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The current mixture of strong macroeconomic signals and what is expected to be a strong showing from today's nonfarm payrolls report is flashing a "green light" to Federal Reserve hawks. Meanwhile, fear of Sunday's Italian vote seems to be fading.
Article / 20 September 2016 at 7:43 GMT

FX Update: Markets showing little fear of the Fed

Head of FX Strategy / Saxo Bank
Denmark
  • RBA minutes 'offer a wait-and-see stance'
  • AUD trade likely to centre on risk appetite
  • 'Ugly overhang' awaits Australian economy
  • BoJ, FOMC outings present 'double whammy' risk

Mind the gap
Mind the gap? Markets appear complacent ahead of the BoJ/FOMC outings, but this very steadiness could give way rapidly if there is any surprising news. Photo: iStock

By John J Hardy

The Reserve Bank of Australia minutes come from former governor Glenn Stevens' final meeting as governor, so they were looked on with little anticipation as the focus switches to any difference in the stance of new governor Philip Lowe, who appears before a parliamentary committee on Thursday this week. 

The minutes offer a wait-and-see stance as policy is “consistent with sustainable growth in the Australia economy and achieving the inflation target over time.” There was a mention of a stronger exchange rate potentially presenting challenges, but the wording was not particularly stern with the release stating that “[an] appreciating exchange rate could complicate the necessary adjustments in the economy”. 

The AUD hardly reacted to the meeting, and the Aussie's fortunes from here will likely correlate with risk appetite on the other side of the Bank of Japan meeting tomorrow morning and the Federal Open Market Committee meeting tomorrow evening. Our stance is that once this credit-fueled phase of growth is exhausted, an ugly overhang awaits the Australian economy, and we may be getting the first signs in this with the slowdown in wage growth that has been unfolding since 2013 in the form of a recent slowdown in house price appreciation. 

As well, Australia’s core CPI has been below the bank’s target 2-3% range for the last two quarters and the trade-weighted AUD is a couple of percentage points stronger in Q3 relative to Q2. 

The unbearable wait for the BoJ and FOMC continues (see our coverage from yesterday), with asset markets inevitably reacting strongly to these meetings as the last final major event risk ahead of the US presidential election with the possible exception of the Italian referendum (still no date). 

The double whammy that would sent volatility soaring would be a Fed rate hike and a BoJ admission that quantitative easing is not producing what is needed and that there will be a strong policy shift to negative rates, with any further purchase expansions only possible if needed to cover deficits due to fiscal expansion (in other words, “we’re done and it is your move, Shinzo Abe”).

Former BoJ member Shirai (on the policy board up until earlier this year) suggested a focus on more negative rates and away from more asset purchases would be the approach from here for the BoJ. This would represent a significant disappointment for asset markets, particularly for longer bonds if there is a simultaneous shift away from buying up longer bonds to ensure a steeper yield curve.

AUDNZD

A little distraction from the USD and JPY charts lately is the AUDNZD chart, though even this pair may be heavily impacted by the result of the BoJ and FOMC meetings, not to mention the Reserve Bank of New Zealand announcement shortly after the FOMC meeting tomorrow evening. 

NZD has risen on the reach-for-yield theme that has been ascendant since the ugly start to the year. Recently, NZD has found a boost on strong recovery in milk prices, NZ’s largest export. The RBNZ’s discomfort with the kiwi exchange rate must be intensifying, even if it has signaled little willingness to link rate cuts with suppressing the exchange rate. 

So, tomorrow, we’ll look at whether the bullish momentum divergence is confirmed with a solid rally and close after the RBNZ, or whether the market celebrates the BoJ/FOMC outcomes as a green light to reengage in the reach-for-yield theme and push the pair toward parity, which was almost touched back in April of 2014.

audnzd

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Source: Saxo Bank 

The G-10 rundown

USD – the market appears to be leaning towards the Fed not administering any shock therapy here, as the USD is firm against the major European currencies but softer against the risk-on currencies and EM. Odds of a hike are perhaps higher than the 20% suggested in market pricing. A Fed rate hike would be an enormous shock with the USD ripping higher versus EM and the commodity currencies first and foremost.

EUR – not entirely sure what this morning’s steep rally attempt is all about, except for perhaps short term positioning shenanigans. We’ll know the lay of the land tomorrow after the FOMC – with the key downside break the 1.1125 area and the upside pivot perhaps 1.1275/1.1300.

JPY – market smells a BoJ “disappointment” (a stepping away from the QE focus), but the burning question is whether long yields have turned higher now and whether the JPY can strengthen any further if they have.

GBP – sterling remains on the weak side despite the market trying to get complacent again ahead of these key event risks in the next 36 hours, suggesting the risk of further weakness. Watching the 1.3000 level in GBPUSD as the psychological support of note and then the cycle lows just below 1.2800.

CHF – watching for higher yields as the most interesting test for CHF complacency – with 1.0950/1.100 the upside pivot zone for EURCHF. USDCHF is the more interesting story, especially in the event of a shock Fed rate hike tomorrow.

AUD – the Aussie creeping back higher as markets trying to get back on the complacency track and buy risk and high-yielders over the last couple of sessions. Meanwhile, wait-and-see RBA minutes aside, there exist growing signs of headwinds for the Australian economy as Q2 house prices rose at their slowest year-on-year rate since 2013.

CAD – the loonie one of the weaker currencies at the moment as oil prices press near recent lows and USDCAD pressing near key 1.3250 resistance despite relatively weak USD. Note that Bank of Canada governor Poloz out speaking later.

NZD – AUDNZD is trying valiantly to turn the corner as we note in the chart comments above, but two-way risks due to RBNZ and depending on outcome for the reach-for-yield theme after BoJ/FOMC meetings tomorrow.

SEK – EURSEK doesn’t seem to want to push lower and at least another test of 9.60 looks likely and could follow through higher still if we get a risk averse response to BoJ/FOMC tomorrow.

NOK - weak oil prices dragging slightly on NOK, as EURNOK chops around without conviction head of Norges Bank on Thursday. NOK is cheap, but deservedly so as NOK features the lowest real rate by a long shot among G10 currencies.

Upcoming Economic Calendar

  • 1200 – Hungary Central Bank Decision 
  • 1230 – US Aug. Housing Starts and Building Permits 
  • 1635 – Canada Bank of Canada’s Poloz to Speak 

— Edited by Michael McKenna

John J Hardy is head of FX strategy at Saxo Bank

20 September
Arvydas Dabulskis Arvydas Dabulskis
Thanks John Hardy for great article.
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20 September
Clare MacCarthy Clare MacCarthy
Thanks Arvydas, our web developers are right now working on a fix.
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