Head of FX Strategy
Summary: The wild ride last week for the Euro in the wake of the ECB meeting and in how the market is pricing future ECB policy relative to its own guidance points to very interesting tests this week for the RBA, which meets tonight, and of course for the dovish Fed, whose guidance looks far behind the curve relative to market pricing. Indeed, it appears that markets are increasingly refusing to take central banks at their word.
FX Trading focus: Existential strain for the EUR? RBA on tap. Big week for the USD
What the market gaveth the euro on Thursday in the wake of the ECB meeting, the market tooketh away on Friday, and then some as the EURUSD lurched into an ugly descent from local highs all the way back to the bottom of the range in one fell swoop. With 20-20 hindsight, the rally Thursday was built on a shaky foundation – possibly linked to the sharp market repricing of how soon the ECB may actually move to hike rates next year (now priced as early as June-July next year). But after Friday’s profound reversal in EURUSD, the ongoing crush lower in EURCHF, and Thursday and Friday seeing a very sharp repricing of EU peripheral spreads (Germany versus Italy 10-year yield blew 20 basis points wider to over 125 bps over the last two days of last week and traded above 130 bps today), it seems the euro is pricing some degree of existential strain.
That makes some sense if the idea is that the ECB will be forced to taper more than the doves would like next year and eventually must hike rates, but could also be overdone – surely the ECB is ready to crush that spread back in the near term? Still, a potential kicker lies in the German coalition talks, where the possibility of the liberal LDP’s Lindner becoming the new finance minister could accelerate the time frame toward a new existential situation for the EU as Lindner is more likely than any other alternative to act as Schäuble and leans against fiscal expansiveness and a cautious stance on the EU.
RBA preview – loud silence from RBA on YCC failure. Last week, the market thoroughly broke the “control” of the RBA’s attempt to provide yield-curve-control out to the April 2024 Australian government bond, which it had declared will not be allowed to rise above 0.1%. But last week’s repricing of RBA rate intentions saw the dam break and the yield on that bond closing the week all the way up at 0.77%. This suggests that the RBA will need to emerge tonight with plenty of egg on its face and make like the Bank of Canada did last week and the RBNZ all the way back in July and walk away from at least this part of its former policy stance. In addition to walking away from the YCC commitment that it de facto already has done, I would expect guidance indicating a QE cut soon if not already now. Then the bank will need to loosen up on that 2024 rate hike guidance, but let’s see how much the RBA is willing to deliver of this. For now, AUDUSD backed up to critical resistance against the 200-day moving average.
Big test for the FOMC on Wednesday. After the market has demonstrated how thoroughly it can second guess even some of the most dovish central banks over the last week – the RBA and the ECB – this week’s FOMC is a huge test of Fed credibility, as the Fed is seen as perhaps the most behind the curve of any central bank on its ponderous move toward a tapering of asset purchases first, followed by eventual rate hikes further down the road. The latter have been brought significantly forward, with the market now pricing the Fed to move approximately twice by the end of next year. Just as with the ECB and as discussed in the RBA preview above, will the market really care what degree the Fed adjusts its guidance, given that guidance seems worth very little and that data outcomes are in control here, not the Fed? I’ll provide more thoughts tomorrow and/or Wednesday, but one idea could be a starting pace of tapering 15B/month, but pre-declaring “flexibility” that could see the pace even doubled if necessary if inflation/wages/job growth make a mockery of Fed caution in the coming couple of months.
Chart: EURUSD
The misleading EURUSD rally last Thursday was wiped away and then some on Friday, leaving a suddenly bearish setup for the pair coming into this week, one that features the latest important US data and the Wednesday FOMC. Post-FOMC, a close above 1.1700 looks bullish and below 1.1500 bearish – fairly straightforward here – but keep in mind that if the Fed indicates a lot of conditionality around incoming data, frequent direction changes are a risk on data releases like the Friday US jobs report.
Table: FX Board of G10 and CNH trend evolution and strength
A solid momentum shift in the US dollar after Friday’s action, but will take a good week this week for the USD to start trending positive. Note the strongest-in-class AUD – can the RBA really meet the market’s pricing much more than halfway?
Table: FX Board Trend Scoreboard for individual pairs
In the individual pairs, note that GBPUSD is trying to join EURUSD in looking back lower again, while that AUDNZD attempt to flip back higher is running low on oxygen and tonight’s RBA is the likely deciding factor.
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
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.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
