Forex 7 minutes to read

USD perched near highs ahead of pivotal FOMC

John Hardy

Head of FX Strategy

Summary:  The greenback is eyeing its highs for the cycle ahead of an FOMC meeting this week that is expected to bring a dovish hike from the Powell Fed. Signs of a widening credit crunch will certainly see a more cautious Fed, but is this already in the price for the big dollar?


A pivotal week ahead after Wall Street closed last week on a sour note near key support levels stretching back to the beginning of the year (the 2600 area in the S&P 500, for example) and the ugly drawdown in equity markets in February. Signs of a widening credit crunch are intensifying in corporate credit, where the FT notes that “December on course to be first month without junk bond sale since Lehman crash” (paywall) and over at Bloomberg, John Authers discusses financial stocks globally and frets whether they are the “canary in the coalmine” for global asset markets, given their tendency to lead the market to the downside in times of turmoil.

This brings us to the matter of this week’s Federal Open Market Committee meeting. Fed chair Powell has been rather clear in expressing his belief that inflation is not a factor driving risks to the economy, and that financial stability is perhaps the most important factor in what drives cycles of economic weakness.

Coming into this week, the alarm bells are sounding in corporate credit and the US dollar is perched at its highest levels since early 2017. It is clearly time for the Fed to blink and that is what the market is pricing – but how profound will the actual blink prove on Wednesday and is the market watching the Fed or has the credit crunch taken on its own momentum that will only be reversed when the Fed not only blinks, but goes into full reverse? 

The US risks another government shutdown ahead of the New Year as Trump demands border wall funding and can’t get it from what will be an increasingly obstreperous opposition next year as the new Congress commences on January 3. The GOP willingness to join battle over the border wall appears less than enthusiastic.

Elsewhere, Brexit dominates the focus in Europe. After EU leaders roundly rebuffed Theresa May’s attempt to alter the existing Brexit deal last week, the markets are at a loss for what happens next. January 21 is the last date for a vote that will see an inevitable rejection of the deal and sterling will likely remain in a nervous holding pattern, particularly as May has taken up a position for now against a second referendum.

Chart: Dollar index

The dollar index posted brief new highs for the cycle on Friday before pulling back slightly into the close ahead of this week’s FOMC meeting. Two factors to look for this week are of course the degree to which the Fed brakes its policy tightening trajectory, but also whether the market finds a more cautious message sufficiently encouraging to boost risk appetite. If so, the dollar may have peaked for now, but if the credit crunch has taken on its own momentum, any Fed downshift may be too little, too late for now. 
The G-10 rundown

USD – the most dovish surprise scenario (low odds) would be a no-hike from the Fed and the most hawkish surprise would be a statement that doesn’t sufficiently address the market’s concerns.

EUR – the Italian budget issue has faded for now, only to crop up next year. Instead, Brexit concerns, German banks and concerns that the EU recovery is cratering are on the menu and could drive new lows in EURUSD if the market mood doesn’t improve. 

JPY – the yen has found little support from the backdrop of falling rates and weak risk appetite and refuses to stand out here in the crosses. Remarkable to see USDJPY perched near the highs despite the decline in US long yields from their highs.

GBP – until the market can get a clearer sense of where the Brexit process is headed, 0.9000 in EURGBP seems the local magnet and implied volatilities will remain very high. Sterling is already quite profoundly discounted.

AUD – employment data up this week, but multi-year lows in the unemployment rate, for example, at a time when Australia clearly in the throes of its own credit crunch linked to its long-standing housing bubble remind that employment is a badly lagging indicator. AUDUSD is trying to break lower as new lows since early November trade, but the status of the break won’t be clear until the other side of the FOMC meeting this Wednesday.

CAD – prefer CAD over AUD and NZD, but all of the small developed market economies dealing with some version of a credit crunch linked to housing sector excesses. CAD has recently dealt with the additional issue of the flap over the arrest of Huawei’s CFO.

NZD – the kiwi’s star has faded after last week’s sell-off and its brief status as strongest G10 currency is likely done for now. NZDUSD posted a sharp technical reversal on Friday in falling well back below the 200-day moving average and other pivot lines.

SEK – the Riksbank meeting this Thursday the main event for SEK, with global markets, the Swedish economy (negative QoQ GDP posted in Q3) and recent inflation tendencies not where the Rikbank wants them for delivering a hike this week. A normalizing Riksbank, whether it hikes this week or not until February, is one that it is admitting that QE and negative rates don’t work and recognizing that failure – not one that is normalizing policy due to an improving economic outlook or inflation risks. 

NOK – the krone continuing to suffer on weak risk appetite and moribund price action in Brent, and there was no hawkish spin on Norges Bank last week, even if their outlook looks too optimistic. If EURNOK rallies above 9.75-9.80, the Norges Bank may more explicitly link hike plans to defense of the currency.

Upcoming Economic Calendar Highlights (all times GMT)

• 1000 – Eurozone Nov. Final CPI
• 1330 – US Dec. Empire Manufacturing
• 1330 – Canada Oct. International Securities Transactions
• 1400 – Canada Nov. Existing Home Sales
• 1500 – US Dec. NAHB Housing Market Index
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