Fed Decision Will Leverage Dollar, Risk and Growth Outlook Equally

2019-09-14 11:48    John-Kicklighter

Fed Talking Points:

  • Risk appetite gained remarkable traction this past week with 8-day consecutive rallies for the Dow, VEU and emerging markets
  • With the Dow ending Friday on the cusp of record highs, the hesitation in the final thrust reflects well appetite and actual potential
  • The FOMC rate decision is top event risk ahead, but six total major central bank decisions makes for a very clear market-wide theme

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Dow Reflects the Appetite and Reality in Risk Trends

Risk trends have sidled up to the threshold of record highs - at least as far as US equity indices represent the undercurrent of sentiment. The Dow offered perhaps the most remarkable performance to close out this past week. The blue-chip benchmark extended an eighth consecutive session's advance to match the longest climb since May 2018. With Friday's close, we are sneeze away from a fresh record high and the torrent of headlines that follows such occasions - events that tend to drum up some speculative appetite all their own. And yet, there is still hesitation in this stance. Friday's range was remarkable small which gives both credit to anticipation for next week's event risk and shows the difficulty in traversing fresh record highs. When we look beyond the recent momentum, the big picture (18 months) shows congestion is still the principal stance which denotes a lack of genuine conviction.

Chart of Dow Index and 1-Day Range as Percentage of Spot (Daily)

Fed Decision Will Leverage Dollar, Risk and Growth Outlook Equally Expert Analysis 1

Chart Created on Tradingview Platform

And, if we are to evaluate risk trends at large, it is important to draw conclusions from a broader mix of assets and various regions. Here too, there has been some very impressive lift in the short-term. This past week reflected a strong bid for many assets with a 'risk' lean - and retreat from the juxtaposed safe havens - but there were also stand outs for their momentum or consistency. The VEU rest of world index (global equities excluding the US) would rally 8 consecutive days itself for the longest charge since January 2018. It is interesting here to note the ratio of US performance relative to rest of world (Dow/VEU) has traded sideways for months. Another equally-impressive climb comes on the behalf of the EEM emerging market ETF whose own 8-day rally also matched the longest run since January 2018, with no longer charges since 2014. All impressive, yet all also significantly further from record highs while also facing their own resistance.

Chart of Ratio Between Dow and VEU Rest of World Index (Daily)

Fed Decision Will Leverage Dollar, Risk and Growth Outlook Equally Expert Analysis 2

Trade War, Growth Forecasts and Monetary Policy Weave Together

The rally in all things 'risk' recently has not come out of the blue. There have been very clear milestones on which to stage confidence. Trade wars has proven the most significant in terms of change to bearings. This past week, China started the ball rolling by making a good faith gesture in waiving 16 US imports from tariffs. That is a small overall effort, but it led the US to respond with its own two-week delay (October 1st to 15th) in the planned upgrade in tariff rate (25 to 30 percent) on $250 billion in US imports. Again, not an actual reversal in course of substance, but adding momentum. China seems determined to build on this trend as it announced Friday that it would exempt future pork and soybean imports from 'additional' duties. This has raised the market's awareness and encouraged deeper reading into unconfirmed reports that President Trump has considered an interim deal or that Washington and Beijing may strike a deal on the '90%' on which they already seem to agree. In the end, this is removing a 'man-made' threat rather than seed real growth or returns. It is important to remember that in a best-case scenario.

Chart of USDCNH (Daily)

Fed Decision Will Leverage Dollar, Risk and Growth Outlook Equally Expert Analysis 3

Chart Created on Tradingview Platform

With the pressure relief of building trade wars, there is naturally a levity to otherwise ground-ridden growth forecasts. The outlook for growth has moderated in most areas but remain a few bastions of confidence such as the US consumer (an important one). This past session, we were issued a run of data that seemed comprehensive for its review of the world's largest economy. The University of Michigan consumer sentiment survey was the most prominent listing and it rose from 89.8 to 92 with an upgrade to the expectations component. Retail sales also grew, and the NY Fed's growth forecast leveled out. Ahead, there is plenty of data that can be interpreted as a signal to the bearing for global economy - nothing more appropriate than the run of August data from China - but more likely, we will likely see fine adjustments associated to the course of monetary policy. And, if the threat of a recession registers as deflating, does that mean the corrective efforts of central banks are no longer necessary?

Top event risk this past week was the ECB rate decision whose full-blown escalation of dovish policy - 10bp rate cut to -0.50 percent, 20 billion euros in monthly asset purchases starting November 1st and tiered interest rates for banks - seemed to have more effect in building up expectations rather than pushing markets to run after it was unleashed. In fact, the Euro rallied after the group鈥檚 infusion, though local markets seemed to still find some buoyancy. Yet, the debate building as to whether further stimulus is generating greater cost than benefit...among the banks' own members.

Fed Decision Will Leverage Dollar, Risk and Growth Outlook Equally Expert Analysis 4Fed Top Billing for a Run of Rate Decisions

All three of the aforementioned themes will likely generate interest and market movement into the week ahead. And, more likely than not, they will be moving more in concert rather than as independent catalysts. That said, there were will be one particular thread that will be heavily pulling against the others: monetary policy. There is a range of six major central banks that will be updating their mix within the span of 24 hours Wednesday into Thursday, but the Fed's (Federal Reserve) gathering is doubtlessly the most important. Sure, it is the quarterly event in which the updated forecasts on rates and economic outlook are due, but it is more important for the context. The ECB has lowered the lower threshold of global monetary policy (support for market and economic health in the absence of natural factors), will the Fed usher down the upper bound? If so, how fast will they move and what does the market expect it will render? Watch closely.

Chart of DXY Dollar Index and Expected Fed Cuts Through End of 2019, 2020 (Daily)

Fed Decision Will Leverage Dollar, Risk and Growth Outlook Equally Expert Analysis 5

Chart Created on Tradingview Platform

The other central banks are of considerable importance locally and in the grand scheme. The Bank of England (BOE) decision is likely to be the most routine of the decisions. With Brexit risks still running high, they are acutely distracted and not likely budge. Significantly more interesting but perhaps not very market moving, the Bank of Japan (BOJ) is unlikely to alter policy at this meeting, but their frustrations have reportedly led to talks about pushing rates deeper into negative territory on the heels of the ECB. We'll see for mention of this option. The Swiss National Bank (SNB) should be watched closely as their policy is primarily linked to the ECB's. Will they account for this new wave and will it match influence? EURCHF in particular is important to watch. Then there are the two emerging market central bank decisions from Brazil (expected to cut 50bps) and South Africa (expected to hold) which still define the carry opportunities - when investors are looking for returns.

Chart of EURCHF (Daily)

Fed Decision Will Leverage Dollar, Risk and Growth Outlook Equally Expert Analysis 6

Chart Created on Tradingview Platform

Pound Seems to Have Signaled a Reversal, Loonie and Kiwi Offer Late Volatility

As always, it is good to find options that may fall outside the influence of the unwieldy systemic. The British Pound continues to forge a remarkable progress - in fact triggering a range of technical reversals this past Friday - as Brexit headlines push and pull. Friday continued to build on the drama around the legality in the suspension of Parliament with Prime Minister Johnson reiterating he would stick to the October 31st deadline no matter what. The trigger for the GBPUSD, GBPJPY and GBPCAD 'neckline' breakouts though seemed to be suggestion that the main Irish party DUP would abide some European rules after the Brexit - reports that the Times made and were rejected, yet the currency gains held.

Chart of GBPCAD (Daily)

Fed Decision Will Leverage Dollar, Risk and Growth Outlook Equally Expert Analysis 7

Chart Created on Tradingview Platform

There were a few other interesting moves among the majors that are not as prominent but should be considered nonetheless. The Australian Dollar is forging a particularly impressive recovery that seems to have a rooting in the RBA's reticence to unorthodox easing and the improvement in trade headlines. So long as that doesn't change, this is a currency at a hefty discount that can keep retracing its steps. Less fundamentally anchored, both the New Zealand and Canadian Dollars took a big hit to close out this past week. There weren't any exceptional charges to these moves, which is encouraging for the spark; but it doesn't offer much in the way of assurances for follow through. Keep tabs on pairs like AUDCAD or AUDNZD though.

Chart of AUDCAD (Daily)

Fed Decision Will Leverage Dollar, Risk and Growth Outlook Equally Expert Analysis 8

Chart Created on Tradingview Platform

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