Today sees one of the most critical and highly anticipated FOMC days in a long time, as we are in the midst of the pivot from an ever accommodative Fed. The only high probability outcome is high volatility.
The evidence of this anticipation is less clear in the currency market, than it is in the short-term interest rate futures market where the swings have reached very large proportions compared to the moves of the last couple of years. The June 2016 EuroDollar STIR future, for example, has suffered its largest sell-off since late 2010 from May to earlier this month. The July 2015 Fed Funds rate future has even sold off as much as 35 ticks from recent highs lately, as some are even anticipating that the actual rate could begin to move by then despite the “late 2015” rhetoric in the Fed’s monetary policy statements for the last couple of years.
To taper or not to taper – that is not the question
The key from here is not whether the FOMC is going to indicate a taper is on the way at this meeting – the indication will be there in a more “concrete” way than ever, whether it is via an escalation of hints in the monetary policy statement itself or more in Bernanke’s press conference.
Focus should rather be on whether the Fed is so petrified of its own shadow over the market that it rolls out the message of the eventual reduction in bond buying in an extremely cautious way. After yesterday’s 53-year low CPI inflation print (), some might believe that the Fed has plenty of time to hem and haw, but as both I and many others have argued lately, the Fed is more concerned at this point about asset markets and financial stability (the reach for yield) than economic data, so the taper is coming.
I don’t have much visibility on what the FOMC will actually say, but one way that the Fed might try to have its cake and eat it too is to ratchet up the expectations that accommodation will slow without being specific on the timing – in other words, keeping conditions easy for the economy, but keeping uncertainty high enough that a lid is kept on asset markets.
Otherwise, if we merely get a version of what Hilsenrath wrote about recently – that the Fed will expend most of its efforts in a silly education attempt aimed at underlining that a reduction of asset purchases is not the same as raising rates, this is the most USD-negative outcome. Also look for the economic projections for signs that the FOMC is trying to send its message about what it will do that way.
FOMC reactions
As for market reactions to the FOMC, the curious pattern of late has been that despite Fed tapering talk, the US dollar has been weak and USDJPY remains rather weak. Eventually, this USDJPY correction has to end if we see higher bond yields again – or even if they merely stop falling – and on the growing consensus that the Fed accommodation will begin slowing – whether that is in September or December doesn’t matter. Sure, USDJPY could spike lower still in the nearest term if risky assets plunge again, but the Fed unwinding accommodation is fundamentally USDJPY bullish eventually.
Looking at EURUSD, yesterday’s action in the face of Draghi’s attempt to talk down the Euro was impressive and the recent run-up has shown absolutely no signs of weakness, so I want to see a big sell-off before I believe that the pair is going to turn around again. In fact, a too cautious Fed message combined with the evident Euro strength could mean sharp additional upside in the near term.
Charts: Taper anticipation versus actual rate differentials
Chart: EuroDollar 2016 June vs. EURUSD
The chart of the 2016 June 3-month EuroDollar STIR doesn’t show any real correlation lately with the moves in EURUSD. (Nor does spreading that against the 2016 June Euribor, by the way.)
Chart: EUR/USD vs. 2-year SWAP spread
Here, we see that the EURUSD strength is nearly perfectly mirrored in the 2-year swap spreads, where the tight ECB is far more evident relative to the Fed. We’ll need to see an easier ECB and a more hawkish Fed to turn this spread around, and therefore to turn EUR/USD around.
In other news…
Elsewhere, we have the BoE minutes up shortly (see my post yesterday that shows all recent BoE minutes days for perspective. The upside key is 0.8600 if the rally is going to hold in EURGBP, while GBPUSD has been mulling whether it really wants to take out that 200-day moving average around 1.5700.
Don’t forget that tomorrow we have the SNB out and that we are going into the meeting with no expectations – meaning asymmetric upside potential (potential doesn’t mean probability). It would be fairly easy for the SNB to surprise the market here, though I still think the JPY needs to stop rallying if the CHF is to weaken unless the SNB sends a very strong message that It is aiming to raise the EURCHF floor.
The Swedish krona is on fire as the government is unloading huge amounts of Nordea shares and on positive employment data today. Watch the 200-day moving average around 8.55 in EURSEK as the key technical level coming up to the downside.
There’s been a lot of talk about the liquidity crunch in China (http://www.bloomberg.com/news/2013-06-19/china-stock-index-futures-fall-amid-ipo-property-curbs-concern.html) at the moment, and tonight we have the flash HSBC manufacturing PMI reading – the situation in China is heating up.
Economic Data
- New Zealand Q1 Current Account Balance out at -0.663B vs. -0.6358B expected and vs. -3.23B in Q4
- Japan May Adjusted Merchandise Trade Balance out at -¥821B vs. -¥890B expected and -¥703B in Apr.
- Japan May Nationwide Department Store Sales rose +2.6% YoY vs. -0.5% in Apr.
- Sweden Jun. Consumer Confidence out at 4.3 vs. 4.5 expected and 3.6 in May
- Sweden May Unemployment Rate out at 7.9% vs. 8.4% expected and 8.4% in Apr.
- US Weekly DoE Crude Oil and Product Inventories (1430)
- US FOMC Rate Decision and release of Economic Projections (1800)
- US Fed’s Bernanke holds press conference (1830)
- UK’s Osborne, Meryn King to Speak and give details of RBS, Lloyds Sale (1900)
- New Zealand Q1 GDP (2245)
- China Jun. HSBC flash Manufacturing PMI (0145)