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We had the ‘Fed put’ for much of 2012 to 2014, whereby markets would rally on evidence of poor data. Bad news meant good news for equity bulls and, as we have learnt time and time again, liquidity trumps economic improvement.
This is a strange world we live in, where investors see improvement as a bad thing and central banks use markets to drive economics, which is contrary to every economics textbook that says stock markets should reflect economics. The USD bulls will argue that theme should be off the table now as the Fed has brought themselves pure flexibility.
US growth likely to snap back in Q2
US economic growth is tracking around 1% to 1.5% for Q1. However, the Fed would be expecting a snap back in Q2 to around 2.8% and this should coincide with inflation at a trough point before moving higher into year-end.
This same inflationary trend is true of the UK economy and China as well, and this is exactly what the Fed would like to see - a global move higher as one. Whether this actually transpires is yet to be seen and wages are key as brent prices still have way too much effect on inflation expectations right now, as we can see from the correlations between oil and bond and swaps pricing.
So higher inflation is key, but it seems that the idea the Fed thinks globally but acts locally is absolutely true, and they know that most other central banks have one eye on Fed policy and another on economic inputs such as energy.
That being said, there has been a noticeable increase in market participants calling for limited upside from here in the USD. I am sceptical of this call and remain a USD bull, although longer-term forecasting is fraught with danger and original calls are generally revised multiple times.
However, it is true that a number of the key macro consensus trades are being questioned at the moment, of which long USD was at the heart of them. I don’t think the Fed are too concerned with the USD where it is, but more that the pace of the appreciation was just way too crazy.
It has occasionally proven beneficial to put an element of doubt into markets over the years, especially when things became so one way. This has worked well for the Bank of Japan of late as they didn’t mind a weakening JPY – just not one that was in freefall.
It has to be said, though, that the volatility in FX markets right now is breathtaking, with volatility in the bond market elevated as well. Both markets have had a strong shake-up of the once-consensus view of a rate hike in the June-to-September window and investors and traders are all working hard to achieve a new equilibrium or fair value as such.
Expect choppy trading in both markets in the short-term and it seems logical that EUR/USD could dictate whether European markets continue their outperformance of US markets. Surely equities are not as binary as where EUR/USD trades, but it seems the influence of the EUR and USD on both markets is very strong at present.
Increased uncertainty for USD bulls
We saw better selling of USDs after the huge reversals overnight and EUR/USD has pushed higher, looking like it could squeeze back into the $1.0800 area. The key (albeit optimistic) sell area in this pair is into the 50% retracement of the 25 February to 13 March sell-off at $1.0927, although the post-FOMC spike high of $1.1044 is the much-watched level.
AUD/USD held the September channel and, given the 90.7% probability the interbank market is pricing in a May cut from the Reserve Bank, suggests we should see rallies contained. Especially with Glenn Stevens holding a very glass-half-full view in today’s economic outlook and admitting monetary policy may not control all Australia’s vulnerabilities. Once again, I’d use the post-FOMC rally high at $0.7848 as a guide.
Asian equity bourses have had very flat moves today and US futures highlight the clear lack of impetus for traders to push markets around in either direction. In upcoming trade we get to hear from Fed presidents Dennis Lockhart and Charles Evans, with the latter only having just released another uber-dovish tilt on monetary policy.
We also get German producer prices and Spanish trade data, although further focus on Greece will be in play. In the UK we have public sector net borrowing data, with cable looking to stabilise above $1.4700 and showing signs of a strong sell into $1.4951 to $1.4984 area (the 23 January low and 38.2% retracement of the 26 February sell-off).