Equities: New extremes and a challenging opportunity set
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Head of FX Strategy
Summary: The US dollar has weakened modestly in the wake of an FOMC meeting that delivered the hawkish shift that more or less perfectly matched expectations if we look at the reaction in interest rate markets. The equity market was more dramatic in reflexively buying-the-fact than either the bond market or the FX market, as we await the calendar roll into the New Year. Elsewhere, central bank meetings abound today, headlined by the ECB and Bank of England.
FX Trading focus: The US dollar sells the fact of the Fed’s hawkish shift.
Last night’s FOMC meeting was already in the price if we look at how forward Fed rate expectations last night and into this morning after the combination of the new monetary policy statement, the new economic and “dot plot” of Fed funds rate forecasts and the Fed Chair Powell press conference. (The market was indicating that somewhere between two and three rate hikes were likely for next year, the new Fed forecasts actually showed fairly clear consensus for three hikes, but this morning, the market is second guessing that forecast after front-running the Fed for many months on its rate hike timing.
The new FOMC monetary policy statement for December upgraded the language on the labor market, but still seemed to suggest maximum employment has yet to be reached, and inserted the specific risk of “new variants of the virus” as a possible risk.In the economic forecasts, while the 2022 PCE core inflation forecast was raised to 2.7% from 2.3%, it was only raised 0.1% to 2.2% for 2023 and kept steady at 2.1% for 2024. As an FT columnist argued, the Fed still thinks that inflation is transitory even if it isn’t saying it, suggesting that a modest rate hike cycle will tame inflation back to the target range within two years. To be fair, the market is even more invested in the transitory narrative, judging from the terminal rate for the coming cycle still priced below 2.0% (either that or the market is saying it sees nowhere to place significant amount of its liquidity safely other than in US treasuries and is happy to take the negative real rate beating for now – more on that later).
With the USD weaker here and risk sentiment buoyed, a “Santa rally” could mean a weak G3 and CHF versus stronger G10 smalls and maybe even a resilient GBP for now – awaiting how the market plays the ECB later. The next big event risk for the US dollar and US rates is the calendar roll into the New Year as I have emphasized in recent updates.
ECB and Bank of England Meetings today – these are happening around pixel time for this article, but not looking for any surprise today from either the ECB or BE. More is at stake for the ECB meeting due to the focus on the series of economic forecasts set for, which will strain credibility if the ECB does not raise inflation forecasts for next year at minimum to closer to 2.0% or even slightly above (currently at 1.9% for 2022 and 1.7% for 2023). In the meantime, the EU is beset by the latest wave of covid and an energy crisis that could trigger a minor recession if it extends for the balance of the winter, which makes it difficult for ECB to manage the need to signal what the it plans to dowith its QE programmeof asset purchases after the emergency PEPP facility runs out in March. We can expect more QE at a slightly different horizon – there is no such thing as stopping balance sheet expansion for the ECB.
For the Bank of England, the market is not expecting a hike at the meeting, but there is some residual uncertainty after prior missteps in communicating their guidance. The UK November CPIout yesterday was out higher than expected and could be a factor as the core reading rose to 4.0%, a modern era high, but covid cases just registered a massive spike to new all-time highs and there are concerns that omicron could mean more restrictions until more is known on whether the healthcare system will come under pressure.
Rip-roaring Australia jobs report. The November Australian jobs report was one for the ages, as Australian payrolls rose a record 366k vs. 200k expected, and the unemployment rate plummeted to 4.6%, close to a 13-year low, after a 5.2% reading in October, and this even as the participation rate jumped back toward cycle highs. Is Australia the next positive output gap country after the US? And the RBA is supposedly not set to consider reducing bond purchases until February? Under any normalized outlook scenario that includes a stimulating China and higher commodity prices, the Aussie could be set for a strong rebound next year.
AUDUSD has jumped higher since yesterday, a move that fits with the backdrop of a weaker US dollar as Fed rate expectations – especially further forward rate expectations – have actually dropped further since the FOMC meeting last night, and on the general rebound in some commodities and especially risk sentiment. A blowout Australian jobs report noted above has surprisingly not driven even more strength in the Aussie here – perhaps P&L budgets are a bit constrained into year end? In any case, watching next steps here for AUDUSD, where we have challenged above the local pivot at 0.7185. The next, more significant sign of a structural reversal would be a move above about 0.7350, which is just above the 61.8% retracement of the last major sell-off wave into the 0.7000 area lows.
Central bank meetings today
SNB - interesting to see the SNB’s Jordan touting allowing the CHF to strengthen as an inflation-lower tactic and yet EURCHF creeps higher on the day as the bank kept the language describing the CHF as “highly valued”. Virus worries were cited as a risk.
Norges Bank – the NOK rallying hard off the lows of this morning as the Norges Bank went ahead with its long-forecasted hike after all, despite mounting covid restrictions and cases. The future policy forecasts essentially unchanged as the bank flagged another hike in March. Steady as she goes – to get EURNOK back below 10.00 we need an improved EU outlook, stronger EUR and oil prices back higher.
Turkey – The Turkish central bank cut the policy rate another 100 basis points as expected as USDTRY had already traded up through 15.00 (up from below 7.5 in March!) ahead of the decision. It must soon be time for a saviour to appear in one form or another – there are too many external actors with deep pockets that don’t want a destabilized Turkey. So whether the next month sees USDTRY trading 20 or 12 or both I dare not guess.
Mexico – set to hike rates again tonight by another 25 bps to 5.25% as Mexico doing its best to keep real rates from negative territory – admirable relative to the Fed running a -600 bps real rate in November! Big reversal in USDMXN yesterday and now watching the 20.80 pivot area for whether the pair plows fully back into the old range down to 20.00 and lower.
Table: FX Board of G10 and CNH trend evolution and strength
Presented for general interest, with few takeaways today as we have a lot of churn on the charts here – especially for many USD pairs. Note the pickup in AUD momentum. I have to believe that the CNH underperforms broadly here after the recent signaling on the currency and as China shifts toward easing.
Table: FX Board Trend Scoreboard for individual pairs.
Noting the JPY crosses beginning to flip positive – but need to see this surviving into the New Year – still impressive that it is even happening with long yields pinned this low.
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