Head of FX Strategy
Summary: The ECB is the latest central bank to suffer the market second guessing its intentions as rate hike bets for next year rose to cycle highs even as ECB President Lagarde pushed back against the market pricing these rate moves. The Euro rose in response, with EURUSD trading above local resistance, but we have a critical week ahead for the US dollar as next week features a busy economic calendar and an important FOMC meeting.
FX Trading focus: Market thumbs nose at ECB. what happens next week with FOMC?
At the ECB press conference, ECB president Lagarde insisted that the bank’s forecasts and outlook suggest that, while inflation will prove more persistent than originally expected, it will fall back next year and that the market’s pricing of ECB rate hikes next year was unwarranted. Even as she did so, rate expectations actually rose sharply while she was speaking during yesterday's press conference, suggesting two things: first, that the market believes that the ECB will have to cave in recognition of inflationary risks and adjust its inflation forecasts significantly higher at the December meeting after projecting in September that inflation would fall back to 1.7% in 2022 and 1.5% in 2023. Second, it is part of the pattern of late in which the market is sharply readjusting rate expectations higher with or without an accompanying guidance shift from a central bank. The three most prominent examples this week have been in Australia (discussed below), the huge shift in Canadian short rates after the Bank of Canada’s hawkish turn, and now the ECB even with the bank actively pushing back against what the market is pricing.
Given that the EURUSD rushed higher in response to yesterday’s ECB meeting as discussed in the EURUSD chart analysis below, the question now is to how the market treats the US dollar over the various US data releases from today (PCE inflation) through next Friday (October jobs report), not to mention the Wednesday FOMC meeting next week that will mark the start of an overdue QE taper. Will the market continue to price the Fed to remain behind the curve relative to what is being priced in elsewhere from other central banks. And even if so, will US treasury yields stay suppressed at the long end of the curve even if short rates continue to rise? If US 10-year and longer yields punch higher to new cycle highs, the volatility risks across asset classes should pick up considerably. Risk off and higher US long yields are perhaps the last route for the US dollar to take a stand. Either way, the US dollar is in a very pivotal spot in a number of pairs ahead of the crucial week ahead.
RBA has loudly not responded to YCC challenge. In Wednesday’s update, I noted that the market was challenging the RBA guidance in the wake of the strong-ish core CPI release, but of course the technical event that precipitated such a powerful change of sentiment in Aussie rates (if less so the currency) was the market directly challenging the RBA’s actual yield-curve-control policy, under which it is supposed to be keeping the April 2024 Australian Government Bond pinned at 0.10%. That yield level was challenged lightly last week, but gave way on Wednesday and flew higher yesterday to above 0.50% and overnight to above 0.75%. This sets up a very pivotal RBA meeting next Tuesday at which the RBA at minimum will need to wiped egg off its face and climb down from the yield target. To meet market expectations, it would also have to loosen up its forward guidance on the expected time frame of hiking rates, but the mood of the market seems to be one of ignoring forward guidance, anyway. AUDUSD is at critical levels as well, trading up against the 200-day moving average overnight near 0.7560, which is also near the range lows that were broken in the wake of that pivotal June FOMC meeting, so next week is critical for whether the pair can achieve a full reversal back into the higher zone.
Chart: EURUSD
Very tempting to get bullish of EURUSD on the close yesterday due to the close above the tactical resistance levels into 1.1665+ , but with the gauntlet of event risks through next Friday that we note above, the bulls will need to prove that this move can stick, and a weak close today south of perhaps 1.1625 would leave us in limbo or even looking tactically lower heading into next week. A 1.1700+ hold after the FOMC next week would certainly help offer up more confirmation that yesterday’s move meant something.
EURCHF, a traditional risk barometer, is an odd one out as the market aggressively reprices central banks to hike rates and risk appetite has been strong until late yesterday, at least. Note that USDCHF slipped below its 200-day moving average yesterday and that the EURCHF pair is now working down into the last bits of its range ahead of the cycle low near 1.0500, where the defense against further CHF strengthening is likely to stiffen significantly from the SNB. Such a persistent move lower suggests either some loss of faith in the real rate outlook for the EU relative to Switzerland (more fiscal coming from Germany post-coalition announcement together with yield-suppressing ECB...) or some safe haven seeking under the radar.
Table: FX Board of G10 and CNH trend evolution and strength
The biggest momentum shifts over the last few days are in the European currencies EUR, CHF and SEK against the rest of the G-10. Next week looks pivotal for whether the USD bears can take full charge or if the currency can take a stand in the wake of key data and the FOMC meeting Wednesday after taking a look over the brink into today’s session.
Table: FX Board Trend Scoreboard for individual pairs
In the individual pairs, EURUSD is trying to flip into an up-trend here, but note the caveats above. Elsewhere, the AUDNZD flip higher is also interesting this week after the moves in Australian rates noted above, and next Tuesday’s RBA is a key test of that development.
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