Global Head of Macro Strategy
Summary: The FOMC brought even less than was expected, which was very little indeed. The USD weakened in reaction, but here we have a dovish ECB statement and strong US data lifting the greenback once again. USDJPY downside protection in options is the most heavily bid since March as traders ponder a Bank of Japan policy move tomorrow, but volatility risk remains two way for USDJPY as the BoJ decision is likely a binary one to either tweak or do nothing.
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The ECB hiked rates as expected and kept a data-dependent message on the odds for a September meeting additional hike. This was no major surprise as several ECB officials have been out and pulling away from pre-committing to any further tightening. The news this week that Q2 bank lending was cratering at a record rate is sending chills up and down the bank’s spine, and we have to remember that the Eurozone is a a more banking-intensive economy. Also, unlike the US, there was less of a cash splash to boost personal income and savings during the pandemic and less of a refinancing boom that keeps so many in the US still operating at record low interest rates from pandemic era loans. Unlike the previous statement, this new statement from the ECB highlights that its policy moves are feeding through: “financing conditions have tightened again and are increasingly dampening demand, which is an important factor in bringing inflation back to target.” This may prove the last rate hike for the cycle, but at minimum should mean the euro’s days as a broadly strong performer are over. It is a bit surprising that the market found the decision as surprising as it did (although some of that was the USD move weaker in the wake of the FOMC meeting that was simply backed out), but now we watch whether the damage to the euro widens out to both EURUSD and EURJPY (the latter on the Bank of Japan risks as noted below). For EURUSD, a close below 1.1000 for the week suggests the highs are in for now.
Just after the ECB meeting, we see strong US data (lowest weekly jobless claims number since February and strong GDP print, although that was on a very low GDP price rnumber of 2.2% annualized vs. 3.0% expected and 4.1% in Q1) complicating the market’s reaction to the FOMC meeting. The FOMC meeting itself was a non-event with an unchanged statement on balance and Fed Chair Powell determined not to say anything except that the Fed remains data dependent. The equity market can hear no evil, however, as stocks continue to soar – that looks a bit out of place in treasury yields heat up again on the incoming data.
The Bank of Japan could yet have influence on the direction in the US dollar if there is a strong reaction off the back of the Bank of Japan meeting tonight, but taking EURUSD by itself, the key here is the 1.1000 area that bears need to retake into early next week to suggest that a top is in for now.
As few have a clue what the Bank of Japan is set to deliver at its meeting tomorrow, it should have the most potential to surprise and trigger a sharp directional move, especially if the Bank of Japan moves forward with a policy tweak and provides guidance for more to come. But even the expression of a likely incoming tweak once a new round of projections is available for the October meeting could do much of the same as the market will see it as pre-committing to a course of action. I see this as unlikely – either the Bank of Japan tweaks or keeps its mouth shut on its intentions and suggests all is unchanged for now as it considers its options and conducts its policy review.
In the meantime, option market implied volatility has blown out considerably in recent days and suggests the greatest anticipation (or at least greatest hedging activity) since the March meeting (Kuroda’s last) that something may be afoot at this meeting. The 1-week USDJPY implied volatility has risen to nearly 18% and one-day risk reversals are extremely bid for downside protection in USDJPY – nearly a 10% premium for puts, perceived for good reason as the side offering the most volatility potential. Arguably, JPY weakness is still a risk if the Bank of Japan delivers nothing at all, especially as all of this option buying will see the unwinding of hedges if nothing happens tonight.
Two way risks for the JPY noted above. The USD bear market is seeing another challenge here as the USD backs up – we should know more depending on whether EURUSD capitulates through the next important area into 1.1000 and whether USDJPY punches back higher (presumably because the BoJ chooses the “do nothing” path once again.
Several USD pairs in play through the end of this week and into next. GBPUSD looks heavy for new down-trend risks if the 1.2800 area fails, AUDUSD trend status is in limbo, etc.
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