Head of FX Strategy, Saxo Bank Group
Summary: Last week’s FOMC saw a brief risk-on celebration of the Fed’s new easing move followed by a single very ugly session on Friday. It’s time for the market to make up its mind whether it is going to celebrate the Fed punchbowl or fret that the party is already over.
The explicit threat from those voting in favour of this initiative is clearly to avoid brinkmanship. Sterling is generally steady but will struggle to maintain a pronounced directional move until there is more clarity on where this leads.
I want to take a brief moment to discuss a great post by Kevin Muir at The Macro Tourist discussing the current market sentiment, whether it is particularly important at this moment to fret the yield curve inversion and to which past market setups we should be comparing the current setup. He argues, as I have, that a yield curve inversion is a profoundly important and usually very negative harbinger for the economy and for markets, but one that offers very little precision on timing. Think of the yield curve inverting already in early 2006, for example, while markets didn’t roll over until late 2007. Further, Muir wonders whether instead of the Fed having arrived too its dovish stance too early, it has merely panicked, just as Greenspan panicked over the Asian financial crisis and LTCM back in 1998, a move that helped turbocharge the last phase of the tech stock craze into early 2000.
This is a provocative stance and arguably has merit – particularly if the economic data over the next couple of cycles fail to show further deterioration. I struggle to imagine a 18-month, blow-off bull market extension of the post-crisis bull market (this is not Muir’s base case, he just raises the idea that there are parallels), but a smaller version is entirely possible... perhaps three or six months?
If so, bears will suffer a merciless squeeze, the USD would likely be weak and the JPY even weaker as long-dated Treasuries come back under some pressure (slight yield curve steepening again). One thing to keep an eye on this week that may offer clues as to the market's stance is the series of very sizable US Treasury auctions this week.
One small aside: Russia has put boots on the ground in Venezuela. I won’t speculate where this could lead, but the US side has to see this as an extreme provocation and the proximity of Venezuela to the US makes this a very different kettle of fish from a Ukraine or a Syria.
Reducing JPY longs by half and tightening stops slightly until we get a sense of which way this market will run – the total lack of follow-through after Friday’s weakness gives pause.
One-week, at-the-money NZDUSD calls cost a bit over 40 pips and are an idea for the Reserve Bank of New Zealand meeting in case the RBNZ fails to wax sufficiently dovish to scare the market and global equity markets start to lean towards the scenario outlined above. If you don’t agree or lean the other way on the outlook, consider one-month puts at strikes about a figure out of the money – NZD vols are cheap.
The broad inter-market setup here looks pivotal and JPY crosses likely offer some of the highest beta exposure to how the markets turn from here – further risk-on and weaker long US Treasuries as the market continues to celebrate the Fed’s dovish turn and perhaps incoming economic data fail to encourage the view that a recession is imminent. Or do we see the opposite – rising concern that the Fed already overreached and further easing is only linked to very bad economic news?
• 12:30 – US Feb. Housing Starts / Building Permits
• 13:00 – US Jan. S&P CoreLogic Home Price Index
• 14:00 – US Mar. Consumer Confidence
• 17:00 – US two-year note Auction
• 19:05 – UF Fed’s Daly (Non-Voter to Speak)
• 01:00 – New Zealand RBNZ Official Cash Rate