- Fed’s hesitance obliterates soft bull positions
- Fed’s data dependency a boon for volatility
- FOMC full employment parameters change
- EUR seeks Greek guidance
Federal Reserve Chair Janet Yellen has been a dollar bull’s friend for a very long time, but yesterday she took the first step to break that symbiotic relationship. Whereas investors have for the past 18 months been depending on the Fed to grease the wheels for capital markets and the dollar’s one directional trade, the Fed’s chief made like a matador and gored the dollar bulls.
The Fed’s aim is to wean investors from relying on central bank guidance on the future path of policy, and wants to avoid excessive rise in bond yields that could sap growth. In other words, halt “free money” thinking without causing too much of a shock to the financial system. The easing policy reactions or dovish rhetoric from nearly all the other major central banks is not making the dollar’s transition straightforward or any easier for the Fed.
With the Fed seeming desperate to normalize policy, as market participants argue over the first rate hike timing, an injection of market uncertainty was required. This is a boon to volatility and provides more opportunities for forex investors. The Fed is expected to rely heavily on data dependency which does away with much of the confined trading ranges that have been the result of central banks’ current policies.
A Bid to Bide Time
Yesterday, as expected, the Fed dropped the word “patient” from its monetary policy statement but it sent a very dovish tone, totally flatfooting the market. The Street got the patient call correct but was completely surprised that the Fed was not more impressed by the improvements in the labor market. They kept intact its outlook of “risks to the outlook for economic activity and the labor market as nearly balanced.” The market went all-in on one of the few aspects of the economy that was actually moving in the right direction, the direction that was sign posted only a few months ago for investors by the Fed.
Back in December, Fed policymakers pegged the U.S.’s economy normal longer-run unemployment rate somewhere between +5.2% and +5.5%. But in its updated projections released yesterday, it lowered its estimate of the longer-run jobless rate to a range between +5% and +5.2%. By moving the goal posts, it indicates the Fed’s concerns that it could have to reverse course after starting the normalizing rate policy. In reality, the market has yet to see the wage and price pressure that has been expected, especially after hitting December’s full employment target of +5.5%. Combined with the revised projected federal-funds rate path lower — slashed by -50% to +0.625% from +1.125% by December — has the market pricing in the Fed’s first rate hike further out the curve. The fixed-income market is pricing in a +40% chance of a September hike, while only +25% seen a June hike down from +50% prior to the Federal Open Market Committee’s (FOMC) meeting.
The market was not prepared for the Fed’s “soft” patience approach, and the over-extended one directional long dollar trade was immediately put under pressure. The dollar index plunged -2%, the largest decline in five years. The EUR surged to above €1.10 as investors scrambled to cover their shorts. However, the dollar bulls are not disheartened, especially now that the dollar’s price levels are moving back to pre-FOMC statement levels for the most crowded of trades (EUR €1.0689). From the dollar bull’s perspective, the Fed’s take on the dollar is still at odds with most other central banks that are engaged in currency wars.
Yellen said a strong dollar reflects a strong economy and the Fed do expect an above-trend growth despite the drag of a strong dollar. Pre-FOMC, there was a lot of speculation that the Fed was trying to talk down the dollar. From an historical perspective, the dollar has the ability to go much higher before the Fed should be really concerned and the U.S.’s stance on the currency is likely to support long-term dollar strength.
Pay to Play
Yesterday’s dollar cleanout has been a long time coming. The market was so tightly wound that the Fed’s hesitant approach instigated the dollar’s spectacular fall. The dollar’s story has not changed. Being short EURs on rate and growth differentials is the right trade. For many, it was the timing and entry point of those trades that perhaps were wrong. The EUR’s rapid reverse is even more surprising that the spike after the Fed statement. The EUR is -3.5% off (€1.0672) its post-FOMC high. Now that the market has a better insight on where the Fed stands, the EUR bear will be looking toward Greece over the next few days in particular for directional conviction.
The dollar’s recovery versus the EUR has been picking up speed in the overnight session. It has fallen through a plethora of intraday supports, especially after the market’s failure to penetrate the EUR’s January €1.1062 low after the Greece’s Syriza’s election win, and €1.1098 after the European Central Bank meeting. Despite yesterday’s volatile reverse, the current levels would suggest that the overall bearish picture has been barely dented. If the market happens to test €1.0600 with any momentum below, it certainly opens up the risk for the market to test to €1.0457 lows in a hurry.
This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.