By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
5 Takeaways
The Federal Reserve raised interest rates for the third time this year by 25bp. The U.S. dollar appreciated against all of the major currencies after the rate decision except for the Japanese yen and Swiss franc. The inconsistency in the dollar’s performance is a sign of risk aversion. The Dow dropped more than 100 points Wednesday while 10-year yields fell nearly 5bp. The Fed’s rate hike should have driven Treasury yields higher, especially after it said that not much has changed since June, but that fact indicates that Chairman Powell failed to satisfy the bulls. Before we explain why the markets behaved the way they did, here are the top 5 takeaways from the Fed meeting:
Takeaways From September's FOMC:
- Fed raised interest rates by 25bp to range of 2-2.25%
- 12 out of 16 Fed officials see another hike in December (up from 8)
- Fed raised 2018 GDP forecast
- Drops “accommodative” from FOMC statement > Powell says don’t read too much into that
- If inflation rises, Powell says they will hike faster BUT he added that if he slows, they will probably CUT
Between the central bank’s economic projections, the dot plot and Powell’s comments on the economy, there’s no question that the Fed will continue to raise interest rates. Fed fund futures were unchanged after the rate decision with the market pricing in a 77% chance of a follow-up move in December. Powell described the economy as strong and said he’s positive on growth.
So why did USD/JPY fail to sustain a move above 113? The answer is simple. Investors were hoping for unambiguously hawkish comments from the Fed chair and while he had a lot of good things to say, the mere mention of the possibility of rate cuts capped the rally. According to Powell, if inflation surprises to the upside, they could move faster but if the economy slows, they would probably cut rates. They also oppose taking away more of their tools (in case there’s a need for them). While the risk of easing is minimal, because of these comments Wednesday's move can’t be described as a hawkish hike (it wasn’t a dovish one either). Looking ahead, 113 could turn into a double top for USD/JPY.
With the Fed meeting behind us, the focus turned to New Zealand's monetary policy announcement Wednesday evening. When the RBNZ last met, it sent NZD/USD tumbling to its lowest level in 2.5 years by pushing out its forecast for a rate hike from Q3 of 2019 to Q3 of 2020. At the time, this was a significant change that reflected RBNZ's concern about growth. Since then, we’ve seen quite a bit of improvement in New Zealand’s economy, especially in consumer spending, GDP and inflation. In the second quarter, the economy expanded at its fastest pace in 2 years. Although weakness elsewhere keeps the central bank neutral, these latest reports reduce the chance of easing by the RBNZ and increases the odds of a slightly brighter outlook by the central bank. If the RBNZ statement contains a hint of optimism, NZD/USD could rise back to 67 cents but New Zealand’s strength should be more pronounced against other currencies like the euro and Australian dollar. If they emphasize external risks and maintain an overly cautious outlook, NZD/USD should be the best pair to trade for a move below 66 cents.
USD/CAD broke to the upside Wednesday following the Federal Reserve’s monetary policy announcement. It is becoming increasingly clear that a NAFTA deal won’t be reached by the end of the month and markets are just starting to absorb that fact. According to our colleague Boris Schlossberg, “add to that the fact that US rates are 25bp higher now and the prospect of lower CAD looms large on the horizon. Tomorrow Governor Poloz is due to speak late in the NY afternoon and if he adds a note of caution to any talk of monetary policy that should drive CAD even lower.”
After consolidating for 4 consecutive trading sessions, EUR/USD is primed for a breakout. Although Thursday’s ECB economic bulletin and Eurozone consumer confidence report are likely to be positive, we think EUR/USD is vulnerable to a correction. Shorter-term charts show a strong rejection of 1.18 and if EUR/USD breaks below 1.1725, we could see a swift sell-off toward 1.1670. Sterling, on the other hand, is surprisingly resilient due largely to the massive short exposure. Everyone who wants to be short sterling probably has a position already and they are looking at any GBP positive news as a reason to get out.