Currency Point: refocusing – USD

The material refocusing of all markets, not just FX, on Constitution Avenue has been astonishing to see.

The rising risk of recession, global slowdowns and geopolitical fall outs have seen the US ‘recession marker’ in the 3mT bill-US10yr differential flashing red.

Since 1900 when this differential inverts, it has forecasted a US recession in the preceding 18-24 months over 95% of the time. Now I should point out that the US currently has some of the best employment figures since the 60’s and its overall ‘wealth’ metrics are booming.

But, you can’t ignore the ‘sign’.

What this all means is the Fed is (amazingly) ‘in play’ and markets are telling us so.

Pricing clearly shows that in the coming 12 months the market now expects the Federal Reserve to cut the Federal Funds rate at least twice, with a full 25 basis points now expected to come out by no later than September.

What is so interesting about these developments is that although bond markets are pricing a dovish Fed, the USD has not.

Thus, there are 2 scenarios to watch for that should start to weigh on the USD:

First would be the increasing volume of Fed speakers coming out in favour of discussing rate cuts (they don’t necessarily need to act, jawboning will be enough).

Second would be explicit guidance and/or thresholds that would lead to a rate cut. I would suggest keeping a sharp eye on Vice Chair Richard Clarida.

The Fed enters the ‘blackout’ period this week head of next week’s FOMC meeting so these points will have to wait. But, June is a press conference meeting and Chair Powell will thus update the Board’s forecasts in the Summary of Economic Projections so the first chance to review the above scenarios will come from the most senior member of the board.

The FOMOC meeting will also see the Fed releasing its latest dot plots here are the March projections.

If the FOMC projections follow the Fed fund futures (purple line) and suggest that the Fed’s base case is for rate cuts in 2019, this, coupled with Powell’s press conference will trigger USD weakness not seen in months. Pairs will shoot around so be prepared.

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