Policy Outlook in Question

STOCK INDEX FUTURES

The indexes are mixed with the S&P and Nasdaq heading lower, while the Dow maintains its strength. Investors are now looking ahead to the delayed CPI report due tomorrow for clues on the Fed’s policy moves for next year, after a set of mixed jobs and retail sales data released yesterday. Energy shares advanced in premarket trading, with Exxon Mobil up 0.9%, Chevron rising 0.7%, and ConocoPhillips gaining 1.6%, after oil prices jumped more than 2%. The rally in crude followed President Trump’s order for a “total and complete” blockade of sanctioned oil tankers linked to Venezuela.

The S&P Global US Services PMI fell to 52.9 in December from 54.1 in November, forecasts of 54. The reading marked the slowest pace of expansion since June, indicating a moderation in the service sector. New business growth dropped to a 20-month low, pointing to weaker demand, particularly ahead of the holiday season. Employment in the sector nearly stalled, recording the smallest payroll increase since April. Cost pressures intensified, with input prices rising at the fastest rate in over three years and selling prices climbing at the steepest pace since August 2022, largely driven by tariffs and higher labor costs. Meanwhile, Manufacturing PMI fell to 51.8 in December, the lowest in five months, compared to 52.2 in November and forecasts of 52. The reading pointed to a weaker improvement in manufacturing business conditions, as production growth dipped to a three-month low and new orders fell for the first time since December 2024.

CURRENCY FUTURES

US DOLLAR: The USD index is higher as markets await CPI inflation data out Thursday following the release of November’s jobs report, which showed an uptick in unemployment but left markets unsure on policy outlook. Markets are little changed on expectations that the Fed will hold rates in January with Fed Funds futures implying a 26% chance of a rate cut. Thursday’s inflation data will help offer further clues on the direction of monetary policy following Fed chair Powell’s comments last week that were not has hawkish as expected and had caught markets off guard. Markets will look ahead to remarks from Fed Governor Waller and NY Fed President Williams later on Wednesday for further clues on monetary policy. Only two voters dissented from cutting rates, far below an expected pushback of five. Markets are pricing in two rate cuts for 2026, while the Fed’s summary of economic projections was unchanged at just one. Powell suggested a rate hike is off the table and that it was not any policymakers base case.

EURO: The euro is lower as final CPI data for November for the eurozone was revised slightly lower to 2.1% from 2.2%. Inflation in the eurozone is expected to stay in a tight range and not deviate much in 2026. The European Central Bank announces its policy decision tomorrow and is expected to hold rates steady at 2.0%. Although the bank is expected to leave rates on hold possibly until 2027, speculation has been growing that the next move could be a rate hike. Money markets are implying a 29% chance of a rate hike in December 2026. Focus at the bank’s meeting will center around the ECB’s growth and inflation forecasts. Near term growth expectations are likely to be revised up, while inflation forecasts are likely to be revised down, as a stronger euro has had deflationary effects on the economy, which in growth terms has proven resilient. Elsewhere, German business sentiment unexpectedly deteriorated this month, amid growing pessimism about the business outlook for early months of next year. The Ifo Institute reported that its business-climate index, fell to 87.6 in December from 88.0 in November, the lowest since May. Companies had become more pessimistic about the first half of 2026, while their assessment of their current business situation remained unchanged. The downtick in sentiment follows a drop in business activity in Germany and the eurozone per S&P Global PMI surveys out Tuesday. Manufacturing activity fell to an eight month low, reflecting a PMI reading of 49.2, below expectations of 49.9 and signaling that activity contracted. The weak reading was primarily attributable to Germany, where the index fell to a reading of 47.7, its lowest reading since January and underscores a continued downturn in manufacturing conditions. New orders declined and output contracted as part a of a drop in exports sales and weaker demand. Hower, German expectations for future conditions rose to a six month high. In the services sector activity slipped, falling to a three month low with a reading of 52.6. Still, the services sector marked an expansion in activity as growth continued for the seventh straight month. Firms reported that they continued to hire, reflecting strong demand conditions, while output price inflation remained stable.

BRITISH POUND: The pound is lower after CPI inflation all but confirmed that the Bank of England will lower rates tomorrow. Consumer price inflation fell to 3.2% in November, its lowest since March, from 3.6% in October. Moderating wage growth and easing price pressures alongside soft activity and the disinflationary impact of budget measures all support the case for the BoE to lower rates. Interest rate futures are now pricing in a close to 100% chance of a 25 basis point cut by the BoE, compared with a 90% chance before the inflation figures. Unemployment data out Tuesday showed Britain’s unemployment rate ticked up to 5.1% from 5.0%, the highest level since the beginning of 2021. Meanwhile, wage growth in the country rose above expectations, possibly a worrying sign for the BoE although it is expected to moderate over the coming months. Price pressures in the country have been evidently been easing with inflation now ticking down to 3.2% from 3.6% alongside the passings of a government budget that is expected to knock half a percentage point off inflation entirely. Elsewhere, S&P Global PMI data on Tuesday showed that UK services and manufacturing sectors both expanded above expectations in December, reflecting greater certainty about economic outlooks with the passage of November’s budget.

JAPANESE YEN: The yen is lower ahead of the Bank of Japan’s policy meeting on Friday, where markets have largely priced in a rate hike from the central bank, lending focus to any signals about future tightening of rates next year. Japanese trade data out Tuesday evening rose well above expectations as exports rose 6.1% in November, surpassing forecasts of 4.8% and marking the strongest growth in nine months. Shipments to the US climbed 8.8%, the first increase in eight months, due to demand for pharmaceuticals, mineral fuels, and construction machines. Core machinery orders, a key leading indicator of capital expenditure over the next six to nine months, also jumped 7%, defying expectations of a 2.3% decline. It is likely that the BoJ will stress that the pace of further rate hikes depends on how the economy reacts to the initial increase in rates. The BoJ said that most of the companies it surveyed expected to raise rates at the same rate they did in 2025. This was a factor, which the bank had said was necessary in order for it to begin raising rates. Meanwhile, the bank’s Tankan corporate survey showed that big Japanese manufacturers’ business sentiment hit a four-year high in the three months to December. Future price moves from the yen will depend on guidance from the BoJ alongside external indicators, mainly US data.

AUSTRALIAN DOLLAR: The Aussie is lower as markets continue to weigh the prospects of a rate hike next year. In its mid-year fiscal update, the Australian government said its budget deficit for 2025/26 would now likely be slightly smaller than first projected at A$36.8 billion ($24.38 billion) thanks to fatter tax receipts. The small change should not require any increase in its planned A$150 billion of bond sales for the year to June 2026, but the lack of spending cuts does put the onus on monetary policy to restrain inflation in the near term. Labor figures last week showed a surprise drop in employment, which led markets to slightly scale back bets on a rate hikes next year. Employment in Australia fell by 21,300 in November as full-time jobs more than reversed a large increase the previous month. However, the unemployment rate held steady at 4.3% despite markets forecasting a rise to 4.4% as fewer people went looking for work. However, the RBA still views the labor market as tight, citing high job vacancies, widespread staffing shortages, rising labor costs, and other indicators that the economy remains near full employment. The Reserve Bank of Australia kept rates on hold last week and signaled that the next move out of the central bank is likely to be upwards. Increased risks to inflation have presented themselves in the economy, requiring the RBA to need more time to assess the persistence of the inflationary pressures. Household spending, monthly inflation, and private demand figures have all posted strong readings recently and are likely to stay elevated. Data from the National Australia Bank also showed that capacity utilization across the economy was at its highest level in 18 months, which will add to the RBA’s level of concern about the inflation outlook.

INTEREST RATE MARKET FUTURES

Yields are higher across the curve as the 10-year hovers just under 4.17%, close to its highest level since early September, as mixed economic data did little to shift expectations for the Fed. November’s jobs report, which showed that payrolls increased by 64,000 in November, more than expected while an abbreviated October estimate showed a decline of 105,000. At the same time, the jobless rate rose to 4.6% in November, exceeding market expectations of 4.4% and marking the highest level since September 2021. The Labor Department revised down payrolls for both September and August, for a total gain of 82,000 jobs, instead of the 115,000 previously reported. Meanwhile, the healthcare sector continues to hold up the labor market as private nonfarm payrolls rose by 121,000 over October and November. During that time period, the healthcare and social-assistance sector, gained 128,600 jobs.

For officials at the Fed, the uptick in the unemployment rate will be a talking point as it signals that the balance of labor demand and supply is changing. However the jump in unemployment is not as big as it seems at first glance. The September figure was rounded down to 4.4%, and the November figure was rounded up to 4.6%, so the gap between them was closer to 0.12% rather than a full 0.2%. Still, November’s uptick in unemployment suggests that the level of hiring is below what is needed.

The spread between the two- and 10-year yields is at 66.20 bps, while the two-year yield, which reflects short-term interest rate expectations, is little changed at 3.495%.

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