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John J Hardy
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Article / 19 September 2016 at 7:34 GMT

FX Update: Inflation swells dollar, but Fed remains the focus

Head of FX Strategy / Saxo Bank
Denmark
  • US CPI beats expectations
  • BoJ, FOMC meetings in focus
  • Emphasis on post-QE central bank policy

USD
A stronger-than-expected US inflation reading has the dollar soaring 
again, but the focus remains on the Fed. Photo: iStock 

By John J Hardy

The US CPI release Friday surprised to the upside, catching the market wrong-footed once again, as this theoretically complicates the outlook around this week’s FOMC meeting. That core US August CPI reading at 2.3% year-on-year matches the highest reading since the global financial crisis, though the Federal Reserve’s preferred PCE core inflation measure is still down at 1.6%. 

This week’s central bank bonanza sees four central banks announcing policy decisions and the minutes from the Reserve Bank of Australia (tonight) and tomorrow (Sweden's Riksbank). The chief focus, of course, is on both the Bank of Japan and Federal Open Market Committee meetings, with considerable uncertainty on the guidance as much as the policy decisions.

But most of all, the chief uncertainty here is how markets navigate the apparent shift away from the focus on QE and transition to the whatever the future of policy holds. Central bankers are losing their ability and desire to do more of the same.

(The European Central Bank and BoJ bumping up against practical limits to further intervention and loudly highlighting the need for a fiscal focus if policy is to move the needle, while the Fed is slowly beginning to throw off signals that it is not confident in its own policy options and has also suggested fiscal stimulus as the next step).

So around the meeting announcements this week, keep in mind the risk that the narrative will focus on whether the BoJ and FOMC have “disappointed” to the hawkish or dovish side, triggering a kneejerk reaction, but that the longer term theme shift and tectonics of what is transpiring – the shift from a QE to a fiscal focus – asserts and renders the immediate reactions meaningless. 

The loudest signal on that front would be “dovish” surprises from both the BoJ that are nonetheless met with an intense sell-off in bonds at the long end and a similar selloff in stocks, akin to what we saw after the ECB failed to move further on policy. 

If we see the opposite, then we have a market that retains the ability to rally on accommodative central banks in the immediate term, even if we suspect this big shift away from QE-to-infinity-and-beyond is well under way.

We’re more or less in line with consensus that the Bank of Japan focuses on lowering the policy rate further into negative territory while suggesting that it would like a more steeply sloped yield curve. We’re actually more uncertain of the Fed’s intention, having a hard time believing that they will hike even if it is clear that many on the FOMC would like to hike. 

If there is a surprise hike or a notably hawkish upgrade for the short-term policy guidance, watch the Fed try to guide the longer term policy forecasts lower on the “dot plot” after all of the recent noise that the neutral policy rate is far lower now than it has been in the past.

EURUSD

EURUSD sold off through the local support on the strong CPI release on Friday and had another look at the key local support and 200-day moving average. We’ll likely have to wait for the other side of the FOMC meeting for whether we’ll get confirmation of the bearish setup and a move to the next key trigger area toward 1.1000.

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Source: Saxo Bank 

The G-10 rundown

USD – all about the FOMC on Wednesday. Very low odds of a rate move priced in, but the CPI last Friday keeps the plot interesting, as does the mix of recent rhetoric from the Fed. Dovish hike or hawkish hold or none of the above? The Fed has lost all credibility so it may not even matter.

EUR – euro looking weaker after Friday’s action but see few catalysts for the currency this week, though would expect general firmness (outside of EURUSD and possibly EURJPY) if we see risky assets disappointed with the BoJ/FOMC decision midweek.

JPY – the market appears relatively confident in what the BoJ will announce and that it is nearing the end of its policy rope. The obvious reaction, given the clear descending triangle setup in USDJPY, would be resolution lower through the 100.00 level, but again, note our interest in the implications of the long term shift from the focus on QE to fiscal and what this could mean for long interest rates, where higher rates have usually been highly JPY-negative in the past.

GBP – an ugly plunge Friday reminds us how . A Lloyds survey released today suggests UK companies’ investment intentions have also been heavily impacted by the Brexit vote. A break of 1.3000 in GBPUSD points to 1.2800, but the trading will likely be treacherous this week.

CHF – continues to do little, but should see far more volatility if the long end of the major sovereign yield curves are heavily impacted by this week’s BoJ and FOMC meetings.

AUD – AUD resurgent after bottoming out at the middle of last week and it looks like AUD is highly correlated with risk appetite this week, so the Aussie should have high beta to the market energy this week.

CAD – the upside break level could not be more clearly etched on the USDCAD chart as we have the 1.3250-plus level now coinciding with the 200-day moving average.

NZD – NZD refuses to stay down for long and NZDUSD has gone sideways for four sessions after the bearish reversal now as we await this Wednesday’s FOMC and BoJ meetings. Little apparent reason for RBNZ to cut rates, but the strength of the currency has to be an intensifying concern.

SEK – EURSEK lacking volatility. Assuming a low beta of SEK to risk appetite, as well as bond yields (either sharply higher yields or weak risk appetite or both as SEK negative). 9.60 is a huge chart level for EURSEK.

NOK – bounce in oil has EURNOK back a bit lower this morning – but EURNOK is coiling in a range until we get a notable spark to shift sentiment. Norges Bank perhaps unlikely to provide that spark this Thursday with its announcement. Why cut rates when you already have the most negative real rates among G10 currencies?

Upcoming Economic Calendar Highlights (all times GMT)

  • 1400 – US Sep. NAHB Housing Market Index 
  • 1700 – Euro Zone ECB’s Mersch to Speak 

— Edited by Michael McKenna

John J Hardy is head of FX strategy at Saxo Bank

19 September
TheNomad TheNomad
indeed core is still down below the 2% target and that high CPI number was due to the medical sector ( bigger medical bill). As always have to bring myself down to the dumb market reaction. But hey it is good bargain hunting
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