FX Update: Will market shrug off FOMC dot plot raise?
Head of FX Strategy
Summary: The US dollar has teased support in places before firming a bit again this morning, as few are likely willing to take a strong directional view on the greenback until the other side of next week’s Tuesday November US CPI print and the FOMC meeting the following day. For the later, the interesting setup is that the Fed is likely to deliver a dot plot forecast for next year that is north of the market’s expectation. Next Thursday features four other G10 central bank meetings.
FX Trading focus: How will the market treat a higher-than-priced dot plot forecast for next year?
As I have discussed recently, there has been an irony in the Fed’s hawkishness that has crept into the picture in recent weeks: the more the Fed convinces the market that it will do whatever it takes to tightening sufficiently to bring down inflation, the more the market takes the Fed at its word for the policy implications for the near future and assumes that the Fed will succeed. Inflation swaps are sub-2.50% all the way out the curve, and yields from two years and out are falling, especially at the longest end of the yield curve. This has powered a solid easing of financial conditions, which may ironically make the Fed’s task more difficult next year if the economy reheats quickly after a possible gentle landing. Significant Chinese stimulus after the winter is a big risk on that front. But it will take some months and really quarters of data to see how inflation is playing out.
More interesting for the immediate future is how the market is pricing Fed policy for the next eighteen months to two years and what the Fed will deliver in the way of the economic projections on the economy and the “dot plot” forecasts themselves next Wednesday, as well as whether the market maintains its own convictions on how the economy will shape up rather than relying on the Fed’s forecasts. The market is pricing that rates will peak just below 5.0%, most likely at the March or May FOMC meeting next year and that the Fed will have already initiated an easing cycle by year-end, with perhaps 50 basis points of cuts through the December 2023 FOMC meeting. A hefty pace of further cutting then is seen continuing in 2024. Of course, the forward market expectations for the Fed should be seen as more of a probability and hedging matrix rather than a forecast, but is does give a sense of where the market will be surprised. I expect, and I suspect the market expects, that the dot plot projections for next year will be north of 5%, while the market has shifted lower to just below 4.50% at present. The 2024 dot-plot projections are probably less important if they show the kind of dispersion from September, with a low of 2.62% (!) and high of 4.62% and median of 3.75%.
If the market can continue to believe that the Fed won’t even have to hike as much as it says it will next year and financial conditions stay complacent, the USD may continue lower here in the near term. Only incoming data that asserts the Fed hiking cycle is not over with soon and/or weak risk sentiment can offer the greenback support.
EURNOK is working up into the last shreds of its range since the brief and tremendous spike from the pandemic outbreak months of early 2020. The Norges Bank is seen hiking another 25 basis points next Thursday to take the deposit rate to 2.75% as it was the first to hike rates but the slowest in following through, and even suggests it will be ending its tightening cycle soon, with today’s undershoot of Norway CPI (5.7% core YoY vs. 6.0% expected) helping encourage that notion. Will Norges Bank suggest that it is pausing already after this coming meeting or leave a “final” 25-bp move up in the air for the first meeting next year on January 19? The weak outlook for Europe and plunging oil prices are obviously weighing here on NOK and the currency is getting rather cheap at these level unless we are set to lurch into a bout of more profound market stress/risk aversion. Still, we must also consider that the ECB is set to hike rates another 50 basis points next Thursday and that the yield differentials between Europe and Norway have rarely been as tight as they are at their present levels – for example, a 5-year Norwegian sovereign bond now yields only slightly more than 100 basis points more than a German 5-year. That yield gap will have a hard time converging much more, with any further EURNOK upside more likely driven by general doom, gloom and weak oil prices rather than the relative yield outlook from here.
Table: FX Board of G10 and CNH trend evolution and strength.
The Bank of Canada meeting this week entirely failed to elevate CAD from its funk as the Bank guided in its statement that further hiking is no certainty for coming meetings and the plunge in oil has also dragged on the currency, just as it has on NOK. The USD outlook to undergo an important test next week on the CPI Tuesday (huge volatility on last handful of releases) and the FOMC meeting the following day as discussed above.
Table: FX Board Trend Scoreboard for individual pairs.
Finally, some two-way action in AUDNZD this week after the long slide. That pair becoming a value proposition for the year-forward if China comes on board with stimulus in the spring and/or on a significant breakout in copper, which is teasing resistance.
Upcoming Economic Calendar Highlights
- 1330 – US Nov. PPI
- 1500 – US preliminary University of Michigan Sentiment
Latest Market Insights
Outrageous Predictions 2023: The War Economy
- The constantly growing global need for energy drives the world's richest to huddle up and launch a R&D project in a size the world hasn't seen since the Manhattan Project gave the US the first atomic bomb.
French President Macron resignsThe political stalemate in France and the rise of Marie Le Pen following the 2022 elections corners President Macron, forcing him to give up on politics and resign from his position. At least for now.
Gold rockets to USD 3,000 as central banks fail on inflation mandateAs markets and central banks realise that the idea that inflation is transitory is wrong, and that prices will remain higher for longer, gold is sent through the roof, hitting a price tag of USD 3,000
EU Army forces EU down path to full unionWith continued challenges in the region and a US military that isn't aggressively enacting its former role as global policeman, the European Union agrees to create its own armed forces, bringing the whole region closer.
A country agrees to ban all meat production by 2030In an effort to become one of the global leaders on the path to net-zero emissions, one country decides to not only put a heavy tax on meat, but to ban domestic production entirely.
UK holds UnBrexit referendumFollowing a recession and domestic pressure, the United Kingdom is thrown into political turmoil that will end with a vote to wind back Brexit.
Widespread price controls are introduced to cap official inflationHistory tells us that with the war economy comes rationing and price controls. And this time is no different, as policymakers introduce strict price controls that lead to a range of unintended consequences.
OPEC+ & Chindia walk out of the IMF, agree to trade with new reserve assetSanctions against Russia have caused widespread turmoil due to US Dollar moves in countries across the globe that don't consider the US an ally. To relieve themselves from this, they leave the IMF and create a new reserve asset.
USDJPY fixed to the USD at 200 as Japan overhauls financial systemFollowing the challenges that faced the Japanese Yen in 2022, the Bank of Japan attempts to keep the currency from sliding. Unsuccessful on the long-term, Japan will launch a reset of its entire financial system.
Tax haven ban kills private equityWith the war economy comes an increased focus on national interests and sovereign nations' ability to assert themselves. In that regard, the OECD countries turn their attention on tax havens and pull the big guns out, banning them altogether.