Head of FX Strategy
Summary: The FOMC meeting sparked a sell-the-fact reaction in equities to the well-flagged dovish Fed shift to an Average Inflation Targeting regime and a choppy reaction in the US dollar after an initial rally. Elsewhere, the Japanese yen has rallied consistently and broadly and has taken USDJPY south of the big 105 for the sixth time since early 2018. Will it finally hold lower?
Trading focus:
Post-FOMC, sorting through JPY strength and whether USD is also strong or merely choppy
The huge 105.00 level in USDJPY – challenged on five prior occasions without really falling for more than a session or two since early 2018, has fallen once again this morning as the USD reaction to FOMC has waxed hot then cold.
The JPY resurgence in evidence yesterday already before the FOMC meeting accelerated as USDJPY took a look below 105, although the move yesterday and overnight was more impressive in other JPY crosses, including the classic risk barometer AUDJPY and EURJPY, where we saw a break below the big 124.50 area. This morning, the move has petered out a bit in a broad sense as the US dollar chops all over the place, confusing the initial USD rally that unfolded late yesterday and overnight as risk sentiment headed south. There was nothing in the FOMC to specifically trigger a market temper tantrum as the sell-off may be a recognition that the Fed’s new policy shift is largely irrelevant here. More concerning is the slowing US Retail Sales data in August on top of a downward revision for July and the ongoing lack of new stimulus, although it looks like Trump is ready to cut a deal with the opposition to get the money flowing into the hands of voters before the election.
As for the FOMC meeting itself, there was nothing on the table that was not already flagged with the Fed’s new “flexible” average inflation targeting regime. It is nominally dovish, but is really only interesting down the road in the event if inflation picks up and the Fed’s resolve and reactivity to data is only tested once inflation starts to shoot north of the 2.0% level for the PCE core, something that only happened in briefly clusters of a few months in early 2012 and for several months in 2018, both times clearly a lagged result of a surge in oil prices and a related decline in the greenback’s fortunes. Inevitably, the Fed will trip over this forward guidance whether a) because inflation fails to materialize and isn’t really within their ability to create in the first place as that power only resides with bank credit creation and fiscal stimulus or b) inflation starts to rise uncomfortably above 2.0% even as employment fails to improve to pre-COVID-19 level. Basically, the AIT regime is the medicine for the past cycle – when in retrospect the Fed feels it could have hiked at a far slower trajectory without creating uncomfortably high inflation. The future cycle may not look so similar. What is the Fed policy rate in a world of 3% inflation, 0% real GDP growth and perhaps a 6% unemployment rate?
Chart: USDJPY weekly
USDJPY has slipped below 105.00 now for the sixth time since early 2018. The pair has only closed below that level on a daily basis a very few times in prior episodes – even including during the COVID-19 panic back in March when intraday price action saw the pair trading nearly to 101 before rebounding sharply. The ability for the JPY to linger at these higher levels could point to a move to the next major support area into 100.00. The Bank of Japan met last night with few headlines and no change of policy as Governor Kuroda pledged to work with new Japanese Prime Minister Suga.
The G-10 rundown
USD – status please? We have seen some confusing price action since late yesterday, when the USD rallied in its oft-played role as the flipside of risk appetite, but the status of that move was thrown into doubt in early European hours. Watching the weekly close as well as the relative strength of the greenback versus the JPY for a sense of direction.
EUR – EURUSD went over the edge below 1.1750 overnight only to snap back above 1.1800 in the European morning, a chop-fest making life miserable for traders. That 1.1750-1.1700 zone is critical for whether we finally get a consolidation to the more notable trend support toward 1.1500.
JPY – the JPY playing catchup with other USD pairs as USDJPY sniffs out the territory below 105.00 – a level the pair has not closed below on a weekly close since early 2018 (and even then it was quickly rejected.)
GBP – Interesting test for sterling today over the BoE as it sifts through its policy options – a lean for more QE sooner rather than later might not prove so damaging, but talking up negative rates policy potential is a different matter. Meanwhile, the course of the Brexit Bill and then negotiations with the EU will prove the bigger key between now and mid-October. GBP has rallied to pivotal levels today in EURGBP (0.9100 area) and GBPUSD (1.3000).
CHF – the franc grinding slightly higher on safe haven seeking and in sympathy with the JPY, and now EURCHF is having a look at its range lows since late July ahead of 1.0700.
AUD – a surprising resilience here – yes the jobs data was positive, but was heavily affected by self-employment gains and part-time work. Meanwhile a bit surprising to see the Aussie so readily bouncing back despite very weak iron ore prices over the last few sessions and cratering risk sentiment. 0.7225-0.7200 the key trigger area for taking AUDUSD out of choppy rising channel if the bears are to prevail.
CAD – our commodities strategist Ole Hansen concerned that oil comeback is challenged by fundamental situation, but USDCAD turned tail back lower after trying toward local resistance into 1.3250+. The 1.3300-50 zone critical for a larger CAD consolidation to the weak side.
SEK – risk sentiment improvement this morning in Europe is seeing EURSEK reject attempt at resistance thus far, but too soon to call an end to upside risks.
NOK – EURNOK caught between weak risk sentiment (NOK negative) and the strong two-day rally in oil (NOK positive).
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
