Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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FX Update: Eyeing Wednesday FOMC meeting expectations
John J. Hardy
Chief Macro Strategist
Summary: The FOMC meeting tomorrow is arguably the last major macro event risk for the year. The meeting carries with it the risk of a market temper tantrum if investors fail to get what they want, namely, even more accommodation from a Fed that has been providing everything expected and more since 2019. The US dollar risks are distinctly two-way over this meeting.
Today’s FX Trading focus:
FOMC meeting on tap tomorrow – will the Fed deliver?
The market has become accustomed to a Powell Fed that has delivered absolutely everything asked of it and more ever since the Fed admitted its policy mistake back in early 2019 and has since adjusted by delivering its flexible average inflation targeting (AIT) regime. The market appears ready to believe that the Fed, with its primary focus on maximum employment and perhaps already losing a bit of confidence on that front in the wake of a few wobbly jobs number, is already ready this week to keep the monetary pedal to the metal with an indication that it is ready to tilt its QE toward longer maturities as a way to provide further easing. This seems the likely next step if the Fed is going to do anything, since there is no real sign that its overall rate of purchases is too modest or that adding to the total will do anything to improve the situation. The hawkish surprise scenario, then, is a Fed that does not deliver this message and protests that its tools are really insufficient to address the risks in the economy. That’s what it should say, at least, whether it does or not. Capping long term lending rates is not going to help the thousands of small businesses that have gone out of business and who don’t need a loan – they need grants if they are to be saved. The Fed doesn’t do helicopter cash grants. Nor would lower yields help keep tens of millions of people from evictions who are either living paycheck-to-paycheck or benefit check to benefit check. That is the job of fiscal policy.
Which brings us to the other remaining factor out there for this market: the status of the US stimulus package, with some risk that it gets divided up into two bills to separate the $160 billion state- and local government aid portion from the rest of the bill. Now that the US election results are official, one wonders how unpredictable the lame duck Trump will prove in his final month in office as he seems ready to burn down the house on his way out the door.
Chart: USDJPY
UDSJPY bounced back strongly once again from a probe below the important 104.00 level yesterday, despite a weak close for equities and long US treasuries rallying again on the day. Hard to conjure up any information value from yesterday’s move – it’s possible the market just doesn’t want to press its case until the other side of tomorrow’s FOMC meeting. On that note, the downside is the side of least resistance if the Fed delivers a strong promise on keeping low rates suppressed with eventual yield curve control and perhaps even to start tilting its purchase toward longer maturities already now. Still, one wonders at the broader upside potential for the JPY in an environment of surging risk appetite and strong interest in EM carry trades. It seems USDJPY can only manage a grinding three-steps down, two steps up progression lower – even if that regime can’t continue forever.
The G-10 rundown
USD – obviously very sensitive to tomorrow’s FOMC meeting with two-way risks – a shoulder shrug from the Fed and wait and see stance could see the USD backing up, while a clear commitment to ensure that longer yields won’t be allowed to rise much could encourage a fresh wave of USD selling.
EUR – the EURUSD seems to be champing at the bit at the topside of the range and ready to progress to the 1.2500+ zone if the market backdrop remains supportive (risk-on) and closely linked to that, whether the Fed delivers tomorrow. No Fed indication on long US yields could drive an significant move lower in EURUSD, at least tactically.
JPY – the Fed clearly moving on the yield-curve issue, as discussed above, could drive a USDJPY move lower, but the JPY may not stand out on the strong side more broadly as long as the reflationary narrative is all the rage. As indicated above, failure by the Fed to signal any interest for now in keeping long yields low could lead to the USD backing up against negative yielders.
CHF - the SNB has apparently had the luxury of reducing its sight deposits, suggesting no pressure from abroad for its currency to strengthen. Ditto comments above on EUR and JPY if Fed fails to deliver. Brexit a side issue that is probably the reason EURCHF is below 1.0800 here and not challenging the important 1.0900+ area.
GBP – the relief rally on the extension of negotiations after the week-end didn’t last long – waiting for next headlines, but the best case doesn’t look so great a this point as it is hard to see the EU yielding much after dragging things out this long and the UK will not accept limitations on its sovereignty – that was the whole point of Brexit.
AUD – iron ore futures have rebounded after a mere one-day sell-off, which is Aussie supportive, but the near parabolic rise there makes me a bit nervous for the correction risk when it does arrive. As well, China is teasing restrictions on Australian coal imports, in the latest sign of growing pressure on the country.
CAD – USDCAD has worked half of the way to the 1.2500 area after breaking down below 1.3000 – this is a pair that will remain sensitive to the reflationary narrative, risk appetite and oil prices.
NZD – the kiwi is impressively weak – another leg higher in AUDNZD into 1.0700+ and that chart has effectively posted a significant reversal.
SEK – Sweden struggling with its outlier Covid-19 policies, but the market largely brushing this off for now, as EURSEK never triggered above the important 10.300 area on this latest bout of consolidation. Risk appetite and hopes for the other side of Covid-19 are the important factors for keeping the focus lower in EURSEK/higher for SEK.
NOK – EURNOK looks ready to challenge the cycle support below 10.400 if the FOMC doesn’t stand in its way and we see a continuation of the reflationary backdrop – but the price action has been bottled up for weeks and we probably need a solid swing above $50/barrel in Brent crude.
Upcoming Economic Calendar Highlights (all times GMT)
- 1315 – Canada Nov. Housing Starts
- 1330 – US Dec. Empire Manufacturing
- 1415 – US Nov. Industrial Production
- 1930 – Canada Bank of Canada Governor Macklem to Speak
- 2200 – Australia Dec. Flash Services/Manufacturing PMI
- 2350 – Japan Nov. Trade Balance
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