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FX Update: Fed surprises hawkish once again with FOMC minutes

Forex 4 minutes to read
John Hardy

Head of FX Strategy

Summary:  A much more hawkish thank expected FOMC minutes took the USD higher late yesterday, though the follow-on price action has underwhelmed somewhat. The Fed is making it clear that it is ready to use all of its tools including accelerated balance sheet reduction to tighten policy. The next step is how the market absorbs the Friday US jobs report after a huge rise in the private payrolls, according to the latest ADP private payrolls survey.


FX Trading focus: USD and, surprisingly, JPY jump on hawkish FOMC minutes

The FOMC minutes surprise market with robust discussion of not only the outright reduction of the Fed’s balance sheet, but one that takes place at an accelerated pace relative to prior cycle. The market expectations for Fed rate hikes shifted sharply higher in the wake of the FOMC minutes release late yesterday, in particular on the balance sheet discussion noted above, even as the Fed stated that its primary tool for now will continue to be signaling rate increases as it feels it understands the effects of those better than it does the dynamics around balance sheet adjustments. But as financial assets are seen as most sensitive to balance sheet moves, the impact was considerable in terms of risk appetite, particularly as the discussion in the FOMC minutes also brought the yield curve into discussion on the idea noted by some Fed members that balance sheet adjustments could keep the yield curve from flattening. Regardless, what is clear is that the Fed is considering firing on all cylinders and possibly in a far different way than in the previous cycle as it noted greater economic strength and a tighter jobs market than in the prior cycle. Not only was balance sheet reduction discussed, but even the possibility that it could run alongside rate hikes. As well, the Fed’s standing repo facility, currently containing some $1.5 trillion was seen as an additional factor in allowing a reduction of the Fed’s balance sheet.

Some of the discussion on whether emphasizing balance sheet moves as opposed to rate hikes was likely inspired by a Kansas City Fed piece from October.

In reaction to the signals in the FOMC minutes, the entire US yield curve lifted, with longer US yields rising more aggressively than short yields, interest-rate sensitive US equities were in for a drubbing, and the US dollar rose sharply versus the G10 smalls, while only modestly rising against the Euro and even falling slightly against the JPY. The last of these is the most interesting development after the spiking in USDJPY into the beginning of this year was one of the main stories of recent weeks. The implication of the JPY rising despite rising US long yields is that risk sentiment could take over as a factor impacting the JPY when deleveraging is particularly strong, with credit spreads in corporate and EM worth extra attention, as a widening might prove JPY positive as conditions for carry trades deteriorates.

Despite the initial reaction, the speed with which many some assets are bouncing back this morning does not look particularly USD positive – oil is bid back toward the cycle highs (some of that obviously idiosyncratic and could be Kazakhstan-unrest related), and risk sentiment broadly trying to stabilize.  It is impressive to see EURUSD back to essentially unchanged despite US yields at new highs for the cycle – if EURUSD can’t sell off more steeply after a day like yesterday, what exactly is supposed to put it under additional pressure?

Yes, if risk deleveraging continues, we are likely to see the smaller currencies under renewed pressure versus the G3, but already this morning, some of these and many EM currencies are bouncing back strongly, though possibly with a “commodity angle” in places – for example, South African rand is resurgent and USDZAR is back towards yesterday’s lows, which may have been inspired in part of an inquiry into former President Zuma finding him guilty of mis-rule, to say the least, with some demanding for his prosecution.  

Next step for the USD and market is the Friday December jobs report, with the market likely leaning now for a strong figure, given the six-month high ADP December private payrolls change number released yesterday at +807k.

Chart: EURUSD
Sometimes, a lack of response can indicate as much as a response to a new stimulus. In this case, it is rather interesting that EURUSD failed to feel much downside pressure after a nominally very USD-bullish fundamental development yesterday on the more hawkish than expected FOMC minutes. Now we’ll be on the lookout for the next move beyond the tight range that was established in December, with the twice-touched 1.1386 pivot the nearest upside trigger. In any case, impulsive downside looks difficult absent major new EU existential worries arising.

Source: Saxo Group

Table: FX Board of G10 and CNH trend evolution and strength
Choppy price action is making the latest trend readings a challenge to interpret, but the JPY weakness certainly eased yesterday. I’m at a loss to explain the GBP strength here other than the “omicron policy differential” as the UK government has taken a far lighter touch on limiting activity due to covid. But if that is the source of relative developments, then the imminent end (hopefully) of omicron impacts could reverse that development as Europe emerges in coming weeks from the restraints on activity.

Source: Bloomberg and Saxo Group

Table: FX Board Trend Scoreboard for individual pairs.
Watching the CNH pairs for signs that China’s intent to ease policy will see a weaker CNH as the USDCNH has simply gone dead rather than rallying. Elsewhere, watching whether the USDCAD reconfirms the recent negative trend crossover: Bank of Canada expectations have potential to catch up with Fed expectations from here. Meanwhile, AUDUSD is likewise near the tipping point after trending positive for 10 days coming into today.

Source: Bloomberg and Saxo Group

Upcoming Economic Calendar Highlights (all times GMT)

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  • 1330 – US Weekly Initial Jobless Claims
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