Afternoon analysis 26.10.2015

The euro dropped in spite of solid reports from Germany. The dollar remained strong before the Federal Reserve. The zloty under the pressure of political risk.

The latest data coming from the United States have increased the probability of interest rates hikes before the end of the year. The solid condition of the labor market, improvement in industry and ongoing expansion in the housing market are arguments for the tightening. The scenario that the Federal Reserve will increase the cost of credit for the first time in almost a decade supports the dollar.

The Federal Open Market Committee is scheduled to decide on the interest rates on Wednesday. There is no change expected. However, investors expect hints on whether the FOMC is going to increase interest rates in December. The last Fed meeting this year is expected to bring an initial hike.

The tightening will be hard to digest by investors as the futures market expects the rates to start increasing in March 2016. As a result, the key issue is the precision of the FOMC's in its communication with the markets.

Easing of tensions in China and an outlook for the European Central Bank to provide more stimulus may push the FOMC to remove from its statement remarks concerning the global slowdown. In September, the anxiety concerning the global economy pushed the Fed to postpone hikes. Currently, the focus may be shifted to the US economy. The FOMC may highlight that only a severe slowdown will force the central bank to leave rates unchanged.

Given the situation, the dollar was eager to rise. The US currency posted significant gains against the euro and other major pairs. During Monday's session the overall dollar gain was however limited. The EUR/USD was supported by solid reports from the eurozone.

The Ifo index that illustrates the German economic expansion was quite positive. The gauge was slightly better than the forecast (more on the issue in the previous commentary). It was the next report from Germany that showed steady growth in spite of the Chinese turmoil and the scandal in the automotive sector. In the last week, the reports from the eurozone were also quite good.

At this moment, the probability of the euro's rebound is minimal. The dovish stance that was shown by the ECB last Thursday will put pressure on the euro in the longer term.

The zloty hit by political uncertainty

Given the initial voting results, the PiS party has won and it will have a majority. If it is confirmed, the political risk will diminish. The worst case scenario will be the situation, if the PiS has to seek a coalition partner.

Comments from the foreign press were clearly negative. In addition, the Standard & Poor's agency warned that it may cut the rating perspective to neutral from positive, if the new government will introduce a more active fiscal policy. However, these reactions seem to be exaggerated. The winning party lawmakers have started to dilute promises from the election campaign. The probability that the new government will try to fulfill its promises at the expense of fiscal stability is limited.

As a result, the political risk associated with the new government will recede. It will provide some space for a rebound. However, the extent of the move will be limited by the expectations that the Fed is going to raise rates.