Follow-up noise from the Fed in focus

Wall Street managed to claw back to positive territory into yesterday’s close and Asia followed through with a strong session for equity markets as US-China trade talks wrapped up amidst hopes that solid progress has been made. A Bloomberg interview with Enodo’s Diana Choyleva offers a good overview of where progress has likely been made and where longstanding issues remain.

All in all, it seems likely that both sides will avoid measures – like the 25% tariff increase – that would deal immediate harsh damage to economic growth and market sentiment, but that lasting intractable issues remain that will not improve for the foreseeable future. The baseline for expectations, therefore, is that trade war concerns have eased considerably.

For incoming US data, however, it will be interesting to see how behaviour linked to the build up in fear that Trump’s original 25% tariff schedule would go into effect has affected inventory buildups and the risk of drawdown signs as the first 2019 data rolls in.

Yesterday’s enormous $38 billion US 3-year treasury auction saw the weakest demand, as measured by the bid-to-cover ratio, since 2009. This deserves note as a supposedly neutral to dovish Fed from here should make two- and three-year treasuries rather attractive for locking in decent yields. Is this finally a sign that the treasury issuance blitz in the wake of Trump tax reform risks outstripping demand?

Further impressions on the strength of demand in today’s 10-year auction and tomorrow’s 30-year T-bond auction as this week’s auction series will be 39% greater than last year’s equivalent. These auctions and the Fed’s QT remain massive absorbers of capital, with or without a rhetorical shift from Fed chief Powell.

Today and tomorrow should give us a thorough update on the Fed’s thinking as a veritable parade of mostly Federal Open Market Committee voting board members will be speaking. As well, late today we get a look at the FOMC minutes from the December 20 meeting. Let’s recall that the meeting was held in the context of equity markets having broken major support and in a freefall, so we should get a sense of how heavily this weighed in the FOMC’s thinking and despite the backdrop, why they were unanimous in voting in favour of the rate hike and a virtually unchanged policy statement.

Chart: USDCAD

An aggressive move lower in USDCAD as the big dovish shift at the December 5 Bank of Canada meeting has seen the Fed more or less following suit – in the market’s pricing of Fed intentions at least. Over the last couple of weeks, heavy speculative positioning caught the wrong way around on CAD, a rally in crude oil, and the Fed’s rhetorical shift have driven a brutal CAD rally into today’s Bank of Canada meeting, which is not likely to deliver any fresh shift after the loud shift in December. So any further CAD strength here will be driven more likely by externalities (oil and risk appetite) while a reminder of the BoC’s prior dovish shift today could see a steep consolidation higher in USDCAD. For a full bearish reversal of the chart, we’ll need to work down through the 61.8% Fibo retracement, 200-day moving average a bit lower and arguably also the 1.3000 level.