FX Update: USD funding issues show up just ahead of FOMC

Trading interest

• Taking profit on the long AUDNZD position above 1.0800 this morning rather than holding for more aggressive target
• Taking off the EURUSD long for a loss ahead of the 1.0980 stop due to the disappointing price action since the ECB and due to the upcoming FOMC event risk.

Somehow, a nine-dollar advance in crude oil prices has failed to trigger much more than a ripple of weak risk sentiment across global markets, with the yen and Swiss franc on their back foot this morning and EM currencies having hardly registered more than a polite retracement since the Monday open. The AUD suffered a minor setback overnight on the further dovish confirmation from the RBA minutes, but the activity in general is lacklustre despite the drama elsewhere.

The market, according to some measures like the CME’s Fedwatch, are pricing significant odds that the FOMC doesn’t cut rates at tomorrow’s meeting. Not entirely sure what the logic is there – due to inflation concerns on the spike in oil prices? Admittedly, the age of booming US shale production means that oil prices are a far different animal for the implications of US economic growth – with a sweet spot probably around here or a bit higher for encouraging activity in the shale patch without over-taxing the rest of the economy. But if the Fed doesn’t cut rates tomorrow, it will prove as large a policy error as any other for the cycle, including the December 2018 FOMC meeting that triggered the last avalanche of equity market selling for the cycle.

The USD funding issue has reared its head again with a sudden spike in measures like the FRA-OIS spread (to 45 basis points yesterday from about 32 basis points the previous day and levels below 20 basis points as recently as May-June) which suggest a sudden tightening of USD liquidity. The rising Trump deficits, the US treasury rebuilding reserves and possible corporate tax payments are the proximate causes here, but the system is running out of room and the Fed needs to indicate it is on top of this issue far more than it needs to signal anything via the dot plot or via its economic projections at tomorrow’s FOMC meeting. To get ahead of the curve, the Fed needs to admit it has lost control of the narrative and to signal QE coming sooner rather than later – the Fed can control its balance sheet or interest rates from here, but not both.

Chart: AUDUSD
AUDUSD finally turned the corner a bit more forcefully overnight and gave a leg up to bears as the important resistance zone over head held up over the last week. The pair is in a well-established downtrend since early 2018. The FOMC meeting tomorrow will decide the immediate fate of the pair, as another Fed policy mistake could risk an aggravated further rise in the US dollar. October will add to the drama for AUD as we await the next round of US-China trade talks. The RBA minutes overnight suggest the RBA is set to ease to at least 0.50% at coming meetings even if October 1 sees a no-change.