FX Update: US CPI on tap. GBP focus beyond Friday.

FX Trading focus: US CPI on tap. GBP focus beyond Friday.

Traders finally abandoned their fear of official Japanese intervention took USDJPY more firmly higher yesterday, to for the cycle since the 1990’s, even as US treasury yields remained tame. Elsewhere, the USD action was generally muted as EURUSD is finding the 0.9700 area sticky and GBPUSD bobs around near 1.1100, with the market mulling what will happen after the Bank of England halts its emergency QE measures, supposedly on Friday.

The next event risk is the September US CPI release later today and whether it moves the sentiment needle on any sharp new move in US treasuries, where yields have consolidated below the cycle highs of two weeks ago and near 4.00%. Judging from the last CPI release in September, where the hotter than expected core data jolted the market and sent the USD higher, we might expect that any surprises could move the market sharply. But in the intervening time frame, we have to remember that the September FOMC meeting spelled out for the first time in the Fed projections that the rate tightening regime was forecast to continue even as inflation is expected to slow considerably and unemployment to rise. The worst surprise for markets and aggravator of the USD rally would be a strong core print of 0.5% or higher.

The FOMC minutes released late yesterday showed that “Many participants emphasized that the cost of taking too little action to bring down inflation likely outweighed the cost of taking too much action.” This was not read as a huge surprise by markets, as Fed rhetoric has consistently pointed in that direction and the market expectations for Fed policy finally now reflect the Fed’s own “dot plot” trajectory of forecasts, in which rates are expected to end next year slightly higher than where they are seen ending this year. Previously, the market had persisted with the view that the Fed would blink at the first sign of trouble and cut rates quickly (note comments on September FOMC above ending that narrative). Still, there was a note of caution in the minutes as “ Several participants observed that as policy moved into restrictive territory, risks would become more two-sided, reflecting the emergence of the downside risk that the cumulative restraint in aggregate demand would exceed what was required to bring inflation back to 2 percent.” But that is already why the market is expecting less than 50 basis points of further tightening beyond the December FOMC meeting, so it is already “in the price”. Late yesterday, Michelle Bowman of the Fed’s Board of Governors argued for continued large rate increases and the early November FOMC meeting is nearly fully priced to deliver a 75 basis point hike, with December’s meeting priced at 50-50 odds of 50 vs. 75 basis points.

Chart: EURGBP
Watching GBP pairs into the end of this week and early next week as the Bank of England still claims that it will wind down its emergency QE tomorrow, while the FT has cited discussions among those in the know that believe the Bank will have to extend its operations. An interesting sign of scapegoating from UK Chancellor Kwarteng, who commented on the sidelines of a conference in Washington that any turmoil in the UK gilt market next week would be the BoE’s fault – an ugly scapegoating move. Two things are notable here: first, that the longer UK gilt yields rose yesterday back to where they were during the worst of the market disorder a couple of weeks ago even as the emergency QE is ongoing. And second: GBP has rebounded quite smartly today as yields have come back sharply lower from yesterday’s highs. At some point, isn’t this ironic? I.e., strong QE driving yields lower and a currency in a world where central banks are tightening and in the Fed’s case, doing QT. We won’t know the lay of the land until early next week – for now, watching GBPUSD and EURGBP closely. The 0.8850+ area in the latter suggests sterling stress, while 0.8575-0.8625 was the important zone on the way up.