FX Update: FOMC will have a hard time pulling a Goldilocks.
Head of FX Strategy
Summary: The Fed has a difficult task at this meeting if it wants to avoid both upsetting the markets with more hawkish guidance and a new speculative rush if it totally fails to adjust its policy guidance and economic forecasts. In that regard, the Fed may not be able to avoid a surprise in the one or the other direction, but if it somehow does avoid a surprise, we may be in for a long wait for volatility to pick up again.
FX Trading focus: Fed will have a hard time pulling a Goldilocks
My update from Monday offers a more thorough preview of tonight’s FOMC meeting, with today’s just offering a bit more spin and bias on what may happen this evening. The Fed is facing the very difficult, if not impossible, task of both:
1) reassuring the market that it is not completely ignoring the recent run-up in inflation even if it continues to believe that the inflation spike will prove transitory
2) at the same time, avoiding spooking the market by signaling excessive urgency on talking up a tapering of asset purchases or bringing forward rate hike forecasts or new strong signals in the economic data forecasts.
What does the Goldilocks scenario look like? Not easy to tell in a market that is simply not moving, but perhaps something like a tease of a taper talk shaping up for future meetings (vaguely leading market to believe something concrete is set for September FOMC, i.e., also post-Jackson Hole) while hinting somewhere that the MBS purchases will be the first to go (no brainer given US housing market on fire). Maybe the median forecast in the “dot plot” drifts into 2023 without a sufficiently large majority for the market for this to look dramatic. Finally, the most intense focus besides any notable policy statement changes (mostly absent in recent meetings) will be on the core PCE forecasts after these reached multi-decade highs over the last couple of months. There, changes to the 2022 and 2023 forecasts will be the most important (in March set at 2.0% and 2.1%) than any one-off rise in the 2021 forecast. A Goldilocks forecast? Pass…maybe a bump of 0.2% to the 2022 forecast and 0.1% to the 2023 forecast?
An added focus for many is whether the Fed will look to actually hike rates on the interest on excess reserves by five basis points, but this doesn’t look to have market implications as it is a technical measure aimed at addressing extraordinary pressure on the rates at the shortest end of the curve due to the excess US liquidity from stimulus check and the US treasury drawing down its general account at the Fed (the latter process to be complete within six weeks, if the Treasury makes good on its declared August 1 deadline).
In the Q&A, the most interesting questions may drill into whether the Fed is concerned that the efficacy of its tools is lacking amidst the recent signs that there are plenty of job openings, but not enough pay on offer to motivate workers to take a position or a mismatch/insufficiency in job skills.
My lean going into this FOMC meeting: the Fed will have to up its credibility on the risk of bringing forward tightening relative to how the market is currently pricing things, possibly resulting in a jump in US treasury yields, the US dollar and a sell-off in risk-correlated and commodity-correlated FX, especially EM. If the Fed errs completely in the opposite direction by totally sticking to its previous dovish guns, we’ll get the opposite, on, as Paul Tudor Jones expressed here in a CNBC interview, the interpretation that the Fed has gone “bat-ass crazy”. I don’t think the Fed achieves Goldilocks, but visibility in outcomes is not riding high after this long period of extreme quiet and the prospects for USD liquidity to remain extremely high through the end of next month.
Chart: AUDUSD and the last best chance for something to happen this summer
AUDUSD has been at the center of the frustration for both USD traders looking for direction and those expecting that a commodity boom will help the likes of a very commodity-linked currency like the Aussie to rally significantly. Unfortunately for AUD bulls, while key prices for Australia’s commodity export mix have rallied significantly since the beginning of the year despite recent weakness, nothing interesting is going on with relative policy expectations for the US vs. Australia, as the two-year rate spread, for example, is almost exactly in the middle of the range established starting over a year ago (!). As well, China has been moving against commodity speculation recently and against specific Australian products in a diplomatic spat with Australia due to the latter’s stance on a number of sensitive issues. This FOMC meeting tonight might be the last best chance to see the pair moving out of the impossibly tight range until at least August.
Upcoming Economic Calendar Highlights (all times GMT)
- 1230 – US May Housing Starts and Building Permits
- 1230 – Canada May CPI
- 1800 – US FOMC Meeting
- 1830 – US Fed Chair Powell press conference
- 2130 – Brazil Selic Rate announcement
- 2230 – Canada Bank of Canada Governor Macklem before Senate committee
- 2245 – New Zealand Q1 GDP
- 0010 – Australia RBA’s Lowe to speak
- 0130 – Australia May Employment Change