Can the Fed deliver and will it be enough?

Forex 5 minutes to read

John Hardy

Head of FX Strategy

Summary:  The market has now staked out a very aggressive rate cut schedule for the Fed, with a sizable minority looking for as much as 100 basis points of easing through the December Federal Open Market Committee meeting. The two outstanding questions are whether the Fed will deliver and whether it will be enough to weaken the USD.


The recent Fed conference was the proverbial cherry-on-top for the aggressive market repricing of the Fed’s policy path from here. Fed chairman Jay Powell’s speech on Tuesday saw him open to a rate cut, talking up the normalisation of QE as a policy tool as the Fed will go into the next recession so close to the effective lower bound (ELB), and linking the Fed outlook strongly to the risks of deepening trade tensions. He also clearly detests the “dot plot” albatross that he has inherited from former chief Ben Bernanke, saying that “In times of high uncertainty, the median dot might best be thought of as the least unlikely outcome.” It wouldn’t be surprising to see the dot plot disappear entirely at the June meeting or soon thereafter.

So now we cut to the market’s reaction to this repricing of the Fed – equities managed a sharp rally from heavily sold levels, the yield curve has finally managed to steepen several basis points (for the 2-10 slope, a decent  amount  more for 2-30, 5-30, etc…) suggesting that if the Fed delivers on what is currently priced, it is starting to provide real stimulus.

The question will be – as always – whether this will be enough to boost risk sentiment, impact the US economic trajectory and weaken the US dollar, or whether the Fed still remains behind the curve on all fronts and will have to deliver even more than is currently priced to get ahead of the curve.  The US dollar was finally impressed to a degree in recent sessions, weakening nearly across the board, but yesterday saw a fairly robust bounce in the greenback’s fortunes, particularly in EURUSD ahead of today’s European Central Bank meeting – more on that below. 

By the way,  a great session over at MacroVoices with Julien Brigden, who offers a balanced outlook on the Fed, tactical uncertainties, and the key questios from here: whether whatever the Fed does, it  will be enough to weaken the US dollar, because without a weak US dollar, the world doesn’t recover because it is the financial “denominator” for everything. I especially appreciate his perspective that it could be asset prices themselves that are a key economic driver.

The ECB is up today and offers President Mario Draghi one of his last opportunities to make a dovish mark before his tenure as ECB president draws to a close. Today will see the announcement of TLTRO-III terms for EU banks lending from the ECB. Our Chief Economist Steen Jakobsen expects a negative rate on the lending (i.e., the ECB paying banks to borrow money). The most dovish combination possible today would be a 10 basis point rate cut (this has been put out there), to -0.50%, the application of that rate to the TLTRO-III round, and then a tiering of the rates applied to excess reserves to prevent banks from having most of their reserves parked at the ECB assessed at the negative policy rate. 

US President Trump is so far not impressed with Mexico’s attempts to make assurances on immigration, leaving MXN in the lurch. A very headline-driven situation there that could change with the next tweet, but more negatives are piling up for Mexico as Moody’s downgraded its sovereign debt outlook to negative from stable and Fitch downgraded its debt to BBB (its second-lowest investment grade rating). Much of the concern for the sovereign debt focuses on the Mexican national oil company PEMEX and whether its massive debt pile is sustainable – made worse by the recent drop in crude prices and long-established fall in Mexico’s oil production.

The next mini-test for market sentiment and across the board will be tomorrow’s US jobs and earnings numbers after a confusing mix of data this week – a weak ISM Manufacturing and terrible ADP payrolls change but a stronger than expected ISM non-manufacturing. But the bigger test awaits at the June 19 FOMC meeting, where the Fed has a delicate communication job in contending with the market’s aggressive stance on where it will take the policy rate from here.

Trading interest

Short AUDUSD as long as below 0.7025 and NZDUSD as long as below 0.6700. Alternatively, short GBPUSD as long as below 1.2780
Short EURUSD via put options – 1-2 months near 1.1200 strikes

Chart: EURUSD

Every surge in EURUSD seems to have its ambitions cut off quickly at the knees and it is tough to work up enthusiasm for the euro ahead of Draghi’s performance today and the risk that he manages to somehow surprise on the dovish side, even with Germany bunds (10-year sovereigns) yielding a record low -23 basis points this morning. The tactical barrier / pivot to the upside through the end of this week is the 1.1300 area after this latest rally attempt and the downside remain a tough nut to crack after multiple failures to generate momentum.
Source: Saxo Bank

The G10 rundown

USD – the big dollar bounced back yesterday. Consider how much the Fed is going to have to deliver to get it to back off, when the incredible repricing already in the bag has failed to do much so far...

EUR – the euro rally backed off yesterday as the market well knows Draghi’s tendency to maintain King Dove status. Still, the last major dovish guidance push in March only managed a one-off weakening.

JPY – the JPY pulled in two direction recently as risk appetite improvement is an opposing force to yen strength from lower bond yields. Using 30-year US yields plus risk sentiment as coincident indicator.

GBP – the GBPUSD rally saw an orderly consolidation that topped out ahead of 1.2750 – we still look lower while EURGBP could yet consolidate if Draghi manages to impress today.

CHF – EURCHF traders seem to be pricing a dovish Draghi today. Despite all of the  news on the budget showdown between Italy and the EU and even Italy’s moving ahead with its alternative currency-like “mini-bot” idea, the Italian-core yield spreads are relatively flat.

AUD – resistance in AUDUSD at 0.700 came in yesterday – that is the local line in the sand for the bears in a heavily speculative short market. 

CAD – USDCAD probed lower on the general USD weakness yesterday, but only deserves attention on a broader USD weakening and a breakdown below 1.3275  (the 200-day moving average) to start.

NZD – a Reserve Bank of New Zealand deputy governor Hawkesby triggered a NZD rally on comments that  “our central view is that New Zealand’s interest rates will remain broadly around current levels for  the  foreseeable future”. Hard to imagine that Governor Orr would approve such a statement – and NZ rates didn’t react – but this has certainly set back the AUDNZD bullish case.

SEK – EURSEK trying below the 9.60-65 pivot zone ahead of the ECB today – the outlook there more dependent on risk sentiment’s reaction to the ECB than the dovish surprise potential. Regardless, the Riksbank’s date for ending NIRP is disappearing over the horizon.

NOK – the crash in oil prices weighing and Norwegian short rates have collapsed in recent sessions, eroding support further. Not sure where any positive catalyst can emerge here.

Upcoming Economic Calendar Highlights (all times GMT)

1145 - ECB Rate Announcement
1230 - ECB President Draghi to speak
1230 - Canada Apr. International Merchandise Trade
1230 - US Initial Weekly Jobless Claims
1430 - US Weekly Natural Gas Storage
1700 - US Fed's Williams (Voter) to speak
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