FX Trading focus: CHF and JPY rise to the top on risk aversion. ECB and BoE weigh
The attempt to put a happy face on the Fed’s hawkish turn at this week’s FOMC meeting fizzled badly yesterday, as safe haven seeking set in across the board, ironically also including a powerful rally in US treasuries at all points on the curve, such that the market pricing of the Fed policy rate for late next year is now below where the Fed itself is forecasting it will be. As noted in this morning’s Saxo Market Call podcast, if we look a bit further forward into 2024, the Fed expected yield is at one-month lows (there is a risk premium that can go in either direction, of course, but the current pricing suggests that the market is leaning more on the risk that the Fed will fail to get anywhere near the “terminal” policy rate it has forecast that it will reach in the coming few years – perhaps because the market thinks that the halt of Fed balance sheet expansion and a few hikes will trigger a massive market deleveraging that will feedback into the real economy/inflation and therefore into the Fed’s rate decisions….).
I suspect that where the market has priced the Fed and the Fed’s own forecast are very likely to prove completely wrong: the market is pricing a lower-amplitude version of the delayed, but eventually smooth lift-off that we saw in the 2016-18 period, (which itself was a low amplitude version of the more straightforward, grinding 2004-06 tightening period). Either we’ll see the Fed stumble after a couple of rate moves and the need to start signaling support for the market because the market is so sensitive to tightening that it collapses, or we get second round inflationary effects that require the Fed to move far beyond anything it or the market ever conceived was likely. The luxury the Fed doesn’t have this time around is to ignore inflation, which would have to fall back considerably for any Fed easing scenario unless asset markets were in some sort of systemic risk-off event/crash.
On that note, yesterday’s market action looked rather ominous on a technical basis, with the broad risk off supporting CHF and JPY the most (EURCHF looks ready to test the SNB’s mettle again soon), while the euro got a slight lift from the ECB (more below) and the USD did manage to mount a comeback late yesterday against especially the riskier currencies. If this mood continues and yields continue to drop, I would expect USD strength to nudge higher, especially versus EM and the smaller currencies, if not necessarily versus the yen.
Chart: AUDJPY
How quickly the mood can shift! Yesterday we were pondering the potential for an upside break in AUDUSD, one that was reversed, and today we look at the even more profound reversal in AUDJPY, as the JPY came back even stronger than the US dollar since late yesterday as safe haven seeking took safe haven US treasury yields lower all along the curve. Structural bears in AUDJPY were looking for a reversal pattern like this after the sharp rally off the lows and after the massive head-like rally and reversal from sub-80 to 86 and then back again. Note the rally failure yesterday coming ahead of the 200-day moving average. Bears will trade with yesterday’s highs as the risk point for a continued sell-of back at least toward the sub-79.00 pivot lows from earlier this month (which would likely coincide with more risk aversion and lower safe haven yields).