Macro: Sandcastle economics
Invest wisely in Q3 2024: Discover SaxoStrats' insights on navigating a stable yet fragile global economy.
Chief Macro Strategist
Summary: The US dollar has worked its way into a huge support zone ahead of the next batch of incoming data. The big test ahead across markets is perhaps when we move away from a one-dimensional obsession with US yields and begin to look at how markets start to price an incoming recession. That could complicate the turnaround process from a USD bull to a USD bear market.
FX Trading focus: USD eyes huge support ahead of next important incoming data next week. Time for a shift in focus for the greenback?
The FOMC minutes Wednesday confirmed the market’s well-established expectation that the Fed is set to downshift to a 50-bp hike in December, with a bit more tightening thereafter and a hold for most of next year. The action in the curve has been farther out, where the market is getting more aggressive in expressing the view that the Fed will be cutting rates quite aggressively in 2024, with the December 24 EuroDollar STIR future pricing some 170 basis points of easing from the mid-2023 peak – that is up from around 100 basis points just a month ago. It is a strong indication that the market is pricing for an oncoming recession, unless inflationary pressures can somehow normalize in a very soft landing scenario.
For now, the markets are celebrating US yields falling (from 3-years and further out, at least), but at some point will have to consider what a recession normally entails in terms of impacts on corporate profits, the credit cycle, asset prices etc. – in other words, a more widespread deleveraging. At this point in the cycle, we have mostly only neutralized many of the excesses inspired by the pandemic, not priced a significant recession. As well, we are in a novel environment relative to every cycle since at least 1982. Especially the 2007-09 global financial crisis is not seen as a good model for what comes next and partially for good reason: the Fed and other central banks have thoroughly learned the lesson that raging contagion in the financial system is unacceptable, and they are so used to extreme intervention to prevent disorder, with further lessons learned in the pandemic response. So markets feel comfortable in taking the financial chaos option off the table. Nonetheless, once we do cross into a recession in the US as well as Europe and elsewhere, the central banks, and more importantly governments in this age of rising fiscal dominance, will have to be far more wary of triggering an inflationary rebound when considering new easing/stimulus.
In that light, there are perhaps three paths from here.
Chart: EURUSD
EURUSD has been interacting with its 200-day moving average again while not quite able to mount an attack on the recent pivot highs near 1.0480. Given our scenarios above, the two+ week into the December 14 FOMC meeting offer an interesting test of the current market backdrop – is data particularly strong and spoils the decelerating inflation narrative, or is it far weaker than expected, raising recession fears? And if the data is indifferent to stronger than expected, how unhappy is the Fed that financial conditions are at their easiest since May, before the Fed even began hiking rates in 75-bp increments? On a somewhat different note, long range weather forecasts are beginning to see very cold weather across Europe starting in about 10 days. Energy markets in Europe are not fretting this development, but if they do, it will remind euro and sterling traders that external deficits remain a risk for the single currency and sterling. Technically speaking, the first sign of weakness would be a run below the 1.0223 pivot low from the start of this week, but the bigger break-down area looks like 1.0100.
Yesterday, the Riksbank hiked the policy rate 75 basis points as a strong majority expected, taking the rate to 2.50%. Interestingly, to buy itself some optionality, the bank issued a baseline forecast for its policy rate in which inflation dropped to sub-2% by early-mid 2024, which would mean the policy rate peaks below 3%, while an “alternative scenario” of inflation failing to fall much below 4% would mean that policy rate would have to rise north of 4.50%. It was an interesting sign of central bank insecurity on the path from here, although Swedish rates hardly moving in the wake of this meeting and the alternative scenario discussion. SEK got a solid boost by the end of the day yesterday and it is now well embedded back in the range since September after the recent upside threat. It is hard to see EURSEK threatening 11.00+ again unless we are about to tilt into a severe bout of risk aversion.
Table: FX Board of G10 and CNH trend evolution and strength.
CNH curiously weak – doesn’t fit with where the also weak USD is trading elsewhere. Sterling strength is getting a bit out of hand here, but could yet continue if the complacent backdrop continues. Still have to believe that nearly all of the short speculation in sterling has been squeezed out.
Table: FX Board Trend Scoreboard for individual pairs.
Note USDCNH close to flipping positive – needs a solid surge above 7.200 for a stronger indication.
Disclaimer
The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.
Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer)