11dembikM

FX Update: The Fed has created its own worst nightmare

Forex 5 minutes to read
Picture of John Hardy
John J. Hardy

Chief Macro Strategist

Summary:  Risky currencies have all gone vertical against the US dollar as we head into year-end as the Fed has gotten well ahead of USD liquidity concerns with its massive balance sheet operations. But how will the New Year treat us as the Fed will start 2020 with clear evidence that it is inflating a bubble in risky assets?


The drivers for the US dollar haven’t been particularly clear in recent months, but the last couple of weeks’ action suggests that the market is finally celebrating the generous Fed liquidity provision into year end and that the Fed has now clearly avoided the issues so thoroughly fretted by market participants since evidence of USD funding issues back in September. The US dollar is weaker across the board and the obvious flip-side of the best performers over the last couple of weeks, the traditionally risk-correlated G10 smalls and many EM currencies like MXN and ZAR, as well as China-sensitive exporters like IDR and KRW.

This year, far more than the average year, the turn of the calendar page from the old year to the new one could prove especially pivotal – on the "now what?" question as we get past the year-end USD liquidity focus and whether the market’s aggressive assumption that the Fed will remain on side in juicing risk appetite at every turn is justified. Way back in the mists of time I seem to recall that Fed chair Jay Powell was most concerned that the source of difficult policy challenges from the Fed would not be inflation but financial stability issues. Well, the Powell Fed’s massive liquidity provision has now created the very monster it most feared – an obvious incipient bubble in risky assets that could prove a nightmare for the Fed to navigate in 2020.

As for whether the unwind in the bubble unfolds in the first weeks of 2020 or not until after the US presidential election will likely depend on three chief drivers: the Fed messaging after the New Year, the course of the US election, and the state of the US economy. All three represent strong risks to the current narrative (particularly if Bernie Sanders continues to gain momentum in the Democratic primaries). Some have fairly compared the current situation with Greenspan’s pump priming heading into 2000, which coincided with the final parabolic rise and mini-crash of the tech bubble by early March, followed by a very volatile year, even as the broader market didn’t peak out officially until September. If history rhymes, we may not be set for immediate setbacks in 2020 – but the combination of an obvious incipient bubble and the US political cycle almost have to mean that we will see a far more volatile 2020 than what we witnessed in 2019.

One thing sounding a wrong note in this environment across the major macro indicators is the long end of the yield curve in the US, where the sell-off has lacked the conviction one would normally see if reflation and a growth boost are supposed to be around the corner.

Chart: AUDUSD weekly
The Australian dollar is celebrating Fed liquidity provision into year-end, hopes for a Chinese growth revival on further stimulus and easing (as well as the USDCNY back below 7.00), not to mention hopes that the US-China trade deal will further boost the outlook. The pair has now thoroughly broken out of the former descending channel that dominated action since 2018 and has cleared the local pivots around 0.6900 after a treacherous false break earlier this month. 0.7000 looks like a psychological key as 2020 gets under way and the next objective looks like perhaps 0.7225-0.7250 if the good cheer spills over into the New Year for a time.  Let’s see how the price action shapes up in the first couple of weeks of January.

30_12_2019_JJH_Update_01
Source: Saxo Group

Quarterly Outlook

01 /

  • Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Quarterly Outlook

    Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Althea Spinozzi

    Head of Fixed Income Strategy

  • Equity Outlook: Will lower rates lift all boats in equities?

    Quarterly Outlook

    Equity Outlook: Will lower rates lift all boats in equities?

    Peter Garnry

    Chief Investment Strategist

    After a period of historically high equity index concentration driven by the 'Magnificent Seven' sto...
  • FX Outlook: USD in limbo amid political and policy jitters

    Quarterly Outlook

    FX Outlook: USD in limbo amid political and policy jitters

    Charu Chanana

    Chief Investment Strategist

    As we enter the final quarter of 2024, currency markets are set for heightened turbulence due to US ...
  • Macro Outlook: The US rate cut cycle has begun

    Quarterly Outlook

    Macro Outlook: The US rate cut cycle has begun

    Peter Garnry

    Chief Investment Strategist

    The Fed started the US rate cut cycle in Q3 and in this macro outlook we will explore how the rate c...
  • Commodity Outlook: Gold and silver continue to shine bright

    Quarterly Outlook

    Commodity Outlook: Gold and silver continue to shine bright

    Ole Hansen

    Head of Commodity Strategy

  • FX: Risk-on currencies to surge against havens

    Quarterly Outlook

    FX: Risk-on currencies to surge against havens

    Charu Chanana

    Chief Investment Strategist

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperfo...
  • Equities: Are we blowing bubbles again

    Quarterly Outlook

    Equities: Are we blowing bubbles again

    Peter Garnry

    Chief Investment Strategist

    Explore key trends and opportunities in European equities and electrification theme as market dynami...
  • Macro: Sandcastle economics

    Quarterly Outlook

    Macro: Sandcastle economics

    Peter Garnry

    Chief Investment Strategist

    Explore the "two-lane economy," European equities, energy commodities, and the impact of US fiscal p...
  • Bonds: What to do until inflation stabilises

    Quarterly Outlook

    Bonds: What to do until inflation stabilises

    Althea Spinozzi

    Head of Fixed Income Strategy

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain ...
  • Commodities: Energy and grains in focus as metals pause

    Quarterly Outlook

    Commodities: Energy and grains in focus as metals pause

    Ole Hansen

    Head of Commodity Strategy

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities i...

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)

Saxo Bank A/S (Headquarters)
Philip Heymans Alle 15
2900
Hellerup
Denmark

Contact Saxo

Select region

International
International

Trade responsibly
All trading carries risk. Read more. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more

This website can be accessed worldwide however the information on the website is related to Saxo Bank A/S and is not specific to any entity of Saxo Bank Group. All clients will directly engage with Saxo Bank A/S and all client agreements will be entered into with Saxo Bank A/S and thus governed by Danish Law.

Apple and the Apple logo are trademarks of Apple Inc, registered in the US and other countries and regions. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.