Head of FX Strategy
Summary: Market expectations for the Fed have eased during the recent bout of significant market volatility. This has prompted the US dollar to maintain a generally flattish performance, caught between its safe haven status and the lower Fed expectations. The FOMC meeting later today will likely see the Fed maintaining course for a March rate hike and unlikely to deliver any notable dovish shift, with its balance sheet guidance in the spotlight, if any new hints are provided on that front.
FX Trading focus: Is lack of fresh FOMC hawkishness dovish?
The US dollar has maintained a somewhat flattish performance despite a fairly remarkable bout of asset market volatility that one might have expected would do more to support the currency. The greenback may be getting pulled in two directions simultaneously – to the downside as the market has taken the top off Fed rate expectations (the expected rate at the end of this year has declined about ten basis points from the peak last week) while that is offset by its safe haven status. As we discussed on this morning’s Saxo Market Call podcast, much of the volatility in asset markets may be down to retail flows, as other important indicators of financial conditions, like corporate credit spreads, have only shown very modest deterioration. In other words, has the safe haven aspect been fully tested of late?
The market is looking for the Fed to avoid hawkish surprises today and perhaps even a slightly nudge toward more caution. I think the latter is very misplaced if this is what some are expecting. I suspect the Fed will do everything it can to stay on message: that it is determined to get ahead of the curve on inflation, while the most dovish thing it can do is avoiding any signaling on the quantitative tightening (QT) issue. By the same token, that QT, or balance sheet, issue could be where the Fed has the chance to surprise the most on the hawkish side, whether in the monetary policy statement or in Powell’s press conference. Especially the Fed simply tapering to zero purchases immediately after this meeting, rather than continuing to guide for a halt to purchases only by mid-March, would be seen as a signal that the Fed would like to begin eventually reducing its balance sheet/performing QT very soon after rate lift-off at the March meeting, even if there is no other evidence to that effect besides a few Fed officials having mentioned QT in recent weeks.
In short: tactically, the FOMC meeting balance of risks points higher for the US dollar if the expectation is that the Fed will deliver some significant deceleration of its hawkish message.
Chart: USDCAD
An interesting test today for USDCAD as both the Bank of Canada and FOMC are set to meet today, with a majority looking for the BoC to hike rates 25 basis points today and initiate its hiking cycle ahead of the US Fed’s likely March lift-off date. The forward yield spreads for the US versus Canada have been within a tight range for well over a month, while USDCAD has lifted off recent lows on the rough bout of risk aversion and the recent consolidation in oil prices. The price action on the chart shows clearly that the 1.2500 area is significant after multiple intraday attempts to break lower were rebuffed. It is also the location of the 200-day moving average. If the market decides that the Fed is benign here post-FOMC and the Bank of Canada hikes (I am with the majority in looking for a hike) and delivers fairly hawkish guidance, the pair could be set for a significant break lower if the 1.2500 level fails on a daily close after today. More cautious BoC guidance with or without a hike and a Fed that keeps the market under pressure with a hawkish surprise, meanwhile, could keep the pair in the current range.
AUDNZD has broken new ground above 1.0700 this morning after its recent lengthy and tight consolidation after establishing credibility around the 1.0600 area and now in the wake of a stronger than expected Australian quarterly CPI release yesterday and as the market continues to watch for Chinese stimulus as iron ore prices have grinded higher in recent weeks. The chart has room to 1.1000 if we avoid new strong AU-negative or NZ-positive catalysts. Tonight it is New Zealand’s turn to release its own Q4 CPI, expected at +1.3% QoQ and +5.7% year-on-year – a taller order to surprise to the upside here relative to Australia. The AUDNZD is not getting any boost from yield spreads, which have gone nowhere over the last two months, but it will be interesting if the RBA is finally forced into a more explicitly hawkish stance at the Feb 1 (next Tuesday) meeting.
Table: FX Board of G10 and CNH trend evolution and strength.
In the FX Board, China’s strong renminbi policy continues to stick out, while an extension of the late JPY strength likely requires further misery for risk sentiment and an extension of the recent rally in safe haven sovereign bonds. I noted in the Q1 outlook that the JPY-CNY divergence is at its most extreme entering this year since 2015, shortly before China announced a major exchange rate regime shift. Elsewhere, NZD and SEK are the weaklings on weak risk sentiment.
Table: FX Board Trend Scoreboard for individual pairs.
Interesting to seek USDCHF trying to flip positive – it has been a pair that both refuses to fall or rise with any persistency over the last many months. Elsewhere, we’ll zero in on new developments for the US dollar post-FOMC, as it is too early to call a headline USD direction here. Watching USDCAD and EURNOK status over coming few sessions on oil prices and due to technical and the Bank of Canada meeting today.
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