FX Update: FOMC to spoil the party or to unintentionally spike the punch bowl? FX Update: FOMC to spoil the party or to unintentionally spike the punch bowl? FX Update: FOMC to spoil the party or to unintentionally spike the punch bowl?

FX Update: FOMC to spoil the party or to unintentionally spike the punch bowl?

John Hardy

Head of FX Strategy

Summary:  Risk sentiment remains strong ahead of tomorrow’s FOMC meeting, even as market expectations for Fed tightening over the next six months have crept back up close to their highs for the cycle. Does the market think that it will be impossible for the Fed to surprise to the hawkish side relative to what is priced in? In short, it is very difficult to believe that the Fed will surprise dovish, but hard to tell what the market will do if the reaction merely keeps current market expectations for the current pace of Fed tightening unchanged.

FX Trading focus: FOMC to spoil the party or to unintentionally spike the punch bowl?.

An RBA meeting overnight saw Governor Lowe and company hiking in the small 25-bp increment established at the prior meeting, further evidence for the narrative that central banks are nearing peak tightness – especially in terms of what is priced in for the coming twelve months – and feeding strong risk sentiment and hopes that the Fed will fail to surprise hawkish at minimum at tomorrow’s meeting.

I spent considerable space in yesterday’s update discussing the weekend piece from purported “Fed whisperer” Timiraos of the WSJ, which suggests that the Fed sees the risk of rates remaining “higher for longer”. Other observers argue that NY Times correspondent Jeanna Smialek may have the better access to Fed sources now. If so, then we need to consider her latest piece, in which she weighs the evidence and after interviewing “10 people who now Mr. Powell personal” suggests “the consistent prediction…he does not want to go down in history as the man who squandered 40 years of price stability.” It is interesting to note at the beginning of that column that reveals how intently Chair Powell studies newspaper coverage of the Fed, as well as prominent economists’ comments on the Fed’s actions.

So where is the surprise side and how badly do Powell and company want to push back against the strong market sentiment? Given the latest coverage of Powell and other Fed sources and Fed rhetoric, the Fed is likely not happy that financial conditions have eased to the extent they have since the mid-October lows. But after the latest bits of data and the possible efforts via prominent journalists like those noted above that indicate the Fed doesn’t want to be seen as growing more cautious or downshifting significantly, strong risk sentiment of the moment is somehow coexisting with the Fed Funds rate expectations now having risen back nearly to the cycle highs, which place the peak next spring at nearly 5% for the policy rate. As well, QT is at least approaching the full intended pace based on the most recent data points, which include a $20B drop in MBS holdings as of October 26 relative to the prior week. It appears the Fed will face a difficult task to surprise on the hawkish side, which would require that it perhaps explicitly pushes back against the market pricing of a downshift for at least the December meeting or somehow specifically targets financial conditions along the lines of Minneapolis Fed president Neel Kashkari.

Another non-trivial consideration is the upcoming mid-term election next Tuesday, November 8. Presumably, the Fed would like to escape notice to whatever degree possible. If so, the Fed would keep a lower profile by keeping forward guidance as tough sounding as possible in terms of the intent to reach its objectives, but without doing anything overtly hawkish beyond current market expectations. If the market is already comfortable with those expectations, and comfortable that it has priced “peak Fed” through next spring, how does the USD rally, It might take more incoming data and a reassessment further down the road to get the USD rally back on track.

The USD focus is critical over the FOMC meeting, where as I note above it will be interesting to observe whether risk sentiment might rally further here if the Fed fails to overtly surprise on the hawkish side. With the SEK traditionally one of the most sensitive currencies to sentiment, a USD sell-off and further rally in risk sentiment could be felt particularly strongly in the USDSEK exchange rate. In any case, the 10.85 area looks very important after the topping formation around 11.50 to possibly confirm a larger scale downside consolidation scenario on the USD selling off after tomorrow’s FOMC meeting. The 200-day moving average is all the way down below 10.20. The pair would need to rally back to 11.25 to suggest new highs threatens.

Source: Saxo Group

The RBA meeting saw Governor Lowe and company going with another small 25-bp hike, together with a revision higher of the inflation forecast but a revision lower of the GDP forecast as the statement remains cautious on the outlook, even if the statement was fairly balanced on the risks. The forward RBA expectations were marked a bit lower and the 2-year Australia-US yield spread is at a nearly record low of -125 basis points. AUDUSD knee-jerked lower on the decision after an earlier rally, but managed to rally back to 0.6450 – showing how sensitive the pair is to risk sentiment. Elsewhere, the weaker AUD was far clearer, as AUDNZD punched down through the key 1.1000 area. Note an important RBNZ financial stability review and jobs report up tonight weighing on NZD.

Table: FX Board of G10 and CNH trend evolution and strength.
CNH weakness remains a theme, but one that hasn’t been refreshed broadly in over a week. Is the USD set to tilt more determinedly into a downtrend here? FOMC reaction tells us. NZD faces a test tonight, but is suddenly the highflier among G10 currencies.

Source: Bloomberg and Saxo Group

Table: FX Board Trend Scoreboard for individual pairs.
The strong risk sentiment turning EURNOK bears into believers as that move extended lower, with EURSEK following lower as well. Look at AUDUSD trying to tilt into a positive trend as well – all USD pairs needing to get a status check on the FOMC meeting tomorrow.

Source: Bloomberg and Saxo Group

Upcoming Economic Calendar Highlights

  • 1400 – US Sep. JOLTS Job Openings
  • 1400 – US Oct. ISM Manufacturing
  • 2000 – New Zealand RBNZ publishes Financial Stability Report
  • 2145 – New Zealand Q3 Average Hourly Earnings
  • 2145 – New Zealand Q3 Employment Change/Unemployment Rate
  • 2230 – Canada Bank of Canada Governor Macklem to speak
  • 0030 – Australia Sep. Building Approvals

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