Equities: New extremes and a challenging opportunity set
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Head of FX Strategy
Summary: The market caught in a vicious whiplash yesterday by a dovish interpretation of the FOMC statement that was then followed by a Powell presser that delivered a hawkish blow as the Fed Chair managed to both indicate that coming hikes may pivot to a slower pace, but that the ultimate peak in Fed rates could prove higher, with the idea that the Fed is thinking about or talking about pausing rate hikes deemed “very premature”.
FX Trading focus: Powell manages to pull off a hawkish pivot.
The market reaction yesterday over the FOMC meeting was a whiplash-inducing one-two as the dovish interpretation of the new policy statement was brutally reversed by a hawkish Powell presser. The key new text inserted into the new FOMC statement that allowed some room for a dovish interpretation was the phrase: “The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time. In determining the pace of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”
The market’s first read was dovish on the assumption that this means the anticipated downshift in Fed rate hikes is well on its way – and this phrase was a likely tip-off for a mere 50 bps increase at the December FOMC meeting. US yields dropped, risk sentiment rushed higher, and the USD sold off.
In the press conference, however, Fed Chair Powell was unabashedly hawkish, saying there is a “ways to go”, and spelling out that the incoming data means that the “ultimate level” that the Fed funds reaches is likely to move to higher levels than was though at the September meeting (yes, the projection then was 4.6%, below current projections, but the implication was above current market projections). This had Fed expectations for the spring of next year edging back toward the cycle highs of 5.00% and then closing the day a full 10 basis points higher near 5.10% and trading higher still this morning.
While Powell did say it may be possible that the Fed steps down to smaller hikes as soon as the December meeting, he felt that the speed of hikes Is becoming “less important” (leaving the market to infer that the Fed just keeps hiking at more meetings if incoming data supports doing so and that we could reach well beyond 5.00%). As well, we must remember that the Fed has cranked up the pace of quantitative tightening in the background, which provides its own tightening pressure on markets and arguably equates with several hundred basis points of rate tightening over the course of a year.
All in all, the meeting firmly puts the USD bulls back in business, with only ugly data misses able to reign in the potential for the greenback to trade to new cycle highs against most other, if not all, of the other G-10 currencies. The next currency to get a test is sterling over today’s Bank of England meeting as discussed below. Norges bank only hiked 25 basis points this morning, with NOK somehow only getting an ugly sell-off and not a thorough thrashing.
A very interesting test today for sterling over the Bank of England, which must preserve a hawkish tone despite signs of a weakening economy, one that will be made that much weaker by the fiscal austerity Sunak and Hunt are cooking up for the budget statement on November 16, otherwise, sterling risks an ugly melt-down again versus the US dollar that will aggravate inflation risks on a flailing currency. I wonder how long Governor Bailey will be able to maintain his position as Governor if he messes things up today by indicating caution on rate hikes beyond today’s (presumed) 75 basis point hike because of the risk of an incoming recession. An insufficiently hawkish message could see 1.1000 in GBPUSD trading in a heart-beat. The October UK Services PMI was revised higher to 48.8 vs. 47.5 originally. The US ISM Services survey later today is expected to drop to 55.3 from 56.7 in September, by contrast.
Table: FX Board of G10 and CNH trend evolution and strength.
The USD is coming roaring back here and will set the tone. Watching JPY as yields rise – the intervention will arrive again at some point – but not until new highs in USDJPY? NOK could be in for some further punishment after the small hike today and watching relative strength in sterling over the Bank of England today.
Table: FX Board Trend Scoreboard for individual pairs.
Fed Chair Powell has spoken and the USD has asserted a new up-trend, with many USD pairs showing a flip to USD-positive trend today – only sudden negative US data surprises are likely to change that development. Watching GBP pairs after today and a small sub-plot is the risk of NOKSEK tilting into a new negative trend after this Norges Bank meeting today, with EURNOK also risking a flip to a positive trend due to weak risk sentiment.
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