three-week winning streak looked to have come to a halt at the time of this writing on Thursday, due among other things to profit-taking from the longs. The USD/JPY was consolidating below its technically-important 104.00-104.50 area, which had been both support and resistance in the past. While below here, the short-term bias remains moderately bearish. But the underlying trend may have turned bullish after the pair held its own on the higher time frames above the key 100-101 area, which as well as representing a psychological level (100) was also a significant support area in the past.  A key downward trend has now broken down and several resistance levels have been taken out, too. As such, we wouldn’t be surprised if the abovementioned 104.00-104.500 area also gives way soon. If the USD/JPY pushes onwards and upwards as we expect it might then the next bullish objective could either be at the 107.50 area – which represents the prior swing high – or at 107.65, where the 200-day moving average comes into play. At this stage, a closing break below short-term support at 102.80 is required to invalidate this short-term bullish outlook. Should that happen, then the support levels at 101.85, 101.25 and 100.00 would then become the next price objectives for the bears.

USD/JPY chart:

Source: City Index and eSignal

EUR/USD

The EUR/USD has been trending lower in recent days after its laborious consolidation phase during most of the summer. As a result, several support levels have broken down including the 50- and 200-day moving averages, the bullish trend line and the key 1.1105-1.1125 range. While this 1.1105-1.1125 range holds as resistance, the path of least resistance would remain to the downside, even if we do see a sharp rebound in the coming days. The next area of support to watch is around 1.0915-10940 where the low from June meets the 61.8% Fibonacci retracement of the last significant upswing. Given the slow and steady move lower, a potential drop to this area will more likely lead to a breakdown rather than a meaningful bounce. If so, the breakdown of support here will potentially pave the way towards the next bearish objective of 1.0755-1.0790 which is where the 78.6% Fibonacci retracement level convergences with the 127.2% extension of the corrective up move since June. Meanwhile some of the short-term resistance levels to watch include 1.1000, 1.1045 and that 1.1105-25 range as mentioned above.

EUR/USD chart:

Source: City Index and eSignal