Fed Taper Confirmed, BoE Takes the Torch
Yesterday, the main event was the FOMC decision, with the Committee signaling that QE tapering may be warranted soon. What’s more, the new dot plot revealed more optimism among officials with regards to interest rate increases. As for today, the torch will be passed to the BoE. It would be interesting to see whether any other officials will join Saunders in voting for asset purchases to stop now, and whether we will get any clues with regards to when they intent to start raising interest rates.
USD Gains After FOMC Signals QE Tapering by Year End
The US dollar traded higher against all but one of the other major currencies. It gained the most versus JPY and CHF, while it lost ground only against CAD.
Although the strengthening of the US dollar is usually a sign of risk-aversion, the weakening of the yen and franc, as well as the strengthening of the Loonie, point otherwise. Therefore, in order to get a clear picture with regards to the broader market sentiment, we will turn our gaze to the equity world. There, major EU and US indices were a sea of green, with appetite softening somewhat today in Asia.
European and US stocks rose on Wednesday, even ahead of an important FOMC decision, perhaps following news that China’s Evergrande would make some interest payments today. However, as we noted yesterday, there are still more bond payments to be settled, which if are not proceeded within 30 days of their scheduled date, the bonds will default. Therefore, the risks related to this story are not vanished yet.
Now, with regards to the FOMC decision, the Committee kept its policy untouched, but in the statement accompanying the decision, it was noted that “If progress continues broadly as expected, the Committee judges that a moderation in the pace of asset purchases may soon be warranted.” What’s more, the new “dot plot” pointed to 9 members in favor of rate increases to start next year, and 17 supporting higher rates in 2023. Remember that back in June, the respective numbers were 7 and 13. It seems that many market participants may have interpreted the statement as a hint for a November tapering, which, combined with a more hawkish view on interest rates, resulted in a dollar rally and an equities pullback. However, US equities rebounded thereafter, and finished their session near their pre-decision levels.
At the press conference following the decision, Fed Chair Powell said that a gradual tapering process that concludes around the middle of next year is likely to be appropriate, a statement implying a USD 20bn taper at each meeting, but also that the process could still start in December. Although the important point here is that if tapering is finished around the middle of next year, interest rate increases are likely to take center stage, it would be interesting to hear what policymakers have to say in the aftermath of the meeting over when they believe it would be more appropriate to start scaling QE purchases back. If most of them insist that November would be a better option, the US dollar is likely to continue being supported.
EUR/USD — Technical Outlook
EUR/USD traded lower as soon as the FOMC decision was released, breaking below the 1.1700 zone, marked by Monday’s low. That said, the pair failed to hit the 1.1665 territory, marked by the lows of August 19th and 20th, and rebounded somewhat. In any case, it is still trading below the downside resistance line drawn from the high of September 3rd, and thus, the short-term outlook remains negative in our view.
Even if the recovery continues for a while more, we would expect the bears to take charge again soon and push the rate down, perhaps this time aiming for the 1.1665 territory. If they are strong enough to overcome it, then we may experience extensions towards the 1.1620 area, defined as a support by the low of November 2nd, 2020.
On the upside, the move that could wake up the bulls may be a break above 1.1797. This could confirm the break above the downside line and may pave the way towards the 1.1832, 1.1845, or 1.1857 barriers, marked by the highs of September 15th and 14th and the inside swing low of September 6th, respectively. If none of those hurdles is able to halt the advance, then we could see extensions towards the peak of September 7th, at 1.1885.
Will the BoE Hint at Interest Rate Hikes Next Year?
Today, the central bank torch will be passed to the SNB and the BoE. The SNB is widely expected to keep its policy unchanged and maintain its dovish stance, repeating that the Swiss franc remains highly valued and that they remain ready to intervene in the FX market when deemed necessary.
Therefore, all the attention may fall on the BoE decision. At their latest meeting, British policymakers lowered the threshold of when they will start reducing their stock of bonds. Specifically, they said that they will do so when the policy rate hits +0.50%, by not reinvesting the proceeds of maturing debt. The previous guidance was for the Bank to not start unwinding its stock of bonds until interest rates were near +1.5%. In our view, this means that the process may start earlier than previously anticipated.
Now, the big question is when the time would be appropriate for officials to start raising interest rates. A couple of weeks ago, BoE Governor Andrew Bailey revealed that, even at the prior gathering, policymakers were split evenly between those who felt the minimum conditions for raising interest rates were met and those who believed that the recovery was not strong enough. This suggests that a rate hike could take place sooner than many may have been anticipating, and the accelerating inflation last week may have allowed market participants to increase their bets on that front.
So, with all that in mind, and also taking into account that the Bank is likely to stop buying additional bonds around the end of this year (but still continue reinvesting the proceeds until interest rates hit 0.50%), it would be interesting to see whether any other members will join Michael Saunders in voting for halting the purchases now, and whether we will get any clearer hints on when officials intent to start raising interest rates. Recently, Saunders said that interest rates may need to start rising next year, a view which, if shared among other members as well, could help the pound rebound.
GBP/AUD — Technical Outlook
GBP/AUD traded higher on Wednesday, but hit the upper end of a possible falling wedge formation that’s been containing the price action since Monday, and then, it pulled somewhat back. Overall, falling wedges tend to be bullish formations, but until the exit out of the pattern happens, we prefer to hold a flat stance.
A decisive break above 1.8900 may confirm the upside exit out of the wedge and could initially target Monday’s peak of 1.8955. Another break, above 1.8955, could pave the way towards the 1.9045 barrier, the break of which could extend the advance towards the peak of August 20th, at 1.9155.
On the downside, a dip below 1.8745 would confirm a forthcoming lower low on the 4-hour chart and may see scope for declines towards the 1.8625 zone, marked by the low of September 8th. If that zone is not able to holt either, then the fall could extend towards the 1.8545 area, marked by the low of September 7th.
As for the Rest of Today’s Events
Besides the SNB and the BoE, we will also get the preliminary PMIs for September from the Eurozone, the UK, and the US. In the Eurozone, both the manufacturing and services indices are expected to have declined somewhat, to 60.3 and 58.5, from 61.4 and 59.0 respectively, which will take the composite index slightly down, to 58.5 from 59.0. Despite the slowdown, this will still reflect a decent pace of expansion, and thus, we don’t expect such results to weigh on the euro. That said, deeper declines could raise questions as to whether the recovery seen after the reopening has reached a ceiling, and perhaps push the common currency lower. No forecast is available for the UK prints, while in the US, the manufacturing index is expected to have inched up to 61.5 from 61.1, and the services one to have ticked down to 55.0 from 55.1.
Canada’s retail sales for July are also due to be released. Both headline and core sales are expected to have slid 1.2% mom and 1.5% mom, from +4.2% and 4.7% respectively.
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