FX Update: FOMC set to surprise with firmer taper talk?

FX Trading focus: FOMC set to bring forward its taper intents?

In part because expectations are so low for new developments at tonight’s FOMC meeting at a time when delta variant concerns are spreading and the US CDC is even asking people to mask up again, there is only one real direction of surprise, and that is in the direction of a more “hawkish” than anticipated message on tapering of asset purchases. A couple of drivers of this, as we discussed in this morning’s Saxo Market Call podcast, are the signs that Fed policy has generated more liquidity than the financial system can handle in an orderly fashion, from the ongoing melt-up in a narrowing slice of US mega-cap equities, to the ballooning of the Fed’s reverse repo facility, which shows the Fed actually having to lend out ever larger quantities of the treasuries it is buying. That facility has pulled back above $900 billion. Elsewhere, yesterday’s huge 17% year-on-year gain in the May US S&P CoreLogic home price is the latest evidence that the US housing market is edging into bubble territory. In short, Fed accommodation is already overstaying its welcome, even if Powell’s most recent indication is that the US economy is still “a ways off” from meeting the “substantial progress” needed to consider a policy shift. Assuming the Fed does surprise, the USD could back up sharply and relatively across the board, although as we note in the USDJPY comments below, how longer yields behave tonight and in coming days will be the key for how broadly the USD rallies on more hawkish than expected guidance on a QE taper tonight (it is our bias, not a certainty by any means).

Chart: USDJPY
Watching the USDJPY chart with particular interest over the FOMC meeting tonight after the crazy gyrations in longer US treasury yields at the June 16 FOMC saw the market struggling to digest the implications for longer treasury yields from the Fed’s more hawkish message as first yields knee-jerked higher (USDJPY positive before they fell back sharply and then went largely flat). We would note this time around that the month of August could bring a different environment for treasuries as the US Treasury presumably will finish winding down its general account with the Fed this week, and as treasury issuance is set to pick up from here as the market may also anticipate the Fed pulling back from its QE purchases soon. USDJPY is in total tactical limbo, having failed to follow through lower recently through the key 109.10 area to confirm the bearish rejection of the early July attempt above 111.00.