Noisy pre-FOMC consolidation

The sell-everything trade has mostly paused for breath over the last 24 hours, with US equities finding their feet overnight, Asian equities rallying today, and the US dollar giving back some of its recent gains. Bond markets remain the exception. The Bank of Japan is buying JGBs furiously to maintain the yield cap, while US bond yields continued to rise leaving the yield curve almost flat and dangerously close to inversion.

Markets brace for 0.75% hike from Fed

Given bond markets saw no love overnight, I am inclined to believe that clawing back losses elsewhere is merely a consolidation ahead of tonight’s FOMC policy decision. The market has priced in at almost 100% an FOMC hike of 75bps this evening. My two cents worth is that the Fed will not go 100bps, as that would further erode their credibility on the forward guidance front, which is already ragged. They may, however, decide to upgrade their forward guidance to an even more hawkish tilt. I suspect 75bps is already built into prices now, and if the guidance is more modest in scope, I am sure the buy-the-dippers will be out in force for the rest of the week.

I remain concerned that the Bank of Japan policy meeting is an underrated risk point this week, perhaps even more so than the FOMC outcome itself. A 100bps hike tonight, and/or a very hawkish outlook, will lift USD/JPY once again and may force the BOJ into lifting the 10-year JGB yield cap slightly, despite their actions in the bond market this week. That could, in turn, prompt a very ugly, somewhat short-term correction lower by USD/JPY that could reach 130.00. Expect GBP/JPY, AUD/JPY, and NZD/JPY to get a pasting as well.

The Bank of England rate decision tomorrow will become murkier as well if the FOMC is uber-hawkish tonight. The BOE most likely intends to hike by 0.25%, but with sterling under some serious pressure right now, its hand may be forced even though it has admitted it has only limited means to manage imported inflation from here. One positive note is that unemployment remains very low in the UK, giving the BOE a decent starting point to inflict monetary pain.

We should be keeping an eye on energy prices over the next few days as well, most notably, European natural gas prices. Nord Stream 1 gas flows from Russia to Germany have been severely reduced as it undergoes summer maintenance. The culprit is a compressor turbine, sent for maintenance in Canada, which now won’t return it as Canada widens sanctions on Russia. Of course, I am sure Russia isn’t using this as an excuse to squeeze Europe, cough, cough. European and UK natural gas prices spiked yesterday, and I have said before that the moment Russia starts messing with European gas supplies, the euro is heading south. You can put the sterling in that basket as well.

Looking at the data releases we have had so far today in Asia, it has been mostly positive. Australian Consumer Confidence improved slightly to -4.50% from -5.60%. Rising living costs and mortgage rates leave consumer confidence in a dire spot still. South Korean Unemployment ticked higher to 2.80% in May from 2.70% in April; however, workforce participation rose strongly, dulling the headline numbers impact. Far more importantly, the truckers’ strike has ended today, allowing goods to flow to ports and removing a potential growth roadblock.

Japan’s Reuters Tankan Index for June improve to 9.0 from 5.0, as business confidence edges higher. A weaker yen is a boon for manufacturers and was likely the main reason for the jump. A similar impact can be seen in Japan’s April Machinery Orders, which outperformed, rising 10.80% MoM. We can expect a similar impact in May and June. ​ The Nikkei 225 gained no benefit, with both it and the Kospi content to track Nasdaq underperformance overnight as the world press fills its pages with tech-layoff headlines.

China has left its one-year MTF rate unchanged at 2.85% but rolled over the entire CNY 200 billion of maturities. Disappointing at the periphery for those of us waiting for a more comprehensive stimulus from China. Offsetting that, were notable improvements in May Retail Sales, Industrial Production, and Fixed Asset Investment. Retail Sales fell by 6.70%, less-worse than expected. Industrial Production and FAI outperformed, rising by 0.70% and 6.20% YoY respectively. All of that can be laid at the door of the reopening of Shanghai and Beijing and the Shanghai Port.

I must reiterate a word of caution on China though. Markets have leapt into thinking that it would be “one-and-done” for China with covid-zero lockdowns. Bitter experience from around the world shows that this is a naïve point of view, especially regarding omicron. I see a high possibility that China will still endure repeated omicron lockdowns this year unless it changes its covid-zero policy. Thus, China’s growth outlook remains challenging to say the least, even more so if key export markets shift to slowing growth as tighter monetary policy bites.

Indonesia releases its Balance of Trade for May shortly, with the surplus expected to fall from USD 7.56 billion in April, to USD 3.83 billion in May. The palm oil export ban will have impacted the headline number, and Indonesia’s commodity exports have bolstered the trade balance this year and supported the Indonesian rupiah. I wouldn’t normally comment on this data point, but the rupiah has weakened sharply this past week. If the trade surplus is lower than expected this afternoon, the rupiah selling may gain more momentum and have a knock-on impact across neighbouring ASEAN currencies. I’m fairly sure a number of Asia’s central banks have been busy this week quietly selling US dollars, including Indonesia. That smoothing may have to accelerate, especially if the FOMC is very hawkish tonight.

India’s Balance of Trade this afternoon should also make for interesting reading as its imported energy bill soars. A May deficit higher than USD 20.00 billion could increase pressure on the rupee as well, which remains near record lows. US Retail Sales will be of passing interest before the main event tonight, especially if the headline and core numbers are soft, with a market on edge about growth stalling in the US.

Otherwise, I believe today will be a “hurry up and wait” messy session as the world awaits the FOMC meeting outcome. I have thrown my two cents in, and I will leave it at that, it has been analysis-paralysis’ed to death elsewhere for those who require more information overload. Today is likely to be the eye of the hurricane, so we should enjoy the temporary peace and quiet.

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Jeffrey Halley

Jeffrey Halley

Senior Market Analyst, Asia Pacific, from 2016 to August 2022
With more than 30 years of FX experience – from spot/margin trading and NDFs through to currency options and futures – Jeffrey Halley was OANDA’s Senior Market Analyst for Asia Pacific, responsible for providing timely and relevant macro analysis covering a wide range of asset classes. He has previously worked with leading institutions such as Saxo Capital Markets, DynexCorp Currency Portfolio Management, IG, IFX, Fimat Internationale Banque, HSBC and Barclays. A highly sought-after analyst, Jeffrey has appeared on a wide range of global news channels including Bloomberg, BBC, Reuters, CNBC, MSN, Sky TV and Channel News Asia as well as in leading print publications such as The New York Times and The Wall Street Journal, among others. He was born in New Zealand and holds an MBA from the Cass Business School.
Jeffrey Halley
Jeffrey Halley

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