FX Update: USD shrugs off Fed’s balance sheet expansion

A trio of news stories late last week doing about everything possible to support risk appetite. First was the Brexit negotiation breakthrough last week that could lead to a Brexit deal, second was the handshake US-China trade deal announced by US President Trump, and finally, late on Friday we get the news that the US Federal Reserve will purchase $60 billion per month in US T-bills “at least into Q2” of next year, bringing far more liquidity than many expected. Markets reacted with restrained enthusiasm, outside of sterling and the bond market, where the price action was more exuberant.

For each of these issues, there are plenty of devils in the details for each of these three developments that may prevent significant follow through in last week’s reaction.

On Brexit, the EU side has tempered some of last week’s enthusiasm by saying that Boris Johnson has a long way to go on the specifics and the schedule could prove too short ahead of this week’s EU summit, set to begin Thursday. Still, some sort of memorandum of understanding could be on the table before the end of the month that the two sides are in agreement, but merely need a three month delay to hash out the details. But are the votes there in the Parliament? We’re still concerned about a UK recession, with or without a deal.

On the US-China trade deal, as our Steen Jakobsen points out in today’s podcast, the risk is that this is merely Trump’s desperation to get a deal and that the key issues remain further down the road, including on technology transfer and national security issues. As well, we still don’t know the fate of the US tariffs scheduled for mid-December, which will be assessed on the last portion of Chinese imports and include popular consumer goods like laptops and mobile phones. Also, what happened to the “currency pact” tease we heard about last week?

On the Fed’s announcement of $60 billion a month in US T-bill purchases, while the magnitude of the programme, at perhaps a minimum of $360 billion if we assume six months of purchases and that the programme ends in April, it was clearly positioned by the Fed as a move to boost reserves and that “These actions are purely technical measures to support the effective implementation of the FOMC's monetary policy, and do not represent a change in the stance of monetary policy.” In other words, it’s not playing as a resumption of QE and the other good news, especially on trade, has driven a slight pull away from pricing an October 30 FOMC rate cut, which this morning sits at around 75%.

Chart: USDJPY
USDJPY found plenty of support last week in the trio of risk sentiment-supportive developments, which drove a chunky sell-off in long treasuries in particular. USDJPY managed to poke above the local pivot levels. Note the resistance from the 200-day moving average, and prior pivot levels around 109.00 as perhaps more important to overcome for the pair to sustain an upside break. Any return of weak risk sentiment and especially any fresh drop in long yields could drive a chunky reversal back to the strong side for the yen. In any case, the next few sessions look important for the JPY.