Macro/FX Watch: Fed’s hawkish hold but dovish bias, AUD rallied and JPY relieved

The Federal Reserve left policy rates unchanged at 5.25-5.50%, in line with expectations and the market pricing. There were only slight changes to the FOMC statement and the door for further rate hikes was left open. Officials noted that they were not confident that rates were “sufficiently restrictive” yet. While Powell tried to signal a hawkish hold, there was a sense that Fed has come to an end of its rate hike cycle with little the Q3 GDP report or the blowout September jobs numbers not being read out to be very strong and warranting more rate hikes.

Powell still emphasized a data-dependent mode, and there are two more inflation reports and two employment reports ahead of the next meeting in December. But growth expectation was changed from ‘solid’ to ‘strong’ and there was some acknowledgement of higher longer-end yields, with tighter financial conditions mentioned alongside tighter credit conditions. Given the weakening consumer and business confidence trends and rising risks of delinquencies, the odds remain tilted to suggest that we have reached an end of the Fed’s tightening cycle. However, Powell was clear that the Fed was not thinking about rate cuts yet.

There was no dot plot at this meeting which could have clearly hinted whether officials see another rate hike or not, but a key signal came from Powell’s comment where he said that the September dot plot – which had another rate hike in place – is now outdated.

Overall, markets interpreted the meeting to have been dovish. Treasury yields slumped, with 10-year yield down close to 20bps to sub-4.75% and 2-year yield down 14bps and heading further lower to 4.92% in early Asian hours.

What does this mean for the path of dollar?

The Fed meeting was just a confirmation of what we have been writing earlier. The upside in US dollar is getting limited with rate hikes coming close to an end and positioning getting stretched. But there remain no clear alternatives to the dollar at this point, and the USD is likely to remain supported until US economic data starts to weaken.

AUD: More sensitive to US yields, RBA ahead

AUD has been one of the most sensitive currencies to US yields lately, more so than the JPY. The slump in Treasury yields overnight further boosted AUD which crossed the 50DMA and 23.6% retracement, suggesting a short-term uptrend. Pair broke above 0.64 and next ley level may be the 0.6519 where the 100DMA and 38.2% retracements levels coincide.

Aussie trade data out this morning, however, showed exports turning negative and trade balance coming in below expectations. This goes to support the case we have been making about the trade terms being a potential negative for AUD compared to NZD. But with RBA rate hike still in play for next week’s meeting, there could still be more upside for AUD. Market is pricing in 50% odds of a rate hike for the November 7 meeting, and more than a full rate hike is priced in by February. This could mean a significant risk for RBA to surprise dovish, while a small upside to delivering hawkish.

Market Takeaway: AUDUSD may have some room for upside as markets absorb Fed’s dovish message, but RBA meeting next week has a high bar to send hawkish signals and structurally AUD remains for downside on trade terms, China underperformance, geopolitical concerns and risks of a global recession.

JPY: Fed takes off the pressure

For now, the Fed has taken off some of the pressure for the Japanese yen after the Bank of Japan managed to surprise dovish again earlier this week. USDJPY rose to 151.50+ as we expected given 150 was no longer the line-in-the-sand, but is now back below 150.50 on Fed’s dovish turn.

From here on, US data will likely remain the key driver of JPY. Any outperformance in jobs data or upside surprises in inflation could still bring USDJPY back towards 152. However, high frequency data suggests that after longer lags, policy tightening may be filtering through the real economy now. If US data starts to show a serious deceleration, there could be an upside potential for the yen, but fundamentals still remain aligned for further yen weakness for now. Treasury yields could still run higher given Fed’s QT and massive Treasury supply, and carry continues to favor a bearish yen view.

Market Takeaway: USDJPY could still go higher to test 152 before the US economic data starts to weaken and Fed rate cut pricing becomes more aggressive.

GBP: BOE on the agenda

Bank of England today will likely try to strike a hawkish tone as services inflation and wages still remain very high, but market is turning its focus to growth headwinds and ability to hiek further for the major central banks remains limited.

Key thing to watch at today’s BOE meeting will be the vote split. One of the members who voted for a rate hike last meeting has since been replaced, and the replacing member is expected to vote with consensus. This shifting vote split towards the dovish side could bring GBP downside. However, GBPUSD has lately seen a high positive correlation to US stocks, and the Fed’s dovish turn may help there. But overall, equities could see downside pressures building amid high rates and mixed earnings, spelling further downside for sterling.