Trader Notes: Will The Fed Pivot and How to Position for It? Trader Notes: Will The Fed Pivot and How to Position for It? Trader Notes: Will The Fed Pivot and How to Position for It?

Trader Notes: Will The Fed Pivot and How to Position for It?

Forex
Danny Khoo

Singapore Sales Trader

Will The Fed Pivot and How to Position for It?

As the Fed raised interest rates for the 5th straight time, making this the fastest rate hike cycle in history, doubts have begun to surface among Federal Reserve officials as more have started to have differing views on the urgency to get to 4.5% - 5% terminal benchmark rate in the past month.

Vice Chair Lael Brainard laid a case for exercising caution as previous increases are still working through the economy and global tightening effects could spill over to the US. Charles Evans has highlighted that he would prefer to find a rate level that restricted economic growth enough to lower inflation and hold it there even with a couple of bad inflation reports to avoid being overly aggressive. Esther George (known to be a hawk) has also said she favoured moving “steadier and slower” on rate hikes and a series of large rate increases might risk oversteering. And finally, just last week, Mary Daly said the time is now to start talking about slowing the pace of recent increases in benchmark interest rates.

There has been a high bar set for the Fed to remain hawkish given the repeated commitments by Powell and his team to keep hiking until data shows that inflation is under control. This is evident in the huge risk off moves we have seen for most of this year in equities and a big swing to the USD in FX as shown below:

SPX: - 20.33%
NDX: - 30%
HSI: - 35%
DAX: - 18.5%
Dollar index DXY: + 17.15%

With market positioned for a hawkish Fed, CPI misses (lower than expected) have led to big risk on rallies / short covering like what we saw in August when July’s CPI print came in at 8.5%, below the 8.9% expected. Market rallied 4.5% in the next 7 days with USD losing bids as well. Right now, the market is pricing a 75-bps hike in November followed by 50bps in December and the terminal rate is expected to be approximately 4.9% by Q1 next year.

Going forward, there is a good probability that the Fed will pivot given the following reasons:

  1. Some of the FOMC members are beginning to be concerned about hiking too fast and rather take a step back to let the effects of tightening work through the economy.
  2. We are starting to see data cooling off, including consumer confidence falling to 102.5 below expectations of 106.5, the Case-Shiller index is down 1.6% (2nd straight month of declines) and Philadelphia Fed Manufacturing Index falling to -8.7 vs -5.0 expected.
  3. The CPI base effect would start to kick in for the October 2022 CPI print with the big jump in prices occurring once in April 2021 and the other in October 2021 last year.

If The Fed Starts To Pivot, What Would Be The Best FX Trade To Participate In?

What does pivot mean? A Fed pivot can mean a pause in rate hikes and keep them at the same level for a few months while monitoring inflation data. Alternatively, the Fed could reduce the quantum of rate hikes going forward to reflect their more cautious stance. In both circumstances, we might see USD strength reverse given market positioning and an extremely hawkish Fed all year.

Let us look at how some of the key FX pairs have moved this year as shown in the diagram below. JPY takes the top spot after falling 22.55% followed by SEK, NZD and GBP. If we look at the policy rate in the G10 space in the next diagram, New Zealand policy rate is currently highest at 3.5% followed by Canada and the US. 

Spot Return
Policy Rates

NZD might outperform

From the list of currencies that declined the most this year, most have reasons to be there though NZD seem to stand out given that their rate hike cycle (current 3.5%) is well ahead of the rest (including the US) and terminal rate is currently above 5% expected some time next year. In addition, recent QoQ CPI data for Q3 came in hot at 2.2% vs 1.6% expected. These factors do not seem to warrant a decline of 15.4% this year relative to the USD and hints that if the Fed were to pivot, NZD could have a decent sized bounce. One possible risk to note is that the NZ current account deficit is quite negative at -7.7% of GDP as compared to the other currencies due to higher prices of machinery/vehicle/energy imports and a lack of tourism spending though these are expected to improve once supply shortages subsides and tourists return in full swing.

How About the Other Large Decliners?

JPY has good reason to be there given the BOJ’s dovish policy and commitment to yield curve control. Given that this has moved the most, any slight change in BOJ’s stance could trigger a large move in the opposite direction. However, barring that change, JPY would still be tough to hold given the huge carry cost and BOJ’s unlimited bond buying spree.

UK is going through one of the toughest times in history due to political and economic turmoil. Therefore, it is not surprising to see GBP fall 14.9% this year as the government struggles to balance growth and inflation. UK has just seen their third prime minister in 3 months and even though there has been the recent reversal of the infamous unfunded tax cuts, the current prime minister Rishi Sunak still has a lot of tidying up to do to regain growth.

Sweden Krona (SEK) has declined this year as Riksbank was known as one of the most dovish central banks before they started hiking more aggressively in September from 0.75% to 1.75%. Even then, these moves seem to be in response to the aggressive tightening central banks to prevent outflows.  Sweden is also not spared from the energy crisis in Europe with 30% of its LNG imports were from Russia before the war, and thus higher rates will not resolve inflation resulting from higher gas prices (which are more supply driven).

The Chinese Yuan (CNH) has also declined quite rapidly in the recent month, reaching new lows against the USD this week as the PBOC is back on an easing cycle to support the property market. There are also concerns that the recent consolidation of power by Xi would stifle business opportunities in the country and impede growth. In addition, with the government keen to support common prosperity this year because of the zero-covid policy, the PBOC is likely going to maintain an easing bias.

Conclusion

In conclusion, NZDUSD seems to have the best risk-reward skew as it has the highest policy rate among G10 currencies with scope to hike further on the back of still firm inflation data and market positioning given huge declines this year, with the key risk being the current account deficit. JPY might be an attractive one to look at if BOJ tweaks yield curve control with short positioning at very high levels and recent gains due to intervention might put pressure on shorts. GBP is in a grey area as we see how the new prime minister will navigate not just the tough economic environment but to push his agenda within his own government being young and less experienced. With a new leadership in place and a government keen on supporting the economy, CNH would be quite an unlikely candidate to go long until the economy stabilizes and PBOC changes their easing stance. Finally, even though inflation is creeping higher in Sweden, Riksbank has historically been more of a follower in terms of hiking rates than a leader, and the Fed pivoting might reduce their need for staying hawkish with an energy crisis to handle.

NZDUSD is now trading in an ascending triangle pattern with key resistance at 0.58 and key support is along trend line at around 0.57.
Disclaimer

The Saxo Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-sg/legal/disclaimer/saxo-disclaimer)

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments. Saxo Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Capital Markets or its affiliates.

Saxo Markets
88 Market Street
CapitaSpring #31-01
Singapore 048948

Contact Saxo

Select region

Singapore
Singapore

Saxo Capital Markets Pte Ltd ('Saxo Markets') is a company authorised and regulated by the Monetary Authority of Singapore (MAS) [Co. Reg. No.: 200601141M ] and is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms & Risk Warning to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products such as Margin FX products may result in your losses exceeding your initial deposits. Saxo Markets does not provide financial advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Markets does not take into account an individual’s needs, objectives or financial situation.

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-sg/about-us/awards.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website are not intended for residents of the United States, Malaysia and Japan. Please click here to view our full disclaimer.

This advertisement has not been reviewed by the Monetary Authority of Singapore.