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FX Update: USD rebounds after initially ignoring hawkish Fed.

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John Hardy

Head of FX Strategy

Summary:  Judging from the rather muted reactions in US treasury yields to the hawkish FOMC meeting last night, the stronger USD today after a choppy evening may have little to do with what Chair Powell and company delivered and more to do with the forward outlook. Looking ahead at today’s ECB and Bank of England meetings, the latter has more potential to provide a catalyst, and a negative one for sterling after its recent remarkable run higher.

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Today's Market Quick Take from the Saxo Strategy Team

FX Trading focus: USD firms suddenly despite market largely brushing off FOMC

My assumption going into last night’s FOMC meeting was that the Fed would want to deliver enough hawkish bluster to avoid any impression of dovishness, but might steer away from too pointed a hawkish stance now that inflation is behaving more in line with their forecasts. On that account, I was partially right, as the Fed delivered hawkish, if more so than I expected, with a median rate projection next year at the hawkish extreme of the likely spectrum at just above 5%, and a surprisingly sharp upgrade of next year’s PCE core projection to 3.5% from 3.1% (perhaps needed to justify such a high projected policy rate?). In the press conference, Powell emphasized that core services inflation – linked closely to hot wage growth as services activity is employment-intensive – is the key uncertainty.

And then there was the market reaction, which was choppy, but in the end underwhelming as the market only raised the 2-year treasury yield several basis points after an initially much larger reaction. The 10-year yield was almost unchanged after an even more modest reaction, and the US dollar actually ended the day on the weak side. With yields little changed, one might have suspected that risk sentiment might have an easy path higher and the US dollar lower, given that the Fed’s own projections continue to see little respect from the market, which still anticipates a peak in the spring/early summer and a roll-over to rate cuts by year-end.

Alas, this morning has seen a solid bout of consolidation lower in sentiment and a suddenly firmer US dollar. This is likely on new flows that are being put to work rather than any follow-on impact from the specifics of last night’s FOMC meeting. If the move lower in sentiment and higher in the US dollar extends a bit and holds into the close today, we may have posted a significant local low in the greenback rather than seeing the market finish the year with a risk-on sprint like last year. As I discussed on this morning’s Saxo Market Call podcast, a key factor may be the anticipation of the imminent reversal of the liquidity tailwind from the US Treasury drawing down its account with the Fed, which has added hundreds of billions of USD in liquidity in recent weeks.

Up later today we get the November US Retail Sales and latest week jobless claims data. If US data softens badly in coming days/weeks/months, will be interesting if market concerns linked to the economic cycle pick up, particularly if the tailwind of USD liquidity falls away, while resilient US data will have the market second-guessing its Fed forecast. Only “goldilocks” semi-soft, disinflationary data that feeds hopes for a soft landing may be able to sustain a renewed market rally and USD sell-off from here.

I anticipate that the ECB will do as little as possible to surprise markets today, not needing to make as much of a point on inflation-fighting credibility as previously, now that inflationary pressures are set to ease further in the near term and after the solid back-up in the Euro exchange rate has also served as an inflation-fighting tailwind. AS well, the ECB is very occupied with rolling out its quantitative tightening plans set to begin in the New Year. The Bank of England may have more of an opportunity to surprise markets today on the dovish side after its rather loud dovishness at the prior meeting was glossed over amidst the dramatic repricing in sterling higher after the trauma of the Truss-Kwarteng train-wreck and squaring of speculative short GBPUSD positions. That repricing has proceeded very far and the chart looks overdone in the near-term. If sentiment is rolling over here and the Bank of England loudly reminds us of its concerns for UK growth today, and again suggests that its additional tightening will likely fall short of the market’s current pricing, GBPUSD could be in for a significant consolidation, with a close near 1.2300  or lower today even suggesting an evening star candlestick formation, if a slightly messy one. The natural first focus lower would be the 200-day moving average, currently pushing down toward the 1.2100 area, but the round, psychologically 1.2000 level is the more likely first target of a reasonable consolidation of the tremendous rally off the lows.

Source: Saxo Group

This morning we got a 25 basis point hike from the Norges Bank with a “most likely” commitment to a further rate hike in Q1, somewhat more hawkish than what I thought most likely, due to the concerns expressed on the Norwegian economy recently, but Norwegian short rates are on the order of 3 basis points higher as of this writing after trading another couple of basis points higher in the wake of the announcement this morning. NOK is weaker versus the Euro amidst the weak risk sentiment in Europe today, but trades mid-range in a very congested, rangebound chart.

Table: FX Board of G10 and CNH trend evolution and strength.
The USD posting a comeback in today’s trade, if it sticks the landing, we could see consolidation there back to a more neutral reading before next steps in the New Year. Elsewhere – finally getting some mean reversion in NZD and CAD – would expect this will continue long enough to take both near zero after a crazy run-up in opposite directions.

Source: Bloomberg and Saxo Group

Table: FX Board Trend Scoreboard for individual pairs.
JPY crosses are rolling back higher even without higher yields, but will take some doing to get USDJPY back in an uptrend, as it will for many other USD pairs.

Source: Bloomberg and Saxo Group

Upcoming Economic Calendar Highlights

  • 1200 – UK Bank of England Rate Announcement
  • 1315 – Eurozone ECB Rate Announcement
  • 1315 – Canada Nov. Housing Starts
  • 1330 – US Dec. Empire Manufacturing
  • 1330 – US Nov. Retail Sales
  • 1330 – US Weekly Initial Jobless Claims
  • 1330 – US Dec. Philadelphia Fed Business Outlook 
  • 1345 – Eurozone ECB Press Conference
  • 1415 – US Nov. Industrial Production
  • 1900 – Mexico Rate Announcement
  • 0001 – UK Dec. GfK Consumer Confidence

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