Weekly Market Update

18/12/2017

US equity indices resumed their record-setting ways and the dollar rallied as market participants appeared to shrug off worries that the tax reform legislation might not be pushed through before the end of the year.

Meanwhile, the Trump administration suffered a blow after Roy Moore, the Republican candidate, was defeated in Alabama’s Senate election. Trump had thrown his full weight behind Moore, but the loss leaves the Senate split just 51–49 in favour of the Republicans. Next year’s mid-term elections are looking finely balanced, and the passage of Trump’s tax reforms may be less certain than it looked last week.

In her last significant act as chair of the US Federal Reserve, Janet Yellen raised interest rates by 0.25 per cent, the third increase in 2017. The move was widely expected and underscored solid gains in the US economy, causing little reaction in the markets. But the Federal Reserve also increased its growth forecasts for the next three years, projecting 2.5 per cent growth in GDP in 2017 and 2018, due, in part, to planned tax cuts. The Fed said it anticipates three further increases in rates next year, unchanged from its previous forecast.

The People’s Bank of China followed suit by raising its policy rate after the Fed’s announcement. For holders of risk assets, such as equities, the generally accommodative stance of monetary policy has clearly been a key element of asset price strength. While central banks are undoubtedly moving to tighten these conditions, it is not at all clear that 2018 will see a sufficient adjustment to upset the applecart.

At home, Theresa May suffered her first major legislative defeat, after pro-European Tories backed a move insisting that parliament have a full vote on any Brexit deal before ministers begin implementing it. However, EU leaders gave the greenlight to second-stage talks with the UK after agreeing that London had offered enough in terms of the divorce settlement to allow for discussions on the future trade relationship to take place. The hard now begins.

UK Inflation rose to 3.1 per cent in November, the highest level in five years. It is quite possible that inflation is now close to its peak, and will decline towards the 2 per cent target in the medium term, even with tentative signs that wages are starting to tick higher. As expected the Bank of England held rates but indicated that modest increases were needed to curtail inflation during the next few years.

The European Central Bank revised its growth and inflation forecasts upwards at its meeting that kept interest rates on hold at record lows. President Mario Draghi hailed the strong pace of economic expansion and a significant improvement in the growth outlook.

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