Head of FX Strategy, Saxo Bank Group
Summary: The US dollar is in a holding pattern here ahead of tonight’s FOMC meeting as the market expects a generally hawkish message, meaning it will be easy, if unlikely for the Fed to surprise on the dovish side, but likewise difficult to surprise on the hawkish side.
Nonetheless, it is an important event risk that tests the market's assumptions about what the Fed will say and the implications for the US dollar. We suspect that the bar for a hawkish surprise is very high, as US yields have persistently risen over the last three weeks and the US two-year rate is some 17 basis points higher than it was at the August 1 FOMC meeting. It is also 27 basis points higher than it was at the June FOMC meeting, the last one to provide accompanying materials on the Fed’s forecasts for the economy and policy.
In “dot plot” terms, therefore, a full 25 bps rise in the dots for 2019 is arguably already "priced in" – although it should be noted that this would take the Fed’s own median policy forecast for the end of next year to firmly above 3.00%, while the market is still stuck down at 2.75% on average. The more conservative takeaway from this may be that the market can absorb a rise of 25 bps in 2019 as long as the dot plot forecasts for 2020 and for the longer run are left alone.
Regardless, given that the dollar has crossed below key support in a number of non-JPY pairings recently, today’s reaction will be an important status check on the quality of that move.
EURUSD stuck in neutral even as the forward Euribor curve has finally started pricing in European Central Bank rate hikes, even if only to a very modest degree. The chart will have to send a clear signal in the next session or two. It won’t take much for the bears to have a hook on selling the pair if it closes back below the recent 1.1700-50 pivot zone in a firm rejection back lower post-FOMC. A strong close back above 1.1800 looks very supportive for the bullish case after the recent bullish break above that key 1.1700-50 zone.
USD – one angle on the US dollar is that, despite widening yield spreads of late in USD's favour, the latest two-year Treasury auction is showing that the blitz of Treasury issuance that is only set to rise farther from here is finally having an effect as the world wonders where the funding for Trump’s deficits will come from. But the other is simply that if yield rises are swinging into motion elsewhere, the bar becomes that much higher for the Fed to surprise to the upside.
EUR – Italy’s Five Star Movement is threatening to spike the budget talks if it doesn’t get a larger deficit and specifically it’s citizens' income introduced. Italian yield spreads look complacent this morning on this story.
JPY – yields ticking lower overnight and this morning, taking the JPY a shade stronger – the yen likely to move with the highest beta to other currencies if the Fed shocks with a dovish message (we consider this highly unlikely) and perhaps even with the most beta if the Fed waxes exceptionally hawkish as the BoJ’s mettle is being tested as the YCC policy cap for the 10-year JGB is only a few basis points higher.
GBP – excellent commentary on all of the difficult angles of Brexitabounds, with the latest from the Telegraph’s Warner particularly compelling, as he sees a Tory party that is unable to deliver Brexit – and the Scylla and Charybdis of a chaotic No Deal or a failure of democracy on a “no exit” if the EU gets its way and the UK is humiliated back into some version of its former status. Also interesting is the clash between the diplomatic signalling of German Chancellor Merkel and French president Macron’s harder stance on terms for Brexit.
CHF – the franc sell-off stopped yesterday by the news that Germany’s Chancellor Merkel’s favoured candidate to lead her party’s bloc in the Bundestag lost to another colleague, Ralph Brinkhaus. It’s not good for the EU existential equation that he is touted as a “fiscal conservative” but looks more promising that he is willing to at least talk with the AfD, which Merkel’s candidat Kauder was unwilling to do.
AUD – AUDUSD trying to get a reversal going recently and waiting for USD direction post FOMC – meanwhile USDCNY is uncomfortably close to the high of the range... 0.7200 looks like the downside swing level and a closing level above 0.7300 post-FOMC would look promising for an attempt higher still.
CAD – 1.3000 is the upside resistance level/pivot as we await USD direction. The strong crude oil prices have not supported CAD as much as in normal times of yore as much of Canada’s crude is so heavily discounted versus US crude, which is in turn far cheaper than the global Brent benchmark.
NZD – market ignores the worst trade deficit print in the country’s history, as issue that will come back to haunt the country in the next global growth slowdown, but for now not a factor. After breaking above the 0.6600 area, potential in NZDUSD toward the 0.6800 area if the USD can’t find a bid after the FOMC meeting tonight. RBNZ meet to follow within a few hours, with the market having decided for whatever reason that it will ignore the dovish leanings of Governor Orr.
SEK – the headline that the sitting Social Democratic prime minister Lofven has been voted out is no surprise and now begins the difficult process of finding a new minority government, which is procedurally possibly as long as a suggested ruling bloc doesn’t have a majority of votes against. This isn’t likely to hold up SEK notably as we look for further SEK gains on a Riksbank change of outlook and mean-reversion in an undervalued Swedish krona.
NOK – the krone looks in good shape with oil above 80 dollars per barrel and short rates still near the top of the range despite last week’s Norges Bank disappointment. EURNOK looking heavy again if it can retake 9.50
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