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FOMC Preview
The main event of today and indeed this week is today’s FOMC rate decision announcement at 1900BST, followed by the post-meeting press conference with FOMC Chairman Jerome Powell at 1930BST. No new economic forecasts are set for release at this event, nor an updated dot-plot. But the tone of the statement and remarks from Powell with regards to how the bank views the economic outlook in the US will be important, as ever.
The main talking point with regards to Fed policy is when it will announce a tapering of its QE programme (the Fed has already openly said discussion on this are underway). Most presume it remains too soon to make such an announcement today given that the Fed is unlikely to deem that “substantial progress” has been made towards its dual mandate goals on employment and inflation just yet. That may take a few more months (i.e. a few more months of strong jobs reports), analysts suspect, meaning a taper announcement is more likely in September (though there are some outside calls for a taper announcement at the Jackson Hole event at the end of last month). Delta variant risks are also being cited as a reason why the Fed might want to hold off on offering any further policy guidance today and instead opt for the cautious/safe approach. Thus, ING caution that there is a risk that today’s meeting will be a non-event and not give markets much to trade off of. However, even if there is no official taper announcement yet, Citi argue that Powell may today offer a strong hint as to when the taper announcement is coming (i.e. he may hint that “if all goes well, we may have made substantial progress towards our goals by x”, thus implying a taper announcement around that time). This could provide some hawkish impetus, they reason.
Elsewhere, traders will be on the lookout for hints of any changes in the Fed’s stance/outlook on inflation. The current stance at the Fed is that the current spike being observed in inflation is set to be “transitory”, i.e. fall back in the coming quarters to a more acceptable level close to 2.0% (in Core PCE). Powell is likely to reiterate this viewpoint, but any hint that the Fed might be becoming a more concerned that inflation is going to be persistently higher for longer than the Fed is comfortable with would be taken as a hawkish signal that would likely see rate increase expectations brought forward, triggering upside in short-end US yields and the US dollar and downside in stocks and commodities.
All in all, risks heading into this Fed event seem balanced. Two hawkish scenarios have been outlined above (that the Fed hints when its taper announcement is coming, or wavers on its inflation stance), but there is also a risk that the bank sounds a little more dovish given rising Covid-19 infections in the US. This could trigger two-way volatility in markets and the USD. But it seems likely that today’s meeting is unlikely to meaningfully shift Fed policy tightening expectations. Things are going to become more interesting in the months ahead given that markets expect a taper announcement to come towards the end of Q3 or in Q4. We may have to wait until then for more clarity on the path for Fed policy (i.e. what its hiking cycle is going to look like).
Market Update
Yesterday’s US session was a downbeat one, as US bourses finally succumbed to the volatility seen in recent sessions in Chinese financial markets. The S&P 500 ended the day down about 0.5% and the Nasdaq 100 lost about 1.1%. Mixed US data also did not help; Durable Goods Orders for the month of June were weak, but CB Consumer Sentiment for the month of July was stronger than expected. However, sentiment in Chinese markets showed some signs of stabilisation overnight as state-run Chinese financial media urged calm and labelled the recent sell-off as an over-reaction. Looking at the performance of equities in Europe and the US this morning, equities in both regions remain fairly subdued with market participants in wait-and-see mode ahead of today’s FOMC meeting; the Stoxx 600 is up about 0.4% and E-mini S&P 500 futures are up about 0.1%, meaning the index is likely to open US trade only about 0.4% below record high levels. Note that European sentiment is deriving a boost from optimism in the Travel and Leisure sector, which is getting some independent support on further reports that UK health authorities are set to ease travel restrictions/remove travel barriers. Separately, in both Europe and the US, import earnings releases have been getting a lot of attention. In the US, tech super-heavyweights Alphabet, Apple and Microsoft all posted better than expected earnings results for Q2, but this failed to inspire a broad market rally. Indeed, Apple is a little softer in pre-market trade given warnings in its new guidance about the negative impact of chip shortages.
Looking at other asset classes, as in equity markets, the tone is one of wait-and-see amid a lack of any meaningful macro-developments. European government bonds in general continue to edge lower amid the ongoing tailwind to European bond prices as a result of the ECB’s recent dovish shift. Greek 5-year yields hitting fresh all-time lows this morning got some attention – the ECB’s bond buying programme has benefitted the more heavily indebted Eurozone countries such as Greece and Italy the most and offer the most support to bond prices in these regions. US yields are a little higher, with the curve bear-steepening a touch this morning; 10-year yields have pushed back above 1.25%, but 10-year TIPS yields (the inflation expectation adjusted yield on the US 10-year bond) remains right on record lows under -1.1%. Some strategists suggest that while a hawkish tone to today’s Fed event might send short-end yields (like the 2-year) higher, it could weigh on longer-term bond yields as market participants revise lower their growth and inflation expectations.
In terms of commodities, crude oil prices are modestly higher on the day, with WTI continued to garner support and trade in the $72.00 region. Oil prices have been underpinned by bullish weekly US API inventory data last night, though traders are clearly refraining from making any big bets right now as the FOMC rate decision looms. Meanwhile, strategists continue to cite the likelihood that global pandemic/lockdown concerns may continue to weigh on crude prices in the short-term, however. Indeed, while the news with regards to travel restrictions perhaps soon being ease in Europe is welcome, Australia is seeing further lockdown extensions (in the Sydney region), the situation in Japan continues to deteriorate as infections continue to spike. Meanwhile, the situation in many EM nations remains dire – the IMF recently cut its estimate for economic growth in 2021 for developing countries, though this was offset on the global level by an upgrade in economic growth forecasts for developed countries, meaning the IMF’s global growth forecast remained unchanged at 6.0%. This is in fitting with the thinking of many commodity strategists who maintain that, despite global virus risks remaining high, the oil demand recovery should continue at a good pace this year leaving oil markets in deficit until at least the end of the year. This, many argue, should keep oil prices supported.
Turning to FX markets; the US dollar is a little firmer on the day as it looks to snap a few days of selling but is subdued as it awaits the outcome of the Fed, which will of course be the main driver of the buck in the coming days. The dollar has been unable to benefit as much as one might have expected amidst the recent turmoil (and outflows from) Chinese financial markets, largely due to the plunge in US real yields in recent days which has raised the opportunity cost of holding USD. Meanwhile, Citi and a few other banks have called for modest month-end USD selling. Elsewhere, GBP and EUR are contained, with the latter not paying much attention to underwhelming German GfK Consumer Sentiment numbers out this morning. Sterling, meanwhile, holds onto this week’s outperformance after the EU announced a pause to its threat of legal action against the UK over its actions with regards to the NI protocol, as they take time to look over a new UK proposal. The currency had previously been deriving a boost from a fall in new Covid-19 infections in the country which has boosted confidence that the vaccines offer a way out of the pandemic. EURUSD is subdued just above 1.1800 and GBPUSD is consolidating just under 1.3900.
Elsewhere in the G10, Underperformance is being seen ahead of tonight’s FOMC in the antipodes, with AUDUSD and NZDUSD both down about 0.3% on the session versus the buck, pushing the currency pairs back below 0.7350 and 0.6950 respectively. Aussie inflation numbers for the second quarter were out last night and were in line with forecasts, thus confirming that inflation in the country spiked as a result of base effects and global supply chain disruptions. The YoY rate of headline inflation rose to 3.8% from 1.1% in Q1. AUD did not show much of any reaction to this as markets seem not to expect that the surge in inflation will result in RBA hawkishness. Rather, it seems likely AUD will be focused on 1) fears that the current lockdowns across the country will result in a recession in Q3 (numerous Aussie banks are calling for this now) and 2) a further deterioration in sentiment in Chinese markets, which matters a lot of Australia given China is its most important trade partner. These latter negative likely explain Aussie underperformance, but base metal prices have done fairly well in recent days, which is offering support to the Aussie.
The Day Ahead
The Fed rate decision at 1900BST and following press conference at 1930BST of course steals the limelight. Loonie traders should keep an eye on Canadian CPI data for the month of June at 1330BST, however, at which time the US Goods Trade Balance for the month of June is also released (though this is unlikely to move markets). Aside from these two data points, official US crude oil inventories at 1530BST is worth watching and could move crude oil.
