Global Head of Macro Strategy
Summary: USD funding issues reappearing suddenly and doing so just ahead of tomorrow’s FOMC meeting. It is far past the time for the Fed to honestly discuss what is going on and why it has lost control of its policy trajectory from here.
Trading interest
Somehow, a nine-dollar advance in crude oil prices has failed to trigger much more than a ripple of weak risk sentiment across global markets, with the yen and Swiss franc on their back foot this morning and EM currencies having hardly registered more than a polite retracement since the Monday open. The AUD suffered a minor setback overnight on the further dovish confirmation from the RBA minutes, but the activity in general is lacklustre despite the drama elsewhere.
The market, according to some measures like the CME’s Fedwatch, are pricing significant odds that the FOMC doesn’t cut rates at tomorrow’s meeting. Not entirely sure what the logic is there – due to inflation concerns on the spike in oil prices? Admittedly, the age of booming US shale production means that oil prices are a far different animal for the implications of US economic growth – with a sweet spot probably around here or a bit higher for encouraging activity in the shale patch without over-taxing the rest of the economy. But if the Fed doesn’t cut rates tomorrow, it will prove as large a policy error as any other for the cycle, including the December 2018 FOMC meeting that triggered the last avalanche of equity market selling for the cycle.
The USD funding issue has reared its head again with a sudden spike in measures like the FRA-OIS spread (to 45 basis points yesterday from about 32 basis points the previous day and levels below 20 basis points as recently as May-June) which suggest a sudden tightening of USD liquidity. The rising Trump deficits, the US treasury rebuilding reserves and possible corporate tax payments are the proximate causes here, but the system is running out of room and the Fed needs to indicate it is on top of this issue far more than it needs to signal anything via the dot plot or via its economic projections at tomorrow’s FOMC meeting. To get ahead of the curve, the Fed needs to admit it has lost control of the narrative and to signal QE coming sooner rather than later – the Fed can control its balance sheet or interest rates from here, but not both.
Chart: AUDUSD
AUDUSD finally turned the corner a bit more forcefully overnight and gave a leg up to bears as the important resistance zone over head held up over the last week. The pair is in a well-established downtrend since early 2018. The FOMC meeting tomorrow will decide the immediate fate of the pair, as another Fed policy mistake could risk an aggravated further rise in the US dollar. October will add to the drama for AUD as we await the next round of US-China trade talks. The RBA minutes overnight suggest the RBA is set to ease to at least 0.50% at coming meetings even if October 1 sees a no-change.
The G-10 rundown
USD – the Fed needs to not only cut rates but bringing USD funding and QE into the discussion (and indicate a readiness to do something about it) to begin a sustainable weakening of the US dollar.
EUR – possibly interesting ECB speakers out later – particularly Lane, who should be seen as the policy guru from here while Lagarde will be the political head of the ECB. The 1.100 area is the line in the sand on daily closes the other side of tomorrow’s FOMC meeting.
JPY – the yen not doing well, perhaps as the oil price rise is a net negative due to Japan’s total dependence on oil imports – US yields remaining fairly elevated and risk complacency also keeping a lid on the yen.
GBP – sterling still looks price for positive outcomes here – would suggest that the risks of an October 31 cliff edge situation are still a danger and even if not, extensions will provide no relief to the weak growth baked into the cake for the UK.
CHF – risk complacency on all fronts keeping CHF well away from any drama and there has been less pressure on the currency to rise in recent weeks, judging from sight deposit data.
AUD – the RBA minutes show members fretting the outlook for the construction sector and the lack of feed-through into the economy from tax cuts. The RBA remains on course for further rate cuts, but may not move on October 1 in hopes that the US and China can piece together a de-escalation of the trade war.
CAD – the oil price has done little to boost the CAD’s fortunes – USDCAD close above 1.3300 after the FOMC would begin to reset the focus higher.
NZD – Australian and New Zealand 2-year rates at par and may be a bit more difficult to find a policy divergence between the two countries to drive further AUDNZD upside unless we see a distinct NZ-negative catalyst.
SEK – SEK strength needs EUR strength and that hasn’t followed on from last week’s ECB meeting. Market beginning to sniff out that Sweden’s Riksbank is hopeless stuck as unemployment jumped in August (out this morning at 7.4%, the worst reading since 2015 and suggesting that July’s jump above 7.0% wasn’t a fluke).
NOK – market in suspense over the Thursday Norges Bank decision with market sharply divided on the prospects for a hike, but the currency more likely impacted by latest on risk appetite direction post-FOMC beyond an initial kneejerk.
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