Today, all eyes are likely to be on the FOMC decision. The Committee is expected to deliver its 4th hike for this year and thus, if this is the case, focus is likely to turn to the new “dot plot”. Investors will be eager to see whether the plot will be revised down, and if so, by how much. Tonight, during the Asian morning Thursday, the BoJ will decide on policy. However, we don’t expect any major changes from this Bank.
The dollar continued trading on the back foot against most of the other G10 currencies on Tuesday. Once again, it gained only versus NOK and CAD, which continued tracking the slump in oil prices. The dollar stayed under pressure against EUR, GBP and JPY, SEK and NZD, while it traded virtually unchanged versus AUD and CHF.
Today, USD-traders, alongside the rest of the financial community, are likely to be sitting on the edge of their seats in anticipation of the FOMC decision later in the day. This is one of the “bigger” meetings, where, besides the rate decision and the accompanying statement, we get updated economic projections and a press conference by Fed Chairman Jerome Powell.
According to the Fed fund futures, the market assigns nearly a 72% chance that the Committee will raise rates by 25bps to the 2.25-2.50% range and thus, if this is the case, all eyes are likely to quickly turn the updated economic projections, and especially the new “dot plot”. Following the dovish remarks by Fed Chair Powell, the minutes from the previous FOMC meeting, and reports saying that Fed officials are considering whether to adopt a wait-and-see approach after hiking today, the market priced out its expectations with regards to the number of hikes throughout 2019. Currently, the market is pricing in only around half of a quarter-point hike.
Thus, the big question heading into the decision is: How many hikes will the new “dot plot” reveal? The September plot suggested 3 rate increases for next year, and market participants are eager to see whether this number will be revised down, and if so, by how much.
In our opinion, the latest slide in the dollar suggests that market participants are positioning themselves for a dovish outcome. Therefore, we view the risks surrounding the dollar’s reaction to this decision as skewed to the upside. We believe that the Fed would need to bring the 2019 median dot down to 1 hike for the dollar to keep sliding. Something like that could also help the equity markets to rebound. On the other hand, although still a downside revision, projections of 2 hikes would still be well above market consensus and may result in the opposite market reaction. The dollar is likely to strengthen, and stock indices could come under renewed selling interest.
We see the second case as a more realistic one. First, a switch from 3 to 1 hike in just three months could raise questions over the Fed’s credibility, and second, data have not been that bad to warrant such a move. The economy continues to expand at a healthy pace, underlying inflation – as measured by the core PCE, the Fed’s preferred metric – is slightly below, but near, the Fed’s objective of 2%, the unemployment rate stands at 3.7%, its lowest since 1969, and wage growth is the fastest since 2009. We also believe that apart from a possible downside revision from 3 to 2 hikes, we could also see officials removing from the statement the part saying that “The Committee expects that further gradual increases in the target range for the federal funds rate will be consistent…”. They could replace it with something suggesting that any future policy moves are likely to depend on how data evolve onwards. In other words, the Committee could become more data-dependent.
The Canadian dollar has collapsed yesterday, which pushed USD/CAD higher to test the upper bound of the rising channel that’s been in place since the end of September. The pair fell shy by about 3 pips of hitting the psychological 1.3500 hurdle, which now plays a role of a key resistance zone that will be carefully monitored, a break of which could be the gateway towards higher levels. But before USD/CAD could move higher again, there is a good likelihood to see a bit of retracement back down.
As mentioned above, USD/CAD could correct slightly lower, especially if it drops below the 1.3450 obstacle, where the pair is currently finding support. Below that, USD/CAD has a good potential support near the 1.3420 area, which is yesterday’s intraday swing high and also around last week’s high. Now it may play the role of a good bouncing ground for the pair. In addition to that, there is a small short-term upside support line that’s running from the low of the 7th of December, which could also help in holding the rate from dropping. This is when the bulls could see a good opportunity to step in and lift USD/CAD back to the area around the 1.3500 level, or even higher.
On the downside, in order to start examining lowers levels again, at least in the short run, we need to see a drop below the above-mentioned upside line and a break of the 1.3388 zone, marked by yesterday’s low. This is when we could aim for the next potential support zone at 1.3322, which was the low the 12th of December. If the rate depreciation continues, a test of the 1.3295 level, or even the lower bound of the rising channel, may be possible.
As for tonight, during the Asian morning Thursday, the central bank torch will be passed to the BoJ. At their previous gathering, Japanese policymakers kept their ultra-loose policy unchanged, maintaining short-term interest rates at -0.1% and the target of 10-year JGB yields around 0%. What’s more, officials reiterated that they intend to keep the current extremely low levels in interest rates for an extended period of time.
Since then, data showed that headline inflation accelerated to +1.4% yoy in October from +1.2% in September, but the underlying rate remained unchanged at +1.0%. On top of that, last week, GDP data for Q3 showed that the Japanese economy contracted 0.6% qoq. Although this was due to natural disasters and a rebound could be possible in Q4, trade tensions could keep the outlook clouded. Thus, we see it unlikely for policymakers to proceed with any policy changes at this meeting, and we stick to our guns that they still have a long way to go before considering a meaningful step towards normalization.
As for the yen, we don’t expect a major reaction to the BoJ gathering. We believe that it is likely to stay more linked to the broader market sentiment, with investors seeking its safety during periods of uncertainty, and abandoning it in favor of riskier assets when their morale improves. A less-dovish-than-expected Fed today may trigger another round of equity-selling, with flows diverted into safe-havens, like the yen. The same applies for the Swiss franc but given that this currency tends to strengthen more when there is uncertainty surrounding Europe, yesterday’s deal between Italy and the EU on the 2019 budget may keep it less attractive. Therefore, even if both currencies strengthen when another round of “risk off” hits the market, we expect the yen to strengthen more, something that shifts the risks for CHF/JPY to the downside.
CHF/JPY continues to slide, and during the Asian morning today, it managed to break slightly below its short-term upside support line drawn from the low of the 26th of October. Certainly, the momentum is still to the downside and even our oscillators, the RSI and the MACD, are somewhat supporting that. But given the fact that the pair did not have a strong break through that support line, we will keep the cautiously-bearish hat on, for now.
A further push lower could test the important support area near the 112.86 hurdle, which is the low 4th of December. Initially, the bulls may decide to enter there to drive the pair back up again, but if they won’t have enough steam, CHF/JPY might reverse south and go ahead with breaking that 112.86 level, which may clear the path towards the 112.60 obstacle, marked by the low of the 18th of November.
Alternatively, a move back above the aforementioned upside line and a break of the 113.50 barrier could invite more bulls to the table and CHF/JPY could travel higher. This is when we will start looking at the 113.80 obstacle, a break of which may lead towards a re-test of the 114.16 level, marked by the peak of the 17th of December.
During the European session, we have the UK CPIs for November. The forecasts suggest that both the headline and core rates ticked down to +2.3% yoy and +1.8% yoy from +2.4% and +1.9% respectively. That said, given the latest tumble in oil prices, if the core CPI ticks down, the headline rate is likely to slide by more. With headline inflation returning to the BoE’s target faster than previously thought and the core rate moving further below that objective, investors may price further out their hike expectations, especially with all this uncertainty surrounding the Brexit landscape. However, given the Bank’s position that interest rates could move in either direction, even in case of a no-deal Brexit, pre-Brexit inflation numbers are likely to continue attracting less attention than usual.
Although a no-deal divorce could hit growth, further tumble in the pound could push inflation up again. The Bank would have to assess the possible trade off and if bringing inflation back down to target appears more urgent than balancing the hit to growth, then it may decide to hike. If the opposite is the case, a rate cut may be appropriate. Having said all that though, we still need to wait for Thursday’s BoE meeting to see whether the Bank still holds that view.
We get inflation data for November from Canada as well. Expectations are for the headline rate to have declined to +1.8% yoy from +2.4%, while no forecast is currently available for the core rate, which ticked up to +1.6% yoy in October from +1.5% in September. At its latest meeting, the BoC left rates untouched, but the accompanying statement had a dovish flavor compared to the hawkish one we got the previous time, prompting market participants to take their January-hike bets off the table. That said, Canada’s record employment numbers for November may have revived some hopes that officials could eventually push the hiking button at their upcoming gathering.
With all this confusion with regards to the BoC future plans, inflation numbers have the potential to shed some light. We understand that the slowdown in the headline CPI may be owed to the tumble in oil prices, but if this is accompanied by a decline in the core rate as well, investors may be convinced that the Bank will refrain from acting in January. On the other hand, an upside surprise in this data set could encourage them to add to their bets.
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