The models are broken
The market is trying to get back to the pre-Covid and pre-war times, but that model is broken. A new dawn is here and the financial world needs to adapt.
Chief Investment Officer
Head of FX Strategy
Summary: Market anticipation around the FOMC meeting later today is fairly muted as the policy outlook for the immediate future is rather flat. Still, how Powell treats questions around how the Fed sees the growth of its balance sheet from here could move markets, which are only where they are due to the Fed bringing back the policy punchbowl this year.
Yesterday saw a fresh round of churning on stories linked to the prospects of a US-China trade deal, first on stories quoting anonymous sources that indicated the US is prepared to delay the December 15 tariffs as long as phase one negotiations are ongoing and then a later statement from White House officials denying any plans to take the December 15 tariff hikes off the table. Clearly, we’re all subject to the whims of President Trump, who might do something like waiting until the weekend to announce that a phase one trade deal is done and that tariffs will be reduced and the December 15 tariffs delayed for a year depending on how Chinese purchases of US goods proceeds and the fate of “phase two” negotiations. The implicit hope being that this punts the trade issue beyond the 2020 election and keeps the issue from impacting the outlook for equities, which close out the year on a high note. This is just a random guess and we could also see the entire process breaking down if the Chinese side is not satisfied with the terms of the deal or Trump is likewise not satisfied.
Speaking of closing out the year, the very influential and credible Zoltan Pozsar, an analyst with Credit Suisse and instrumental in helping the Fed to navigate the financial crisis back in 2008-09, was out with a long piece suggesting that the Fed is still far from getting ahead of USD liquidity problems into year end and it will have to do “real QE” (purchasing longer term treasuries in addition to T-bills) to avoid a market meltdown and melt-up in yields into year end. This is a bold call – especially given the compressed time frame. Cue this evening’s FOMC meeting and Powell press conference. The Pozsar piece got such extensive coverage that we could even see questions directly linked to this piece in the Q&A. In any case, Powell’s observations on its balance sheet plans are likely to carry more weight than dot plot adjustments or anything in the statement.
The quarterly Norway Regions Survey out yesterday saw a sharp deterioration in the measure of the 6-month forward outlook, which dropped to an 11 quarter low of 0.96 vs. 1.23 expected and 1.35 in the prior quarter. This is one of the sharpest drops in several years.
We have an interesting test of the Riksbank’s apparent determination to hike rates to 0.00% as Sweden’s parlous activity surveys and weak growth in Europe and globally are at odds with tightening. Today’s CPI brought SEK a bit of a further boost and EURSEK is working down through the 10.50 area, possibly opening up for 10.25-20 if the backdrop is friendly (risk appetite stable, positive US-China trade outcome etc..)
The G-10 rundown
USD – the US dollar inert ahead of the FOMC as we await Fed spin on its policy outlook – more on the balance sheet observations and from the Powell Q&A (questions linked to Pozsar observations could prove particularly interesting) rather than any shifts in the dot plot outlook.
EUR – EURUSD trading right at the mid-line of the last two months of price action and trying to find a pulse over the FOMC and ECB meetings today and tomorrow after recent record lows in shorter- and longer term options implied volatility.
JPY – the recent bearish reversal in USDJPY not getting any support from higher bond yields and strong equity markets – but still impressed that we are trading below 109.00 despite the strong US jobs report Friday. Ten-year JGB’s trading above 0% are part of that story.
GBP – sterling sharply weaker on one of the more influential polls suggesting a tightening of the race and the chief question here is the immediate size of the relief rally in GBP if the consensus outcome of a . I would suggest around 1.3500 in GBPUSD and perhaps 0.8250 in EURGBP, but this could prove too cautious – as indicated in the piece I put out on the election yesterday, my main idea is that there are many uncertainties for the longer run once we get past the election and formal Brexit hurdles.
CHF – curious strength in the franc given action elsewhere, but not worth comment unless EURCHF is pressing below 1.0850, where SNB likely leaning against further strength.
AUD – a weak NAB survey yesterday and a fresh drop in Australia’s consumer confidence in December after the big bounce in November are not good news here, though iron ore prices (Australia’s largest exports) are buoyant.
CAD – the weakness from the Friday November jobs report fading slowly and awaiting any catalyst on the USD outlook from the FOMC tonight.
NZD – the long slide in AUDNZD finally checked slightly overnight on no apparent catalyst. The NZDUSD rally has faltered around the key 61.8% retracement of the prior sell-off.
SEK - solidly bid as we discuss above as this morning’s Swedish CPI boosts expectations that the Riksbank may carry out the rate hike next week rather than waiting until February. Regardless if markets stay away from any fresh meltdown into year-end on USD liquidity issues or trade deal concerns, the next major objective lower for EURSEK is 10.20-25 if a break below 10.50 is sustained.
NOK – if NOK manages to overcome this latest setback versus the euro after this weak Regions Survey with a solid sell-off back below 10.10 in EURNOK we have a decent signal that the market has front-run the end-of-year seasonality issue, otherwise, we don’t really know where NOK stands until the first weeks of the New Year.
Today’s Economic Calendar Highlights (all times GMT)
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