Article / 22 July 2016 at 13:00 GMT

FX 4 Next Week: Looking for Fed to nudge rate expectations upward

Head of FX Strategy / Saxo Bank
  • July 27 FOMC could try to talk rate rise expections up a bit to avoid Sept surprise
  • Upside seen for USDCAD as lower oil weighs on CAD
  • We continue to like AUDNZD higher
  • Traders may want to wait for a technical break in EURUSD before getting involved
  • Downside seen in JPY crosses, perhaps especially GBPJPY

The Bank
 The Fed and Bank of Japan are on the slate for the coming week. Photo: iStock 

By John J Hardy

Our outlook over the next week is in the shadow of two key central bank meetings, the Federal Open Market Committee on Wednesday and the Bank of Japan on Friday. We suspect that the FOMC would like to talk market expectations for a rate hike a bit higher, simply to avoid a “surprise hike” in September if the economic data in the US continues to firm. 

As for the BoJ, we suspect that market expectations have got ahead of where the BoJ is ready to go, leaving the JPY to consolidated back to the strong side after its recent weakness.

USDCAD upside

Oil prices have been settling lower and weighing on CAD lately as USDCAD has coiled in a tightening range in recent weeks. As well, ugly trade numbers for Canada point to the continued erosion of structural fundamentals, as does the enormous private sector debt leverage in the Canadian economy, which serves as a longer term negative drag on CAD. 

After the strong pull higher for risk appetite recently on the anticipation of post-Brexit easy liquidity from global central banks, we could see the FOMC in a somewhat more hawkish stance since Brexit failed to dent global confidence. A Wednesday FOMC statement could see the Fed trying to talk the market into a more balanced outlook for the probability of a rate hike, which is still judged at only a 25% likelihood for the September meeting. This, or simply some mean reversion after a long run higher for global risk appetite could keep risk-correlated currencies on the defensive versus the USD.

Trading stance: Traders will look for a break of the 1.3140 area in USDCAD on daily closes and look to add if the FOMC statement release Wednesday strengthens the USD for a run toward 1.3300-1.3400.

AUDNZD longs

We continue to like AUDNZD higher, both for fundamental reasons because of greater potential for the RBNZ to reduce rates and thus drive the interest rate spread wider. The risk this coming week is that we get a weaker than anticipated Q2 CPI number out of Australia mid-week – but as long as the daily closes stay north of the 1.0550/1.0600 zone, bulls will continue to prefer the upside after the recent new lows were strongly rejected. The RBA meets on August 2 and the RBNZ meets on Aug 11.

Trading stance: AUDNZD bulls will buy into weakness for a try toward 1.0950 in the weeks ahead.

EURUSD breakouts post-FOMC

This is a carryover once again from last week, as we never got a breakout signal for EURUSD out of the current tight range and something needs to give as we await a directional resolution soon after a tease below the 1.1000 level this week. We still prefer the downside, but traders may want to wait for a technical break before getting involved after a long, frustrating bout of trading within the range. And if the Fed fails to deliver sufficiently hawkish guidance to boost odds of a rate hike in September or December, the price may resolve higher again.

Trading stance: EURUSD traders may want to wait until after the FOMC meeting to trade EURUSD next week, especially if we fail to see a close above 1.1150 or below 1.1000. Those are the breakout levels that could lead to 200-pip extension of the price or more in the direction of the break after the FOMC statement release.

JPY cross downside

The next Bank of Japan meeting is up on Friday next week after a recent JPY selloff driven by expectations that after the strong endorsement of Prime Minister Abe after the upper house elections, some bold new policy moves could be forthcoming. The market may be over-anticipating on this front, and the risk is that the BoJ underdelivers at next week’s meeting when most of the focus is on fiscal stimulus/eventual helicopter money anyway. And it could take more time to define and launch the eventual fiscal stimulus, while helicopter money (cash injections into consumers’ hands) looks very far off after government officials explicitly rejected the legality and possibility of the idea.

Trading stance: When the JPY moves, it often does so across the board, so traders may choose relatively indiscriminately among JPY crosses, though GBPJPY downside might merit extra consideration given the weak UK flash PMI data on Friday that pushed the sterling firmly back lower after an attempt to the strong side this week.

— Edited by John Acher

John J Hardy is head of FX strategy at Saxo Bank


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