FX Daily: Fed brings tidings of comfort and joy
In a somewhat surprising move, the Fed has acknowledged recent disinflation trends and poured gasoline on the fire of easing expectations for 2024. The news has understandably been greeted by global asset markets, where stagflationary bets are being replaced by reflationary ones. This is broadly dollar negative. Look out for the ECB, BoE and SNB today.
USD: Fed softens stance earlier than we thought
Last night's FOMC release, dot plots and press conference surprised us and the markets. Instead of the Federal Reserve pushing back against the 100-125bp of rate cuts priced by the market for 2024, the overall message was a softer one. In effect, it welcomed disinflation trends and fed into the narrative that if inflation is under control, why does the US economy need very restrictive monetary policy in the form of a real policy rate above 2%?
Asset markets responded very well to the prospect of the Fed releasing the handbrake on the US and global economy, with both bond and equity markets rallying broadly. For us in FX, we had not expected it this early but last night's dovish Fed shift triggered a massive bull steepening in the US curve – a move that is the centre piece of our call for a broadly lower dollar next year. US two-year Treasury yields fell 30bp and the 2-10 year Treasury curve bull-steepened by 12bp. As discussed in our 2024 FX Outlook, we think this shift towards a more reflationary policy setting stands to see outperformance of the undervalued commodity currencies, and again, overnight the under-valued Australian and New Zealand dollars led the pack. We are also pleased to see EUR/AUD 3% lower over the last month, a move we highlighted in our outlook.
Looking ahead, the focus switches to four rate meetings in Europe and to what degree the likes of the European Central Bank or the Bank of England do a better job than the Fed in pushing back against easing expectations for next year. If indeed they do a better job, it will only add to rallies in EUR/USD and GBP/USD. And the Fed's dovish turn last night continues to trigger an unwind in yen short positions as USD/JPY falls further. Next Tuesday's Bank of Japan policy meeting is eagerly awaited. Even though we do not look for any material adjustment in BoJ policy next week, USD/JPY may still well drop to 140 beforehand.
Away from policy rate meetings in Europe, today sees US November retail sales and the weekly initial claims. Given the market firmly has the easing bit between the teeth, any signs of weakness in this data could trigger another leg lower in the dollar.
DXY has support at 102.50/65 below which the 100.80/101.00 area looms large.