USD Deleveraging & Tech Applications
USDX broke above that key neckline resistance of the inverted H&S formation, coinciding with the 55-DMA. The big question facing the FX market remains whether this is a dollar dead-cat bounce or the start of a longer retracement cycle. The price action on Tuesday highlighted the scope for further gains as it broke some technical levels and neared others. The bid in the dollar was strong and steady even as the news and market sentiment varied.
Below, is Ashraf's chart & trade idea on the DOW30 before the close of Tuesday's cash session, highlighting the 27500 neckline support turned resistance.
The steady bid in USD/JPY is certainly a curious element of the playing field as it climbs from levels that are undoubtedly a headache for Japanese officials. That extra bid could be providing some of the marginal strength in the dollar.
Another part of the equation is undoubtedly the resurgence of the virus in Europe. The UK placed a new curfew on bars and encouraged companies to allow work from home. Eurozone consumer confidence was better than anticipated on Tuesday but cases throughout the continent are moving in the wrong direction just as cold-and-flu season begins.
In the battle of easy money vs uncertainty the certain of low rates appears to be priced in while the uncertainty around the virus and US election is encouraging some deleveraging. That shift to the sidelines is helping to unwind crowded positions like long stocks and short USD.
The Moment of Truth?
Since the pandemic bottom, the balance of rates vs uncertainty has tilted towards the massive influx of central bank easing. It's led to unprecedented bounces is equities, a major move in gold and never-before-seen lows in interest rates.
By many metrics, it's gone too far. Then again, central banks may have also gone too far. In explaining his FOMC dissent on Monday, Kaplan said the Fed risked inflating a bubble by pledging to keep rates at zero even after its goals are accomplished.
Up until Monday, the dip in technology stocks was largely ignored by the FX and rates market. That changed with equities taking a broader leg down on Monday, led by Europe. What may have changed is that rising COVID case numbers are triggering fears of new restrictions. The US has so far shown a high threshold for COVID-driven economic weakness but other jurisdictions haven't been challenged in the same way. Most likely, the kinds of numbers many US states are tolerating right now would lead to major curbs in the UK or Canada but that remains to be seen.
The balance of it all begs for another look at the charts. Despite some larger moves on Monday, there were few breakouts. Cable held the Sept low, the euro rebounded back into the range from a five-week low and gold finished back above $1900. Here is a recap of Ashraf's calling the top of gold & silver 15 hrs before the peak.
Note too that markets bottomed in June on the Monday after the FOMC.
In spite of the mountain of worries, the potential for a vaccine and easy policy are powerful tools and it's far too soon to say that balance is broken. Ultimately, it will come down to the charts and the data. On Tuesday we get August existing home sales (exp 6.0m) and the September Richmond Fed (exp +12).
Soft numbers and other day like Monday would be a strong signal.FX Shrugs, Indices Shaken
The strikes against the US dollar are adding up. Thursday's risk aversion produced a dollar bid for a time but it faded in fairly short order, even against commodity and emerging market currencies. It begs the question: If the dollar can't rally on a day like that, when can it rally?
The economic data was mixed once again. Initial jobless claims were a touch higher than estimates while continuing and PUA claims were better. Housing starts fell 5.1% in a rare miss on the red hot real estate market while the Philly Fed was bang-on expectations at +15.0.
Data has been more up-and-down in the past few weeks after months of consistently beating expectations. That run of data sent the Citi economic surprise index to the highest ever but – notably – even with that the dollar has struggled since March. We may now be seeing what happens when economists (and markets) finally get a handle on the direction of the economy.
Fed's 2023 Special, BoE Thinks Negative
The FOMC decision and communication were in line with expectations. There were tweaks to incorporate average inflation targeting and the 2020 growth estimate was boosted. Markets expressed some disappointed when the Fed didn't offer any hints at more QE or other easing, except to say that it retained tools in the toolbox.
The short-term market reaction is understandable but it's ultimately the long-term vision that will win out. The Fed's 2023 forecasts and dots were all new. They showed 4.0% unemployment, 2.5% GDP growth, 2.0% core PCE inflation and 13 of 17 policymakers said they still expected to have interest rates at zero at the end of that year.
Ashraf tells me to start focusing on US 5-year break-even rates (now at 1.55%) and a possible H&S formation in this little-noticed rate.
Forecasts change but the Fed's vision is clear: There will be no rate hikes even when the pandemic is forgotten and the economy is relatively strong. The 2023 economy that Powell laid out is similar to what we saw in 2019 – a year with 2.2% growth, 1.7% inflation and 3.7% unemployment. The big difference is that the Fed funds rate was 1.5% and the Fed's balance sheet was half its current size.
The picture the Fed paints of 2023 is paradise for risk assets, emerging market currencies, precious metals and commodities. It would argue for massive leveraging at ultra-cheap rates.
In the shorter term, there are undoubtedly mixed messages. The August US retail sales report missed estimates with core sales down 0.1% as the prior was also revised lower. At the same time, home builder sentiment jumped to a record and a US HHS official said the country could be vaccinated in April.
Trading in & out of the Fed
The FOMC decision is on Wednesday at 14:00 EST(18:00 GMT, 19:00 London, 22:00 Dubai) and it will include the latest economic projections and a press conference from Powell 30 mins later. (See Ashraf's view here on the Fed in orange).
There is little intrigue in the decision itself. Better economic data in Q3 has cut the chance of further easing to nearly nil. Instead the focus will be on communication about lower rates for longer, particularly via the dot plot.
This edition will feature the introduction of the 2023 dots and will also include some important changes to this year's forecasts. For 2023, the main question is on the median on rates. In the June forecasts, the median was still on the floor but some FOMC members likely see liftoff in 2023. If it's enough to move the dot, it could be seen as hawkish and USD positive.
Importantly, the pandemic has also unfolded better than the Fed anticipated. The 2020 growth forecast will illustrate that as the GDP estimate will move to around -3.5% from -6.5% along with better unemployment. A tail risk is that better economic outcomes lead some to see liftoff as soon as 2022.
There could also be a shift in PCE higher to account for average inflation targeting and if so, that could also underpin a selloff in bonds and bump in the dollar. Along those same lines, there is a seasonal bottom in Treasury yields that occurs in mid-September and a higher inflation forecast could be the tipping point.
A more-straightforward element to watch is the statement and whether it continues to include a nod to 'considerable risks' surrounding the outlook. Given the pandemic and election uncertainty, that's not likely to be altered but there is a chance.
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