Monthly Forex Market Outlook – December 2016

As traders look to a new trading month and the last one for this year, the month of December looks promising as far as volatility is concerned.

There are a lot of fundamental event risks that promises to keep the markets volatile and offer short-term trading opportunities.

Here’s your guide to the key fundamental events scheduled for this month.

December 4^th: Italian Referendum on Constitutional Reforms

There are strong indications that the electorate will reject the constitutional reforms which could put Italy on an uncertain course as well as embolden further euro-skeptic parties especially as France, Germany, and Netherlands head to polls next year.

On December 4th, Italy has scheduled a public referendum to bring about sweeping changes to the constitution. Voters will be asked whether they approve of amending the Italian constitution which includes reforms to the appointment of powers of the Parliament of Italy and also a partition of powers of the state, regions, and administrations.

Italy’s Prime Minister, Matteo Renzi, after going back and forth vowed to resign if the electorate rejects the proposals and will hold fresh elections.

What does the Italian referendum mean for the markets?

At the heart of the issue will, of course, be the single currency which could come under pressure especially if the electorate rejects the proposal, which is what polls are pointing to. But given the recent performance of opinion polls, nothing can be taken for granted.

A rejection of the referendum is expected to set in motion widespread repercussions across the EU. French and German elections next year will be in focus, especially France where Marine Le Penn of the National Front seems to be the most well-prepared candidate, especially after ex-president, Nicolas Sarkozy lost in the first round itself.

December 8^th: ECB Meeting

ECB officials have repeatedly pointed out the risks of a premature tapering of QE and the lack of conviction in the rise in inflation expectations. The markets expect the ECB to extend QE by another 6-month, which is likely to be priced in.

The December ECB meeting will be interesting especially in the backdrop of the Italian referendum. Still, traders will be focusing on whether the central bank will extend its QE or taper. A decision on QE is expected to be announced.

Initially, the markets were expecting to see some form of QE tapering, but recent comments from ECB chief, Mario Draghi and other members of the governing council point to the potential for further QE expansion.

What does the ECB meeting hold for the markets?

An expansion to the QE timeline will no doubt weigh on the single currency which has already been battered in the post-US election landscape. Still, with the markets now expecting this to happen, the reaction could be muted, unless of course, the ECB also expands its QE war chest, which is unlikely at this point. The euro could react to the decision, but it could very well be a guarded response.

December 5^th – 8^th: UK Supreme Court appeal hearing on Article 50

The Supreme Court of the UK will be setting aside a hearing date for four days between December 5 – 8, 2016. The appeal was filed by the government following the November 3rd ruling by a UK high court on November 3rd where the verdict was that the UK cannot start negotiations on Article 50 until the parliament approves.

Four months after the UK voted to leave the EU, the Brexit is still engulfed in uncertainty. On November 3^rd a UK high court ruled that the government must put the Article 50 to a parliamentary vote for approval before negotiations with EU begins.

The UK Government filed an appeal with the Supreme Court on the issue which is slated for hearing for four days from December 5^th – 8^th.

What are the implications of the UK’s Supreme Court hearing on Article 50?

If the Supreme Court overrules the high court verdict, then Theresa May’s government is likely to remain on course to invoking Article 50 by as early as March 2017. This could potentially kick-start another bout of selling in the British pound as the market’s edge closer to date.

On the other hand, if the Supreme Court rules that the Article 50 must be put to parliamentary approval, it could provide a short-term delay but still, doesn’t change the fact that the UK is already one foot out of the EU. The British pound could rally on this news, but the gains could be limited.

Either way, the GBP will come under pressure early December.

December 14^th: FOMC Meeting

With the markets now assigning a 100% probability of a Fed rate hike, the US dollar is likely to continue to strengthen. Of course, between now and the December 14th FOMC meeting there are a lot of data points that could dent the market expectations. Despite the risks, the expectation for a rate hike remains strong.

Nearly a year after hiking interest rates by 25 basis points and more subdued approach to rate hike expectations, the Fed and the markets look to be finally aligned for another rate hike that could see the short-term interest rates rise to 0.75% this December.

The markets have taken this event in its stride with the equity markets trading at all-time highs and the US dollar rising steadily on hopes that inflation will increase quicker than initially anticipated. Various Fed officials have also repeatedly said that there is no reason why the Fed should not delay rate hikes any further.

What does the Fed rate hike mean for the markets?

With the markets well prepared for another rate hike, it is clear that the event will not be a surprise. Spare for some knee-jerk reaction to the announcement, the US dollar is likely to sit firm at the current levels. Traders are aware of the market behavior last December when after the initial euphoria had subsided; equities plunged and led to one of the strongest rallies in gold prices. Will we see a repeat of this event or will the markets react differently this time?