Dollar drops across the board as the Fed delivers a much expected 25-bp rate cut in the Fed funds rate and discount rate to 4.50% and 5.00% respectively. The accompanying dissent from Kansas Fed president Hoenig voting for no change and the markedly more hawkish language have triggered fresh losses in the dollar, while triggering choppiness in a confused equity market.
Three Signs the FOMC Statement is more Hawkish
The FOMC statement indicated a move towards a more balanced policy stance by stating that: ???The Committee judges that, after this action, the upside risks to inflation roughly balance the downside risks to growth???. This in our view is a hawkish stance, considering that housing deterioration shows no signs of a reprieve, while labor markets and consumption are continue to weaken.
The Fed firmed its inflation vigilance by stating that ?????¦recent increases in energy and commodity prices, among other factors, may put renewed upward pressure on inflation???, compared to September??™s statement indicating ???Readings on core inflation have improved modestly this year??? without interjecting on the risks from commodity prices.
The third sign of hawkishness is the dissent from Kansas fed president Hoenig, who voted for no change in interest rates. This neither suggests that Chairman Bernanke has complete command over the Committee, nor augurs well for the continued data erosion in housing. Whether Hoenig??™s decision reflected a -wait-and-see stance, or a more definite stance towards inflation remains to be seen.
Yield Curve Back up & Dollar Decline = Double Whammy for Long term Treasuries
Although the Fed??™s stepped up inflation vigilance suggests that future rate cuts are less probable, we expect the economic realities to resurrect the downside risks for the economy, whether via interest rate resets next year (exacerbated by further gains in long term yields) or looser labor markets. 10-year yields have risen to 3.91% from 3.8% before the announcement, which should further raise the risk for foreign demand for US Treasuries, especially given further dollar losses ahead.
Today??™s decision reduces the US Fed funds rate to the same level as Canada for the first time since February 2005, while reducing the dollar??™s yield advantage over that of the Eurozone to the lowest level also since February 2005. Despite the dollar??™s absolute rate advantage over rates in Japan and Switzerland, it is the expectations of further currency losses that is expected to erode the remaining rate differential. The onset for prolonged Fed rate cuts is similarly matched by the likelihood of non-US interest rates remaining unchanged, or even rising in the short-term as is the case of Australia . The unwinding in US housing continues unabated from a perspective of falling prices, falling sales of new and existing homes, increased months??™ supply and falling construction jobs. Today??™s latest advance in gold to a fresh 28-year high (January 1980) of $798 per ounce at the NY Comex is clearly a manifestation of the deteriorating dollar fundamentals and outlook. Indeed, soaring gold prices have also been driven by falling production (lowest in 10 years), slower rate of selling by global central banks and record high interest by purchases of ETFs and futures contracts
The contrast between record high equities and the corrosion in the housing data resurrects shades of late February and mid July when sharp equity selloffs caught up with the weakening economic data, prompting a sharp unwinding of risk appetite trades. Although the resulting decline in the dollar has been considerable, further losses in the greenback are largely dependent upon the monetary policies of overseas central banks, which currently remain neutral to hawkish.
POST FOMC FX STRATEGIES
CADJPY Bull on Course for 122.50
A stronger than expected 0.2% increase in Canada??™s August GDP following an 0.2% rise in July GDP sustains the lonnie??™s bull across the board. Also spurring the CAD is new highs in oil at $94 per barrel after the bigger than expected drawdown in weekly crude stocks of 3.3 mln barrels. Considering the latest Japanese data (housing starts fell 44.0% y/y in September, posting their largest drop on record and greater than expected projections of for a 32.0% drop) and considering ongoing risk appetite fuelling equities, we expect further gains in CADJPY to test the 121.50, followed by 122.00. The weekly chart on the right hand side suggests a bullish candle structure, calling up 122.50 before mid November.
NZDCAD Downside Seen Intact, Eyes 0.7220
We extend our bullish CAD assessment against the high yielding Kiwi as downside ground remains ample towards 0.7255, especially considering escalating risks for a pullback in equities. The argument that today??™s Fed??™s announcement may not guarantee future easing should shakeoff the bulls in equities, especially amid inevitable deterioration in the housing market. The striking aspect about taking a bearish view in NZDCAD is characterized by the bearish outlook in NZD in case of sharp equity losses, and prolonged gains in the CAD in the event of improved risk appetite. Indeed, a phase of rising risk appetite and equity buying is also known to be NZD positive, but the CAD has proven to be the outperformer during broad equity gains. Key target stands at 0.7220.
AUDGBP to Extend Bounce towards 0.45
With Aussie and sterling at 23 and 26-year highs vs the US dollar, both currencies command high yield structure and sustainable growth foundation. But going forward, the onset of rate hikes is more potent for the Aussie, where the odds of a Reserve Bank of Australia next week stand at 55%, while the more likely interest rate change by the Bank of England is a cut. Although today??™s release of the Nationwide home price index showed an unexpected increase, the underlying trend has begun pointing to weakness-as seen in the RICS and Hometrack surveys. With the FOMC decision behind us, Aussie markets look for Australia??™s September retail sales, seen u p 0.5% from 0.7% (9.30 pm EST), which is expected to sustain odds of a 25-bp rate hike next week. Interim support stands at 0.4410, while upside remains ample for 0.4480 and ultimate target at 0.45 into next week.
EURGBP seeks limited downside at 0.6950
While cable hits fresh 26-year highs and EURUSD surges to fresh all time highs, the last 3 days have been won by the British pound as a result of comments from dovish MPC members dampening chances of a near-term rate cut (Blanchflower, Beane and Barker). Nonetheless, rather than chasing a runaway train, we side with taking preliminary long positions in EURGBP especially as the upside inflation risks in the ECB remain greater, while downside risks stand greater in the UK. Although today??™s release of the Nationwide home price index showed an unexpected increase, the underlying trend has begun pointing to weakness-as seen in the RICS and Hometrack surveys. Most of all, the quarterly BoE inflation report due on Nov 14 will be essential key in determining rate expectations in the medium term.
EURGBP proved to have a fairly negative correlation with the S&P500, which boosts chances of stability in the pair in the midst of an equity pullback. We reiterate that the risk of upcoming equity declines based on worries that the Fed has concluded its easing campaign should be positive for the cross pair. Although the daily techncials appear negative, we look for stability at the 0.6950 trend line support. Key foundation stands at 69.40, at which point gradual rebound is seen regaining 0.6970 and 0.6990.
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