FX Update: Fed dovish, but not dovish enough for this market

Forex 5 minutes to read

John Hardy

Head of FX Strategy

Summary:  Global markets are in a funk with a bit of an FOMC-hangover, even if the Fed was largely dovish and pledged to continue the current pace of balance sheet expansion. The G3 currencies are all higher versus the G10 smalls and EM FX on a bout of consolidation after the recent breathtaking ramp-up in speculative froth.

Risk appetite has so far taken a “sell the fact” approach to last night’s FOMC meeting, which ironically was rather dovish and saw long-end treasuries leaping higher as the Fed simply promised to continue QE at the current pace and dropped its forecasts for the policy to zero through 2022. No mention was made of yield-curve-control, perhaps as the Fed would like to get a sense of how things are shaping up before establishing a stickier policy framework.

As an aside, yield curve control policy only becomes necessary when:

  1. long rates drop too low as Japan felt was the case back in 2016 when 10-year rates dropped even below the -10 bps policy rate, as an inverted curve kills credit creation. With significant recent steepening in the US yield curve, this is not the Fed’s problem.
  2. Long rates threaten to rise too aggressively and act as a headwind on credit creation and make the load of interest payments on newly rolled debt act as a brake on the economy. Specifically, one factor that could prompt longer rates to rise could be excessive fiscal stimulus/money creation by the government that eventually drives inflation. While we are currently registering very low inflation due to the demand shock from this crisis, this is the most likely eventual reason for the Fed to have to act to suppress rates at the long end of the yield curve – at least out to five years, but possibly farther out the curve (like after WWII, when price controls were set to be lifted and the at the time non-independent Fed was told to cap 20-year yields below 2.5% until well after inflationary pressures had eased. The Fed gained back its independence in 1951 . With current very low rates, there wouldn’t seem to be any rush to cap rates. The Fed can, of course, signal yield-curve-control well ahead of the fact as a way to greenlight fiscal stimulus of a new magnitude.

So in continuing with a historically aggressive pace of QE – even if much slower than the panic level in March to early May – the Fed reassures the market that it will continue to support the market with liquidity for now and will have to in order to finance current and future deficits as long as the economy requires such large scale support (effectively, we are already in an MMT-style regime, just an undeclared one and one that hasn’t abandoned the pretense of issuing treasury debt)

Please have a listen to today’s Saxo Market Call podcast, where we take a look at the FOMC meeting and reaction, pull out interesting evidence of recent speculative froth and discuss the money quote from the FOMC meeting that was pulled out by John Authers in his latest column.

AUDUSD could finally be set for a more determined consolidation after never seeing any notable consolidation all the way up from below 0.6000. The first read of note is perhaps the 0.6800-0.6750 area, depending on where one draws the starting point for the latest up-wave (we choose the 0.6250 area pivot), but the more important levels start around 0.6675 – an obvious line of resistance on the way up and near the 200-day moving average. To get below that level, we probably need to see a far more significant consolidation settling in across asset markets than anything we have seen since late March.

Source: Saxo Group

The G-10 rundown

USD – the USD bouncing back in sympathy with the consolidation in risk appetite more than anything that was remotely supportive from the Fed yesterday. Watching for any signs of a correlation break on that front.

EUR – interesting to see the euro clawing back higher versus weaker currencies today – a sign that the G3 currencies plus CHF could all rise together if we face further consolidation across asset markets – but key idiosyncratic risks for the EU through next week’s EU Council meeting on the level of agreement with the approach for the EU recovery package.

JPY – the current market backdrop is the ideal driver of JPY strength – but will take a considerable unraveling of global markets to threaten the JPY weakening cycle since late March.

GBP – sterling on its back foot and a weak close today could point to a consolidation toward 1.2500, with the prospect of tough Brexit negotiations stretching out from here and probably out the last minute of this year, if previous patterns of EU and UK behavior are set for repeat.

CHF – the CHF rallying in sympathy with the G3 rally and EURCHF is back to half-way between the 1.0500 area lows and recent 1.0900 spike. 1.0650-1.0700 looks important for establishing whether the pair can stay in the higher portion of the range. EU existential questions a key factor there as well through next week’s meetings.

AUD – the consolidation thus far in AUD is nothing to write home about save perhaps in AUDJPY (much of that JPY driven), but further broad risks here for AUD if sentiment sours for a bit. Watching industrial metals and BHP Billiton shares as coincident indicators.

CAD – the 1.3500 area in USDCAD looks important for establishing whether this bounce can threaten higher and we wonder (as noted on the Saxo Market Call podcast this morning) why WTI oil prices have managed to scrape 40 dollars recently.

NZD – we prefer AUD over NZD for the longer term from a current account and relative monetary policy perspective, with the near term caveat that the NZD could outperform in the near term if the reflation narrative eases

SEK – EURSEK is consolidating back higher – currently 10.50 providing some resistance. Structurally would like to be short, but hard to know if risks extend in near term back toward the 200-day moving average above 10.65.

NOK – EURNOK reached the major milestone at the 200-day moving average around 10.44 and we watch for the amplitude of this bounce and for technical hooks to re-engage for more downside. The key resistance is perhaps 11.00, with 38.2% Fibo of latest wave at 10.915.

Upcoming Economic Calendar Highlights (all times GMT)

  • 1230 – US May PPI
  • 1230 – US Weekly Initial Jobless Claims
  • 1430 – US Weekly EIA Natural Gas Storage



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