The story that the Fed could rein in their rate profile next year has been gaining traction in recent weeks, and it has been hard to ignore when there have been tentative signs in the US data that a higher rate environment is impacting on the economy. The recent drop seen in the NAHB housing index gave the markets a sharp jolt, though, before this, the ISM PMIs also suggested tighter financial conditions are starting to rein in business activity. It would have been somewhat short-sighted to believe that with higher rates and an ever-strengthening USD, there would be no impact on the growth dynamics.
Now we have a situation where the Fed could start to reassure markets that data dependency prevails and that a rigid path of normalisation should not be counted upon. This has tempered the outlook in short-term interest rate futures market and may well prove to be supportive on the mid-part-longer end of the yield curve, though into Dec, we may see the strongest reaction in the USD itself. Fed chair Powell is due to speak on Wednesday evening when he gets the chance to prep markets for any potential softening in forward guidance. He will be preceded by vice chair Clarida on Tuesday.
This week, however, we are looking to another month end of USD demand, as rebalancing requirements are pointing this way given another bout of heavy losses on Wall St equities. The return of stock markets today has seen a rebound in all the major indices, though, for material traction, we still feel the Fed will have to offer some solid indication of restraint. Indeed, today’s rally may be a case of pre-empting this scenario, as well as technical levels and an oversold status in the short term adding to the near-term relief.
In line with this price action, USD/JPY as wasted no time in pursuing the upside as we make a beeline for the mid 113.00’s if not 114.00, though the Fed meeting next month is a double-edged sword for the JPY spot rate if yields start to come off again – recall 10yr testing 3.00% and dragging USD/JPY back through the mid 112.00’s before basing out around 112.30 or so.
Elsewhere, EUR/USD will have a task and a half to push back and sustain the 1.1400-1.1500 area. Eurozone data gives little incentive to price in higher levels in the EUR just yet, with some possible flexibility from Italy in its budget considerations providing the modest relief early on Monday morning.
The EU Summit’s agreement of the withdrawal text and the declaration were also cause for some EUR upside, just as it was for GBP, though the latter lacks conviction either way as investors choose to sit this one out on the sidelines until we get more insight into the balance of sentiment in parliament over the deal. Cable support at 1.2790-1.2800 is the closest prop for now, while 1.2925-30 was evidently a push too far after last week’s initial response to the deal PM May brought back from Brussels.
Risk sentiment may have stabilised in Monday’s session, though this has failed to translate into any upside in the AUD or the CAD, with oil prices also edging back up again. As a result, we can only assume market players are looking lean on the anticipated month end flow expected into Friday, which could see a push for new USD highs over coming days.