USD
FUNDAMENTAL BIAS: BULLISH
1. Monetary Policy
The Jan FOMC decision was hawkish on multiple fronts. The statement signalled a March hike as expected, but Chair Powell portrayed a very hawkish tone. Even though Powell said they can’t predict the rate path with certainty, he stressed the economy is in much better shape compared to the 2015 cycle and that will have implications for the pace of hikes (more and faster). Furthermore, he explained that there is ‘quite a bit of room’ to raise rates without damaging employment, which suggests upside risks to the rate path. A big question going into the meeting was how concerned the Fed was about recent equity market volatility. But the Chair explained that markets and financial conditions are reflecting policy changes in advance and that in aggregate the measures they look at isn’t showing red lights. Thus, any ‘Fed Put’ is much further away and inflation is the Fed’s biggest concern right now. The Chair also didn’t rule out the possibility of a 50bsp hike in March or possibly hiking at every meeting this year, which was hawkish as it means the Fed wants optionality to move more aggressive if they need to. We didn’t get new info on the balance sheet and Powell reiterated that they’re contemplating a start of QT after hiking has begun and they’ll discuss this in coming meetings. Overall, the tone and language were a lot more hawkish than the Dec meeting and more hawkish than consensus was expecting.
2. Global & Domestic Economy
As the reserve currency, the USD’s global usage means it’s usually inversely correlated to the global economy and global trade. Thus, USD usually appreciates when growth & inflation slow (disinflation) and depreciates when growth & inflation accelerates (reflation). With expectations that growth and inflation will decelerate this year that should be a positive input for the USD. However, incoming data will also be important in relation to the ‘Fed Put’. There are many similarities between now and 4Q18, where the Fed were also tightening aggressively going into an economic slowdown. As long as growth data slows and the Fed stays aggressive that is a positive for the USD, but if it causes a dovish Fed pivot and lower rate repricing it would be a negative input for the USD.
3. CFTC Analysis
With the USD still sitting on the biggest net-long position for large specs and leveraged funds, the odds of mean reversion are always higher, especially with more than 6 hikes priced in for the Fed. However, if there is enough demand for safe havens due to further Russia/Ukraine challenges then positioning might not matter too much.
4. The Week Ahead
It’s a relatively quiet week for the US on the data front. Tuesday kicks off with Markit Flash PMI’s where focus will be on whether the recovery in Retail Sales and Industrial Production was also felt in the forward-looking and sentiment-based PMI’s. In terms of USD reaction, as both are growth measures, there is the chance the USD sees a similar inverse reaction like we’ve seen with other growth measures in recent weeks. On the inflation side we do have the Fed’s preferred measure of inflation (Core PCE) on the schedule for Friday. As the Fed has tunnel vision for inflation right now the print will be important for us to watch. After a solid beat in CPI and PPI the market is skewed towards an upward surprise, which means it will arguably take a very sizable move above
maximum expectations to see a meaningful bullish reaction in the USD and US10Y, while it also means that a surprise miss, especially after CPI and PPI can have an outsized reaction to the downside for both. Fed speak will also be watched to see whether appetite for a 50bsp hike has grown. Keep in mind the Fed’s blackout period for the March meeting starts next week Friday (5 March), so any prep of a potential 50bsp move needs to be communicated clearly by the Fed before then in order to avoid jumping that type of surprise on markets when they don’t expect it. Risk sentiment will once again be a key potential driver for the USD given the heightened geopolitical risks around Russia and Ukraine. Any risk off flows from further fears of invasion or actual escalations should be supportive for the USD as the world’s reserve currency and a safe haven, while strong de-escalation is expected to be negative driver in the short-term.
FUNDAMENTAL BIAS: BULLISH
1. Monetary Policy
The Jan FOMC decision was hawkish on multiple fronts. The statement signalled a March hike as expected, but Chair Powell portrayed a very hawkish tone. Even though Powell said they can’t predict the rate path with certainty, he stressed the economy is in much better shape compared to the 2015 cycle and that will have implications for the pace of hikes (more and faster). Furthermore, he explained that there is ‘quite a bit of room’ to raise rates without damaging employment, which suggests upside risks to the rate path. A big question going into the meeting was how concerned the Fed was about recent equity market volatility. But the Chair explained that markets and financial conditions are reflecting policy changes in advance and that in aggregate the measures they look at isn’t showing red lights. Thus, any ‘Fed Put’ is much further away and inflation is the Fed’s biggest concern right now. The Chair also didn’t rule out the possibility of a 50bsp hike in March or possibly hiking at every meeting this year, which was hawkish as it means the Fed wants optionality to move more aggressive if they need to. We didn’t get new info on the balance sheet and Powell reiterated that they’re contemplating a start of QT after hiking has begun and they’ll discuss this in coming meetings. Overall, the tone and language were a lot more hawkish than the Dec meeting and more hawkish than consensus was expecting.
2. Global & Domestic Economy
As the reserve currency, the USD’s global usage means it’s usually inversely correlated to the global economy and global trade. Thus, USD usually appreciates when growth & inflation slow (disinflation) and depreciates when growth & inflation accelerates (reflation). With expectations that growth and inflation will decelerate this year that should be a positive input for the USD. However, incoming data will also be important in relation to the ‘Fed Put’. There are many similarities between now and 4Q18, where the Fed were also tightening aggressively going into an economic slowdown. As long as growth data slows and the Fed stays aggressive that is a positive for the USD, but if it causes a dovish Fed pivot and lower rate repricing it would be a negative input for the USD.
3. CFTC Analysis
With the USD still sitting on the biggest net-long position for large specs and leveraged funds, the odds of mean reversion are always higher, especially with more than 6 hikes priced in for the Fed. However, if there is enough demand for safe havens due to further Russia/Ukraine challenges then positioning might not matter too much.
4. The Week Ahead
It’s a relatively quiet week for the US on the data front. Tuesday kicks off with Markit Flash PMI’s where focus will be on whether the recovery in Retail Sales and Industrial Production was also felt in the forward-looking and sentiment-based PMI’s. In terms of USD reaction, as both are growth measures, there is the chance the USD sees a similar inverse reaction like we’ve seen with other growth measures in recent weeks. On the inflation side we do have the Fed’s preferred measure of inflation (Core PCE) on the schedule for Friday. As the Fed has tunnel vision for inflation right now the print will be important for us to watch. After a solid beat in CPI and PPI the market is skewed towards an upward surprise, which means it will arguably take a very sizable move above
maximum expectations to see a meaningful bullish reaction in the USD and US10Y, while it also means that a surprise miss, especially after CPI and PPI can have an outsized reaction to the downside for both. Fed speak will also be watched to see whether appetite for a 50bsp hike has grown. Keep in mind the Fed’s blackout period for the March meeting starts next week Friday (5 March), so any prep of a potential 50bsp move needs to be communicated clearly by the Fed before then in order to avoid jumping that type of surprise on markets when they don’t expect it. Risk sentiment will once again be a key potential driver for the USD given the heightened geopolitical risks around Russia and Ukraine. Any risk off flows from further fears of invasion or actual escalations should be supportive for the USD as the world’s reserve currency and a safe haven, while strong de-escalation is expected to be negative driver in the short-term.