The End Game has arrived
Shocks from covid and the war in Ukraine have forced the global financial and political world to change, but what will the end game be?
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Market begging for FOMC mercy
John Hardy
Head of FX Strategy
Summary: Another weak session on Wall Street saw the S&P 500 close at the lowest level since October 2017. Will the Federal Reserve prove willing to pull a dove or two out of its hat, or is Powell determined to hit neutral?
The US S&P 500 suffered the lowest close for the year yesterday, just two days ahead of the Federal Open Market Committee meeting and the rate hike Powell and company are expected to deliver.
Weak risk appetite was the dominant theme yesterday as US equities suffered another soft session. The S&P 500 index probed below the prior 2018 intraday lows before closing at the lowest level since October of last year. The US dollar, however, failed to find a safe haven bid – perhaps as the market has recently priced out the majority of the further policy tightening from the Fed that was priced in for 2019.
Adding to the mix is the government shutdown that now appears imminent after the end of this week as Trump hasn’t been able to wrest support for his border wall from Democrat party leaders.
Over 40 basis points of rate hike expectations have been priced out of the December 2019 Fed Funds future since early November. The yen, on the other hand, is finally waking up to the declining US yields all along the curve and weak risk appetite and USDJPY is staring down interesting levels (see chart below) ahead of tomorrow’s pivotal FOMC meeting.
There are many ways to signal a dovish hike but the only very clear dovish signal for now would be a decision not to hike at this meeting. The cherry on top would be a shifting attitude toward the Fed’s quantitative tightening regime, which Powell inherited on autopilot. The Fed could ease significantly by merely reducing the rate of its balance sheet reduction.
Elsewhere, markets are in a nervous holding pattern on the intense uncertainty on the FOMC’s move tomorrow, but as we await the next steps for Brexit from mid-January (vote on the deal expected for week starting Jan 14 now rather than the week after) and the ongoing US-China trade negotiations. There is considerable focus on China’s celebration of the 40-year anniversary of “opening up”, but there were no new hints in Xi Jinping’s speech yesterday of new initiatives, with the speech largely centered on celebrating the CCP’s achievements and defending China’s attitude on the world stage.
NOK is twisting in the wind after the Norges Bank carried out its final NOK purchases for the year on Friday and crude oil prices continue to crater. Note the action in EURNOK at the end of last year for a possible repeat – though a recovery in risk sentiment and energy prices may be necessary ingredients as well.
Chart: USDJPY
USDJPY once again having a look at the Ichimoku support with which the pair has been playing cat-and-mouse over the last few months. If animal spirits pick up sharply in the wake of an FOMC meeting that manages to surprise on the dovish side, USDJPY could survive a test of support once again, even if the USD is weaker against riskier currencies – in any case, a strong risk-on response to the FOMC meeting is far less interesting for JPY volatility potential. On the other hand, if risk appetite craters further despite a dovish hike scenario (in which the Fed confirms the markets forward expectations that no further hikes will be forthcoming for the foreseeable future) and the aggressive bid in US long Treasuries continues, USDJPY could tumble through the local supports for a run into 110-111.00.
Weak risk appetite was the dominant theme yesterday as US equities suffered another soft session. The S&P 500 index probed below the prior 2018 intraday lows before closing at the lowest level since October of last year. The US dollar, however, failed to find a safe haven bid – perhaps as the market has recently priced out the majority of the further policy tightening from the Fed that was priced in for 2019.
Adding to the mix is the government shutdown that now appears imminent after the end of this week as Trump hasn’t been able to wrest support for his border wall from Democrat party leaders.
Over 40 basis points of rate hike expectations have been priced out of the December 2019 Fed Funds future since early November. The yen, on the other hand, is finally waking up to the declining US yields all along the curve and weak risk appetite and USDJPY is staring down interesting levels (see chart below) ahead of tomorrow’s pivotal FOMC meeting.
There are many ways to signal a dovish hike but the only very clear dovish signal for now would be a decision not to hike at this meeting. The cherry on top would be a shifting attitude toward the Fed’s quantitative tightening regime, which Powell inherited on autopilot. The Fed could ease significantly by merely reducing the rate of its balance sheet reduction.
Elsewhere, markets are in a nervous holding pattern on the intense uncertainty on the FOMC’s move tomorrow, but as we await the next steps for Brexit from mid-January (vote on the deal expected for week starting Jan 14 now rather than the week after) and the ongoing US-China trade negotiations. There is considerable focus on China’s celebration of the 40-year anniversary of “opening up”, but there were no new hints in Xi Jinping’s speech yesterday of new initiatives, with the speech largely centered on celebrating the CCP’s achievements and defending China’s attitude on the world stage.
NOK is twisting in the wind after the Norges Bank carried out its final NOK purchases for the year on Friday and crude oil prices continue to crater. Note the action in EURNOK at the end of last year for a possible repeat – though a recovery in risk sentiment and energy prices may be necessary ingredients as well.
Chart: USDJPY
USDJPY once again having a look at the Ichimoku support with which the pair has been playing cat-and-mouse over the last few months. If animal spirits pick up sharply in the wake of an FOMC meeting that manages to surprise on the dovish side, USDJPY could survive a test of support once again, even if the USD is weaker against riskier currencies – in any case, a strong risk-on response to the FOMC meeting is far less interesting for JPY volatility potential. On the other hand, if risk appetite craters further despite a dovish hike scenario (in which the Fed confirms the markets forward expectations that no further hikes will be forthcoming for the foreseeable future) and the aggressive bid in US long Treasuries continues, USDJPY could tumble through the local supports for a run into 110-111.00.
The G-10 rundown
USD – the charts leaning back toward USD weakness at the moment – hard to see the Fed delivering a message that is USD-supportive unless it blasts confidence with a cold shoulder, indicating it won’t be cowed by the latest trends in markets and financial conditions.
EUR – EURUSD stuck in a narrow sideways box and ready to spring through either side post-FOMC.
JPY – our model suggests two moving parts for the yen: the direction of yields and the direction of risk appetite, both of which we assume will move in the same direction and correlate negatively with JPY. Risk-off and lower yields most supportive post-FOMC and risk-on and higher (long) yields the most negative.
GBP – expecting a holding pattern centered on 0.9000 for EURGBP until we see new developments on the next steps for the Brexit process. The vote on the current deal is less relevant than the endgame that ensues on whether a second referendum can be agreed and/or a Brexit delay and the terms for the UK during the delay period.
CHF – fading safe haven bid suggests CHF upside potential constrained or that market doesn’t want to fight the Swiss National Bank, which will likely continue to signal that it will defend the franc from further weakness at Thursday’s SNB announcement
AUD – AUDUSD likely a high-beta pair to the USD reaction in the wake of the FOMC meeting. A sufficiently dovish surprise together with a risk-positive market action the most supportive. Still, the stuck-in-the-mud USDCNY rate and wait for news on the US-China negotiations front could mean a muted reaction.
CAD – fresh lows below $50/barrel in WTI weigh on the CAD crosses – it appears that CAD rather strongly tracks USD direction in those crosses and this may persist.
NZD – kiwi jumps higher again, looking ready to challenge the cycle highs versus the AUD – but AUDNZD looks long-term cheap at these levels.
SEK – market divided on the prospects for a Riksbank hike this week, with most now believing that the hike won’t arrive until February. Weak risk appetite and NOK tumbling into the abyss at the moment are not helping the SEK’s case, but SEK could yet rally after Thursday, even if the Riksbank doesn’t hike, provided global markets are in a better mood post-FOMC.
NOK – NOK running away to the downside after the Norges bank halted its purchases Friday. Note the price action late last year that saw a similar dynamic, with the 9.98+ high posted in the last half of December even as oil prices were rising steadily.
Upcoming Economic Calendar Highlights (all times GMT)
• 1330 – Canada Oct. Manufacturing Sales
• 1330 – US Nov. Housing Starts/Building Permits
USD – the charts leaning back toward USD weakness at the moment – hard to see the Fed delivering a message that is USD-supportive unless it blasts confidence with a cold shoulder, indicating it won’t be cowed by the latest trends in markets and financial conditions.
EUR – EURUSD stuck in a narrow sideways box and ready to spring through either side post-FOMC.
JPY – our model suggests two moving parts for the yen: the direction of yields and the direction of risk appetite, both of which we assume will move in the same direction and correlate negatively with JPY. Risk-off and lower yields most supportive post-FOMC and risk-on and higher (long) yields the most negative.
GBP – expecting a holding pattern centered on 0.9000 for EURGBP until we see new developments on the next steps for the Brexit process. The vote on the current deal is less relevant than the endgame that ensues on whether a second referendum can be agreed and/or a Brexit delay and the terms for the UK during the delay period.
CHF – fading safe haven bid suggests CHF upside potential constrained or that market doesn’t want to fight the Swiss National Bank, which will likely continue to signal that it will defend the franc from further weakness at Thursday’s SNB announcement
AUD – AUDUSD likely a high-beta pair to the USD reaction in the wake of the FOMC meeting. A sufficiently dovish surprise together with a risk-positive market action the most supportive. Still, the stuck-in-the-mud USDCNY rate and wait for news on the US-China negotiations front could mean a muted reaction.
CAD – fresh lows below $50/barrel in WTI weigh on the CAD crosses – it appears that CAD rather strongly tracks USD direction in those crosses and this may persist.
NZD – kiwi jumps higher again, looking ready to challenge the cycle highs versus the AUD – but AUDNZD looks long-term cheap at these levels.
SEK – market divided on the prospects for a Riksbank hike this week, with most now believing that the hike won’t arrive until February. Weak risk appetite and NOK tumbling into the abyss at the moment are not helping the SEK’s case, but SEK could yet rally after Thursday, even if the Riksbank doesn’t hike, provided global markets are in a better mood post-FOMC.
NOK – NOK running away to the downside after the Norges bank halted its purchases Friday. Note the price action late last year that saw a similar dynamic, with the 9.98+ high posted in the last half of December even as oil prices were rising steadily.
Upcoming Economic Calendar Highlights (all times GMT)
• 1330 – Canada Oct. Manufacturing Sales
• 1330 – US Nov. Housing Starts/Building Permits