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While you were sleeping: ECB warns of reversal

Friday 25th November 2016

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The European Central Bank warned that “the potential for an abrupt reversal remains significant” on financial markets in its twice-yearly Financial Stability Review.

The warning came on a quiet day with US markets closed for the Thanksgiving holiday. On Wednesday both the Dow Jones Industrial Average and the Standard & Poor’s 500 Index closed at record highs. 

Trading will resume in New York on Friday though many market participants are expected to remain on the sidelines until next week.

Europe’s Stoxx 600 Index finished the day with a 0.2 percent advance from the previous close. The UK’s FTSE 100 Index rose 0.2 percent, Germany’s DAX Index gained 0.3 percent, while France’s CAC 40 Index also added 0.3 percent.

Elsewhere, the US dollar touched the highest level in fourteen years before giving up some its gains. Zinc and copper advanced in London trade.

“More volatility in the near future is likely and the potential for an abrupt reversal remains significant amid heightened political uncertainty around the globe and underlying emerging market vulnerabilities,” the ECB said in its twice-yearly review.

“Elevated geopolitical tensions and heightened political uncertainty amid busy electoral calendars in major advanced economies have the potential to reignite global risk aversion and to trigger a major confidence shock, thereby weighing on the underlying global and euro area growth momentum,” the ECB noted.

The central bank specifically warned about the potential impact of policy by US President-elect Donald Trump.

“The implications of the recent US election for euro-area financial stability are highly uncertain at the current juncture,” the ECB noted. “This notwithstanding, economic policies in the US will likely become more inward-oriented, while the fiscal deficit may grow as a result of tax reductions and increased infrastructure and defense spending.”

“In such a scenario, the euro-area economy may be impacted via trade channels and by possible spillover effects from higher interest and inflation rate expectations in the US,” the ECB said.

Meanwhile, analysts see further gains for the greenback ahead.

"There doesn't seem to be anything stopping US yields going higher in the near-term so I think people are going to stay on the dollar trend," State Street Global Markets' head of global macro strategy, Michael Metcalfe, told Reuters.

"The only risk to this are that the dislocations in markets outside of the US, particularly in emerging markets, get to a point where they start to feed back into concerns” for the Federal Reserve as it looks to raise interest rates, he said.

The Federal Open Market Committee next gathers for a two-day meeting starting on December 13.

The odds of a December hike surged to 100 percent and the probability of additional moves by June climbed to 66 percent, according to fed fund futures data compiled by Bloomberg.

Gold extended its recent slide overnight. Oil was relatively steady, edging higher, as OPEC members prepared for a key meeting early next week.

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