FX Update: USD drops to new lows ahead of FOMC minutes.

Not that markets are expressing and concern, but the next round of US stimulus may prove smaller than expected, if we are to believe Bloomberg sources in an article outlining the risk that a stimulus deal may only be struck on terms that both sides can agree on until the other side of the election. This could mean a deal as small as $500 billion versus the original $1 trillion Republican plan and far larger $3.5 trillion Democratic plan. At the same time, many companies are pushing back against Trump’s payroll tax deferral idea as unworkable and many states have not yet even signed up for the $300/week new Federal unemployment benefit that replaced the $600 payments through end of July.

The USD was pushed lower still yesterday, led by a solid pull higher in GBPUSD (more on that below) and USDCAD falling steadily as it explores the last bits of the range ahead of the pivotal 1.3000 area. Some enthusiasm for CAD could be on Prime Minister Trudeau promising a strong stimulus plan with this new Finance Minister Freeland when Parliament resumes business on September 23 after a proroguing to end the current session. But surely an oil breakout higher is a first necessity to see USDCAD challenge the 1.3000 level. Today’s US energy inventory data may spark oil volatility.

Looking ahead to the FOMC minutes tonight for any sense of urgency in the Fed’s observations on the need for further stimulus, or any disc. As outlined yesterday, the more important signals ahead from the Fed will arrive with the Fed’s comprehensive policy review results (allowing inflation to run above target without responding and yield curve control already flagged) as well as any hints from the Kansas City Fed’s symposium late next week. Assuming the Fed is not set to begin injecting money straight into the economy (by transforming its balance sheet liabilities into legal tender, for example, something that would likely require a change of mandate) the market reaction could prove somewhat muted. The real power to move markets in a yield curve control regime would come from a fiscal impulse that forces inflation higher and real rates lower, with the currency taking the punishment – that was the “relative negative real rates plus current account considerations” argument I forwarded back in April when trying to figure out what the post-COVID-19 environment might mean for currencies. I called it “the coming brave new world of FX trading”:

In markets, if you put your interventionist thumb down on one asset class – here sovereign bonds and policy rates for the entire curve – then another asset class will have to become the speculative vehicle to absorb the implications, for example, of what one might call the “relative financial repression game”. In this game, the key inputs for the FX trader are relative current accounts, which should loom larger in a world where capital markets are less dynamic and more manipulated than ever, and the severity of financial repression, i.e., to what degree the money printing in a given country is taking inflation beyond the policy rate – the relative ugliness of the negative real yield. In this game, FX could risk becoming the preferred instrument to trade and keep volatility quite high with every policy move and inflation release. At least, I would like to think so – imagine the depressing outlook for sovereign traders from here – stuck with capped yields and terminally manipulated markets. Even corporate bond fundamentalists must be throwing up their hands in disgust after recent interventions. 

It's too early to say to what degree this brave new world is taking shape, but it could be behind the persistent relative weakness in the JPY (shrinking current account surplus over last couple of years - currently around 3% of GDP) versus CHF (rebound in current account surplus to above 11% by end of last year) and the AUD rise versus both NZD and CAD (both current account deficit countries versus Australia having moved into surplus), etc..

On that note, then, inflation and current account data will merit close attention once the COVID-19 disruptions fade.

Chart: GBPUSD
GBPUSD popped above local resistance and traded at a new high for 2020. It’s rather ironic that sterling rose sharply in the wake of a strong CPI release (1.8% year-on-year at the core, the highest in nearly a year and far beyond expectations), as higher inflation with ongoing low rates should theoretically weigh on a currency, but others touted the number as a sign of pent-up demand. Elsewhere, there was certainly nothing in the Brexit talks to encourage a bid into sterling as the EU is pushing back against UK proposals for UK-based truckers’ access to the single market. Time is running out and promising headlines are needed for sterling to maintain course. For now, the technical break above the 1.3200 area here is in focus and it arguably needs to hold above 1.3150 to stay viable. The weak US dollar is doing most of the lifting here. The next level higher is the massive 1.3500 area, the high since back in early 2018 when the USD was in a rut.