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Last thoughts ahead of FOMC

Forex 5 minutes to read
John J. Hardy

Chief Macro Strategist

Summary:  Trump will meet with Xi at G20, throwing a new twist in the plot just ahead of a pivotal Federal Open Market Committee meeting. Today we consider the most likely scenario and draw the conclusion that a lack of sufficient surprise could mean a “sell the fact” reaction.

Yesterday’s announcement from US President Trump that he would have an “extensive meeting” with China’s Xi Jinping sparked a flurry of market activity, punching the US dollar lower and throwing gasoline on an equity market rally that was earlier sparked by dovish comments from European Central Bank President Draghi.

Speaking at the ECB Forum in Sintra, Draghi let loose with a dovish broadside touting the bank's ability to continue cutting rates and noting plenty of headroom for QE if needed. EU rates markets took note and priced another seven basis points or so of easing by year-end, so that a 10 basis point cut is fully priced by then and some forecasts are shifting to an even lower policy rate than the implied -0.50%. The futility of it all is astounding, but Draghi perhaps figures that, with nothing to lose as he will be leaving the scene at the end of October anyway, he may as well shoot all of his remaining ammunition.

While Trump’s announcement that he will meet with Xi does bring a new angle to tonight’s FOMC meeting, it may not do much to alter the message the Fed will deliver tonight. My general stance ahead of tonight’s FOMC meeting is that the Fed will have a hard time bringing an overall dovish surprise relative to the market’s comprehensive forward rate expectation adjustment.

To divide that  up a bit, I suspect the Fed will more or less deliver what the market is expecting for the near term (indication of a tilt in favour of a July rate cut and adjustment to the statement to remove the  word “patient”). As for the pricing of the Fed’s rate schedule beyond July, the Fed may have a hard time delivering a message that offers clear evidence it expects to cut as much as the market now expects. Exhibit One in that regard will be the dot plot and Powell’s stance during the questioning. Another way the Fed could shift expectations, however, is to bring the US dollar into the discussion as an indicator the Fed is closely watching, given that the Fed’s own measure of the USD is near its highest level since 2002..

The USD reaction may prove clearest if the market draws the conclusion that it has over-baked its expectations for the Fed policy path from here, at least versus riskier currencies – that being said, confidence in the reaction function is low as the USD has generally maintained altitude well despite the drastic repricing. One of the few correlations that has held well has been the link between long US yields and USDJPY, as we discuss with the chart below. 

Chart: USDJPY

The market that has moved most aggressively ahead of the FOMC has been the US treasury market, with the entire curve shifting sharply lower over the past couple of months. USDJPY has reliably taken its cue from long US yields, so any “sell the fact” reaction in US treasuries (higher US yields) could set the USDJPY on a consolidation path back higher, with the first overhead level of note around 109.00. The Bank of Japan does meet tomorrow but is unlikely to surprise. 
Source: Saxo Bank
The G10 rundown

USD – again, difficult to assess the reaction function for the US dollar in the wake of the FOMC, with USDJPY perhaps the most straightforward, but a “hawkish” surprise might also see weaker risky currencies and even keep EURUSD under pressure, given Draghi’s dovish blast yesterday.

EUR – Draghi touting the ECB’s ability put new pressure on the euro in some of the crosses and this could deepen from here – note the tremendous reversal in EURAUD yesterday – a possibly interesting one to watch if the temperature between the US and China improves from here for a time.

JPY – again, the most compelling reason to pay attention to the JPY is in the event we see a pivot point here after the incredible slide in global yields in recent weeks.

GBP – the UK CPI up shortly this morning, but interesting to see EURGBP reversing the local highs even as Boris Johnson saw his leadership vote strengthened in the latest elimination round. 

AUD – the Aussie knee-jerking the hardest within the G10 on the news of a Trump-Xi meeting – a potential squeeze risk in the crosses here after the recent extension lower. 

CAD – Canada’s CPI release up later interesting, as well as the rate reaction to the FOMC for the US, as the market has far less aggressively priced the Bank of Canada’s policy intentions (only looking for slightly better than 50/50 odds that the Bank of Canada cuts rates through December meeting).

NZD – the GDP up tonight a few hours after the FOMC and provides interesting test for the relative strength of the kiwi in the crosses.

SEK – the krona’s inability to find any support despite the positive market mood and the Trump-Xi announcement is notable, and weak manufacturing survey data today (and unemployment rate ticking up) were no help. EURSEK staring down local 9.70+ area resistance.  

NOK – plenty at stake for NOK over the next 24+ hours as we await the FOMC impact across all markets and then the near certain Norges Bank hike tomorrow and more important, the guidance on the future path of the policy rate from the central bank.

Upcoming Economic Calendar Highlights (all times GMT)

0830 – UK May CPI / RPI / PPI
1230 – Canada May Home Price Index
1230 – Canada May CPI
1400 – ECB’s Draghi closing remarks at Sintra
1430 – US Weekly DoE Crude Oil and Product Inventories
1800 – US FOMC Rate Decision
1830 – US Fed Chair Powell Press Conference
2245 – New Zealand Q1 GDP

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