FX Trading focus: FOMC – sell the fact? Even more German fiscal
FOMC meeting today. It’s finally FOMC time today as we await the Fed’s decision and guidance at a time of enormous uncertainty on the course of inflation due to the new pressures stemming from the war in Ukraine (although interestingly, oil prices have already almost come full circle). Making life difficult for the Fed are whether spiking and unpredictable commodity prices will slow real economic growth, with or without the series of rate hikes that the market has now priced in.
The majority of observers are looking for the Fed to hike 25 basis points and to indicate that it is likely to hike by 50 basis points at the May meeting, with a total of around 1.75% of rate hikes priced this year. The Fed should have ended QE early if it really wanted to start regaining credibility, and perhaps the war in Ukraine and volatile asset markets will keep it erring slightly on the cautious side here, but it would go a long way to gaining credibility if the Fed would move 50 basis points today rather than waiting until May and then ditching the “dot plot” of its policy rate forecasts in the “projection materials” it releases at every other meeting, including today’s. If it does release a dot plot, the forecasts for 2022 will need to match the current market pricing to maintain inflation-fighting credibility. Elsewhere, the market will also scrutinize the latest Fed economic projections for credibility, especially the 2022-2024 PCE forecasts, which for core inflation were at 2.7, 2.3 and 2.1 in the December round. Finally, the degree to which the Fed emphasizes balance sheet reduction timing and severity will also be closely watched for potential impact on longer yields that are important inputs for valuation models and credit and risk sentiment.
The Fed may have a hard time exceeding market expectations in terms of the impact on US yields – possibly meaning a “sell the fact” moment for the US dollar. But if the Fed does manage a hawkish surprise, risk sentiment could be heavily impacted and long yields might not follow short yields higher as the market brings forward the feared recession timeline – support for the USD could prove mixed in such an event. There are many moving parts here.
German fiscal bazooka just got bigger – after German Chancellor Scholz pledged EUR 100 billion in new defense spending at the initial, ground-breaking speech in the wake of Russia’s invasion of Ukraine, today the intended figure for both defense, climate and other spending was raised to EUR 200 billion. This only adds to the longer term support for the single currency as we now have a very significant fiscal impulse of a few percent of Germany GDP and more when the EU common issuance-driven fiscal priorities are added it. These measures will also deepen Germany’s and the EU’s capital markets, keeping capital at home and in euros rather than recycled abroad – all very positive for the euro in the longer term. If the Ukraine war ends soon as we all must hope, it could sharply bring forward a significant rally in EURUSD back toward 1.1500 in an initial rush to start. EURCHF is another vehicle for expressing euro upside, especially as Switzerland’s joining of sanctions against Russian assets and individuals reminds us that the Swiss banking and secrecy system of yore is largely no more.
Note the big move in SEK today to the upside as the krona was already finding very solid support from better risk sentiment and the powerful EU fiscal signals (the Swedish economy seen as leveraged to the rest of Europe). But the krona got an additional boost today from a more hawkish tilt in Riksbank rhetoric as Riksbank governor Ingves said in a radio interview that the bank will probably have to hike before the 2024 timeline it absurdly maintained in its most recent meeting in February. Rates at the front-end of the Swedish yield curve were already ripping higher in recent days, but this nod from the Riksbank itself is an important signal. From here, the krona should be less held back by the Riksbank, with the key risk only on the liquidity side if markets suffer a proper deleveraging event.
USDJPY is remarkably stretched and the JPY is at record low levels in inflation-adjusted real terms as we approach the critical end of the Japanese financial year at the end of this month. Let’s not forget that US long treasury yields and USDJPY peaked on the very last day of March last year – strong indications of a link there – before rolling over in April and tracing out a range in the following months. We may not be headed for a repeat this year, but given USDJPY’s history, the FOMC tonight and the Bank of Japan on Friday and the fact that the 10-year JGB yield is bumping up against the key 0.25% yield cap under its yield-curve-control (YCC) policy, we’re likely at an important inflection point in USDJPY, both today and through March 31. Pressure on the JPY will mount if US yields continue higher and the BoJ maintains YCC or the JPY could find sudden support if global energy prices calm due to an end of the war in Ukraine and/or a strong downdraft in yields on concerns that a recession is on its way. 120.00 is the next focus to the upside and let’s keep in mind that the almost 20-year high in USDJPY is 125.86. Bears would need a very sharp reversal of this latest leg to argue that the up-trend is threatened with a reversal. Either way, the end of the month and transition to the new Japanese financial year bears watching.