FX Update: Will market shrug off FOMC dot plot raise? FX Update: Will market shrug off FOMC dot plot raise? FX Update: Will market shrug off FOMC dot plot raise?

FX Update: Will market shrug off FOMC dot plot raise?

Forex
John Hardy

Head of FX Strategy

Summary:  The US dollar has teased support in places before firming a bit again this morning, as few are likely willing to take a strong directional view on the greenback until the other side of next week’s Tuesday November US CPI print and the FOMC meeting the following day. For the later, the interesting setup is that the Fed is likely to deliver a dot plot forecast for next year that is north of the market’s expectation. Next Thursday features four other G10 central bank meetings.


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FX Trading focus: How will the market treat a higher-than-priced dot plot forecast for next year?

As I have discussed recently, there has been an irony in the Fed’s hawkishness that has crept into the picture in recent weeks: the more the Fed convinces the market that it will do whatever it takes to tightening sufficiently to bring down inflation, the more the market takes the Fed at its word for the policy implications for the near future and assumes that the Fed will succeed. Inflation swaps are sub-2.50% all the way out the curve, and yields from two years and out are falling, especially at the longest end of the yield curve. This has powered a solid easing of financial conditions, which may ironically make the Fed’s task more difficult next year if the economy reheats quickly after a possible gentle landing. Significant Chinese stimulus after the winter is a big risk on that front. But it will take some months and really quarters of data to see how inflation is playing out.

More interesting for the immediate future is how the market is pricing Fed policy for the next eighteen months to two years and what the Fed will deliver in the way of the economic projections on the economy and the “dot plot” forecasts themselves next Wednesday, as well as whether the market maintains its own convictions on how the economy will shape up rather than relying on the Fed’s forecasts. The market is pricing that rates will peak just below 5.0%, most likely at the March or May FOMC meeting next year and that the Fed will have already initiated an easing cycle by year-end, with perhaps 50 basis points of cuts through the December 2023 FOMC meeting. A hefty pace of further cutting then is seen continuing in 2024. Of course, the forward market expectations for the Fed should be seen as more of a probability and hedging matrix rather than a forecast, but is does give a sense of where the market will be surprised. I expect, and I suspect the market expects, that the dot plot projections for next year will be north of 5%, while the market has shifted lower to just below 4.50% at present. The 2024 dot-plot projections are probably less important if they show the kind of dispersion from September, with a low of 2.62% (!) and high of 4.62% and median of 3.75%.

If the market can continue to believe that the Fed won’t even have to hike as much as it says it will next year and financial conditions stay complacent, the USD may continue lower here in the near term. Only incoming data that asserts the Fed hiking cycle is not over with soon and/or weak risk sentiment can offer the greenback support.

Chart: EURNOK
EURNOK is working up into the last shreds of its range since the brief and tremendous spike from the pandemic outbreak months of early 2020. The Norges Bank is seen hiking another 25 basis points next Thursday to take the deposit rate to 2.75% as it was the first to hike rates but the slowest in following through, and even suggests it will be ending its tightening cycle soon, with today’s undershoot of Norway CPI (5.7% core YoY vs. 6.0% expected) helping encourage that notion. Will Norges Bank suggest that it is pausing already after this coming meeting or leave a “final” 25-bp move up in the air for the first meeting next year on January 19? The weak outlook for Europe and plunging oil prices are obviously weighing here on NOK and the currency is getting rather cheap at these level unless we are set to lurch into a bout of more profound market stress/risk aversion. Still, we must also consider that the ECB is set to hike rates another 50 basis points next Thursday and that the yield differentials between Europe and Norway have rarely been as tight as they are at their present levels – for example, a 5-year Norwegian sovereign bond now yields only slightly more than 100 basis points more than a German 5-year. That yield gap will have a hard time converging much more, with any further EURNOK upside more likely driven by general doom, gloom and weak oil prices rather than the relative yield outlook from here.

Source: Saxo Group

Table: FX Board of G10 and CNH trend evolution and strength.
The Bank of Canada meeting this week entirely failed to elevate CAD from its funk as the Bank guided in its statement that further hiking is no certainty for coming meetings and the plunge in oil has also dragged on the currency, just as it has on NOK. The USD outlook to undergo an important test next week on the CPI Tuesday (huge volatility on last handful of releases) and the FOMC meeting the following day as discussed above.

Source: Bloomberg and Saxo Group

Table: FX Board Trend Scoreboard for individual pairs.
Finally, some two-way action in AUDNZD this week after the long slide. That pair becoming a value proposition for the year-forward if China comes on board with stimulus in the spring and/or on a significant breakout in copper, which is teasing resistance.

Source: Bloomberg and Saxo Group

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