FX Update: Too quiet markets await FOMC guidance, US macro data

Tonight’s FOMC meeting sees the Powell Fed faced with the tough task in framing their recent resumption of balance sheet expansion and cutting rates even as the US economy is supposedly performing well. As well, how does the Fed provide forward guidance without either goading markets into a further melt-up on the one hand or engineering a possibly ugly correction on the other? Guidance on the policy rate therefore will likely lean heavily on “based on incoming data” while the discussion of the balance sheet expansion is a more awkward affair as the Fed may be at pains to skirt the simple truth that it must begin to resume balance sheet expansion and lose control of its balance sheet if it wants to maintain control of policy rates (and if the US government wants to continue running ever larger deficits that are crowding out liquidity and funding elsewhere in the system). In effect, one can argue that the Fed is doing MMT already, but simply MMT driven by Trump’s supply side tax reforms that leave gaping holes in the budget, rather than MMT designed to direct additional spending on large-scale investments in infrastructure or other large scale projects. Regardless, the interesting bit is how this market reacts to whatever the Fed delivers, given what it is doing and the complacency it is expressing.

Elsewhere, the Bank of Canada set to meet today and could surprise the market if it sounds the least dovish note, given the scale of recent CAD strength and Canadian short yields pulling to new highs since early this year as the market has almost removed all anticipation of rate hikes, now that the 2-year rate is trading just a few basis points lower than the 1.75% policy rate.

Brexit has been shelved now that the EU has granted a delay until January 31 and Boris Johnson finally got his druthers and we are headed for a rare December election, December 12, to be specific. There are a number of ways this can hasten Boris Johnson’s path to the Brexit deal as currently agreed or open for all manner of mischief, from a fight over the terms in the deal to the calling of a new referendum – with Remain as one of the options – if a determined Remain vote shows up at the election and results in a hung Parliament. The great John Authers over at Bloomberg outlines how the risk of outcomes has dramatically raised the probability (if still a rather slim one) of an eventual Remain.

Chart: USDJPY
With US long yields at pivotal levels (US 10-year benchmark within a few bps of the 1.90% high from September) and both the FOMC and BoJ to meet inside the next 24 hours, together with the blitz of important US economic data starting Friday, USDJPY volatility should pick up from here as the pair also trades at pivotal levels around 109.00. Arguably some kind of upside down head and shoulders style formation neckline is in play here, but certainly also the flat-line resistance of 109.00 is very clear and the 200-day moving average is conveniently making an appearance as well. Higher levels likely require higher bond yields, further strength in risk appetite, etc., and a pivot back lower the opposite.