FX Daily: Immobile Fed to give a nod to higher yields

The Federal Reserve is in a desirable position as it prepares to announce policy this evening thanks to the combined effect of rate hikes and higher Treasury yields keeping pressure on prices. The economy has proven resilient so far. In the art of central banking, inaction is action, and inaction is broadly what we expect from the Fed today as we discuss in our preview.

A pause is widely expected by markets and economists, as numerous FOMC members signalled higher Treasury yields were adding enough extra tightening of financial conditions to stay put. One question for today is to what extent the statement and Fed Chair Jerome Powell will acknowledge this non-monetary tightening of financial conditions. It’s unlikely the Fed wants to drop any dovish hints at this stage, but a market that is well positioned for a broadly unchanged policy message could be rather sensitive to the wording on this topic and may interpret an “official” recognition of tighter financial conditions as an implicit signal more tightening is off the table.

The typically cautious Powell may anyway try to mitigate any dovish interpretation of the statement during the press conference. After all, the Fed dot plot still says one more hike by year-end and has a strong commitment to higher rates for longer. The first of these two statements was never taken at face value, but the latter is what is contributing to higher yields. Expect no divergence from it. The Fed isn’t the only event in the US calendar today, and markets will likely move on the ADP payrolls release (although these are unreliable), JOLTS jobs openings and the ISM manufacturing figures for October.

There is room for a short-lived dollar correction today as markets will be on the hunt for implicit admissions that another hike is actually off the table with higher yields. Positioning adjustments have favoured some dollar slips recently but they have not lasted, as the overall message by the Fed has been one of higher for longer with a hawkish bias. That message won’t change today (barring any great surprises) and we think that buying the dips in any dollar correction will remain a popular trade, especially given the more and more unstable ground on which other major currencies (JPY, EUR) are standing.

Francesco Pesole

Yesterday was a volatile session for EUR/USD. Eurozone headline inflation dropped more than expected to 2.9%, but markets might have focused on core staying relatively high at 4.2% by looking at the positive EUR/USD reaction. Anyway, the rally was very short-lived. Above-consensus US employment costs and consumer confidence, Canada entering a technical recession, and sustained USD/JPY demand all prompted a dollar comeback and EUR/USD is now trading closer to its 1.0550 anchor.

Today, the direction of travel for EUR/USD will be set by US data releases first and the FOMC then. As discussed in the USD section above, we might see a dollar correction, but our base case is that it would follow the pattern of the one we saw yesterday, with gains above 1.0650 in EUR/USD proving hardly sustainable.

Most of Europe is on holiday today, so European calendars are quite empty.

Francesco Pesole

Japanese authorities are already stepping up efforts to contain the unwanted impact on rates and FX of yesterday’s Bank of Japan meeting. The BoJ announced unscheduled bond-buying operations this morning as the 10-year JGB reached a 0.97% high. The top currency official at the finance ministry said authorities are on standby to intervene in the FX market if needed after the JPY slump.

The signals included in the latest BoJ announcement will probably be enough to keep markets stay on the bearish side of JGBs (i.e., 1.0% to be hit soon in 10-year JGBs). Today’s unscheduled bond operation appears more as a warning signal against excessively sharp moves in yields, but putting a hard ceiling below 1.0% would not be very consistent with the policy message.

On the FX side, there is a good chance that investors will keep adding pressure on the yen despite the FX intervention threat by Japanese officials, effectively pushing them into intervening to test the new intervention level. That may be as high as 152.50 or 153.0, and with the message from the Fed unlikely to give a sustainable respite to treasuries, it seems unlikely that there will be much incentive to take bearish positions on USD/JPY positions.

Francesco Pesole

Brazil’s central bank (BCB) meets to set rates today. Economists and investors are unanimous that, unlike Chile last week, the BCB will not be blown off course from its forward guidance. Here a 50bp cut has been well-telegraphed, which would take the selic policy rate to 12.25%. Since embarking on its easing cycle in August the BCB’s statement has consistently guided for 50bp cuts at future meetings. We would expect that phrasing to re-appear today.

However, market pricing now only looks for a 44bp cut at the December meeting and the depth of the 2024 easing cycle has been re-priced 125bp higher over recent months. This has largely been down to higher US yields and the strong dollar, but more recently has been a function of President Lula late last week questioning his government’s commitment to a zero budget deficit next year. The fiscal side has long been Brazil’s Achilles heel and the BCB has not been shy about emphasising fiscal risks in its statements.

We think the BCB will have to acknowledge the more difficult external environment. And that could see the BCB easing cycle priced a little shallower still. That could be seen as a mild Brazil real positive. Yet, fiscal risks look set to hold the real back and we much prefer exposure to the Mexican peso. Look for BRL/MXN to drop back to 3.50 later this year.

Chris Turner