A WSJ report last week set the cat amongst the pigeons on Friday, as the question over the balance sheet runoff was brought to light. While it is now widely acknowledged that the Fed is set to pause on its series of rate hikes, some are now considering the possibility that the pace of quantitative tightening may be addressed in order to further ease up financial conditions for both the financial markets and the real economy. Despite the fact that equity markets have materially stabilised, the story has gained traction and the USD has softened as a result, with notable losses seen against some of its weakest counterparts.
The EUR is a clear case in point, with the ECB now clearly concerned about the persistent weakness in the Eurozone data, in what has so far been assumed to be a correction in the strong pace of activity seen through 2017 and very early 2018. As a result, the governing council sees risks skewed to the downside, though this was already firmly priced into the markets given rate normalisation has been pushed further out into 2020. Nevertheless, EUR/USD only managed a brief dip below 1.1300 and has since tested back above 1.1400 again in what looks set to be some very tight ranges ahead as we go into the FOMC meeting this week.
Elsewhere, the Brexit mood has been lifted by widespread agreement within the House of Commons that a no deal outcome should be avoided at all costs, but how this then translates into affirmative action remains to be seen as we look to the start of the debates on the various amendments which will be put forward and voted on from Tuesday this week. In recent weeks, GBP has readjusted the risk probability of a hard Brexit, though optimism may start to run out in the days ahead as we get back to acting on the way forward. Optimism is one thing, but can only carry GBP so far. NY desks, followed by Asia today, pushed the Cable rate through 1.3200, but we are seeing some moderation this morning as the realisation that a no deal Brexit is not completely off the table yet.
We then come onto the Fed impact on risk. Should the FOMC communicate openness towards a resumption in reinvestment, then we expect to see risk assets receiving a further boost over coming weeks. There are however many crosswinds to consider this week, not least of all the earnings reports out of the US from a number of key names – Caterpillar today, Apple on Tuesday. We also have the Chinese delegation traveling to Washington this week to resume talks on trade, and while there have been mixed signals from members of the Trump administration on progress – of the lack off – we know at that intellectual property remains a core issue in breaking the deadlock and avoiding an increase in tariffs, which would come into effect at the start of March if negotiations do not bear any positive results.
In the meantime, AUD, NZD, and CAD continue to stay on the front foot, though conviction looks unconvincing as yet. Based on the fact that bearish sentiment on stocks can return at any moment, bullish sentiment is a long way off, with recent moves here looking corrective at best. We could pick out the CAD as perhaps the pick of the bunch given Oil prices have stabilised. There is also the backdrop of continued expectations that the BoC remains on course to raise rates again at some point this year, narrowing differentials with the US as the Fed decides to pause for now.
Ending with USD/JPY, the spot rate is caught between a rock and a hard place. As USD sentiment will be tempered by that of the mood in stock markets, we look set to remain in a state of limbo over coming sessions, so expect little in the way of movement unless we get poor earnings results this week. 109.80-110.30 continues to provide strong resistance up top, but we cannot help but think that the early Jan ramp in the JPY, and subsequent sharp reversal, has underpinned the downside in the near term.