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Bannockburn Global Forex: Time Warp

By Andrew C. Collins | Managing Partner | Bannockburn Global Forex, LLC
 
I am beginning this currency update email at 11:18 am EDT.  I note this because it is my intent not to send it until later this afternoon, probably 3:30 pm.  The purpose of this time delay is to highlight the differences between my thoughts on the market now versus how they might change – in real time – this afternoon after the FOMC meeting.
 
As of now (11:21 am) the market is quiet.  All eyes are on new Fed Chair Jerome Powell and the market’s anticipation (95% according to current market pricing) that the Fed will tighten monetary policy by raising the Fed Funds target rate a quarter point, from 1.25-1.50% to 1.50-1.75%.  This effective rate of 1.63% would be the highest since 2008 when the Fed was taking rates lower in the wake of the Great Financial Crisis.  After this announcement, which will come at 2 pm, Mr. Powell will hold a one-hour press conference beginning at 2:30 pm. 
 
At this presser, market participants will be looking very closely at the Fed’s statement with regard to the so-called “Dot Plot” – a chart showing the median forecast of where the Fed Funds rate will be over the next few years.  Translation – when/how quickly will the Fed continue to tighten monetary policy?  A few months ago, the Dot Plot suggested a total of three rate hikes in 2018, but that number has shifted to closer to four hikes (including the one expected later today).  While the recent correlation between relative interest rates and currency strength has somewhat diminished, the USD indeed stabilized when the expectation of quicker tightening emerged (see Bloomberg chart of the dollar index below).
 
 
The FOMC meeting later is not the only market driver today.  In big NAFTA news, the MXN and CAD have both rallied significantly on the U.S.’s reported compromise on one of the more contentious aspects of the NAFTA renegotiations – a requirement that all autos exported from Canada or Mexico to the U.S. contain at least 50% of U.S. content.  Removing this requirement is perhaps evidence that the U.S. is backing off its hardline stance on the NAFTA talks.  The loonie has recovered 1.13% from its 1.3103 low yesterday to the current (11:41 am) 1.2955.  For its own part, the MXN has gained 1.05%, from 18.8066 yesterday to 18.5820 currently.  As previously reported in these updates, the CAD is this year’s biggest G10 loser, and it’s clear that NAFTA chatter is one of the biggest reasons why.
 
In Brexit news, a deal has reportedly been reached between the EU and UK and will be signed tomorrow in Brussels.  However, many UK members of parliament (MP’s) have vowed to vote against the deal as is currently constructed.  At issue: fishing rights.  In short, the current deal subjects Britain to the EU’s Common Fisheries Policy, while the objecting MP’s demand that Britain set its own policy.  The GBP initially fell on this news, but has recovered those losses and now trades comfortably above 1.4000, heights reached Monday when news of the Brexit deal first broke. 
 
Japan’s yen remains the strongest YTD G10 currency.  I can point to a few reasons why.  First, the Bank of Japan has hinted that its decades-long, extremely loose stance on monetary policy might be coming to an end.  Second, there has been just enough risk-off sentiment (geopolitical issues, equity sell-off, government shutdown(s) to name a few) percolating in the market, and we all know investors flock to the safe-haven yen during turbulent times.  Third, Japan’s fiscal year end is March 31 when many Japanese exporters repatriate their foreign currencies back into JPY.  USDJPY’s YTD intraday low is 105.25 and we are trading about a yen higher than that now (12:06 pm).
 
In Europe, Angela Merkel has begun her fourth term as Germany’s Chancellor, and today delivered her first policy speech since being re-elected.  The EU’s largest economy continues to improve, but the social and political divide between her Christian Democratic-led bloc and the nationalist Alternative for Germany group remains a concern: said nationalists entered parliament for the first time.  The uncertainty surrounding Merkel’s ability to ‘get things done’ is surely partly to blame for the EUR’s recent move lower.  However, given the EUR’s meteoric rise over the course of the past year, one could make the argument that this is simply profit taking.  Chart-wise (see below), you can see the shallowness of the current EUR dip.
 
 
The Antipodean currencies (AUD and NZD) have traded with a weaker bias recently on news that China could be planning countermeasures in response to U.S. tariffs.  China is by far Australia’s and New Zealand’s largest trading partner, and such countermeasures would likely negatively impact their economies.  Specific to Australia, the RBA was more dovish than expected at its most recent policy meeting, and the AUD has been on the defensive since.  Markets are currently pricing in no change to interest rates this year (1.50% cash target rate), and only a quarter point hike in the first half of 2019.  This is in stark contrast to the typically hawkish RBA, and a big reason the AUD is the second worst performing G10 currency in 2018.
 
Equity markets are comfortably higher as we await the Fed, perhaps a sign that the market is expecting a slightly less hawkish announcement than previously expected.  I will now (12:37 pm) take a pause and resume this update once the Fed news begins to hit the wires.
 
 
2:03 pm:  As expected, the Fed has raised the Fed Funds target rate a quarter point to 1.50-1.75%.
 
Highlights of the Fed statement:
                – Fed expects ‘gradual rate increases’
– Median forecast is for three total rate hikes in 2018 (slightly dovish)
– Median forecast is for three more hikes in 2019 (more than the two previously expected, thus slightly hawkish)
– Median forecast is for nearly three more hikes in 2020.  This would be the target range at just under 3.40%
– Indicates that rates will ultimately moderate at lower levels than the historic norm, lower than the 3.40% 2020 projection
– Economic outlook has ‘strengthened recently’
– No change to anticipated inflation rate but lowers unemployment forecast to 3.6% – ‘Goldilocks’
 
Market Reaction:
                – Yields spike then moderate, equities were up pre-announcement and have added to those gains – more evidence of a ‘Goldilocks” numbers
                – Dollar index spikes then falls (see chart below), seemingly awaiting Mr. Powell’s comments in nine minutes
 
 
 
Press Conference (2:34 pm) Highlights:
 
                – Median fed funds target by year:
                                2018: 2.1%
                                2019: 2.9%
                                2020: 3.4%, which is higher than the long-term projection
                –  Higher growth and lower unemployment expectations, yet little change in inflation target.  Reflects that the correlation between slack and inflation is not so much there.
                – Trying to take a middle ground between raising rates too quickly and thwarting growth and getting behind the curve and risking higher inflation (obvious).
                – Median growth estimate of 2.7% is just that – a median estimate.  White House estimate of 3.0% growth from tax reform impact is higher than almost every Fed governor’s projection.
 
(2:45 pm – equities have erased pre-Fed gains and are now only marginally higher for the day.  Yields are well off their intraday highs.  The dollar is modestly weaker.)
               
                – Will use monetary policy as the principal tool in adjusting policy, likely not balance sheet manipulation.
                – Some asset prices are above historic norms
                – Trade policy was a low profile risk that has become a more prominent risk
 
(2:52 pm – equities have now turned negative.  S&P now down 5.77 points after being up nearly 25 points earlier.  Dollar weakness picking up steam)
 
                – Wage growth should reflect inflation and productivity increases, both of which have been muted.
                – Election cycles are irrelevant when determining to/not to raise rates
                – In response to the flattening yield curve, which historically can lead to a recession: Recession probability is not any higher now than it has been.
 
3:14 pm – the press conference just ended.  The 10-year yield spiked at 2.92% and has come off, currently at 2.892%.  Equities have now come off their lows at 2:52 pm, the S&P 500 up 10.65 points.  The dollar is broadly weaker.
 
Indications:
EUR:      1.2328
GBP:      1.4132
JPY:       106.10
CHF:       0.9502
CAD:      1.2910
AUD:     0.7769
NZD:      0.7217
SEK:       8.1940
DKK:      6.0432
NOK:     7.7095
RUB:      56.9294
CNY:      6.3232
INR:       65.2100
SGD:      1.3125
HKD:      7.8459
BRL:       3.2708
COP:      2851.02
MXN:    18.4750
 
As always, call for anything FX related.
 
 

Compliments of Bannockburn Global Forex, LLC, a member of the EACCNY