FX Update: RBA dovish, but… JPY firms on lower US long end.

Big test for market themes on the FOMC tomorrow. As discussed in yesterday’s update, this week’s FOMC is an important test of how much stock the market puts in Fed guidance, as much as it is an exercise in wondering what the Fed will actually deliver tomorrow. The Fed is seen as the central bank most behind the curve in bringing policy tightening, relative to what is unfolding in the US economy. It is supposedly set to launch a ponderous asset purchase tapering move this month that will be followed, only on the completion of that tapering to zero, by eventual rate hikes further down the road. The base case for the pace of tapering was laid out in the September FOMC meeting at a sedate $15B a month ($10B less per month of treasury purchases, $5B less of MBS purchases) which would require a long eight months to complete. But pre-declaring that pace without forward flexibility is a dangerous bit of forward guidance, requiring an embarrassing backtrack if inflation and earnings jump further in next few months (See the risk already here in the great discussion of “trimmed mean” inflation in a recent opinion piece from John Authers) Given all of the embarrassing tripping over prior guidance we have seen under the Powell Fed since the early 2019 about-face from tightening to loosening policy, and now as “transitory” seems to be leaving the Fed’s vocabulary, the Fed may try to provide as much flexibility as it can on how quickly QE will wind down. So the range of options is perhaps: $15B to start plus flexibility as the base case, with no flexibility indicated the unlikely dovish outcome, and a more rapid pace of $30B the most hawkish conceivable guidance. Then we shift to whether to how the market actually prices Fed actions in the wake of what they deliver: thumbing the nose at the USD in the belief that no matter what the Fed is saying, it will stay behind the curve relative to other central banks and relative to inflation risks (i.e., no real improvement prospects for real US rates), or expressing the belief that the Fed and other central banks are risking having to hike rates and upsetting the economic growth outlook and especially financial markets and therefore committing a “policy mistake” as the market beast needs ever more stimulus to continue higher. Some of the latter may be why yield curves are flattening as aggressively as they have recently, with the longest treasury yields actually dropping.

The latter have been brought significantly forward, with the market now pricing the Fed to move approximately twice by the end of next year. Just as with the ECB and as discussed in the RBA preview above, will the market really care what degree the Fed adjusts its guidance, given that guidance seems worth very little and that data outcomes are in control here, not the Fed? I’ll provide more thoughts tomorrow and/or Wednesday, but one idea could be a starting pace of tapering 15B/month, but pre-declaring “flexibility” that could see the pace even doubled if necessary if inflation/wages/job growth make a mockery of Fed caution in the coming couple of months.

NZD on the move lower in Europe today. The FX Board is off-line due to technical difficulties – hope to have that back as soon as possible. NZD traders should note the important data up late today from New Zealand as AUDNZD traded near the locally pivotal 1.0400-25 zone today. The big bounce in the latter and the sell-off in NZDJPY suggest that NZD longs are a bit crowded ahead of these data. With markets second guess all of the dovish central banks, does that also mean that the most hawkish central bank suddenly seems far less as we have to discount all guidance now, don't we?

Upcoming Economic Calendar Highlights (all times GMT)

• 1120 – ECB's Elderson to speak
• 1155 – ECB's de Cos to speak
• 1230 – Canada Sep. Building Permits
• 2000 – New Zealand RBNZ to publish Financial Stability Report
• 2030 – API weekly report on U.S. oil inventories
• 2145 – New Zealand Q3 Average Hourly Earnings
• 2145 – New Zealand Q3 Employment Change/Unemployment Rate
• 0030 – Australia Sep. Building Approvals
• 0145 – China Oct. Caixin Services PMI