Head of FX Strategy, Saxo Bank Group
Summary: The Fed delivered a rate cut and an end to QT, but not much else as the press conference left the market feeling like it is dragging its heels and falling farther behind the curve. The USD jumped, which sets the clock ticking for action from the Trump administration.
Those looking for a limited further USD upside from this and an eventual transition to weaker risk appetite:
- Building USDJPY shorts ahead of 110.00 with stops above 110.25 for a move back sub-107
- Taking profit on recent short term EURUSD long put strategies
- Long term EURUSD calls as spot approaches 1.1000 (for example 1.1300 calls for 3-months or longer)
Fed delivers cut, end of QT, and frustration
The Fed’s deliver of the expected 25 basis point cut, the new statement and two hawkish dissensions were seen as a slightly hawkish mix, despite the fact that end of QT was hastily brought forward to today’s date. The initial USD-positive reaction was perhaps most of all about the binary question of “50 or 25?” being settled, as a non-trivial minority of market participants were looking for the larger cut. Two hawkish dissensions were no major surprise, coming as they did from two known hawks among the voters (George and Rosengren). The statement changes were minimal and only one full sentence, besides noting the changed QT end-date, was changed to indicate the actual rate cut: “In light of the implications of global developments for the economic outlook as well as muted inflation pressures, the Committee decided to lower…[the target rate]”
But it was in the Powell press conference that the USD pulled stronger across the board as Chair Powell positioned the cut as a “mid-cycle adjustment” in an answer to one of the first questions from journalists. This quickly flattened the US yield curve, as short yields spiked back higher on the worry that the Fed is dragging its heels and getting further behind the curve again. He spent much of the rest of the press conference answering questions weakly and tripping over his own comments on whether this is the first in a series of solitary cuts or that “mid-cycle adjustment”. It is only clear that the Fed isn’t sure what it will do and wants to keep all options open as it crosses its fingers behind its back.
Between the lines, the hasty ending of QT is a sign that the Fed is concerned about USD liquidity issues, something that will constantly return and worsen materially on larger and large US deficits if the US slowdown continues into a recession later this year. Effectively, the Fed no longer has control of its policy and this strong USD move only hastens Fed policy along the path to the next rate cuts and eventual QE.
As expected, we got a quick response from US President Trump, who lambasted Powell for being insufficiently dovish: “As usual, Powell let us down, but at least he is ending quantitative tightening, which shouldn’t have started in the first place – no inflation.” And “What the Market wanted to hear from Jay Powell and the Federal Reserve was that this was the beginning of a lengthy and aggressive rate-cutting cycle which would keep pace with China, The European Union and other countries around the world....”
What then from here?
USD upside limited – in places. The USD strength in and of itself sows the seeds for the Fed’s next move, and President Trump will likely move very aggressively if the USD rallies any further from here (and even if it merely stays here). Where the USD might weaken eventually will hinge on the question below, but would expect USD to roll over first against the other major currencies first, especially the JPY, even if EM currencies are struggling.
When does Trump more than tweet? Real policy change is coming as Trump will soon pull out all stops to weaken the USD as the Fed is not moving fast enough to do so. Even many in the US Congress seems on board, with an insane bill proposal from the Democrats to tax all US-bound short-term and real estate investment. Not going to pass, but there is certainly a signal value there.
Will risk appetite change gears? Really the most critical question. So far this year, global markets have celebrated the dramatic turnaround in the Fed’s policy outlook and the support all around the world from central banks’ policy trajectory. But as so many others have pointed out, most often, a central bank begins an easing cycle because a real economic slowdown is afoot, which requires a rerating of risky assets. So whether risk appetite finally rolls over here is critical and ironically, could come from two very different developments: either a) on very weak data, for example this week’s ISMs and the Friday July US jobs report, which sees the market fretting the economic cycle rather than celebrating the implication for policy cuts, or b) sufficiently strong data that sees the market throwing another tantrum because it indicates a shallower rate cut path.
The G-10 rundown
USD – the flattening US yield curve suggests market sees the Fed as reluctant to realize where it must head and dragging its heels somewhere behind the curve. Strength may not last against the major currencies as this will quickly go political in a larger way and Fed doesn’t have any control anyway as its path is pre-ordained.
EUR – The 1.1000 level the next major area for EURUSD – eventually looking for support, but some risk of slippage on Brexit risks and Draghi pulling out all of the stops ahead of his departure.
JPY – higher US yields see USDJPY kneejerk a bit higher – but long end of US yield curve more stable on the flattening curve yesterday – so looking for this move to peter out, possibly ahead of 110.00.
GBP – a Bank of England non-event for the day. The BoE has no real policy options for a hard Brexit that will soften the blow in any meaningful way. EURGBP trying to turn a corner yesterday despite lack of any real developments on news of PM Johnson sending envoy to deliver his message to EU leaders yesterday.
CHF – EURCHF at 1.1000 barely hanging in there after trading below that level last week – likely to correlate with EURJPY and risk appetite and any Brexit developments.
AUD – after slightly beat on the Q2 CPI print, the odds of an RBA rate cut next week receding close to nil – but more rate cuts are coming and AUDUSD has now touched that sub-0.6830 area once again – new lows in the cards likely there.
CAD – important resistance zone from here up to about 1.3300 in USDCAD if we are to ever see CAD regain the upper hand.
NZD – a very weak ANZ survey for July out yesterday – are we finally seeing AUDNZD turning the corner higher – may need a bigger catalyst to answer in the positive.
NOK and SEK – the recent disappointing Swedish GDP print dragging on SEK and USDSEK posting new highs today not seen since…2002. NOK struggling near major support versus the euro as all of the small DM currencies are out of favour at the moment despite the Norges Bank positive policy rate.
Upcoming Economic Calendar Highlights (all times GMT)
- 0715-0800 – Euro Zone Jul. Manufacturing PMI’s
- 0830 – UK Jul. Manufacturing PMI
- 1100 – UK Bank of England Rate Decision / Inflation Report
- 1100 – Czech central bank policy rate
- 1130 – UK BOE’s Carney press conference
- 1230 – US Weekly Initial Jobless Claims
- 1400 – US Jul. ISM Manufacturing
- 2200 – New Zealand ANZ Consumer Confidence
- 2350 – Japan BoJ Minutes of June Meeting
- 0130 – Australia Jun. Retail Sales
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