USD kneejerk to very dovish Fed underwhelms

Forex 5 minutes to read

John Hardy

Head of FX Strategy

Summary:  The Fed exceeded dovish expectations on nearly all fronts in providing a schedule for a halt to its balance sheet reductions by October 1, and in lowering economic growth and policy forecasts. And yet the reaction in markets underwhelms – likely due to concern for the reasons behind the Fed’s very cautious stance.


We suggested in our preview of the Federal Open Market Committee meeting that the bar was rather high for a dovish surprise from the Fed, given how extensively the market had pre-priced Fed guidance and celebrated the anticipated easier stance with a strong surge in risk appetite.

But the Fed surprise many – and certainly us – by more than delivering yesterday with a dovish broadside. The accompanying materials chopped the forecasts for this year and next for both GDP and headline inflation and raised the forecasts for unemployment and lowered the rate forecast guidance for this year all the way to the market’s pricing of no further hikes in 2019.

The 2020 forecast was for a single additional hike. On QT, the Fed announced a QT tapering plan that is set to halve sales of treasuries beginning in May from $30 billion per month to $15 billion and will stop selling treasuries altogether after September. Its $20 billion of MBS sales will continue until they are all gone and after September 30, MBS sales up to going $20 billion rate will be replaced with treasuries, i.e., the Fed will entirely stop reducing its balance sheet at the end of September. 

Now on to the market reaction: the USD fell, if not particularly impressively, but the more notable developments were the lack of more enthusiasm in equity markets and a powerful surge in US treasuries. The entire US yield curve was smashed lower – by about seven basis points for the two-year and more or less the same out to 30-years. This combination of weak stocks and strong bonds, especially if it deepens, offers the most support for the yen, although other measures of risk appetite – like the strength in EM currencies on the weaker USD – temper some of that enthusiasm for JPY upside.

Elsewhere, we are finally hitting full force crunch time for Brexit. Prime Minister May will try to put her plan to a third vote next week. The Brussels stance is that it will only offer a short delay if May’s deal passes a vote – and likely a delay that only would extend to the cusp of the late May EU Parliamentary Elections rather than to May’s preferred June 30 date. A failure of May’s deal brings the nail-biting scenario of last-second negotiations and either a No Deal exit or a very long delay. These are less sterling positive options – the former brutally so and the latter only extending the uncertainty over the horizon.

Trading interest

EURJPY downside and AUDJPY downside as ways to trade away from the US dollar on further global consolidation in risk appetite. Stops above 126.50 in EURJPY and above 
We’re sitting on our hands on the USD – not entirely sure a sell-off persists if risk appetite doesn’t pick back up and will be ready to pounce on short AUDUSD or long USDCAD positions if the FOMC reaction is fully unwound
Long half a position of NOK (via short EURNOK) going into Norges Bank meeting.  

Chart: EURJPY

Why talk about EURJPY on the day after an FOMC meeting? Our lack of enthusiasm for jumping in on USD selling here is down to the early January experience, which saw the first dovish Fed pivot and yet entirely failed to sustain USD selling for more than a couple of days.

Rather, the USD may sail through all of this without significant damage if investors begin to consider the implications of the source of the Fed’s unease: the risk of a slowing economy and even a recession. If so, yields will continue to fall and risk appetite could come under more pressure, tending to favour the JPY. Alas, we have had a head fake here in EURJPY on the prior sell-off wave, but still like it lower if the market stops celebrating the policy punchbowl and instead considers the risk that policymakers are still way behind the curve.
Source: Saxo Bank
The G10 rundown, express edition

USD – an impressively dovish turn from the Fed and makes sense to see the USD knee-jerk lower – but the magnitude of the move underwhelms – trainwreck ahead if we get immediate reversal already today – for the moment, we’ll sit on our hands.

EUR – EURUSD struggling to maintain 1.1400 after a profound dovish turn from the Fed – not impressed – but would have to see a full reversal and close below 1.1350 today for sense that the USD is going to reject yesterday’s reaction.

JPY – if global markets decide they have over-celebrated the policy punchbowl having been rushed back to the party, the JPY stands to benefit the most.

GBP – as per above, if May’s deal fails, then longer delay more likely than No Deal in last minute disaster avoidance – and this not necessarily GBP positive?

CHF – would expect directional sympathy with JPY in the crosses.

AUD – market celebrates headline jobs figures and dovish Fed, but caution – the Australian central bank is going to ease and risk off would do the AUD no favours. Contrarian on AUD strength.

CAD – hardly impressive reaction to the Fed – if US economy is weak and the Fed cutting, the Bank of Canada will be doing the same and perhaps greater risks to the Canadian economy from private debt levels.

NZD – kiwi stretches higher still on a solid Q4 GDP print. Getting increasingly contrarian on NZDUSD from here, but need a technical setup to generate trading interest.

SEK – approaching pivotal zone in EURSEK if we dip below 10.40 – hard to get enthusiastic for a significant run lower if EU data fails to pick up. Interesting test with tomorrow’s flash March EU PMIs

NOK – productive on NOK, but Norges Bank will need to deliver on guidance and upside may prove a bit curtailed if global growth outlook concerns rise from here.

Upcoming Economic Calendar Highlights (all times GMT)

0900 – Norway Norges Bank Rate Announcement
0930 – Norway Norges Bank Press Conference
0930 – UK Feb. Retail Sales
1200 – UK Bank of England Meeting 
1230 – US Philadelphia Fed Survey
1230 – US Weekly Initial Jobless Claims
1430 – US Weekly Natural Gas Storage
2200 – Australia Mar. Flash PMI’s
 
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