By now, it should have become painfully obvious that USD demand is now predominantly a function of the weaknesses elsewhere, rather than expressing a positive view on the US economy. Naturally, it is hard to argue against a more favourable position stateside, but the US is not without its risks, which will be exacerbated every time the Fed decides to hike. The normalisation process was long overdue, and I argued that the Fed was perhaps a little too hesitant in tightening as Fed chair Yellen, at the time, wanted to wait for clear signals. Well they came through, and while the market focused on the twin deficits, the USD index was pounded into the ground and few could see a reason for the turnaround. And now here we are.
The market cannot get enough USDs, and at a time when the balance sheet is slowing contracting, the backdrop of year-end shortage maintains a relative bid in the greenback despite the prospects of a dovish hike tomorrow night. It would not surprise me if the Fed decided to stick on this one, and as per Jerome Powell’s rhetoric, watch the data. There is, however, one distinct drawback in taking this course of action, that being the perception of yielding to political pressure. President Trump makes no secret of his disappointment in the current Fed path, though come 7.00pm tomorrow evening, we will know through the dot plot whether there has been any moderation in how policymakers now believe the normalisation process should continue – if at all.
Anyone choosing to stick to the script need only look at the housing market, where yesterday’s NAHB House Price Index took another dip from 60 to 56, having fallen from 68 in the previous month to this. Domestically, neutral rates may be closer than the Fed thinks, and their recent commentary is certainly moving this way. Any suggestion of a pause tomorrow night will confirm Fed concerns, so in this respect, perhaps some of the outliers for an unchanged stance are a stretch at this point. The level of market dependency for direction from central banks has been raised significantly in recent years. so policy communication has to be dealt with kid gloves these days. In this regard, we do expect the Fed to direct market participants towards the data and coerce the mindset towards what is actually happening in the economy. It is long overdue.
That said, it is hard to steer the market away from the USD at the present time. The EUR is riddled with political instability in the region, exacerbated by the Brexit fallout, and the domestic data has taken a hammering from export-led weakness. The Pound, as undervalued as it is, faces a crisis of a magnitude not seen since the ERM debacle in the early 1990s and global trade worries continue to weigh on the majors closely tied to Asia. Australia, along with Canada also faces serious housing concerns as well as private debt thereon, and with Oil prices dropping like a stone, we cannot count on the traditional followthrough in the Canadian economy which has been a staple default scenario as a tailwind of US growth.
We still see room for a modest correction in the USD should the dot plot fall in line with market expectations. Whether this can effectively mark a more significant turnaround at this stage is in the balance. It will take some significant improvement in some of the USD’s major counterparts for this to develop, and this is clearly not going to happen overnight. The JPY and CHF look the obvious choice in the current climate, though both the BoJ and more so the SNB will have something to say on this, so the playing field is a bumpy one, to say the least. EUR/USD is making all the running this morning alongside a reluctant push lower in USD/JPY. 116.00 and 111.35-30 are levels we are watching for in either case.
(EUR/USD Technical Analysis)