The US S&P 500 suffered the lowest close for the year yesterday, just two days ahead of the Federal Open Market Committee meeting and the rate hike Powell and company are expected to deliver.
Weak risk appetite was the dominant theme yesterday as US equities suffered another soft session. The S&P 500 index probed below the prior 2018 intraday lows before closing at the lowest level since October of last year. The US dollar, however, failed to find a safe haven bid – perhaps as the market has recently priced out the majority of the further policy tightening from the Fed that was priced in for 2019.
Adding to the mix is the government shutdown that now appears imminent after the end of this week as Trump hasn’t been able to wrest support for his border wall from Democrat party leaders.
Over 40 basis points of rate hike expectations have been priced out of the December 2019 Fed Funds future since early November. The yen, on the other hand, is finally waking up to the declining US yields all along the curve and weak risk appetite and USDJPY is staring down interesting levels (see chart below) ahead of tomorrow’s pivotal FOMC meeting.
There are many ways to signal a dovish hike but the only very clear dovish signal for now would be a decision not to hike at this meeting. The cherry on top would be a shifting attitude toward the Fed’s quantitative tightening regime, which Powell inherited on autopilot. The Fed could ease significantly by merely reducing the rate of its balance sheet reduction.
Elsewhere, markets are in a nervous holding pattern on the intense uncertainty on the FOMC’s move tomorrow, but as we await the next steps for Brexit from mid-January (vote on the deal expected for week starting Jan 14 now rather than the week after) and the ongoing US-China trade negotiations. There is considerable focus on China’s celebration of the 40-year anniversary of “opening up”, but there were no new hints in Xi Jinping’s speech yesterday of new initiatives, with the speech largely centered on celebrating the CCP’s achievements and defending China’s attitude on the world stage.
NOK is twisting in the wind after the Norges Bank carried out its final NOK purchases for the year on Friday and crude oil prices continue to crater. Note the action in EURNOK at the end of last year for a possible repeat – though a recovery in risk sentiment and energy prices may be necessary ingredients as well.
USDJPY once again having a look at the Ichimoku support with which the pair has been playing cat-and-mouse over the last few months. If animal spirits pick up sharply in the wake of an FOMC meeting that manages to surprise on the dovish side, USDJPY could survive a test of support once again, even if the USD is weaker against riskier currencies – in any case, a strong risk-on response to the FOMC meeting is far less interesting for JPY volatility potential. On the other hand, if risk appetite craters further despite a dovish hike scenario (in which the Fed confirms the markets forward expectations that no further hikes will be forthcoming for the foreseeable future) and the aggressive bid in US long Treasuries continues, USDJPY could tumble through the local supports for a run into 110-111.00.