The data has finally pushed the Federal Reserve’s head out of the sand, something we had been forecasting in March. There was every reason to believe that the strength of the US recovery was more than just a ‘transitory’ event and that some of this is indeed structural.
Last week’s Federal Open Market Committee’s (FOMC) finally confirmed that they could no longer look through the data and that the inevitable taper and rise in the Federal funds rate will come sooner that expected.
This has certainly set the FX market alight but here are the key points Policy – unchanged which was widely expected and there wasn’t a significant difference between its April and June meeting communiques.
Dot plots movements – median average for the FOMC’s dot plots is now for 2 rate rises by 2023 seeing the Fed Funds rate moving from 0.125% to 0.625%. From a FX positions it was the now 7 committee members up from 4 expecting a hike as early as next year that played into the hands of traders.
Economic projections – materially increased (finally) and now reflect the immense improvement in activity here is the key lines from the statement: economic activity and employment have strengthened, while inflation has risen, largely reflecting transitory
- Personal Consumption Expenditure (PCE) inflation forecast for 2021 revised to 2.9%- 3.1% up from 2.0%-2.3%.
- Core CPI was moved a full 1% from 2.4% to 3.4%.
- 2021 GDP was raised from 6.5% to 7% – which would be its fastest rate of growth since the World War II.
All are significant upgrades highlighting that some of the data is transitory but clearly some is structural too.
Tape talk – Powell during the press conference stated they were “talking about talking about it”. The conclusion on tapering is that if rates are to rise in 2023 QE will have to be materially wound back before this starts – so question of when it begins and judging by the recovery one can make the argument it could be as early as January 2022.
As mentioned above FX light up and has finally woken up to the fact USD is undervalued. In Looking at each G10 pair the difference was large with USD/JPY up 0.5 per cent through to a 2% positive move in USD/NOK but all lost ground on the USD.
EUR/USD has crashed from $1.2115 to $1.1892 it lowest read since April and is trending lower still. GBP/USD sank from $1.4100 to $1.3896 its lowest read since May 7.
Then there is the AUD/USD, this has been a pair of most interest. Australian data has been very strong of late collimating in the May labour force data where unemployment fell to 5.1% with 115,000 jobs added. But this has no material impact on the pair in fact it just accelerated the decline. This conformed the view that risk currencies are in for a rough time as rates ‘normalise’ and QE programs end.
The AUD/USD fell from $0.7705 to $0.7540 its lowest level since 1 April and there is every reason to see it testing $0.74 handle in the near future. It is the pair to watch going forward.