Chief Macro Strategist
Summary: Summary: The initial reaction to the FOMC meeting this week proved misleading, as the risk rally yielded yesterday to a vicious sell-off that saw safe haven seeking across the board, out of equities and into gold, treasuries and especially the Swiss franc and Japanese yen. The euro and sterling are trying to keep pace as well after ECB and Bank of England meetings yesterday that each brought surprises.
FX Trading focus: CHF and JPY rise to the top on risk aversion. ECB and BoE weigh
The attempt to put a happy face on the Fed’s hawkish turn at this week’s FOMC meeting fizzled badly yesterday, as safe haven seeking set in across the board, ironically also including a powerful rally in US treasuries at all points on the curve, such that the market pricing of the Fed policy rate for late next year is now below where the Fed itself is forecasting it will be. As noted in this morning’s Saxo Market Call podcast, if we look a bit further forward into 2024, the Fed expected yield is at one-month lows (there is a risk premium that can go in either direction, of course, but the current pricing suggests that the market is leaning more on the risk that the Fed will fail to get anywhere near the “terminal” policy rate it has forecast that it will reach in the coming few years – perhaps because the market thinks that the halt of Fed balance sheet expansion and a few hikes will trigger a massive market deleveraging that will feedback into the real economy/inflation and therefore into the Fed’s rate decisions….).
I suspect that where the market has priced the Fed and the Fed’s own forecast are very likely to prove completely wrong: the market is pricing a lower-amplitude version of the delayed, but eventually smooth lift-off that we saw in the 2016-18 period, (which itself was a low amplitude version of the more straightforward, grinding 2004-06 tightening period). Either we’ll see the Fed stumble after a couple of rate moves and the need to start signaling support for the market because the market is so sensitive to tightening that it collapses, or we get second round inflationary effects that require the Fed to move far beyond anything it or the market ever conceived was likely. The luxury the Fed doesn’t have this time around is to ignore inflation, which would have to fall back considerably for any Fed easing scenario unless asset markets were in some sort of systemic risk-off event/crash.
On that note, yesterday’s market action looked rather ominous on a technical basis, with the broad risk off supporting CHF and JPY the most (EURCHF looks ready to test the SNB’s mettle again soon), while the euro got a slight lift from the ECB (more below) and the USD did manage to mount a comeback late yesterday against especially the riskier currencies. If this mood continues and yields continue to drop, I would expect USD strength to nudge higher, especially versus EM and the smaller currencies, if not necessarily versus the yen.
Chart: AUDJPY
How quickly the mood can shift! Yesterday we were pondering the potential for an upside break in AUDUSD, one that was reversed, and today we look at the even more profound reversal in AUDJPY, as the JPY came back even stronger than the US dollar since late yesterday as safe haven seeking took safe haven US treasury yields lower all along the curve. Structural bears in AUDJPY were looking for a reversal pattern like this after the sharp rally off the lows and after the massive head-like rally and reversal from sub-80 to 86 and then back again. Note the rally failure yesterday coming ahead of the 200-day moving average. Bears will trade with yesterday’s highs as the risk point for a continued sell-of back at least toward the sub-79.00 pivot lows from earlier this month (which would likely coincide with more risk aversion and lower safe haven yields).
The Bank of England surprises with 15 basis point rate hike – The Bank of England surprised consensus once again by hiking rates 15 basis points to 0.25% and voting 8-1 in favour of the decision, with one dovish dissent (Tenreyro). This surprise came after the market was nearly sure of a rate hike in November that didn’t happen. While sterling rallied hard intraday, EURGBP trades this morning back to where it was before the meeting, while GBPUSD rose above 1.3350 before easing back lower. Perhaps it was the recent November core CPI print reaching 4.0% year-on-year, a multi-decade high, that prompted the decision. The Bank predicts that inflation could peak at around 6% in April. The market is pricing high odds of another 25 basis points of tightening at the next meeting in February. While
ECB meeting offers marginal support for the euro. The ECB inflation forecasts still suggest that inflation will prove temporary, but the size of the upward revision to the 2022 CPI forecast (to 3.2% from 1.7%) was interesting, even if the 2023 and 2024 forecasts were raised only modestly to 1.8% for both years. By raising the nearer term inflation forecast so much, the ECB allows itself the luxury of not having to adjust policy guidance higher if inflation falls back a bit in coming months and allows it to look more credible if inflation does persist longer than expected, which will allow it a more hawkish adjustment down the line to future inflation forecasts if necessary. Regarding the ECB QE programme, the PEPP of emergency pandemic-inspired QE purchases will roll off in March, but ECB President Lagarde said there would be no “brutal transition” to lower QE as the bank is set to continue purchasing EUR 40 billion/month for three months (versus around EUR 70 billion now), then EUR 30 billion for three additional months before reverting to the EUR 20 billion that was in place before the pandemic outbreak. President Lagarde said it was unlikely that the ECB would hike rates in 2022.
The Turkish central bank cut interest rate as expected and despite cratering lira but signaled the end of cutting cycle. The Turkish central bank lowered the policy rate 100 basis points to 14% as expected, even after TRY had lost more than another 10% in the few sessions before the meeting. The central bank committee said that this would be the final cut for now, but signaling from Turkey’s president Erdogan will be more critical from here, as the central bank is under his political sway as he has cast the lira devaluation (and fight against the high rates needed to shore up confidence in the lira) as a fight against foreign speculative interests and that lower rates are a boon to the economy. Wrong. Yesterday, Turkey announced a 50% increase in the minimum wage, risking a wage-price spiral. As of this writing, the lira had lost some 9% against the US dollar from yesterday’s close before a large rebound from above 17.00 in USDTRY.
Table: FX Board of G10 and CNH trend evolution and strength
More churn since yesterday as much of what we saw was a sharp move that was counter to the prior session – need fish swimming in the same direction for a while to see trend readings solidifying, but do note the loss of altitude from CNH – probably one of the most solid developments to hang our hats on for some time from here after recent policy signals out of China.
Table: FX Board Trend Scoreboard for individual pairs.
Some of the JPY crosses that were trying to flip positive have now stumbled, but it is finely balanced in for example EURJPY and AUDJPY, both of which I would expect to move lower if risk off extends here. Note USDCNH trying to flip positive on the trend today on a close higher – this one could stick for some time, with CNHJPY joining the action and XAUCNH doing likewise, with EURCNH close to flipping higher as well.
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