Powers that be plead for Powell pause

US equity markets put in another weak session yesterday, though the S&P 500 ended the day more or less unchanged before rebounding again overnight. US treasuries remain firm, with a Bloomberg article noting that the recent portfolio shifts into government debt have been the largest ever measured.

In FX, the USD was firm yesterday, but eased back lower into this morning as we all await today’s pivotal Federal Open Market Committee meeting and the market reaction. USD volatility has been pent up by the cross-fire of themes that work with opposing effects as well as the unknown of China’s intentions for its currency.

What will the FOMC deliver and how will the market react?

Two important resources to consult before tonight’s meeting. First of these is hedge fund manager Stanley Druckenmiller’s long interview with Bloomberg, in which he lays out a very sober and compelling case against the Fed hiking rates tonight based on the risk that we are suffering some sort of liquidity event that could get out of hand and then force an ugly over-correction of course. The timing of this interview and his recent op-ed together with former Fed official Kevin Warsh are no coincidence: it is a cry for the Fed to ceases and desist before causing irreparable damage. The second is an excellent rundown of scenarios on what the Fed may do and how the market will read it from Bloomberg’s John Authers.

The market is supposedly pricing a dovish hike scenario, but sufficient uncertainty is creeping into the pricing of Powell’s rate hike conviction and expectations may be more finely balanced than the purported odds show (in other words, hot money may be pricing 50/50 or higher that the Fed pauses here). My impression is that the Fed needs to both pause and second guess its forward guidance regime to bring significant relief to global markets.

How the Fed alters guidance via the dot plot and in discussion of the autopilot levels of quantitative tightening are key factors here. Some suggest a tweaking of dot plot levels is significant while I would argue that Powell likely detests the dot plot and would like to do away with it entirely, so a simple shift in Fed forecasts wouldn’t look terribly compelling, given that the market has virtually removed all expectations for further hikes in 2019.

Then on to the market’s reaction in the wake of the meeting. We discuss this a bit below under the USD blurb for the G10 rundown, and the reaction could play out in multiple legs, from the initial hike/no hike decision to how the Fed puts its decision in context with guidance from here. We suspect that a relatively robust downshift is in the making from Powell and company and the chief question will be whether the market finds that this adjustment has cleared the bar and can provide relief from the gathering clouds of the last couple of months.

The scariest situation for global markets will be one in which the Fed has clearly exceeded expectations on shifting to a more dovish stance, and yet global asset markets are unable to find solace and continue to sell-off. This would then bring forward our Steen Jakobsen’s feared Policy Panic scenario.

Chart: EURUSD

EURUSD may offer a more straightforward response to the post-FOMC market response, now that the Italian budget situation has receded (though the euro still faces the big question of Brexit in coming weeks and, dare we say, months). A sufficiently dovish Fed together with an enthusiastic response from global equity markets should see the pair launching a stout rally focused on taking down the 1.1500 resistance and poking into the higher range.