Market thinks the Fed's resolve is wavering

In a speech yesterday, Fed Chairman Powell put what the market felt was a new spin on his view of the Fed’s policy rate, which he described as “just below the broad range of estimates of the level that would be neutral” rather than previous rhetoric, suggesting his view that the rate was far from neutral. This is rather less dovish than the headlines shouting the “just below” portion of his comments out of context.

Still, Powell’s rhetoric suggests a range of possibilities: perhaps Powell really is second guessing his prior, more pointed comments because he finally does see risks materialising that warrant a bit more caution beyond the December rate hike. Also, the policy description is far more passive and less direct than his usual style – is Powell finally starting to change behavior due to the pressure supplied by Trump’s expression of dissatisfaction with Fed “tightness”?

Regardless, the market has decided to take the comments and style change and run with it, pricing out some seven basis points or so of tightening through the balance of 2019 as expectations are shifting increasingly in favour of one or even no further hikes through the December 2019 meeting after an assumed hike at next month’s meeting. 

In reaction to Powell’s speech, risk appetite has gunned higher, the USD (and somewhat less so the JPY) is under renewed pressure and the traditionally risk-correlated currencies are enjoying a significant bid, led within the G10 by AUD and NZD, where there is perhaps also a hope that this weekend’s G20 meeting produces a supportive breakthrough.

Sterling tried to put in a rally as the UK parliament will have the option to forward and vote on motions  –  like calling for a second referendum – ahead of the December 11 vote on the May deal. The broad rejection of this deal by key swing voters in parliament suggests that it has no chance of passage, which points to perhaps four scenarios, assuming the May deal fails:

– A “no deal crashout” – market more concerned than previously but reluctant to price this into anything save for implied volatility.

–  A second referendum – increasingly likely, but what are the choices, the May deal versus reverting to pre-Article 50 status quo?

–  An attempt at a last ditch “Norway-style” deal, with a declaration that a state of national emergency that enables the UK to retain control of its immigration (more akin to a “Liechtenstein-style” deal). This would be the UK having its cake and eating it too and the EU would be against this…

– No deal, but a significant delay of the deadline to avoid a crash-out, with new elections possibly on the agenda and head-scratching on how to restart the negotiation process.

Chart: AUDUSD

AUDUSD snapped to attention again as the market marked down the anticipated pace of Fed tightening at coming meetings. We’re still not clear of the recent range and need to see détente or better in the US-China relationship at the G20 meeting tomorrow and Saturday to get further traction higher. Given still heavy and increasingly stale speculative shorts out there, a further squeeze might easily overtake the 200-day moving average and pull the pair well north of 0.7500 if a rally sticks past this weekend’s events.