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: Fed commits to staying behind the curve.
John J. Hardy
Chief Macro Strategist
Summary: The market got what it expected from the FOMC meeting yesterday, as the Fed is set to taper asset purchases at the expected pace, with some flexibility on a shift in the pace in the likely event that the overheating US economy requires that they second guess the ponderous move toward rate lift-off. The US dollar is back firmer this morning nonetheless as focus shifts to the cycle lows in EURUSD ahead of the latest jobs and earnings data tomorrow.
FX Trading focus: FOMC delivers expected QE pace, ECB talks down, BoE preview
Interesting that USD firm after as-expected FOMC The market continues to price the risk that the Fed will have to hike rates far more quickly than anything it has provided in its forward guidance and certainly in anything delivered in yesterday’s FOMC meeting as the likelihood of rate lift off is priced to pick up dramatically around mid year next year. At last night’s meeting, the new statement delivered the as-expected base case of $15 billion a month of asset purchase tapering ($10B monthly of treasuries and $5B monthly of MBS), which would take the Fed down to zero balance sheet expansion at the end of June next year. That looks unbearably slow relative to the backdrop of 5.8% expected CPI inflation for October and signs of rising wage pressures, with specific anecdotal and statistical evidence of that in logistics discussed in this morning’s Saxo Market Call podcast.
The statement did see the Fed buying some insurance in altering the pace of tapering by declaring that the Fed is “prepared to adjust the pace”… “if warranted by changes in the economic outlook”. Some changes are indeed likely to be warranted – potentially already at the December meeting? For the Fed to indicate a speed-up of tapering, we would likely need for the October and November jobs reports, both of which the Fed will have a look at before that meeting, to come in strong as well as for the average hourly earnings data to indicate a tilt toward a wage-price spiral developing. The sense of the US economy overheating was palpable in yesterday’s record ISM Services survey reading for October at a stunning 66.7.
Otherwise, the general impression in the press conference is that Chair Powell is sticking to his guns on the view that inflation will fall back eventually, if on a more delayed time frame than originally expected, even if there was some humility expressed that the Fed is still “learning”. One of the problems with Powell’s outlook is the lack of recognition that the US and global economy is in a very different place than it was pre-covid, with everything linked to supply constraints on multiple levels and a lack of investment in key economic inputs like commodities likely to much more extend. As well, in the US specifically, a chunky percentage of older baby boomer workers who lost their jobs are likely to stay away from the jobs market, some enriched by what are arguably asset market bubbles in equities and real estate. A recent Wall Street Journal article (paywall) on this very issue gained widespread coverage.
Let’s keep in mind that with this FOMC meeting we will very likely have the announcement of who President Biden will nominate for the next Fed term before the next Fed meeting. The announcement could come at any time, with Lael Brainard the “dovish” alternative while the Atlanta Fed’s Bostic looks nominally more hawkish. I would be surprised if any strong reaction to the nomination of Brainard sticks, as it is hard to believe that there is anyone really more ready to default to the dovish side than Chair Powell save for perhaps the Minnesota Fed’s ultra-dove Kashkari? Bostic could be another matter.
Chart: GBPUSD
An important day today for sterling after the market’s sharp repricing of the forward rate curve as it prices the Bank of England to achieve lift-off on rate hikes as early as today and prices in a whole series of hikes next year. Interesting to see if the Bank is willing to provide forward guidance that fully endorses the market’s aggressive view. GBPUSD trades in a descending channel, but arguably, the 1.3600 area looks quite important after it was a major support area that only gave way briefly in late September before a spike reversal back higher. Sterling risks look tilted to the downside in the wake of today’s meeting, in my view.
Bank of England meeting later today, with a slight lean in favour of the bank initiating its rate hike cycle at this meeting rather than waiting for the December meeting. Given the Bank’s 0.10% policy rate, most believe that it is likely that the bank would hike a modest 15 basis points if it moves today before beginning normal 0.25% hikes in subsequent decisions. Given that the market has priced a series of rate hikes for the year ahead, the Bank’s guidance relative to the market’s pricing of its future policy trajectory will be critical, and Governor Bailey has offered very confusing guidance in recent months, sounding dovish and then suddenly hawkish in recent weeks, likely due to Chief Economist Huw Pill’s declaration that inflation is likely to hit 5% in the months ahead and that “this is a very uncomfortable place for a central bank with an inflation target of 2 per cent to be.” . More dovish BoE members are cautious about indicating too much tightening on the transitory logic seen elsewhere, as well as due to the financial tightening already in the bag in the forward curve.
ECB President Lagarde talks down odds of rate hike next year. In a speech yesterday, Lagarde indicated that the ECB viewed it unlikely that conditions would be favourable for rate lift-off next year, and the Euribor strip continued it recovery off the remarkable lows late last week. Some of that volatility last week and the couple of weeks prior may be down to an over-positioned market getting into trouble with its positioning and certainty around the near-term rate path. The ECB will certainly be able to hike next year in the likely event that inflation outcomes make a mockery of their forecasts, all while the euro remains quite weak.
CEE focus as National Bank of Poland hikes more than expected. The National Bank of Poland hiked a surprising 75 basis points yesterday, more than the 25 basis points expected, and Governor Glapinksi harangued the audience at the press conference with a nearly 1-hour speech defending the bank’s tardy initiation of rate hikes. The forward guidance on further hiking was confusing even as Glapinski said that the central bank would do “whatever it takes” to get ahead of inflation, which they oddly and specifically forecast would peak out at 7% in January. PLN was sharply stronger yesterday but has erased much of its gains already as of this writing. Elsewhere, the focus is on the escalating spat between Poland and the EU on rule-of-law issues and whether the EU will release recovery funds in the budget.
Czech central bank up today and is expected to bring a 75 basis point hike to take the rate to 2.25%, as the central bank there has done one of the more credible jobs of defense against inflationary pressure and there has been quite the solid carry trade in the range bound EURCZK since early this year.
Table: FX Board of G10 and CNH trend evolution and strength
We’re approaching a crossroads here on many charts as the US dollar threatens back to the strong side – most pressingly in EURUSD and GBPUSD, while other recent trades have faded to almost nothing, including the uptrends in commodity currencies, especially after yesterday’s notable dump in oil prices. Do we enter next week with the USD in a broad uptrend on strong US October jobs/earnings numbers tomorrow?
Table: FX Board Trend Scoreboard for individual pairs
In the individual pairs, watching whether AUDNZD tilts fully negative on the chart after the dovish RBA this week. Also note that the EURNOK squeeze has been pronounced enough to put bears at unease, while GBPUSD has tilted fully back lower awaiting confirmation or rejection from Bank of England today and the 1.3600 area trigger on the chart.
Upcoming Economic Calendar Highlights (all times GMT)
- 1000 – Euro Zone Sep. PPI
- 1000 – UN FAO’s Global Food Price Index
- 1200 – UK Bank of England Rate Announcement
- 1230 – US Weekly Initial Jobless Claims
- 1230 – US Sep. Trade Balance
- 1330 – Czech Central Bank Repurchase Rate Announcement
- 1400 – ECB’s Elderson to speak
- 0030 – Australia RBA Statement on Monetary Policy
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