Powell hears the market, USD falls

Friday’s remarkable interview with the Powell, Yellen and Bernanke trio triggered a dramatic boost to risk appetite as Fed Chairman Powell made it clear that he is listening to the market and its concerns. The market saw echoes of Bernanke’s reaction (at a speech in July of 2013) to the May 2013 “taper tantrum” in this appearance as it marked a further and louder shift in the Fed’s confident stance on its current policy mix and supposed intention to maintain balance sheet reductions and gradually hike rates. 

Nonetheless, Powell continued to express confidence in the economy, thinks the market is ahead of the data in expressing downside risk concerns, and doesn’t’ believe that treasury issuance is a big part of the market’s turbulence. Still, in the wake of the December 20 Federal Open Market Committee meeting and press conference, which delivered virtually no alteration in the outlook or and very little adjustment to the Fed’s policy forecast, this interview was clearly a downshift to the dovish side in the Fed’s guidance, indicating that further market pain or tightening of financial conditions will eventually elicit a Fed policy move. 

We’ll have plenty of additional follow-up noise from Fed officials as Powell himself will be out speaking on Thursday again and we have the FOMC minutes on Wednesday, together with many of the new voters (Rosengren, Evans, Bullard) speaking later this week as well. The key question is how much of the Fed’s shift is already in the price. A mini-test arrives today with the US ISM non-manufacturing survey release for December. This survey has just posted three reading above 60 for the first time in its more than 20-year history.

As Powell’s rhetorical shift coincided with a fresh RRR cut from China at the end of last week, the Aussie reacted the most strongly among G10 currencies to the double whammy of positive news. Volatility in AUD was further aggravated by all of this news emerging less than 48 hours after the JPY cross flash crash – more on AUD in the chart below.

But the thing I’m struggling with the most about Friday’s session is the dissonance or incoherence as US yields rose sharply (due to a strong jobs report, especially the fresh bump in earning growth) on the very day when the market expressed profound relief that the Fed has supposedly just made a dovish turn. This and the recent extreme and vicious turn in volatility leaves us reluctance to jump on board this latest shift in momentum and believe that the US dollar is set to sell-off in a straight path.

Chart: AUDUSD

AUDUSD the most enthusiastic in reacting to the developments late last week as China boosted liquidity and Powell waxed dovish in Friday’s interview. The bounce was grossly exaggerated by the JPY cross flash crash (which fed a simultaneous AUD flash crash), but any chart technician will take a look at this chart and note the rejection of the 0.7000 break nonetheless, so the bar is suddenly much higher for AUD bears. Next resistance levels are the 0.7200 area and then the November top just ahead of 0.7400. We’re sceptical that this move is anything more than a short squeeze, but also cognisant that it could extend viciously higher in the short term.