Head of FX Strategy
Summary: Fed Chair Jay Powell in the hot seat this week as this week’s Federal Open Market Committee meeting arrives with almost unprecedented pressure on the Fed to “send the right message” and signal a path to an aggressive easing cycle. Is the Fed there yet?
We’ll run through some scenarios on what the Fed may do Wednesday and how the market might react – but for now, suffice it say that this week’s FOMC meeting is one of the most anticipated in recent memory and almost can’t avoid sparking significant volatility, possible in either direction, or both directions, for that matter (i.e., a kneejerk reaction that is quickly faded). Traders should recognise this and reduce leverage accordingly and consider ways to trade outcomes via long volatility trades or have protective hedges in place.
For now, a couple of past examples of how past Fed “first rate cuts for the cycle” played out are worth considering for perspective on how this can play out:
September 18, 2007: The market was increasingly uneasy about the US housing market and had already suffered an ugly >10% correction over the summer. The market was clearly expecting the first cut for the cycle heading into the scheduled FOMC meeting in September, but only a minority were looking for a 50 basis point cut, and Fed Chairman Bernanke over-delivered. The equity market was duly impressed and managed to rally for around a month and even posted an all-time high before rolling over into the most vicious bear market since the Great Depression. The Fed was extremely behind the curve.
January 3, 2001: US short rates were collapsing as the market priced incoming rate cuts from the Greenspan Fed. The economy was clearly hitting the wall and tech stocks had collapsed into the end of the 2000 (the Nasdaq 100 index was off more than 50% from its early 2000 peak heading into 2001.) Fed Chairman Greenspan didn’t wait for the regularly scheduled meeting for the end of January and slashed rates 50 basis points in a completely unanticipated move on January 3. Equity market bears found themselves ensnared in an epic one-day squeeze that saw the Nasdaq 100 close 18% higher from the previous day on January 4. Tech stocks and the broader market managed to piece together a rally for a few weeks, but were already beginning to roll over in early February despite Greenspan adding another 50 basis points of easing at the end-January FOMC meeting. The bear market was in full swing and the Fed was behind the curve.
The US dollar was in a very different spot in these two historical situations – very strong in 2001 and very weak in 2007. In the earlier case, the US dollar was marginally weaker heading into 2001 after a strong 2000, but firmed again and headed to new cycle highs even as Greenspan launched his aggressive cutting regime, only bottoming out “for good” in 2002 – as it remained a safe haven until it was clear that the bear market bottom was in the rear view mirror. In late 2007 and into mid-2008, the USD continued to weaken on the weight of Fed easing and the thinking that the source of weakness was mostly limited to the US housing market and US banks. But once the global contagion was clear, the USD went vertical – somewhat like the 2001-2003 cycle in that it only turned around the time the equity market bottomed out in March of 2009.
Chart: NZDUSD – weekly
An interesting setup for NZDUSD this week as after the potential FOMC earthquake on Wednesday, New Zealand reports its Q1 GDP number a few hours later. Note last week’s sell-off bar entirely engulfing the previous week’s rally of consolidation and also note that we have now worked down the final layers of support stretching back over the last five years.
USD- enough said above – again, the main point here is that the US dollar remains strong despite the significant easing priced. Can or will the Fed get ahead of the curve?
EUR – watch out for European Central Bank president Draghi speaking at the ECB forum in Sintra late today to see if he challenges the notion that the ECB has an exhausted policy mandate and lack of further tools.
JPY – the yen passively tracking long US yields and will likely continue to do so unless the Bank of Japan chooses it’s Thursday meeting to make a new policy point.
GBP – EURGBP poking around at the cycle highs as Tory leadership candidates debated scenarios forcing a hard Brexit while runaway leading candidate Boris Johnson sat out the debate. The next vote takes place tomorrow and over the following days. See our piece from Friday on longer-term trades for sterling as the shape of Brexit is likely to crystallize from the fog in coming months.
CHF – EURCHF trading at the significant 1.1200 area and risks slipping to 1.10 if the market doesn’t find encouragement for risky assets this week, after the Swiss National Bank did little in rhetorical defense against CHF strengthening at last week’s SNB meeting.
AUD – AUDUSD is running out of range and is close to the lowest non-flash crash lows from early 2016 – awaiting the USD response to the FOMC meeting this week.
CAD – USDCAD has done an about face after a period of CAD overachieving and now trades precisely in the middle of the three-month range ahead of the FOMC this week.
NZD – trading heavily and any risk-negative reaction post FOMC and weak Q1 GDP print from New Zealand could see new lows for the cycle in NZDUSD in a hurry.
SEK – SEK firmed on the CPI beat last week, but needs to work through 10.60 in EURSEK to make an impression. Beginning to question the traditional correlation SEK has with risk appetite – more later.
NOK – the price action has gone dead in EURNOK – awaiting Norges Bank guidance after this week’s expected rate hike (yes, hike).
Upcoming Economic Calendar Highlights (all times GMT)
1230 - US Jun. Empire Manufacturing
1400 - US Jun. NAHB Housing Market Index
1700 - ECB’s Draghi to speak in Sintra at ECB Forum
2100 - New Zealand Q2 Consumer Confidence
0130 - Australia Q1 House Price Index
0130 - Australia RBA Minutes