Chief Macro Strategist
Summary: The Powell Fed must continue to deliver on market expectations at minimum as it is too early in the cycle to surprise to the dovish side. This will mean that Powell should have a hard time not allowing that even larger rate hikes are set for a coming meeting or two. But how high is the bar for the USD to continue rallying and for USD yields to continue higher along all points of the US treasury yield curve?
FX Trading focus: FOMC expectations and the reaction function. BoE important tomorrow.
I am expecting the Fed to hike 50 basis points today and for Chair Powell to indicate in the Q&A that there is the possibility of a 50 basis points “or greater” at coming meetings (the “s” important there) . I expect the Fed will guide as expected on quantitative tightening to ramp up to the $95 billion/month pace over the summer (NOT waiting until Labor Day in September) with guidance for future fine-tuning reviews. The Fed is least comfortable with its understanding of QT impacts and won’t want to surprise on that front by much for now).
In general, a hawkish surprise could raise the front end of the yield curve ever so slightly. I could be wrong at the margin in leaning for far higher odds of a hawkish surprise. An alternative scenario could be Powell simply making a blanket comment that he refuses to comment specifically on the size of coming hikes, but that they will be appropriate to the circumstances (in a way that could be read as even more potentially hawkish). Regardless, the conviction comes as it is far too early for the Fed to not at least signal that it is willing to do what the market expects for the coming few meetings and odds are not small that the Fed goes ahead with 75 basis points today (favourite scenario still at 62.5-bp hike to get the rate to 1.00% and ditching the upper/lower bounds that are irrelevant when policy isn’t close to zero). The market is pricing high odds that at least one of the following two FOMC meetings will see a larger than 75-basis point move. As for the USD reaction, that will depend on the pair, but the only way I can see tonight as USD negative is if the market is leaning even harder for more Fed hawkishness than what the Fed delivers – and I am not seeing signs of that. the most supportive for the US dollar would likely be a further lifting of US yields all along the yield curve – for more thoughts on that, consider the USDJPY chart discussion below.
Chart: USDJPY
USDJPY will focus squarely on the long end of the US yield curve in all likelihood on the back of tonight’s FOMC meeting. If Powell and company surprise significantly to the hawkish side, it won’t necessarily spark a durable rally higher in USDJPY if long US treasury yields don’t follow suit, as discussed above. Ergo, the only likely path lower for a more pronounced USDJPY sell-off would be on a sharp jerk lower in long US yields on the assumption that the Fed is getting ahead of the inflation risk and that the policy tightening priced in for the next few quarters will lead to an inflation-crushing softening of the economy. Probably the most bullish development for the pair, on the other hand, would be a Fed that generally fails to surprise expectations much and sees US longer yields rushing to new cycle highs. Momentum is slightly divergent – but that setup would likely only find confirmation on US treasury yields in steep retreat post-FOMC and a move and close below perhaps 128.50 to start.
A brief preview of the Bank of England tomorrow is in order as well, as I have been surprised at the degree to which UK yields have backed up, if not as aggressively as their US counterparts. The Bank of England is clearly holding its nose as it reaches for the rate hike lever at every meeting and is faced with the prospect of rolling out active QT at tomorrow’s meeting (versus the passive it has already been doing, i.e., not replacing maturing bonds.) Can’t help but wonder whether the market will pick up again on the contrast of the determined Fed and its hawkish inertia versus the BoE reluctance to continue to do what it is doing. The psychologically important 1.2500 has been in play in GBPUSD, but the really big focus lower is the massive 1.2000 level. EURGBP has continued to find sloppy resistance around the 200-day moving average for many months now – currently just below 0.8450. While yes, the BoE has beaten the ECB to the punch by a mile in beginning its tightening regime and will do far more than the ECB over the next six months, the UK structural headwinds are greater in terms of external deficits, a fiscal belt tightening lies ahead, contrasting with a powerful EU fiscal expansion, and the UK supply-side limitations are even greater.
Table: FX Board of G10 and CNH trend evolution and strength.
Not much changing of late here – watching USD over FOMC, but also JPY given long yield discussion above, watching GBP post-BoE tomorrow and watching CNH as Chinese markets are back on line tomorrow after the long holiday.
Table: FX Board Trend Scoreboard for individual pairs.
USD fully embedded in powerful uptrend – will take a massive shift to end that status. Given the JPY and yield discussion above, interested in watching whether the JPY gets a boost or a blast lower post-FOMC – AUDJPY and CNHJPY in the spotlight for trend status in coming days on that front. And then – watching the EURGBP if it pulls into the upside trigger area post-BoE for a purer read on GBP than that provided by GBPUSD.
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