Morning Commentary: Center of Focus

Foreign Exchange - Morning Commentary
Center of Focus
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Once again, central bankers have found themselves at the center of the market’s attentions.  Overnight, Mario Draghi indicated that “additional stimulus will be required” if the economic outlook doesn’t improve.  With Mr. Draghi’s term set to end on October 31, his acknowledgement that rate cuts and QE remain in the toolkit appears to be setting the table for his successor to continue the “whatever it takes” mantra Mr. Draghi started roughly 5 years ago.
 
However, it should be noted that although Draghi considers there to be “considerable headroom” for further easing, the political support for additional measures remain less certain.  Nevertheless, European yields have fallen across the board with German 10 year yields down nearly 30% on the session. 
 
President Trump immediately seized on the possibility of additional European stimulus to further highlight his desire for easier conditions in the US, putting additional attention in the two day Fed meeting that kicks off today. 
 
Fed meetings, particularly quarterly ones such as this month’s where new dots are released have become important market events.  However this month’s meeting carries significant importance for the following reasons:
 
  • The degree of Fed rate cuts currently priced in the markets have only occurred before a global recession or a financial crisis.
  • The deviation between the rate path as priced by the markets and forecasted by the Fed has reached its largest gap since the Fed started publishing its dots forecast.
  • There is an unusual dichotomy between the narrative that different parts of the markets have for a cut.  Some see is as a move to prolong the current expansion while others see it as a move to buffer against a global recession.  
 
It is this last point that should drive the market’s reaction tomorrow as the focus will be on why the Fed is taking the stance it is, i.e. is it attempting to extend the expansion or protect against a recession. 
 
In our view, the bar remains high for Chair Powell to meet market expectations, skewing near term risk towards dollar strength.  With markets aggressively pricing in the expectations for a rate cut this year, anything short of actually delivering a preemptive cut would likely be insufficient to justify current market pricing and achieve sustained USD weakness.     
HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT:
  • The GBP has hit its lowest level since January.  The markets appear to be focused on the downside risk associated with Boris Johnson taking over as PM and his view that Brexit must happen by October 31, deal or no deal. 
  • Reserve Bank of Australia minutes were released overnight and has renewed pressure on the AUD as it raises the possibility for additional rate cuts as it is “more likely than not” to cut rates further.
  • The Pentagon has released new evidence to back its claim that Iran is behind a tanker attack in the Persian Gulf and plans to send 1,000 additional troops to the Middle East. 
  • The US Treasury has reported that China’s holdings of Treasuries has hit a two year low. 
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