Market gunning for QT signals from FOMC

We’re not entirely certain what to credit for the sudden pivot in sentiment on Friday and deep sell-off in the US dollar and rally in risk assets, but most signs point to a Wall Street Journal article suggesting that the Federal Reserve may be set to signal an earlier than expected halt to its quantitative tightening policy, seen by many as a key factor driving negative sentiment and tightness in global liquidity – more so than the Fed’s policy rate signalling.

The article merely reviewed prior Fed statements and offered no inside scoop or quoting of unnamed insiders. But the market reaction is real and sets up higher stakes for the Federal Open Market Committee meeting and considerable two-way risk if these hopes are unfounded.

Given the spike higher in hopes for a Fed pivot, a failure to bring that pivot sets up an especially large negative surprise scenario.

Elsewhere, China fixed the yuan sharply stronger and at its highest level for the cycle versus the US dollar, likely in part simply a reflection of the dollar’s widespread weakness. The coming week will provide a better sense of the temperature of US-China relations after a string of throwaway and sometimes conflicting statements from Trump and his administration.

China’s top trade official, vice-premier Liu Hu is set for a trip to Washington mid-week and will arrive on the very day that is also the purported deadline for the US to officially inform Canada whether it will seek extradition of the Huawei CFO held there on accusation of having violated US trade sanctions against Iran.

The stronger yuan comes as the People's Bank of China rolls out its own liquidity measures ahead of the Chinese New Year holiday, including large liquidity injections and a the first use of a recently launched tool to add liquidity via purchases of banks’ perpetual bond issuance.

Sterling headlines could take on added urgency this week as Parliament will vote on Theresa May’s 'Plan B' to revisit the existing deal and if that vote fails, a series of amendment votes could see Parliament taking control of the process from here, possibly voting on a delay of Article 50 at minimum, but other options are also on the agenda.  At the weekend, the Irish foreign minister claimed that the European Union is not willing to make changes to the Irish backstop portion of the original deal, where May has her highest hopes she can make changes that will make the deal palatable in a second vote. The market appears confident that we are headed for a delay of article 50 at worst – any creeping doubt that this or better will prove the outcome could spark a head-spinning change of sentiment for sterling.

In the US, facing mounting airport chaos and tanking popularity ratings, President Trump signed on to a three week opening of the government. The immediate implications of the end of the government shutdown are positive, but others would argue that a Trump with egg on his face is a dangerous Trump as he will look for other ways to appear powerful and disruptive, especially in areas over which he has more control, like in the trade deal arena.

Chart: AUDUSD

The AUDUSD turnaround was fairly typical of the price action seen last week as the pair posted a massive reversal bar from new local lows that builds a bullish technical case ahead of the FOMC meeting this Wednesday. If the Fed delivers, an extension significantly higher could be in the offing here on a melt-up in assets traditionally correlated with risk appetite – possibly through the 200-day moving average and toward the important 0.7500 area. But in the longer term, we continue to urge caution for enthusiasm for the AUD on concerns linked to China’s slowdown and the domestic credit crunch in Australia linked to the unwinding credit bubble.