Today's edition of the Saxo Morning Call features the SaxoStrats team discussing the continuing weakness of the US dollar as commodity prices recover ground and in the wake of key US equity indices hitting all-time highs Thursday.
Article / 12 June 2017 at 7:16 GMT

FX Update: FOMC in times of ebbing volatility — #SaxoStrats

Head of FX Strategy / Saxo Bank
  • Macron's huge majority is good news for France and potentially EU and euro
  • Extreme right suffered, also in Italy, hinting at increased stability
  • This week's FOMC meeting comes at awkward time
  • Fed may have to provide a clear dovish surprise to move the USD broadly lower
Set to get a huge majority in parliament: French president Emmanuel Macron and his LREM. Photo: Shutterstock
By John Hardy

This weekend’s first round of France’s primary election has confirmed the polling showing that the Macron revolution continues as his upstart party is set to reap the largest parliamentary majority in a generation, a mandate that should lead to much needed change in France. That news won’t become formal until this Sunday’s runoff election. 

The economic upside potential for the country is tremendous, on Macron’s promised policies, especially labour force mobility and tax reform. Whether France’s labour unions will see the political writing on the wall or choose the disruptive tactics of the past and the exact shape of reforms remain open questions. 

Then, the critical longer term question for the euro is whether Macron’s vision for a more integrated Europe eventually leads to a stable foundation the EU has always lacked, providing a path toward mutualisation of debt. The Italian election will inevitably prove the next existential test – as the latest attempt at a change to Itay’s electoral law has failed. The latest news is that Italy’s five-star movement has suffered a setback in local elections over the weekend and is therefore less likely to clamour for a snap election. 

This week, we have a key FOMC meeting that arrives at a very awkward time for Yellen and company, as the US economy has hit a soft patch just as they were gearing up to discuss how the Fed plans to unwind its balance sheet. The most recent minutes suggest the Fed wants to look through recent data as transitory, while it appears expectations from the market are increasingly leaning toward a “dovish hike”, in which the Fed upgrades the concerns on the soft patch slightly and perhaps makes further tightening sound more conditional. 

Given the USD’s marked weakness of late, the Fed may have to provide a clear dovish surprise to move the USD broadly lower. So the upside surprise (Fed remains commited to slow unwind and gets specific on balance sheet reduction timing) is perhaps the side with more volatility.

Regardless of the spin from the FOMC and Yellen’s performance this week, we’ll watch the US 10-year yield as an important barometer, as recent lows in yield failed to hold and are a critical coincident indicator for USDJPY, as we watch the pivotal 110.00-50 area this week.

Elsewhere, it will be a week of watching the political noise out of the UK on the shape of the government and whether the Conservative can succeed in shaping a workable agreement with the small DUP party, as a number of social issues could yet stand in the way. The noise from the commenting class is that this uncertain outcome actually shifts the risk for a softer Brexit, though that will depend on the EU’s mercy.

USDCAD looks heavy after last week’s May jobs data out of Canada, but can CAD bull higher with oil prices pinned near the lows for the year? Tough to trust any downside attempt amid very weak volatility environment (subject to false breaks) and we’ll have to see the lay of the land for the greenback after this week’s FOMC meeting.
Source: Saxo Bank
The G-10 rundown

USD – pivotal on the FOMC this week as discussed above. Some risk that the FOMC fails to provide any real takeaway (after all, conditional guidance simply means the Fed will react to incoming data…) and that we drift into a summer of very low volatility.

EUR – a very dovish ECB last week and euro can only consolidate gently – watching EURUSD over FOMC this week on whether we risk a dip into low volatility doldrums this summer.

JPY – the yen likely to key on US interest rate direction this week – if US 10-year holds the line and pulls back into the range, USDJPY will likely slip higher as well – 110.50-75 area critical after last week’s rally attempt.

GBP – We still don’t fully know the shape of the UK government, but the latest noise is that the risks are pointing toward a softer Brexit stance after the Conservatives weak showing at the election and its possible coalition party, the Northern Irish DUP. wants to maintain a soft border with Ireland. Not sure how the Bank of England contributes anything at all to the equation this week. 0.8750 and 0.8850 are the two lines in the sand for the moment in EURGBP, the purest way to judge sterling’s direction this week.

CHF – watching whether we finally print a smaller number in the SNB’s weekly sight deposit data this week after a nearly flat reading and whether the market cares. If yields head higher on this week’s FOMC, could prove a CHF negative.

AUD – near record low volatility in AUDUSD options and the fact that we have been coiling in a range established more than a year ago has us questioning the quality of the latest rally.

CAD – USDCAD pushing into the pivotal sub-1.3400 area and the 200-day moving average that is rising quickly from below. Oil prices are not at all supportive, though last week’s May jobs report was very strong. USDCAD looks technically heavy, though it’s a tough sell, given the focus on the risk of a Canadian housing bust and current energy prices. Will take some USD weakness as much as CAD strength, likely, if we’re to see a notable break lower.

NZD – The Q1 GDP report the focus this Thursday after the kiwi has been on a nosebleed-inducing run higher of late. Any miss in the number may be heavily punished. Meanwhile, noticing that housing activity has plummeted, with a -31% drop in house sales. Could the NZ housing market be the next shoe to drop? Activity leads prices.

SEK – watching whether tomorrow’s CPI provides a much needed catalyst for EURSEK outside of 9.70-9.80 range.

NOK – oil prices pinned near the lows for the cycle while EURNOK has stayed corralled below the previous highs for the cycle around 9.58. Tomorrow’s Region Survey (somewhat like a Fed Beige Book) the notably event risk of the week.

— Edited by Clemens Bomsdorf

John J Hardy is head of FX strategy at Saxo Bank


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