The focus of proceedings falls on the number of hikes implied this year through the ‘dots plot’ projections. Although, the Fed will try and downplay these changes and the market is more concerned on just how likely the Fed will be in actually cutting rates in 2020. We are also watching to hear of a formal end the balance sheet normalisation plan for Q3 (or early Q4), with the full details expected to be revealed in the FOMC minutes (due 11 April). We are also keen to assess the tone of any potential downturn in inflation, while any views on financial conditions will also be well received.
USD/JPY should have the purest read on sentiment towards the Fed meeting, as it tracks US Treasury yields most closely. That said, USD/JPY has no pulse, and just isn’t moving, with 10-day realised volatility at just under 4%, with the 5-day average true range (ATR) at a lowly 40-pips. I touched on the low volatility environment in yesterdays note, so won’t go over old ground, however, on balance it feels unlikely we see the FOMC meet play out as a vol event and the market expects a move no greater than 49-points.
Peak noise in the Brexit talks
We focus on Brexit and the pound when we think of volatility (vols) in markets, although vols have settled down a touch and the implied move through the remainder of the week in GBP/USD is 150 pips - which considering the news flow seems quite orderly. We await Theresa May’s address to the 1922 Committee of Tory MPs tonight (4 am AEDT), where there is reportedly a ‘revolt’ underway and a huge disdain surrounding May’s request to the EU for an extension. There is even talk of a growing motion for May to hand in her resignation. It is all a bit chaotic, and the uncertainty is palpable, and it feels as though this is the point where we have hit peak noise, and for that, I am leaving the pound well and truly alone.
I still like GBP/AUD higher and have it on my radar should we see a close through 1.88.
AUD sellers easy to find
This leads us into a good segway in the Australian dollar, where the focus falls firmly on the Aussie rates and bond market. After a deep dive into yesterdays RBA minutes it is clear the door is now open for a rate cut from the RBA, and the bank has come a small step towards where rates pricing already was.
The idea the bank is on hold until “new information becomes available” has been noted, as has the emphasis the bank put on the unemployment rate. The detailed discussion on ‘the bank's operations in repurchase and foreign exchange swap markets and their role in achieving the Board's target for the cash rate’ has also been widely talked about on the floors and again leads us to think we can see cuts in the coming months.
So, strategists have the labour market as the key trigger for the cut rates, although on the flip side it feels as though a decline below 5% will have little bearing on those who still feel the next move is up in rates. Consider the 12-month average sits at 24,900 jobs created (per month), while the six-month average resides at 26,700 net jobs, so the trend has been strong yet rates cuts have been continually priced in. Still, despite the potential sensitivity to the jobs report, no one is buying volatility in the options market, with the market expecting a 44-point move through the session, suggesting the market feels quite calm about unemployment rate meeting the Street's forecast.
Consider in the prior two easing cycles in 2008 and 2011 (see Bloomberg chart above), rate cuts preceded a rise in the unemployment rate, although it was largely down to external factors and isn’t perhaps the best case-study. Either way, should the unemployment rate radically surprise and come out at 5.2%, then there is no doubt the May meeting will become a live event. Looking across the Aussie rates market today, we see 6.5bp of cuts priced in for May (or a 25% chance), which is the contract rates traders are most intently focusing on. The probability of a cut at the June meeting is priced at 40%.
We can go further out the curve and see 45bp of cuts priced in over the coming 12 months and granted the likes of Japan, Switzerland and Europe are more likely to lean on its balance sheet than cut rates. But, aside from India and Mexico, the market expects the RBA to be the most aggressive bank out there cutting interest rates over the coming 12 months. In a world where macro FX traders align trading strategies to economic and central bank divergence, it’s not hard to see why the Australian dollar finds few friends.
So, the market has been focused on domestic factors, and fast money sellers continue to fade any strength in the Australian dollar. But now we add in the talk that the US could be concerned that China may be backing away from American demands. Perhaps this is just brinkmanship, but it is music to Australian dollar bears ears and the fact Chinese equity markets are finding sellers today is also weighing.
We await next week’s meet between Lighthizer, Mnuchin and China’s Vice Premier Liu for more colour here. So, one to watch, as AUD/USD has been closely linked to the Aussie-US bond yield spread, but a breakdown in talks and it could see a higher correlation with Chinese equity markets again. With uncertainty picking up a touch, I have taken profits on my DAX longs and have moved to the sidelines here.
