FX Update: A few last thoughts ahead of the FOMC meeting

Forex 5 minutes to read
John Hardy

Head of FX Strategy, Saxo Bank Group

Summary:  The FOMC meeting tonight will help reveal both where the Fed is in its thinking as it observes its effect on both the economy and of increasing importance, on the financial markets. There is certainly room for the FOMC to disappoint on the hawkish side by indicating no urgency to act with any new easing, but how much is expected? Elsewhere, sterling is working its way back higher on Brexit hopes and the Japanese yen is stirring.


Today’s FX Trading focus:

FOMC on tap – how much is expected and does Fed under-deliver
I covered this thoroughly in yesterday’s post and we also discussed this in today’s Saxo Market Call  podcast, but want to underline that I have a hard time understanding why the Fed would want to pour gasoline on the housing market, for example, by signaling already now that it feels it necessary to tamp down on long lending rates. By the way – some excellent charts and thoughts over at Tim Duy’s Fed Watch. It would be entirely appropriate for the Fed to point at the most loose financial financial conditions ever and shrug its shoulders, still expressing concerns about the status of the recovery, especially for vulnerable households, but saying that it doesn’t have the right tools here to add further support, with fiscal policy a more appropriate approach.

Shortly put, I think that if the Fed does move here, it could prove a policy mistake that over-gooses the market with further stimulus and liquidity (with more to come as the Treasury draws down its cash levels). Far better to flag that it will do what is necessary if conditions materially worsen, but passing on acting now. What then, will the fallout be? If the Fed does fail to act and fails to indicate much urgency beyond exhorting the US treasury to do more to address economic risks, and more importantly, if the market finds the monetary policy statement and/or guidance and/or comments from Powell to be a shocking development, it will presumably mean a bout of risk off and USD appreciation. But beyond that, the critical question is what happens to long US yields – if these simply fall on safe haven seeking (and despite the Fed not indicating a shift to buying more longer maturity treasuries), then the JPY could come in strong across the board. If, on the other hand, US treasuries sell-off steeply on the signal that the Fed is willing to tolerate higher yields, the JPY and CHF and EUR might prove especially weak as the negative yielders among the G10. So there are a few moving parts higher – and I’ll round up all that happened tomorrow.

JPY – the Japanese retail trader heavily trading
On Twitter and in today’s Market Call podcast, I also have flagged a Bloomberg article noting that Japanese retail traders are trading JPY at a record clip and have a record open interest in the currency – with the article seeming to indicate that most of the interest is from the short side. For those who haven’t been around in the market as many years as I have, they should note that these retail traders in Japan can be a real force in the market, as was especially case leading up to the global financial crisis in 2007-09, which saw the tail-end of the epic JPY carry trade (shorting the basically non-yielding JPY versus higher yielding currencies like AUD and NZD) that had developed  since around 2002. From 2002 to early 2007, this trade was a spectacular one way street yielding more than 300-400% without even extensive leveraging (for a forex trader). Of course, the trade was so good, that the leverage was raised and raised and retail accounts were heavily involved in the late stages of that trade – even before the broader global markets begin gyrating on the systemic crises unleashed by the derivatives linked to the US housing market and then the Lehman bankruptcy. The AUDJPY and NZDJPY drops in July and August of 2007, for example, were the beginning of the end.

Fast forward to today: if we get a disruptive event, whether today’s FOMC meeting (more above) or otherwise, the JPY could suddenly come alive here – and that generally means to the upside, if leveraged speculators are heavily short the currency. Given the tendency for the USD and JPY to move in sympathy in the crosses, the high beta currency pairs would likely again be the AUDJPY and NZJDPY’s and EM/JPY pairs even more so, as the latter are very risk sensitive and provide some carry while AUD and NZD no longer do. That being said, as pointed out below, if US yields head higher, the JPY risks weakening versus the USD, with or without the presence of retail traders.

Chart: USDJPY
Will be intriguing to watch how the USD reacts after the FOMC meeting, regardless of the outcome, but a little extra interest than usual in USDJPY here, both because of the apparent interest among Japanese retail traders, as noted above, but also as the pair is approaching the cycle lows once again and could be ready for a run to 100.00, the next major chart point to the downside. If, on the other hand, the Fed fails to signal any interest in providing fresh easing and US long yields shoot higher, the pair could jump sharply higher and set a squeeze in motion to the upside.

Source: Saxo Group

Strong initial PMI’s out of Europe
Despite the widening lockdowns, the flash December PMI’s out of Europe were far stronger on the services side than expected, with France registering a very surprising 49.2 vs. 40 expected and the Euro Zone figure at 47.3 vs. 42.0 expected. This boosted EURUSD to a new cycle high, although we need to wait for the FOMC for confirmation/rejection. Also perhaps helping at the margin for Europe was the boost in sterling as progress on the fisheries issue helped boost GBPUSD up through 1.3500 today for the first time and briefly to its highest level since early 2018 as well.

Upcoming Economic Calendar Highlights (all times GMT)

  • 1330 – US Nov. Retail Sales 
  • 1330 – Canada Nov. CPI
  • 1445 – US flash Dec. Markit Manufacturing and Services PMI
  • 1500 – US Dec. NAHB Housing Market Index
  • 1900 – US FOMC Meeting Announcement
  • 1930 – US Fed Chair Powell Press Conference
  • 2145 – New Zealand Q4 GDP
  • 0030 – Australia Nov. Employment Change / Unemployment Rate

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