Head of FX Strategy
Summary: The market watching nervously whether the FOMC meeting tonight delivers the expected 75 basis point hike, the largest since 1994, as well as if it matches expectations for the policy trajectory for this year and next in the dot plot and economic data forecasts. Elsewhere, the ECB is suddenly in emergency meeting mode to address peripheral spreads today. And towering above all other event risks this week is the Bank of Japan meeting and whether and to what degree the Bank of Japan is prepared to capitulation on its yield-curve-control policy.
FX Trading focus: Is market ready for a 75-bps hike from Fed
I was surprised to see a Twitter poll today from Newsquawk on the Fed decision tonight, which showed nearly a third of respondents believing that the Fed will only move by 50 basis points tonight despite the market forwards fully priced for 75 basis points for tonight and for the July meetings. Could it be that the market is not fully ready for the larger move? The US dollar move this week suggests that we have made a significant adjustment, but we’ll only know in the wake of the meeting. My general belief is that the Fed only wants to do what is priced into the market and won’t go for a larger 100 basis point hike, but my conviction has been lowered considerably by the sudden rush in repricing due to a big shift in inflation expectations, which are a new and possibly more intense source of concern for the Fed. Also to watch for tonight are the dot plot shifts in the forecast, with the market at 3.6% for the December meeting and near 4% for the end of next, versus a median of 2% in the March projections for the end of 2022 (!) and 2.75% for end 2023.
Chart: EURJPY
All JPY crosses will be critical to watch ahead of and after the Bank of Japan meeting on Friday, with an added twist for the EURJPY pair the peripheral spread situation in the EU and how the ECB moves to address it. Would a successful crushing of yield spreads prove EUR positive (lowered existential strain) or EUR negative (semi-QE for parts of Euro Zone even if the overall ECB balance sheet is not expanding and the ECB is set to raise rates)?. If the market reads this as ECB dovish for the implications for the forward rate hike potential (not what we are getting in the chatter from various ECB officials arguing for possibly larger hikes after the July move), the euro may weaken more broadly, otherwise EURJPY may simply fall more or less in line with other JPY crosses if the Bank of Japan capitulates on the YCC policy this Friday. Technically, watching the 140.00 area.
The ECB is holding an emergency ad hoc meeting due to “current financial conditions” after a prominent speech from ECB board member Schnabel yesterday indicating a limitless commitment to ensure that there are no “disorderly” moves in yields, particularly for peripheral EU economies. The end of QE was always going to be difficult for the ECB, but the fact that they are already out with an emergency meeting less than a week after their regularly scheduled meeting speaks to the sense of panic. The scale and speed of the sell-off in Italian BTP’s with the sharp rise in global yields is clearly behind this move – the ECB perhaps thought that it could bide its time until the fall, but the US yield curve put the pressure on right away. As noted above in the EURJPY chart commentary, it was interesting to see the market reacting with a EURCHF rally due to the improvement in the peripheral spreads, but lower spreads are only a durable positive for the euro if the ECB is able to set up a way to crush spreads that doesn’t prevent a more rapid pace of rate policy tightening in general – a somewhat incoherent policy, even if the ECB’s balance sheet is so vast that if technically speaking, it can still eventually even reduce overall holdings while shifting existing holdings to the periphery to reduce spread volatility. But to do so it would have to move even more aggressively away from old “capital key” principles linking its holdings to the relative size of each member’s economy. Depending on the last of these angles in particular, there doesn’t have to be a strong angle on the euro, provided the rate outlook stays supported.
Finally, I extensively discussed the Bank of Japan meeting risks on Friday (overnight between Thursday-Friday for those of us not in Asia), with thoughts on how to trade this in yesterday’s update, mostly in anticipation that the Bank of Japan will have to give way in some fashion, particularly on a net-hawkish FOMC meeting that takes US yields higher still. For further discussion, have a listen to this morning’s Saxo Market Call podcast. Also, the pressure has built further on the Bank of Japan as speculators are aggressively selling JGB futures, taking the implied yield on these to well above the 25 basis point nominal cap that the BoJ enforces on 10-year JGB yields, and with 10-year rates in 1-year marked well above 50 basis points in forward markets overnight. Beware the risks of discontinuous moves and also beware, as Steen Jakobsen suggested is a scenario for the BoJ, that Kuroda and company might try some kind of incremental approach – moving the YCC target to 50 basis points or 100 basis points, for example. Sooner or later, the BoJ breaks.
Table: FX Board of G10 and CNH trend evolution and strength.
Risks of discontinuous moves in JPY crosses over the Friday BoJ. Otherwise, noting the broad sterling weakness as GBPUSD dipped briefly below 1.2000 at one point.
Table: FX Board Trend Scoreboard for individual pairs.
Chiefly watching JPY cross status over the next few sessions in terms of new developments, as well as trend check on USD pairs in the wake of tonight’s FOMC meeting.
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As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
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