FX Update: FOMC set to surprise with firmer taper talk?
Head of FX Strategy
Summary: The market may be too complacent on the FOMC meeting tonight as Powell and company may be set to signal a desire to bring forward the tapering of QE purchases. This could very well catch a complacent market by surprise and boost the US dollar on a renewed bout of volatility. Elsewhere, the Chinese renminbi weakened past a key technical level versus the US dollar yesterday.
FX Trading focus: FOMC set to bring forward its taper intents?
In part because expectations are so low for new developments at tonight’s FOMC meeting at a time when delta variant concerns are spreading and the US CDC is even asking people to mask up again, there is only one real direction of surprise, and that is in the direction of a more “hawkish” than anticipated message on tapering of asset purchases. A couple of drivers of this, as we discussed in this morning’s Saxo Market Call podcast, are the signs that Fed policy has generated more liquidity than the financial system can handle in an orderly fashion, from the ongoing melt-up in a narrowing slice of US mega-cap equities, to the ballooning of the Fed’s reverse repo facility, which shows the Fed actually having to lend out ever larger quantities of the treasuries it is buying. That facility has pulled back above $900 billion. Elsewhere, yesterday’s huge 17% year-on-year gain in the May US S&P CoreLogic home price is the latest evidence that the US housing market is edging into bubble territory. In short, Fed accommodation is already overstaying its welcome, even if Powell’s most recent indication is that the US economy is still “a ways off” from meeting the “substantial progress” needed to consider a policy shift. Assuming the Fed does surprise, the USD could back up sharply and relatively across the board, although as we note in the USDJPY comments below, how longer yields behave tonight and in coming days will be the key for how broadly the USD rallies on more hawkish than expected guidance on a QE taper tonight (it is our bias, not a certainty by any means).
Watching the USDJPY chart with particular interest over the FOMC meeting tonight after the crazy gyrations in longer US treasury yields at the June 16 FOMC saw the market struggling to digest the implications for longer treasury yields from the Fed’s more hawkish message as first yields knee-jerked higher (USDJPY positive before they fell back sharply and then went largely flat). We would note this time around that the month of August could bring a different environment for treasuries as the US Treasury presumably will finish winding down its general account with the Fed this week, and as treasury issuance is set to pick up from here as the market may also anticipate the Fed pulling back from its QE purchases soon. USDJPY is in total tactical limbo, having failed to follow through lower recently through the key 109.10 area to confirm the bearish rejection of the early July attempt above 111.00.
China and CNY as this is more than a “crackdown”
The significance of China’s reformation drive can’t be overestimated and is not merely a “crackdown” on specific equity sectors, but really represents a major policy shift as we also discussed in the podcast today with Steen Jakobsen. The basic outlines of the ideological and practical objectives driving the shift are covered well in an article by Shuli Ren over at Bloomberg. The policy moves’ implications for large swathes of the Chinese equity market are beginning to spook foreign investors, a development that has clearly spread to the CNH as can be seen in the trend tables below and could risk further strain on Asian EM FX and even to EM more broadly, with even risk sentiment globally potentially impacted as the hope fades that China will soon merely stimulate relatively indiscriminately with massive credit expansion as it has done in the past cycles. The confluence of this pointed development in Chinese policy and markets with an FOMC surprise could aggravate any volatility event that materializes in the wake of tonight’s meeting.
Table: FX Board of G10 and CNH trend evolution and strength
Note that the CNH no longer trades with any direction sympathy with the US dollar in the crosses as the recent policy impulses from China have created their own dynamic and seen a huge negative relative shift in the CNH relative to its normal, quiet behaviour.
Table: FX Board Trend Scoreboard for individual pairs
USDCNH moved into a positive trend more than a month ago and crossed above its 200-day moving average yesterday (right near 6.50), but note that now EURCNH and XAUCNH (gold priced in CNH) both managed to pull into a new uptrend on the close yesterday – watching for further signs of an isolated CNH move lower developing. Also note EURGBP trading on the cycle lows after its recent squeeze while GBPUSD is trying to shift gears to the upside – needing a hold above the 200-day moving average (around 1.3730 currently) for that situation to develop from here.
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