Risk sentiment improved yesterday following comments by ECB President Mario Draghi that additional stimulus may be required, and after US President Trump said that he will hold an extended meeting with his Chinese counterpart Xi Jinping at the G20 summit. As for today, all lights are likely to fall on the FOMC decision, with investors eager to find out whether policymakers are indeed willing to reduce interest rates soon in order to avert a steep economic downturn. As for tonight, during the Asian morning Thursday, the central bank torch will be passed to the BoJ.
The dollar traded mixed against the other G10 currencies on Tuesday and during the Asian morning Wednesday. It gained against SEK, EUR, CHF, NOK and JPY in that order, while it underperformed versus AUD, NZD, GBP and CAD.
The strengthening of the risk-linked currencies and the weakening of the safe-havens suggests that investors had reasons to cheer about. Indeed, major EU and US indices were a sea of green yesterday, with the positive sentiment rolling into the Asian session today. Both Japan’s Nikkei 225 and China’s Shanghai Composite rose 1.80% and 0.96% respectively.
The first boost in risk appetite came after ECB President Mario Draghi said that additional stimulus will be required if a sustained return of inflation to the ECB's aim is threatened. The President added that the Bank could still cut rates, adjust its forward guidance on interest rates, and that there is “considerable headroom” for more asset purchases. He also hinted that a tiered deposit rate was still on the table.
At the latest ECB meeting, the Bank pushed back its guidance on interest rates, noting that they are expected to stay untouched “at least through the first half of 2020”. Yet, the euro surged back then, due to expectations of a more dovish stance. After all, investors were already pricing in a 10bps cut in the deposit rate early next year. With this in mind, yesterday’s even-more-dovish remarks by the ECB Chief may have prompted investors to bring forth their cut expectations and that’s why the euro tumbled and EU indices rose. Indeed, according to Euro area money markets, a 10bps decrease in the deposit rate is now almost fully priced in for this September.
Later in the day, US President Donald Trump offered investors a second reason to increase their risk exposure. Using his twitter account, the US President noted that he had a very good telephone conversation with China’s President Xi Jinping and that the two will have an extended meeting at next week’s G20 summit. He also added that negotiations between the two sides will begin ahead of the meeting.
Up until now, it was not sure whether such a meeting would take place, with China declining to comment on that front, and Trump threatening with more tariffs if Xi did not attend the summit. Thus, Trump’s remarks and China’s confirmation for talks revived hopes over a potential accord between the world’s two largest economies. We still believe that a final deal is unlikely to be struck at the G20, but “progress” remarks, pointing towards that direction, may be enough to support risk appetite.
The German DAX cash index skyrocketed yesterday, breaking above the key resistance territory of 12200, which prevented the price from edging north on May 22nd, June 11th and June 13th. That said, the rally was stopped by the 12360 barrier, and then the index consolidated below that level. Bearing in mind that the price structure is higher peaks and higher troughs above the tentative upside support line drawn from the low of June 2nd, we believe that the near-term outlook is positive.
That said, before the next leg higher, we see the case for a corrective setback as yesterday’s rally appears overstretched. A clear dip back below 12305 could confirm the case and may pave the way towards the 12200 area, from which the bulls could jump back into the action. The subsequent positive leg could aim for another test near the 12360 zone, the break of which would confirm a forthcoming higher high on the 4-hour chart and may allow the bulls to put the 12455 hurdle on their radars. That barrier acted as a resistance on May 3rd.
Shifting attention to our short-term oscillators, we see that the RSI moved above 70, but retreated thereafter and flattened fractionally above that line. The MACD, although above both its zero and trigger lines, shows signs of slowing down. These indicators detect slowing upside speed and corroborate our view for a corrective setback before the next leg north.
Nevertheless, in order to start examining whether the near-term outlook has turned negative, we would like to see a clear dip below 12140, or even better, below the aforementioned upside support line. Such a dip could initially aim for the 12050 area, the break of which could carry extensions towards the yesterday’s low, at around 11985.
As for today, the spotlight is likely to turn to the FOMC policy decision. This will be one of the “bigger” meetings, where apart from the rate decision, the statement and Fed Chair Powell’s press conference, we also get updated economic projections, and a new “dot plot”. When they last met, officials reiterated their “patient” stance, with Powell noting that some transitory factors may be at work with low inflation and that there is no strong case for moving in either direction. The minutes of that gathering echoed Powell’s remarks, revealing that officials’ approach could remain appropriate for “some time”.
However, the meeting took place ahead of the latest escalation in trade tensions between US and China, and recent headlines suggest that several officials may have changed their minds. A couple of weeks ago, St. Louis Fed President James Bullard said that a rate cut may be “warranted soon”, while Fed’s Chief Jerome Powell noted that the Committee would respond “as appropriate” to the risks posed by a global trade war. Officials’ willingness to reduce rates in order to avert a steep economic downturn has prompted market participants to add to their already elevated expectations with regards to lower US rates. According to the Fed funds futures, a 25bps rate cut is now fully priced in for August, while there is a 68% chance for this to happen in July. Another decrease is factored in for November.
With regards to this meeting, the cut chance is around 21% and thus, if the Committee refrains from acting as it is mostly anticipated, the focus will quickly turn to the accompanying statement and the economic projections, especially the new “dot plot”. The March dots were pointing to no action this year, one hike in 2020, and again no action in 2021. Following the aforementioned cut hints, we see the case for the plot to be revised down, but the big question is by how much. Even if the plot points to one cut this year, this would still be more optimistic than what the market currently anticipates and thus, we doubt that it could hurt the dollar. It could even support it. For the greenback to come under selling interest and the equities to rally further today, we believe that the plot would have to point to at least 2 cuts in 2019.
EUR/USD tumbled yesterday after ECB President Draghi said that additional stimulus may be required, falling below the key support zone (now turned into resistance) of 1.1200. Overall, the pair continues to trade within the range that’s been containing most of the price action since March 22nd, between 1.1110 and 1.1325, but in the short run it is printing lower peaks and lower troughs within that range, below a tentative downtrend line taken from the peak of June 12th. Thus, we believe that the rate could continue drifting south for a while more.
Despite the pause after the dip below 1.1200, we believe that the break may have opened the door towards the low of June 3rd, at around 1.1160. The catalyst for the next leg down could be a not-as-dovish-as-expected FOMC today. If the bears are strong enough to overcome that barrier as well, then we may see the slide extending towards an intraday swing low formed on May 31st, near 1.1137.
Looking at our short-term oscillators we see that, after flattening slightly above 30, the RSI ticked back down, while the MACD, also flat, lies below both its zero and trigger lines. It could also tick down soon. The indicators suggest a pause in the rate’s negative momentum, and thus we would stay careful over a minor corrective bounce before the next leg down, or perhaps some further consolidation ahead of the FOMC decision later in the day.
In order to assume that the bears have abandoned the field for a while, we would like to see a clear recovery above 1.1245. Such a move would drive the rate above the short-term downside line taken from the peak of June 12th, and would also confirm a forthcoming higher high on the 4-hour chart. The bulls may get encouraged to drive the rate higher within the broader range, initially aiming for the 1.1268 zone, defined by the inside swing low of June 13th. Another break, above 1.1268, could open the path towards our next resistance, at 1.1290, near the high of June 14th.
During the European morning, we get the UK CPIs for May. Expectations are for both the headline and core rates to have ticked down to +2.0% yoy and 1.7% yoy, from +2.1% and +1.8% respectively. That said, we doubt that something like that would tempt BoE policymakers to alter their stance on monetary policy when they meet tomorrow. Recent comments by several of them suggest that they will reiterate the view with regards to an ongoing tightening.
We get CPIs for May from Canada as well. The headline CPI is expected to have accelerated to +2.1% yoy from 2.0%, but the core rate is forecast to have declined to +1.2% yoy from +1.5%. According to Canada’s OIS (overnight index swaps), investors see a nearly 45% chance for BoC interest rates to be lower by the end of the year, and a potential slowdown in the core CPI may prompt them to push that percentage slightly higher.
With regards to the energy market, we get the EIA (Energy Information Administration) report on crude inventories for the week ended on June 14th. Expectations are for a 1.077mn barrels slide, following a gain of 2.206mn. The case for a small decline is also supported by the API report, which revealed a 0.812mn inventory decrease.
As for tonight, during the Asian morning Thursday, the central bank torch will be passed to the BoJ. Last time, Japanese officials kept their ultra-loose policy unchanged and revised their forward guidance, saying that they intend to maintain the current extreme low levels of interest rates “at least through around spring 2020”. However, this was just a few days before the latest round of tensions between the US and China, and well before Fed officials' hints over lower rates. If the need for lower rates is confirmed by the FOMC today, this would add pressure on the BoJ to prevent a narrowing rate spread with the US, especially amidst subdued inflationary pressures and a stronger yen due to trade tensions. Even though we don’t anticipate further easing measures as early as at this gathering, we will be eager to find out whether Japanese officials will decide to push further back their guidance, or not.
We also get New Zealand’s GDP for Q1. Expectations are for the nation’s economy to have grown 0.6% qoq in the first three months of 2019, the same pace as in Q4, 2018, something that would drive the yoy rate up to +2.5% from +2.3%. A +0.6% qoq growth rate would be above the RBNZ’s own projection for the quarter, which is at 0.4%, and would add more credence to recent comments by RBNZ Assistant Governor Christian Hawkesby, who said that interest rates would “remain broadly around current levels for the foreseeable future”.
Apart from Fed Chair Jerome Powell, we have two more speakers on today’s agenda. ECB President Mario Draghi will speak again, while ECB Executive Board member Benoit Coeure will also step up to the rostrum.
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